While the massive interest rate hikes have hammered the commercial real estate market, the recent Federal Reserve decision to hold rates unchanged will give the market a break. After 11 collective rate hikes in the last 18 months, commercial real estate credit has gotten even tighter as lenders have been more cautious after the recent collapse of the two regional banks in March of 2023. According to the Federal Reserve survey, small and mid-sized banks — holding most commercial real estate loans — reported tighter lending standards in the year’s second quarter. In the meantime, delinquency rates for commercial real estate loans have increased, albeit remaining historically low. Although the Federal Reserve is signaling more rate hikes to follow by the end of the year, this pause will give some time to assess the impact of higher rates on the economy.
As low-interest loans mature at higher rates, all commercial real estate sectors face challenges. Higher vacancy rates and slower rent growth remain the dominant trends of the current market. Negative net absorption and new supply have pushed the office vacancy rate to another all-time high at 13.3% in August 2023. Even though multifamily rent growth decelerated even further, demand for apartment buildings has increased as many people are priced out of the market due to higher mortgage rates. Retail availability remains tight as this sector holds the lowest vacancy rate of any other sector at 4.2%. Finally, the industrial real estate sector remains strong, with the fastest rent growth among other sectors, but demand seems to be sliding closer to the pre-pandemic level.
Commercial Real Estate Sector Performance in August of 2023
The unprecedented surge in delivered units has amplified the available space within the multifamily sector. Over the last 12 months leading up to August, there has been a notable 32% upswing in units delivered to the market compared to the previous year. Consequently, vacancy rates registered a 1.2% uptick in contrast to last year’s corresponding period. Nonetheless, absorption rates have sustained their upward trajectory into August, demonstrating a substantial 23% surge compared to a year prior. The multifamily sector is expected to remain strong compared to the other CRE sectors, owing to favorable demographics, a strong job market, and low housing affordability due to higher mortgage rates.
Despite the pandemic coming to an end, employees are lacking enthusiasm for returning to physical office spaces. Meanwhile, the amount of office space delivered to the market remains high. These dynamics, coupled with the progression in remote technology and the rise of flexible work environments, have led to a massive surplus of 59.4 million square feet of unoccupied office space compared to occupied space in the 12 months ending in August. Consequently, the office vacancy rate has reached one of the highest in the past 10 years at 13.3%. With a growing number of office construction projects in progress and ongoing technological advancements, the office sector is poised to face considerable challenges in adapting to evolving work arrangements and demands.
Although the industrial sector of commercial real estate has tapered off from its peak last year, it has now reverted to pre-pandemic levels. Net absorption has fallen by 47% compared to the previous year. A record-high 525 million square feet of additional industrial spaces entered the market, coupled with decreased demand, have elevated the industrial vacancy rate to 5.4% and moderated rent growth to 7.5%. Nonetheless, rental expenses for industrial spaces have persisted in rising faster than in the pre-pandemic period.
The rise of e-commerce has posed challenges for the conventional retail sector over the past decade, and the pandemic has further exacerbated this decline in activity. However, the retail sector remains robust, with 12-month rent growth ending in August decreasing by 1.2% compared to the previous year’s record-breaking 4.4%, now at 3.2% but still higher than pre-pandemic levels. The vacancy rate has plateaued for the last five quarters at 4.2%, the lowest among all CRE sectors. As inflation continues to recede and interest rates are projected to stabilize later this year, the outlook for retail space demand remains strong.
Hotel demand has remained on the rise, leading to increased occupancy rates and higher room rates. The hospitality industry has made a noteworthy recovery, with hotel revenue receiving an additional boost after being impacted by COVID-19 restrictions and quarantine measures. The revenue per available room (RevPAR) is now more than 13% higher, and the average daily rate (ADR) is about 18% higher than their pre-pandemic levels. With business and leisure travel gaining momentum, the demand for hospitality establishments will continue its upward trend throughout 2023.
Source: “September 2023 Commercial Real Estate Market Insights“
