Cyclical and structural changes in real estate are one area of risk and opportunity worth highlighting for the coming year. While capital values have undergone a sharp correction, occupier markets have remained surprisingly resilient. For property owners, the past few years have been challenging, but this was no crisis. It was a cyclical adjustment in asset pricing; not a black swan event. 

Changing market conditions drove illiquidity of real assets, with valuations eventually reflecting this. As transaction volumes begin to recover, it’s now tempting to declare the end of that difficult market. But it’s also crucial to recognise that cyclical and structural shifts can occur simultaneously.

Consider hybrid working as an example of the latter. It’s had a profound impact on office rents and, while prime offices are commanding record-high rents, there’s also significant weakness in the broader office sector. Obsolescence is a real risk for older buildings, and outside major cities, new office development has become largely unviable as rents fail to keep pace with construction costs. 

Hybrid work hasn’t changed what we do but it has changed where we do it. And for an immovable asset class like real estate, the ‘where’ matters deeply. Even if yields tighten, parts of the office sector will likely not see a recovery in occupier demand.

The AI revolution adds another layer of disruption. It’s driving huge energy demand and needs data centre infrastructure to support it. But the pace of technological change brings the risk of faster depreciation of older assets. In the wider economy, AI will reshape tenant activity, sometimes enhancing tenants’ ability to pay rent, sometimes undermining it. As business models evolve, so too will the appeal of certain locations, and with that, rental tones will shift.

So even if we do see a cyclical rebound, could we be simultaneously facing structural changes in the occupier market? Are tenant failures a concern? Certainly, a weakening economy could lead to rising tenant defaults, with limited prospects for replacing tenants. We believe both real estate owners and lenders must remain vigilant, closely monitoring tenant mix and sector exposure.