While massive interest rate increases have hit the commercial real estate market, the Federal Reserve’s recent decision to keep rates unchanged will give the market some breathing room. After 11 collective rate increases in the last 18 months, commercial real estate credit has become even tighter as lenders have become more cautious following the recent collapse of the two regional banks in March 2023. According to the survey From the Federal Reserve, small and medium-sized businesses Large banks, which hold the majority of commercial real estate loans, reported tighter lending standards in the second quarter of the year. Meanwhile, delinquency rates on commercial real estate loans have increased, although they remain historically low. Although the Federal Reserve is signaling that more rate hikes will come before the end of the year, this pause will allow some time to evaluate 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 rental growth remain the dominant trends in today’s market. Negative net absorption and new supply have driven the office vacancy rate to another all-time high of 13.3% in August 2023. Although multifamily rental growth slowed further, demand for apartment buildings has increased as many people are priced out of the market. at higher mortgage rates. Retail availability remains scarce, as this sector has the lowest vacancy rate of any other sector, at 4.2%. Finally, industrial real estate remains strong, with the fastest rental growth among other sectors, but demand appears to be approaching its pre-pandemic level.
Commercial real estate sector performance in August 2023
The unprecedented increase in units delivered has amplified the available space within the multifamily sector. Over the past 12 months to August, there has been a notable 32% increase in units delivered to the market compared to the previous year. Consequently, unemployment rates registered an increase of 1.2% compared to the same period last year. However, absorption rates have maintained their upward trajectory through August, demonstrating a substantial 23% increase compared to the previous year. The multifamily sector is expected to remain strong compared to other CRE sectors, due to favorable demographics, a strong labor market, and low housing affordability due to higher mortgage rates.
Even though the pandemic is coming to an end, employees lack enthusiasm for returning to physical office spaces. Meanwhile, the amount of office space delivered to the market remains high. These dynamics, along with the progression of remote technology and the rise of flexible work environments, have led to a whopping 59.4 million square feet of unoccupied office space over occupied space in the 12 months since. They finished in August. Consequently, the office vacancy rate has reached one of the highest in the last 10 years: 13.3%. With a growing number of office construction projects underway and technological advancements underway, the office sector is set to face considerable challenges in adapting to evolving demands and work arrangements.
Although the commercial real estate industry sector has declined from its peak last year, it is now back to pre-pandemic levels. Net absorption has fallen 47% compared to the previous year. A record 525 million square feet of additional industrial space entering the market, along with lower demand, has pushed the industrial vacancy rate to 5.4% and tempered rental growth to 7.5%. However, rental expenses for industrial spaces have continued to rise 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 strong, with 12-month rental growth ending in August declining 1.2% compared to the previous year’s record 4.4%, now at 3.2% but still higher than pre-pandemic levels. The unemployment rate has stagnated for the last five quarters at 4.2%, the lowest among all CRE sectors. As inflation continues to retreat and interest rates are expected to stabilize later this year, the outlook for demand for commercial space remains strong.
Hotel demand has continued to increase, causing occupancy rates and room rates to rise. The hotel industry has made a remarkable recovery, with hotel revenues receiving an additional boost after being hit by COVID-19 restrictions and quarantine measures. Revenue per available room (RevPAR) is now more than 13% higher and average daily rate (ADR) is approximately 18% higher than its pre-pandemic levels. With business and leisure travel gaining momentum, demand for hotel properties will continue its upward trend throughout 2023.
