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Real estate expert details what’s driving the commercial market resurgence

DLA Piper Partner and U.S. Real Estate chair John Sullivan weighs in on the state of the commercial real estate market and what's behind its comeback, especially in big cities like New York.

Video Transcript

RACHELLE AKUFFO: Welcome back. Despite the down day in both markets, there is optimism to be found in commercial real estate. That's according to DLA Piper's annual State of the Market Survey for 2022. Well, joining us now is the company's real estate chair, John Sullivan, to let us know what's happening. So, John, what are the key drivers here that are really prompting this optimism?

JOHN SULLIVAN: Yeah, well, first of all, I think your expression just before the break of post-pandemic resurgence is a good-- was a good turn of phrase, because I think that's exactly right. And it's actually quite remarkable. If you look back to the headlines in Q2 and Q3 of 2020 with respect to commercial real estate, it was the end is nigh. And it reminded me a little bit of after 9/11, when we all watched the horrible images of the planes hitting the World Trade Center, and some people were saying, well, that's the end of high rise office buildings. So it didn't come to pass, and real estate's death didn't come to pass in the pandemic.

So, what's driving it? And it's a couple of things. It is, there's an abundance of capital out there, dry powder to invest in real estate. And some of that is buildup because everybody was on the sidelines during the pandemic. So our survey respondents, the DLA Piper Survey cited exactly that, the abundance of investment capital, strong fundamentals in most asset classes, and a generally positive outlook for the US economy as the three primary drivers of the currently strong commercial real estate market.

SEANA SMITH: John, you briefly touched on it, but just drilling down into office space because I think a lot of people think about office space when they think about commercial real estate, there's been a number of surveys out there saying that some of these office buildings are only 30% to 40% of the workforce is actually coming in. I guess, how do you see this, then, how is that reshaping maybe the way we should be thinking about investing in this space?

JOHN SULLIVAN: Right, well, I think that office is the asset class where there is certainly the most uncertainty because everybody is trying to get to grips with what is going to be the long-term impact of the remote working phenomenon. And I think we have to be a little careful when we talk about office in general, because there's a big difference between, for example, brand new ESG-friendly office buildings and 1970s office buildings, just to take kind of a stark contrast.

But in our survey, it's interesting. There were-- the majority of people said that in general, office vacancies-- or I'm sorry-- office occupancies are never going to get back to what they were before the pandemic. So I think that there's no doubt that the remote working trend is certainly, over the next couple of years and probably over the long-term, going to have an impact on office space and the demand for office space. But as I said, I don't think that's going to be felt evenly across the sector. I think it's going to be felt by some types of office more than others.

RACHELLE AKUFFO: And as you mentioned, obviously, there are different subsectors within commercial real estate. Which ones do you see having the strongest growth? And how does that also vary regionally by state by state in terms of places that you're seeing the strongest demand?

JOHN SULLIVAN: Sure. So the strongest demand-- and some of this was happening before the pandemic and then was supercharged by the pandemic. And logistics is the best example of that. Logistics was a very-- and by that, I mean warehouses, distribution centers, things like that. And they were a strong acid class before the pandemic. It got supercharged by the pandemic. 66% of the respondents to the DLA survey identified logistics as the area, the asset class that they thought presents the best investment opportunity, followed by multifamily, so apartments.

Another interesting one is life science, and again, it was starting to emerge before the pandemic, but it has really emerged since the pandemic. So, life science related real estate and data centers. So those are the asset classes that are attracting the most capital right now. And in terms of geographies, we're seeing a very interesting thing. We were starting to see it before the pandemic, but now we're seeing it even more. And that is an increased interest in the Sun Belt cities, and at least for now, as somewhat dampened interest in some of the urban cores that have been traditionally the magnets for investment capital.

SEANA SMITH: John, do you think the attitude might be changing, though? Because it seems like it's very positive, but there's still certainly a lot to worry about when you have higher inflation, the risk of recession. You're seeing the markets act the way that they have been over the last couple of weeks. How do you see that-- how do you see the commercial real estate market responding to this?

JOHN SULLIVAN: Yeah, so right, everything's changing so quickly. Our survey was taken in February and March, not that long ago. But in this world, actually, that's quite a while ago, right? So, even back then, the market was pricing in interest rate increases, to some extent, but I don't think to the extent and the speed with which they've happened. And I would say that the same is true with inflation. So those are definitely creating some-- so I don't mean to kind of imply everything is roses for the commercial real estate sector. There are definitely some headwinds, and rising interest rates and inflation certainly being one of them.

I'll just say a kind of quick aside about inflation, though. It's an interesting one, and it's a double-edged sword because real estate is viewed-- some types of real estate, as you probably know, are actually viewed as a pretty good inflation hedge. The kind of real estate where you can reset your rents with some frequency are viewed as good investments in an inflationary environment, because you can try to raise your rents to keep up with and hopefully exceed, have a little bit of margin on inflation.

RACHELLE AKUFFO: And I just quickly want to ask you, because in your notes, you talked about opportunities from non-US investments and pent-up consumer demand really carrying expectations. Break that down for us.

JOHN SULLIVAN: Yeah, so there has been, over the last 10 or so years, increasing interest by non-US investors in commercial real estate. It's the biggest market. It's the most transparent market. And these are sovereign wealth funds and other big investors that have capital they have to put out. It's usually long-term capital. And so they just can't ignore the US market. And they tend to not be too driven by what they see as short-term changes versus long-term cyclical and structural, you know, try to distinguish between cyclical and structural changes.

So that's one of the reasons I think that you see continued interest in US real estate from those non-US investors. And then if you throw in some geopolitical uncertainty and instability, in that environment, sometimes-- and the US isn't the only safe haven market, to be sure, but it is viewed as probably the safe haven market. And so that also can increase that interest by the non-US investors in commercial real estate.

RACHELLE AKUFFO: Lots of great insights. We do appreciate you joining us today. John Sullivan there, DLA Piper's US real estate chair, thank you so much.

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