Summer 2023 Commercial Real Estate Update
Given the recent developments across commercial real estate and the macroeconomy, we thought a seasonal update might be useful.
Overall, multifamily and industrial real estate show continued strength across most markets, yet uncertainty persists across most commercial real estate (CRE) asset classes. The Federal Reserve and interest rates provide the backdrop of this uncertainty, but it’s worth remembering that this very uncertainty may, in our opinion, create some great opportunity.
Interest Rates & Credit Contraction
After ten consecutive rate hikes, the Fed finally took a breather at its June 13-14 meeting. However, market watchers hoping for looser monetary policy going forward were hit instead with the likelihood of two more 25-basis-point rate hikes later this year.
The Fed's potential actions in the second half of 2023 are creating persistent uncertainty while CRE owners continue to adjust to the furious pace of recent interest rate hikes.
Heavily intertwined with the fastest rate hike pace in decades are expectations of further credit contraction and talks of the upcoming maturity wall for chunks of CRE debt. In fact, billions, if not, trillions of dollars in loans are coming due in the next three years and that could be an opportunity for many investors looking for distressed assets.
While this is certainly not an ideal commercial real estate environment, many of the CRE pros in our network agree the underlying fundamentals deals are still there in many cases. Sure, the cost of capital is higher, but numbers still have the potential to work on many deals.
Multifamily
Who doesn’t love a juicy multifamily deal? Multifamily housing has pockets of strength, like in the Southeast, and it has proven its resilience over the past few years and into 2023.
As multifamily tenant expectations change and rise over time, many operators are adding hospitality-inspired amenities–not just in luxury rentals, but in apartment buildings, too.
Price adjustments continue in many multifamily markets in response to capital costs, while rents remain resilient nationwide.
Industrial
Propelled by the “I need it now” consumer, industrial real estate has been hot for several years. Strength persists, but vacancies inched up to close out the first quarter of 2023 at 4.3% versus a record low of 4.1% in 2022.
Let's remember there has been a lot of new industrial coming online. New construction of over 700 million square feet was underway in the second quarter of 2022. Now, construction completions are peaking.
Are we at risk of overbuilding in industrial? CommercialEdge compiled some excellent data in June regarding the industrial space in this macroeconomic environment. Make sure you check out that article.
Office
The rise in work-from-home roles continues to erode office space demand. However, companies with long-term office leases in place have the potential ability to ride out the correction.
Conversions to residential units continue to attract investment, with opportunities arising in major coastal cities like Boston and Los Angeles.
According to CoStar, a third of older office building stock in some of the largest cities across the United States and Canada is considered ripe for apartment conversion.
That being said, the high cost of capital and the tightening in the lending market may slow projects down over the next few years.
Office Conversions / Narrative
Speaking of office conversions, try 4 New York Plaza on for size. This conversion is the largest office-to-residential conversion in the U.S., featuring 1.1 million square feet and creating 1,300 new apartments with a $535 million redevelopment price tag.
“The worst is behind us” for office vacancies, says JLL CEO Christian Ulbrich. Is he right?
Headlines across office CRE are as bearish as one could imagine, and according to them, there is blood on the street. It is always darkest before dawn.
Retail
Is retail the new darling of CRE?
Sure, e-commerce gets all the attention and brings 15.1% of total sales, but people cannot get everything online. Consumers must leave their homes to visit the beauty salon, gas stations, strip malls, etc.
As such, mixed-use retail continues to merit attention as 2023 continues. It is not immune to the macro conditions, however. Special servicing has found its way into mixed-use, too.
Self-Storage
Operating expenses for self storage assets are generally lower than other property types. That means potential cash flows are higher than other types real estate. This is especially true when the facilities are being run by large companies rather than mom-and-pop operators.
Though transaction volume slowed during the back half of 2022 and into early 2023, self-storage is still seeing a lot of institutional capital inflows. Extra Space Asia was recently acquired by Dutch Pension fund manager APG and Singaporean real estate investment manager CapitaLand Investment last October for an initial $433 million to drive its regional expansion.
What does that mean for investors? There is a lot of institutional interest in self-storage and it may be worth paying more attention to.
Proptech Opportunities
We all know that costs remain mostly high across capital, labor, and material markets. So, it is an opportune time to look at proptech and what it can do for investors to potentially boost returns. Artificial intelligence (AI) & proptech are here in CRE–now.
For multifamily applications, proptech software is hoping to help increase net-operating income in different ways. In construction, emerging proptech technology is used in the design and build phase.
Now is the time to analyze and research what technology can do for your own applications within CRE. It is not going away.
Narrative vs. Future
Banking giants, including JPMorgan Chase CEO Jamie Dimon, are calling for continued pain across CRE. Headlines are uber-bearish. Interest rates are an unknown, with the Fed most recently signaling for two more 25-basis-point rate hikes later this year. We think they could even go higher.
What if interest rates peak and the most bearish news coincides with it sooner rather than later? It is one possible scenario–that the worst is almost over. News flow and fundamentals (as lagging indicators) tend to be the most bearish near market bottoms. It is food for thought and these are big “what ifs”
Conclusion
Multifamily and industrial numbers seem to remain strong, with retail starting to turn some heads under the right conditions. Don’t expect office to multifamily housing conversions to slow anytime soon, even though it is capital-intensive.
Bid-ask spreads are wide in some cases, as the cost of capital keeps sellers and buyers far apart in some markets/segments. That said, there is always a market price, and opportunities exist. As such, it is key to analyze deals individually.
With that said, if a deal has come across your desk, or you want to talk about CRE opportunities, feel free to give us a call. We love talking shop.