From our Thought Leader Contributor, EY.
Guest post by Brett Johnson, EY US Strategy and Transactions Real Estate Valuation Solutions Leader.
This article was originally published on EY’s website.
On the heels of a record-breaking M&A year by volume in 2021, real estate executives look to retrench in 2022 amid ongoing uncertainty.
In brief
- Inflationary risks and the need to digest acquisitions are expected to drive a slowdown in real estate M&A activity in 2022.
- Geopolitical risks and logistics costs push real estate executives to rethink their operations and supply chain strategies.
- Creative investment strategies and disciplined execution will help real estate companies remain resilient.
Uncertainty appears to be a consistent theme for real estate executives according to the recent EY 2022 CEO Outlook Survey.
As we explore how real estate and construction CEOs in the US are responding to the pandemic and the recovery, we find that while 36% of real estate executive respondents say the pandemic caused short-term disruption to the industry, a much larger portion — 59% — believe that the COVID-19 pandemic has fundamentally reshaped the industry permanently. This percentage is more than 2 1/2 times higher than global respondents across all sectors, suggesting outsized and long-term disruption for the real estate, hospitality and construction (RHC) sector, which of course will create opportunity for both users and investors.
Over the last 15 years, and in the name of diversification, there’s been a marked move away from traditional asset classes and toward alternative real estate investments. In 2021, partly in response to the pandemic, this trend accelerated, with alternative investments now representing nearly two-thirds of real estate investment trust (REIT) market capitalization. As real estate users re-evaluate their home and office needs, investors are trying to stay ahead of emerging trends, such as single-family rentals for millennials and more flexible working spaces, while further mainstreaming investments in cold and self-storage, data centers, and student and senior housing.
Expect a slowdown in real estate M&A activity in 2022 following record transaction year in 2021
Following the execution of record transaction volume in 2021, we expect to see a slowdown in M&A activity throughout 2022. According to Real Capital Analytics, US 2021 transaction volume totaled $809b, a year-over-year increase of 88% from 2020 and a 35% increase from 2019. After this record year, only 39% of real estate executives say they plan to pursue M&A in 2022, vs. 59% across all industries.
We attribute this hesitancy to inflationary risks in the form of anticipated interest rate increases, as well as record-high asset pricing and labor challenges. Additionally, following a record year of acquisitions, real estate executives may be more inclined to focus on the integration of new properties into their existing business platforms. The following chart show EY-Parthenon’s near-term expectations for both the federal funds rate and 10-year Treasury yields.
Even though 2021 was a record year for M&A deals, real estate executives demonstrated measured discipline, with 75% of respondents saying they failed to complete or canceled a planned acquisition in the last 12 months as a result of the COVID-19 pandemic. We expect real estate executives to be equally disciplined in considering their M&A options in 2022 as interest rate risk continues to loom among unprecedented asset pricing.
While 61% of real estate executives overall have no plans to pursue an acquisition in the next 12 months, they have differing outlooks as to how the M&A market will unfold. More than half (52%) expect a slowdown in M&A activity overall in the next year. However, two-thirds (66%) anticipate an increase in hostile bidding, and nearly half (49%) expect to see more megadeals (US$10b+). A divergence in strategies between risk-takers betting on emerging trends and more conservative players who are willing to take a wait-and-see approach may attribute to the variance of opinions. Moreover, a near-term focus on integration may stall the breakneck pace in M&A.
We see a similar divergence in how real estate executives are adjusting their strategic investments as a result of geopolitical challenges. Overall, 63% say they’ve shifted their strategy in the past year. However, while 64% of these respondents say they have delayed or stopped previously planned cross-border investments in the last year, 36% are accelerating their international investment activities.
Geopolitical risks and logistics costs force a shift in operations and supply chain strategy
With geopolitical tensions and costs on the rise, real estate executives are adjusting their operations and supply chains accordingly. Across the real estate industry, 83% say they’re making changes to their operations and supply chains. Within the construction subsector, this percentage rises to 88%.
Significant increases in input prices have been a particular challenge for 90% of real estate executives overall and 96% of construction executives specifically. In response, real estate executives are being forced to either slow down planned development activities or take matters into their own hands, diversifying their supplier base to increase resilience while seeking to strengthen critical supply relationships.
We also believe that the urgency to adjust operations and supply chains is pushing real estate executives to buy established platforms and capabilities rather than building from within. Nearly one-fourth (22%) say they’ll be putting most of their M&A focus on increasing operational capabilities.
Looking ahead, creative investment strategies will dominate the agenda
As real estate executives continue to navigate the uncertainty that is likely to prevail throughout 2022, we expect the focus to be on creative investment strategies that enable them to remain resilient. This could include ongoing investment interest in nontraditional property types as well as platform and people expansions.
Whatever forms their investments take, real estate executives will remain vigilant and disciplined in the execution of their strategy.
Joanna Acosta and Meg Quinn contributed to this article.
Summary
The EY CEO Survey 2022 is a part of the CEO Imperative Series, which provides critical answers and actions to help CEOs reframe the future of their organizations.
The views expressed in this article are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.