Commercial Real Estate Investment Decisions: A Top-Down Framework

The order of analysis

Real estate lags the economy. Rents and vacancy rates emerge as a result of corporate activity, and corporate activity responds to interest rates and the phase of the cycle. Reading the asset first and checking the macro picture afterward therefore cannot answer the question of timing.

• Step 1, the expected shape of the economy: in which direction is the economy moving?
• Step 2, inflation and interest rates: how is the financing environment changing?
• Step 3, the position in the business cycle: where in the cycle does the economy stand now?
• Step 4, commercial real estate conditions and judgment: what state is the asset in as a result?

Step 1 · The expected shape of the economy

The first step distinguishes whether the economy sits in a recession or in a recovery. One country's indicators are not enough for that call, so US, OECD and Korean indicators are read together.

• Recession indicators: whether a recession has begun or ended
• OECD leading indicators: the direction of activity in the major economies
• KOSIS composite leading index: the leading movement of the Korean economy (113.7 in January 2024)

Recession indicators point to the United States having entered a recovery. OECD leading indicators have also turned up, which gives grounds to read activity in the major economies as having passed its low point. Korea's composite leading index recorded 113.7 in January 2024 and continues its gradual climb.

Step 2 · Inflation and interest rates

The second step is the financing environment. Real estate carries a high share of debt, so the direction of interest rates changes the assumptions behind any return calculation. That direction turns on prices, which is why inflation indicators are read alongside it.

• The US federal funds rate and PCE inflation: the basis for judging when monetary policy turns
• KOSIS inflation expectations: the price path economic agents anticipate
• KOSIS inflation rate: whether actual prices have settled
• The Bank of Korea base rate path: the direction of domestic monetary policy

With PCE inflation confirmed to be slowing, a US rate cut appears imminent. Korea, judged by inflation expectations and the inflation rate, is more likely to hold its base rate at the current level. When the two policy directions diverge, the Korea–US policy rate gap that had widened begins to close.

Step 3 · The position in the business cycle

Once the direction is settled, the next question is position. Even in a recovery, entering at the start rather than midway changes the terms in a buyer's favor or against it. Growth, composite indices and cycle-phase indicators are set side by side to fix that position.

• Real GDP growth: holding at around 2%
• The business cycle clock (BCC) average index and the composite economic index: the overall level of activity
• The KOSIS business cycle clock: whether the economy has entered recovery and expansion

Real GDP growth is holding at around 2%, and both the composite economic index and the BCC average index show the economy passing its trough. On the KOSIS business cycle clock the main indicators sit in the recovery and expansion phases. That the three measures point the same way raises confidence in the reading.

Step 4 · Commercial real estate conditions and judgment

The final step narrows to the asset. If the first three steps point to the early stage of a recovery, the leasing indicators and the transaction structure of commercial real estate have to be consistent with that reading.

• Rent index for medium and large retail units and offices: holding firm
• Vacancy rate: continuing to fall
• CBRE survey-based office net absorption outlook: demand turning up
• Effective rents across all Seoul submarkets: expected to rise
• Office transaction share by buyer type: active corporate purchases for owner occupation

The rent index is holding at a firm level and vacancy rates continue to fall. The survey-based net absorption outlook also points to recovering demand, and effective rents across all Seoul submarkets are expected to rise. The change that deserves closest attention is in the composition of buyers. Within office transaction share by buyer type, corporate purchases for owner occupation are becoming more active, which means the money entering the market is corporate capital that will occupy the space itself, not investment capital seeking rental income.

An owner-occupier purchase reflects the company's own view of supply and demand in the leasing market. A decision to buy a headquarters building is hard to reach without assuming several years of rising rents and a need to secure space.

Conclusion

The composite leading index, real GDP growth and the business cycle clock all show the Korean economy moving into a recovery. What has to be judged now is whether an asset will still serve its purpose five years from now. In the commercial real estate market, companies have sensed this and are moving first.

The purpose of this framework is not to forecast the market. It is to fix the phase a property sits in before weighing that property's own conditions, and to keep the basis for the judgment in published indicators. Only a judgment reached in this order can be explained to a client.