Update September 2023
The recent decision by the Federal Reserve to maintain interest rates offers a respite for the beleaguered commercial real estate market. After enduring 11 rate hikes in the past 18 months, lenders tightened credit following the collapse of two regional banks in March 2023. Small and mid-sized banks, which hold most commercial real estate loans, reported stricter lending standards in the second quarter of this year. Meanwhile, delinquency rates for these loans have risen, although they remain historically low. Despite signaling further rate hikes later this year, the Fed’s pause allows time to assess the impact of higher rates on the economy.
Commercial real estate sectors are grappling with challenges as low-interest loans mature at higher rates. Increased vacancy rates and sluggish rent growth dominate the current market landscape. Office vacancy rates hit a record high of 13.3% in August 2023 due to negative net absorption and new supply. Multifamily rent growth has slowed, but demand for apartment buildings has risen as higher mortgage rates price some out of homeownership. Retail remains tight, boasting the lowest vacancy rate at 4.2%. Conversely, the industrial real estate sector, while still strong, shows signs of demand reverting closer to pre-pandemic levels.
Commercial Real Estate Sector Performance (August 2023):
Multifamily Sector: The multifamily sector has seen a surge in delivered units, increasing available space by 32% compared to the previous year. Consequently, vacancy rates rose by 1.2% year-over-year, but absorption rates increased by a significant 23%. The multifamily sector is expected to remain strong due to favorable demographics, a robust job market, and reduced housing affordability because of higher mortgage rates.
Office Sector: Despite the pandemic’s end, employees remain hesitant to return to physical offices, and a significant amount of office space continues to enter the market. This, combined with remote work trends, has led to a substantial surplus of 59.4 million square feet of unoccupied office space in the past year, pushing the vacancy rate to 13.3%. With ongoing office construction and evolving work arrangements, the office sector faces considerable challenges.
Industrial Sector: While the industrial sector has tapered from its peak, it has returned to pre-pandemic levels. Net absorption dropped by 47% compared to the previous year, with 525 million square feet of additional industrial space added. This has increased the industrial vacancy rate to 5.4%, moderating rent growth to 7.5%. Rental expenses for industrial spaces, however, continue to rise faster than pre-pandemic levels.
Retail Sector: The rise of e-commerce and pandemic challenges have affected traditional retail, but it remains robust. Twelve-month rent growth, at 3.2%, is down from the previous year’s 4.4% but still higher than pre-pandemic levels. The vacancy rate has plateaued at 4.2%, the lowest among all CRE sectors. As inflation subsides and interest rates stabilize, retail space demand remains strong.
Hospitality Sector: Hotel demand is on the upswing, leading to higher occupancy rates and room rates. The hospitality industry has made a notable recovery, with hotel revenue exceeding pre-pandemic levels by over 13%, and average daily rates up by about 18%. With business and leisure travel on the rise, the demand for hospitality establishments is expected to continue growing throughout 2023.
Data Source by: Oleh Sorokin Analyst of Commercial Real Estate Research – National Association of REALTORS®