More Regulation, Less Revenue: What CRE Execs Worry About For 2023

Commercial real estate professionals are known for their persistent optimism, a necessity on the bruising roller coaster the industry can often be, but with economic, climate and regulatory challenges bearing down, many finance executives from major property firms aren’t looking forward to 2023.

These executives expect revenues to drop next year because of a slowdown in the economy, leading them to cut costs, plus there is growing uncertainty about the industry's response to climate change, especially how to deal with the evolving climate regulatory environment.

"The global economy is currently in a state of heightened uncertainty, due to economic shocks that have threatened a pandemic-era recovery," a new Deloitte report said. "Declines in equity prices reflect not only economic concerns, but also geopolitical instability and lingering disruptions brought on by Covid-19."

A global survey of 450 CRE chief financial officers by the Deloitte Center for Financial Service found that only 40% of them expect to finish 2022 with higher revenues than last year, while 48% expect lower revenues.

North American CFOs were a little more optimistic about next year, with only 43% expecting a decrease and 44% expecting an increase. The rest expect no change.

Compared with the same survey last year, the results show a marked increase in pessimism. At the end of 2021, only 9% of global respondents and 11% of North American ones expected a drop in revenues for the coming year.

The respondents cited a number of worries for the coming year, including inflation, finding workers and cyber risk as top impediments to financial performance.

Despite the sour outlook for revenues, the respondents weren't completely pessimistic, said Tim Coy, research leader on commercial real estate at the Deloitte Center for Financial Services.

"Some optimism still exists around real estate fundamentals," Coy said. "More than half of our respondents expect leasing activity to improve for the coming year, and we heard corresponding optimism about rental growth and tightening vacancies."

Nervousness about next year's revenues doesn't come as a surprise, according to Bel Air Investment Advisors Senior Vice President Richard Ratner, since rents for most sectors might take a hit.

"We expect the downward pressure on rental rates to continue through 2023," Ratner said, with the sectors most affected being office and retail. 

"The exception in the office sector will be Class-A trophy assets in certain CBDs, as well as new construction in some suburban markets," he said.

Hudson Yards in Manhattan and new construction on the west side of Los Angeles, Ratner said, are prime examples of strong demand at pre-pandemic rental rates in this niche. 

"In other real estate sectors, such as multifamily and industrial, we're still seeing rent growth, albeit at a slower pace as these rental rates may be peaking," Ratner said.

Commercial property investors, according to the Deloitte report, are targeting digital economy and logistics properties, but they haven't lost sight of the opportunities posed by downtown and suburban office properties.

Commercial properties will be impacted by the overall sluggishness in the economy next year.

"Financials may see greater decline due to low business confidence to borrow and invest, and the increase in interest rates," University of New Haven Associate Professor of Finance Demissew Ejara told Bisnow.

Economic indicators such as consumer spending and business confidence indexes hint at a slight decline or modest growth in economic activity over the next several quarters, Ejara said, though he noted that projections always have margins of error.

"Industries with heavy reliance on microchips will also see modest decline or no growth," Ejara said. "An expected decline in consumer confidence will decrease spending, which would affect business revenues negatively."

For commercial property financial executives, environmental, social and corporate governance, or ESG, is also still top of mind, Deloitte reports, and many feel that their companies need guidance on how to implement changes and monitor progress.

"Our survey shows managing ESG expectations is fairly new for this industry, and surprisingly only 12% of respondents have been planning for major regulatory action and are prepared to implement changes to meet requirements," Coy said.

Twenty-four percent of the respondents said they don’t have the data or capabilities required to comply with regulatory action, Coy said.

"Regulators around the world are enacting ESG disclosure rules and expecting transparency on ESG topics," the report says. "CRE companies will need to respond to both regulators and investors, who also are raising expectations regarding ESG disclosure."

A proposal released by the Securities and Exchange Commission in March would require publicly held companies to report climate-related risks, emissions and net-zero transition plans. If finalized, the rules aim to increase transparency and provide data for investors making decisions based on a company’s ESG performance.

A system that standardizes the reporting process and sets a minimum requirement makes sense because investors are including ESG when making capital decisions, said Tony Liou, president and co-founder of Partner Energy.

“Shareholders are asking for this,” he told Bisnow. “More and more folks are interested in, and take climate change seriously. It’s a risk for your business when you’re not addressing these things.” 

Beyond that, CRE companies are feeling the impact of climate change.

Ninety-seven percent of respondents to Deloitte's survey said their companies have already been negatively impacted by climate change, and about half said their operations have been affected, such as via a disruption to business models or supply networks worldwide.

Climate change impacts properties via extreme weather, wildfires and rising sea levels. The climate risk to physical properties is fairly well understood, according to the Center for Active Design President Joanna Frank, but the impact to people in those buildings is less so — the "S" in ESG needs further work, she said.

"How do you identify and measure the human-centric risk?" Frank said. "The real estate industry has been thinking in terms of brick-and-mortar risk, but it will need to better understand how to minimize the impact on climate change on the people in buildings. After all, it's people that ultimately determine the value of real estate."