33 | 2023 Investment Outlook | December 12, 2022 PRIVATE REAL ESTATE Strong Fundamentals Offset Capital Market Weakness for High-Quality Assets KEY POINTS Tony Charles Strong fundamentals continue to offset capital market weakness for high-quality Global Head of 1 assets, even as capital flows back into equities and fixed income. Research and Strategy, Morgan On the horizon are more dynamic and highly leveraged markets, ESG retrofit Stanley Real Estate opportunities to optimize asset energy efficiencies, and arbitrage between public and Investing 2 private markets and funds seeking liquidity. We see potential for distressed or forced selling in the weakening environment, as 3 well as increased M&A activity between public and private companies. What We Are Seeing ƒ Real estate fundamentals generally remain strong and are helping to offset capital market weakness for high-quality assets. New construction on projects that haven’t begun has stalled, bolstering fundamentals over the intermediate term. Meanwhile, embedded rental income growth should help to protect values amid a weaker macro backdrop. Industrial and residential fundamentals are leading, buoyed by record-low vacancy and secular tailwinds such as eCommerce and high rentership. ƒ Investors are increasing allocations to niche sectors, such as student and senior housing, healthcare and self-storage, which have counter-cyclical demand drivers. Hotel recovery is accelerating for leisure and lagging for corporate. Hybrid office working models and more discerning occupiers are disrupting office demand. Inflationary headwinds continue to challenge retail real estate. ƒ ESG is growing in importance for investors, occupiers and employees, and is critical to optimize rent and asset value. ƒ Real estate transaction markets have stalled due to lower availability and elevated cost of debt, as well as heightened market uncertainty. Japan remains the exception, where financing costs remain at record low levels. Fund flows into real estate have slowed due to the denominator effect, which is shifting capital back into equities and fixed income as investors rebalance portfolios. What We Are Doing ƒ Increased volatility and the pullback in market liquidity provide a more favorable environment for investors who have capital to acquire high-quality assets in preferred sectors with robust fundamentals, at a reduced basis. ƒ We are targeting more dynamic and highly leveraged markets where re-pricing is expected to be fastest due to higher debt costs (U.S., UK, Australia, South Korea), and we continue to use existing relationships to acquire assets at an attractive basis in Japan. We’re also considering credit opportunities, including gap financing through mezzanine/preferred equity positions.