Not All Real Estate is Created Equal
As thematic investors, we’ve always believed that where you invest matters – but today’s environment reinforces how important it is to invest in the right sectors and geographies. Major changes in the ways we live and work have created huge bifurcation across commercial real estate, with unprecedented strength in some areas and unprecedented weakness in others.
Sector Selection Matters
The one sector where the negative headlines tend to be correct? Office. Vacancy rates for US traditional office are above 20% and rents are under pressure. Even before the pandemic amplified remote work trends, Blackstone Real Estate saw that capital expenditures were rising faster than rents and intentionally reduced its US traditional office exposure from ~60% in 2007 to ~2% today across our real estate equity portfolio.
But commercial real estate is more than just office. Logistics – Blackstone Real Estate’s largest exposure (40% of the BXRE equity portfolio) is experiencing vacancy rates at only 4% nationally and rent growth that materially exceeds inflation, driven by e-commerce and onshoring of manufacturing. We see this bifurcation reflected in investor demand. There are few buyers of office today, but
sophisticated, well-capitalized investors are stepping up to buy logistics assets. We recently announced the sale of a $3.1 billion portfolio of warehouses to Prologis – a testament to strong investor demand for the right assets despite market volatility.
Geography Selection Matters
Selecting the right geography is just as important as selecting the right sector. Case in point: We recently sold the JW Marriott hotel and resort outside San Antonio for $800 million – 35% more than we paid for it in 2018, despite owning it through the pandemic and a historic increase in interest rates. In stark contrast, that same week, a different owner defaulted on two hotels in downtown San Francisco, where values have declined over 50% since 2016. Cities are moving at different speeds and in different directions. San Francisco hospitality faces challenges today, but Sunbelt markets are among the fastest growing in the country.
Growth in Data and Artificial Intelligence
Just like e-commerce drove demand for warehouses, cloud computing, content creation and the artificial intelligence (“AI”) revolution are driving demand for data centers. At QTS, a leading provider of data centers which we purchased in 2021, we are seeing 22% market rent growth and 3% national vacancy.5 QTS’s leasing pipeline has doubled over the past year. Yet we believe it’s still early days: Large technology companies are expected to invest nearly $1 trillion over the next five years into their digital infrastructure, creating what we anticipate will be a once-in-a-generation growth engine.
Falling New Supply
Having invested in real estate for over 30 years, what stands out to us about this cycle is that we didn’t see over-building, in part because of elevated construction costs and because the cycle was interrupted by the pandemic. Amidst that backdrop, we’ve seen a further dramatic decline in construction over the past nine months because of higher interest rates and more limited availability of construction financing. In logistics, our largest sector, construction starts are down 63%. We think this will ultimately be a significant tailwind: rents and occupancies are a function not just of demand, but also of supply, and fewer permits today will result in lower deliveries for the next several years.
Inflation in the Rearview
Another tailwind for commercial real estate? Cooling inflation. Elevated interest rates had an impact on commercial real estate over the last 15 months, but as we look forward, the story is quickly shifting. With inflation slowing we believe the upward pressure on long term interest rates has abated and this could represent a tailwind for real estate values over time.
If you look beyond the headlines, you’ll quickly see what we’ve said before: not all real estate is created equal.
- CBRE Econometric Advisors, as of June 30, 2023. Office vacancy represents national availability rate.
- Logistics per CBRE Econometric Advisors and traditional office per Blackstone Proprietary Data based on select investments, as of June 30, 2023. Market rent growth since Q1 2020 represents total growth in net effective rents from Q1 2020 to Q2 2023.
- This transaction may not be representative of future dispositions or Blackstone’s other portfolio holdings.
- 2016 value represents HVS Consulting and Valuation Services valuation as part of the loan origination in 2016. Defaulted debt balance value represents $725M loan balance which Park Hotels & Resorts announced on June 5, 2023 that it has ceased payments on.
- DatacenterHawk, as of June 30, 2023.
- DatacenterHawk, as of December 31, 2022.
- U.S. Census Bureau, as of June 30, 2023. Represents decline in seasonally adjusted U.S. new housing permits from the 2022 peak to today. Today refers to the trailing three-month period ended June 30, 2023.
- CoStar, as of July 17, 2023. Today refers to the quarter ended June 30, 2023.
- Reflects the Consumer Price Index, not seasonally adjusted.