The past 12 months have been challenging for commercial real estate. Despite economic growth that is firmly above trend and a robust labor market expansion—both of which tend to predict healthy fundamentals and investment performance—commercial real estate values are down 12.5% from their peak during the current correction that began at the end of 2022. As difficult a year as 2023 was, however, there is a flicker of light at the end of the tunnel for private equity markets in 2024 (Read our full 2024 Real Estate Outlook). Despite numerous headwinds, the U.S. economy enters the New Year on solid footing and there are signs that inflation is slowly trending toward the Federal Reserve's (Fed) inflation target. Absent any significant shocks to the economy or capital markets, we believe that private equity capital values are nearing their trough for the cycle, with another quarter or two of write-downs in the offing, which we estimate at approximately between 5 to 7% by the middle of 2024.

EXHIBIT 1: NPI appreciation – peak to trough declines, percent

Test
 
1990-91 (S&L Crisis)
 
2001 (Dot Com Bust)
 
2007-09 (GFC)
 
Current
Source: NCREIF NPI, Principal Real Estate, Q3 2023. S&L Crisis = Savings & Loan Crisis; GFC = Global Financial Crisis

The correction in real estate values has been pervasive across property sectors, including two of the most favored among investors: apartment and industrial, down 11.1% and 8.5% respectively according to the NCREIF NPI. While space market fundamentals within these sectors have shown signs of weakening in 2023, which is due more to excess supply than a lack of physical demand, the primary cause of declining capital values has been capital market headwinds, which have conspired to depress both investor sentiment and capital values.

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Real estate
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Risk Considerations
Investing involves risk, including possible loss of Principal. Past Performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. All these risks can lead to a decline in the value of the real estate, a decline in the income produced by the real estate and declines in the value or total loss in value of securities derived from investments in real estate.

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MM13862 | 1/2024 | 3330218-122024

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