You’d be forgiven for gaining a case of whiplash moving from 2020 to 2021. Disaster—a seemingly closed economy, crashed supply chains, tight labor availability, and many millions out of work—turned into rising values, some hot sectors, and rising rents and increased stability by 2021.

Stepping into 2022 should be a good deal less jarring. And yet, there might be changes and surprises. Here’s what experts see as coming up.

Capital Markets React to Rising Rates

“The starting point is values on everything that’s either offered for sale or selling are at historic low yields or cap rates and historic high prices driven almost completely by long-term historically low interest rates,” Stephen Bittel, founder and chairman of South Florida real estate firm Terranova Corporation, says. Money at under 3% over a five- to seven-year span has been widely available.

The Fed has said that may be on the way out, with rising interest rates almost a certainty. But if it happens early, that would likely be toward the end of 2022, leaving much of next year’s financing dynamics like 2021.

“I think most of us think interest rates are going to stay about where they are,” says Bittel. “There’s a small chance of them going down, but more likely they’re going up, but not by a lot. The challenge is that most of us believe, in five years or seven years, interest rates have to be higher. That makes it a challenge if you have to refinance.” That could cause some rethinking in next year’s long-term planning.

Some, like Lisa Pendergast, executive director of the CRE Finance Council, remember back to the 1980s and remain concerned about what could happen with interest rates. “I do remember trying to get a mortgage and [the rate] was in the mid-teens,” she says. “It was, ‘How do I make payments without it being a tent in my backyard?’ I do worry about interest rates.”

Even if interest rates were to rise, they’d have a way to go to make investments like bonds more attractive than real estate. Ten-year Treasury’s real interest rates have been running between 80 and nearly 120 negative basis points in the second half of 2021.

“It’s worse than ever, with corporate BBB are negative real yields,” Steven Cornet, head of U.S. research and strategy at BlackRock Real Assets, says. “We have an extreme shortage of yields. You look at the charts. It’s stunning how much is negative.”

Then there is also the growth of inflation. “I’m very worried about the inflation numbers ticking up at a time we can least afford it,” Pendergast adds. “I feel like we’re all stepping back and saying I’m concerned about some of the macro signs, but with the pandemic it’s difficult to understand what the data is telling you. I tell my guys, ‘You need to be watching these numbers and have a view on the impact of the marketplace.’” Then again, as she notes, “hard assets are a good place to be,” so if inflation kicks in, there are industries that will fare far worse than commercial real estate.

Inflation also offers some additional advantages, in a way. “Excess supply is a killer for real estate,” says Todd Henderson, co-global head of real estate for DWS, as it is in any industry depending on the interaction of availability and demand. “With inflationary pressures, you get an increase in costs to build real estate.” That reduces supply and helps support prices. Inflation also tends to bring higher wages. “That’s creating more buying power and it typically corresponds with higher GDP growth and real estate has historically displayed a correlation with inflation,” he adds.

However, higher inflation means bigger costs. “I worry about what would happen if we were faced with an increasing interest rate environment and not having these costs in check,” Gary Holloway Jr. , president at GMH Communities, says. “Just because we have a lot of apartments doesn’t mean we have access to furniture. We need to get people back to work and we need to get goods produced [for availability and lower prices].”

Sectors Running Hot and Cold

But what parts of CRE are safest? It depends on that mix between looking for value and for an opportunity.

As everyone seems to say these days, industrial is about as hot as things can get without melting a hole down to the center of the earth. The only thing sinking is cap rates. That’s leading to two different views.

“I think the valuations are getting a little uncomfortable,” says Matt Argersinger, lead investor at the Motley Fool’s Millionacres. “Historically, there’s been about a 300 basis point spread between cap rates and the 10-year treasury if you go back 20 years. In industrial, you’re seeing cap rates in the threes, which doesn’t seem sustainable. There’s such a hunger for yield that there’s a lot of money being parked. It will continue only because I think there’s such a fundamental supply and demand imbalance, but it feels like valuations will hit a peak somewhere in the near term.”

Then again, some argue things are still strong, given demand from well-financed, strong credit organizations like Amazon, Walmart, Target, FedEx, UPS, and others hungry for last-mile locations for e-commerce.

“We just had a strategy meeting where someone said industrial still looks cheap,” BlackRock’s Cornet says, noting that 2020 industrial cap rates were in the fours in 2020 and then now look cheap compared to 2021. “Industrial has such strong rent growth that it’s the rent growth driving down the cap rates, not just the low interest rates. In certain markets, the rent growth is 1% to 2% per month, not year. We see annual escalations at 3% or 4%. We hear 5% annual escalations with a new lease in certain markets. People are willing to pay up for that because it’s hard to get.”

While industrial may get top billing, it’s not the only attraction for the coming year.

“In general, I would say that multifamily is almost as hot as industrial and industrial is pretty damned hot,” says Taurus Investment Holdings CEO Peter Merrigan. “Multifamily has been booming since the vaccination program kicked in. The rent increases have been way above inflationary increases. That implies a sort of a healthy market. I believe it’s also partly a matter of supply. Starts are too low. There’s a big population base coming into the renter market now with the next generation. The millennials are becoming a home buyer generation, but there aren’t enough homes. The market hasn’t been able to keep up with demand.” There isn’t a chance that construction will catch up in 2022, putting even more pressure on buyers and renters alike.

“It appears 2021 will be at, or in excess of, 2019 volumes, which were an all-time high,” Matthew Lawton, executive managing director and investment sales and advisory platform leader for JLL Capital Markets, and who specializes in multifamily, says. “We anticipate 2022 being stronger than 21 based on our pipeline and based on what is coming on the market.”

While cap rates haven’t hit the subbasement like those of industrial, they have still been under pressure, falling to near 5% with a floor not yet in sight. The cap rate crash in multiple sectors has caused many to reconsider how they evaluate deals. After all, capitalization rates are so 2019. “People are looking at unlevered IRRs,” Lawton says. “Because we’re seeing such strong fundamentals in rent growth, pro formas are very strong.”

Significant portions of other areas—retail, hotels, and office—are still seeing uncertainty along with conflicting social forces.

Many employers have said they want workers back in the office. But continuing concerns over Covid variants, as well as an improvement in work-life balance that many found with greater flexibility in how they work, has made many employees dig their heels in.

“That fact that people are able to work from anywhere is causing a big shift in employment patterns and certainly office space patterns of knowledge workers,” says Marc Betesh, CEO and founder of Visual Lease, a lease management software company, who says the main driver of migration is work opportunities. “People move around because, ‘I got a job in Chicago or Cincinnati, and I have to move. I want to move to California, but I don’t have a job there.’” But if many, even if not all, people can work virtually from anywhere, then that is no longer an issue. “It’s obviously going to have an impact on commercial space, predominantly office space, because of this.”

Location, Location

Retail might continue to be a mixed bag, depending on vaccination rates and the impact of the Covid delta variant and others if (or probably when) they appear. Some types like grocery stores and pharmacies have done well because people needed them. Others, not necessarily so well, especially if they depended on foot traffic rather than

The impact on office rentals will be there in 2022, though not evenly. Kastle Systems’ back-to-work barometer showed a 33.1% 10-city average occupancy rate at the end of August. By September 22, it was 34.4%. But the range was 21.2% for San Francisco’s metro area to 48.7% for Houston. And within a city, the variations can be huge, depending on whether the building in question is high-end or B- to C-grade, in which case the occupancy rates are around a fifth.

And yet, the office isn’t some losing segment. “Your cash-on-cash yields for offices are actually quite attractive now,” Merrigan says. “You have to make a bet on acquiring assets we like in the long term, that have a strong rent roll, that are well positioned for a strong recovery in a normal world.” Though it can take nerve. “You’d have to be pretty courageous,” he thinks. “In the Boston market, for example, there are a lot of conversions of those facilities into labs [for life sciences].”

“I often get asked about the office sector,” says Henderson of DWS. “I think it’s one of the most challenging sectors to predict. Our view is work from home will have an impact on office demand and certain areas of the country will experience that impact to a greater level than others.”

That’s not only true for offices but retail, multifamily, and virtually any other sector. Real estate thrives where there are people and companies who need land and buildings.

For example, one area that doesn’t appear in the Kastle barometer is Miami, which is a “complete outlier,” according to Bittel. “The urban retail, restaurants with big outdoor seating areas like on Miracle Mile, are doing great,” he says. “Their challenge is they can’t find enough staff in the kitchen and [front of the house]. Leisure hotels are performing significantly well, especially in tourist areas.” But while domestic tourism “filled the gap” for convention and international traffic in Miami, it didn’t in places like “New York, San Francisco, Los Angeles.”

Office space is also hot in and around Miami. During October through December last year, Miami and Palm Beach saw a migration of people “that was unprecedented in terms of numbers,” Tere Blanca, CEO and chairman of Blanca Commercial Real Estate, tells GlobeSt.com. “Miami as we understand has attracted three times more migration of people than other cities in the country.”

Because there wasn’t a significant glut of office space at the time, it went quickly. “Every company wants to have a footprint and an office,” Blanca observes. But not even Miami is immune from pandemic realities. “I think that across the board you’ll find that down here high-rise towers are not at full occupancy, and they won’t until the Delta variant is under control,” she adds.

Looking for Alternatives

“I do think hospitality is a major opportunity right now,” Argersinger says. “I think there’s clear vision. If you focus on destination places, highly amenitized resorts or unique offerings. To me, hospitality in really good markets, unique locations, present tremendous opportunity.”

Many real estate investors are also looking for alternatives that might offer a better return and see less investing competition. Some seem sound, others are more of a risk.

“Real estate investors are looking at other kinds of investments that have a real estate component but have a more active business,” Bittel says, pointing to self-storage, cold storage, and life science.

But the uncertainty can grow. “Investors are buying film studios now,” says Bittel. “They’re so starved for yield that they’re reaching into other sectors that have a real estate component. You own a studio, and you hope someone rents it for six months to shoot a movie or TV show.” And yet, investors need longer-term leasing to nail down financing. If they have oversupply, like self-storage in a geographic area with a shrinking population, it’s possible to get stuck.

Feeling Pressures

Other pressures will increase during 2022. One is ESG: environmental, social, and governance.

“It’s influencing real estate from every perspective,” Brad Dockser, CEO of GreenGen, says. “It’s impacting the tenants, the space they want to use and their willingness to return to the office. It’s impacting access to capital markets to raise equity and debt. It’s also impacting the value as more and more cities, states and countries look at regulation to drive ESG.”

SEC chair Gary Gensler, for instance, has said in congressional testimony that he’s asked the agency’s staff to begin drafting climate change disclosures for corporations. Commercial real estate would ultimately feel an effect, whether directly by publicly held real estate businesses and REITs or indirectly from companies leasing properties that will want the information to add to their disclosures.

“They realize their ability to raise money is correlated to the strength of their ESG program,” Dockser says. “Investors are saying, ‘If you don’t have a strong ESG program, you’re not going to get our money.’”

Environmental concerns could have unobvious impacts, like an increase in adaptive reuse. “Doesn’t that check off a lot of boxes?” asks George Kroculick, co-chair of Duane Morris’ real estate practice group. “Adaptive reuse almost always involves some kind of environmental cleanup that definitely involves ESG.” It also provides new uses for existing properties that may be otherwise out of favor, reducing the need for expensive construction of a greenfield site.

Pendergast thinks there will be a wave of rehabbing. “I think they have to,” she says. “There’s been a lot of new space that’s come on the market, so there’s competition, but that space isn’t inexpensive.”

At the same time, new construction is again picking up. “Right now, our business is primarily in the institutional, private commercial space,” says Juan Segarra, president and CEO of Foresight Construction Group. “Now we’re starting to see a lot of activity on the estimating pre-construction side. I see between now and first quarter having heavy activity in pre-construction,” with building increasing in 2020. But prices and availability of materials remains a gating factor.

The coming year will have promise, but a lot of challenges as so many things in life and business remain unpredictable.