Here’s What to Expect for CRE M&A This Year

Merger and acquisition activity across the CRE spectrum is likely to continue to be high, though deals will likely be concentrated across the industrial and residential sectors, according to Deloitte.

“Pent-up demand, ready access to capital, a low-interest environment at least for the near term, and abundant private equity dry powder should have investors clamoring for properties” in those asset classes, despite sky-high pricing, the firm notes in a new research report. “Optimism appears to be growing for a moderate uptick in the office and hospitality sectors, and retail’s surprising fourth-quarter performance may be an indicator of better times ahead.”

Industrial buyers will face several challenges: high valuations and tight competition for assets, to name a few. Inventory remains low to warehouse and distribution facilities, leading to continued supply and demand imbalances. Data centers and cell towers will likely see a plethora of “willing buyers,” but fewer able ones, as such assets are quite complicated.

“We expect industrial M&A will have a fairly long run; however, high prices may reach a tipping point that prompts potential acquirers to look at other value-add investment opportunities,” the report notes.

Meanwhile, pricing and inflationary pressures could cool residential M&A activity for the balance of the year, as potential buyers may be led to pursue creative financing options or pass on deals if the value isn’t clear.  And on the retail front, appetite for grocery-anchored centers and upscale specialty retail should continue while “a shakeout is likely” for Class B and C indoor malls.

This year could be a turnaround time for hospitality, Deloitte predicts, though the recovery would be led by leisure: “the fate of downtown/CBD and convention hotel properties will likely remain in limbo as long as the resumption of business travel remains questionable,” the firm notes. The sector will also continue to grapple with a labor shortage in the foreseeable future.  But M&A in the sector could see an increase in 2022, “with acquirers particularly interested in hotel, leisure, and gaming properties in traditional domestic vacation destinations such as Hawaii and Florida,” the report notes.

And as for office, Deloitte says uncertainty will continue to plague the sector and drag down M&A activity, which will remain “on the slow side” until deal teams can be assured of firmer underwriting. And “the continued surplus of subleased space could entice occupiers to try to take advantage of the favorable conditions44 to renegotiate lease terms,” the firm states. “REITs and landlords may continue to employ aggressive concession packages, particularly in urban gateway markets, to attract and retain tenants.”

Overall, Deloitte analysts say that potential headwinds include “fierce competition for scarce assets,” inflation, rising interest rates, and ongoing geopolitical pressures. In particular, the combination of inflation and interest rate hikes could impact CRE company financials, operations, and M&A decision-making.

“Real estate is often thought to be a ‘safe’ investment and a hedge against inflation because it isn’t subject to wild fluctuations and investors generally are able to recoup higher leverage/interest costs by passing inflationary pressure on to tenants; for example, raising rents for residential properties, especially when occupancy rates are high and supply is limited,” Deloitte notes. “However, when costs are rising across the board but a company’s earnings aren’t rising commensurate to expenses, it may mean less available capital to apply against M&A. This can be especially troubling for the office and retail sectors, where new tenants may not be able or willing to accept rent increases on new leases or renewals.”

The prospect of additional interest rate hikes is also looming large, and could swing both ways for M&A activity.

“As interest rates rise so, too, will investment income, which increases cash flow that, potentially, can be applied to M&A. In another positive, higher interest rates typically increase company valuations, which can strengthen sellers’ negotiating positions,” Deloitte notes. “Buyers, however, may not fare as well, as the cost of debt will go up and they will have to pay the price for those previously mentioned increased valuations.”