The tightening of lending conditions, while showing signs of easing, has made it more difficult for investors to secure traditional financing prompting a rise in the use of alternative financing structures.Key trends shaping the future of commercial real estate investment: Shifts in capital allocation and investment strategies: The post-COVID-19 pandemic volatility in commercial real estate capital markets led many investors to adjust their strategies. Institutional investors and lenders, in particular, tended to became more selective during the market’s nadir, focusing on assets that offered long-term growth potential and stability – often referred to as core and core plus. These categories traditionally encompass stable, income-generating assets, which have historically included office buildings. Recent shifts in demand preferences and market fundamentals described earlier have strongly influenced the risk perception of those asset classes. As a result, while investors remain drawn to core and core plus for their relative safety, there is heightened scrutiny of what qualifies as “core” in today’s environment and alternative asset classes are expected to attract increasing attention. Meanwhile, higher-risk strategies such as value- add and opportunistic investments – which involve enhancing or substantially repositioning assets with an expectation of greater returns – may attract renewed interest as risk-aversion abates with market recovery. At the same time, there is growing recognition of the need for pricing of climate risk and related insurance costs in asset values. These include more careful assessments of physical and transition risks as sustainability and resilience become increasingly important criteria for investment decisions. An evolving environmental, social and governance landscape: Overall, environmental, social and governance (ESG) has become a focal point for both businesses and governments striving to meet global sustainability goals. However, in some parts of the world, ESG has also become highly politicized, leading to polarization that impedes progress towards the framework’s vision. Opponents of ESG frameworks might argue that they prioritize social or environmental goals at the expense of economic growth, job creation or energy independence. This politicization can lead to regulatory pushback, as seen in certain US states, where legislation has been introduced to limit or outright ban the consideration of ESG factors in investment decisions. Such measures hinder the ability of businesses and investors to fully align with sustainability objectives, ultimately slowing down efforts to transition to more sustainable practices. The framing of ESG as a political or ideological issue rather than a pragmatic approach to long-term resilience, risk management and profitability creates unnecessary divisions, making it harder to build the consensus needed to address pressing global challenges and, often, to fulfil fiduciary duties.Emergence of alternative asset classes: In response to the shifts in traditional property sectors, investors are exploring alternative asset classes that are less affected by economic cycles. Segments such as healthcare real estate, senior housing and student accommodation continue to gain traction, driven by demographic trends, stable demand and an exodus from more traditional asset classes like office. Additionally, technological advancements are creating new opportunities in areas like data centres, which are seeing increased demand due to the growth of cloud computing and AI applications. Focus on debt and structured finance: The tightening of lending conditions, while showing signs of easing, has made it more difficult for investors to secure traditional financing, prompting a rise in the use of alternative financing structures. Private lenders, debt funds and other non-bank financial institutions are stepping in to fill the gap left by traditional lenders, offering mezzanine financing, preferred equity and other creative capital solutions. While lending standards have eased for many high-quality borrowers and assets, and commercial mortgage-backed security (CMBS) issuance activity has recovered somewhat in the US, the shift to a more diversified lending landscape is expected to continue. Distress will remain a driver of these outcomes for the foreseeable future, with investors seeking flexible financing options in support of acquisitions and refinancing as banks and other legacy lenders work through varying levels of distress, consolidation and refinancing hurdles for seasoned loans. The outlook for distress in regional banks’ commercial real estate loans in the US reflects ongoing adjustments in the banking sector, but recent signs suggest a gradual improvement. Regional banks are key capital providers to commercial real estate and typically have more sizeable exposure to real estate than larger banks. According to 2023 FDIC data, the largest banks ($160 billion plus in assets) had a total of 4.4% total direct exposure to real estate (multifamily, commercial and construction loans), while banks with assets between $10-160 billion had 17.8% total direct exposure.3 While regional banks are still managing a portfolio of distressed loans, and that portfolio may increase in size, there are indications that underwriting standards for new loans are beginning to ease. This shift comes as different classes of lenders cautiously return to levels of activity approaching pre-COVID-19 pandemic norms, providing increased liquidity to the market. While lending remains selective, particularly for assets in weaker segments, easing standards is expected to facilitate refinancing for stabilized properties and new acquisitions. As this gradual recovery unfolds, distressed asset sales and loan workouts may taper, though the pace will depend on broader economic conditions and how effectively banks can manage their exposure across different asset classes. Reimagining Real Estate: A Framework for the Future 15

Reimagining Real Estate 2024