Opportunities and Challenges Ahead for Four Commercial Real Estate Sectors
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Among the many ways COVID-19 impacted the real estate market was how it changed the face of commercial real estate (CRE). As an income-producing property, CRE is solely used for business (rather than residential) purposes. Its primary sub-categories are office spaces, retail, industrial and multifamily.
Office Spaces
Thanks to technological innovations, many office workers began working from home during the pandemic. Nearly 3 ½ years after COVID forced office buildings to close, close to 1 billion square feet of office space remains unoccupied in the United States, as of the first quarter of 2023.
This occurred despite more than 2 million in-office jobs being added to the economy since 2020. Although some employees have mandated a “back to the office” post-COVID directive, a hybrid model is here to stay. By some estimates, 64% of employees say they “would consider leaving a job” that did not offer the flexibility of a virtual and/or hybrid model.
A suggestion that often comes up is converting empty office buildings into housing to help reduce U.S. home shortages (especially affordable ones). But nearly half of real estate professionals in a recent U.S. Chamber of Commerce survey said that government red tape/regulations are a “primary barrier to office space conversion.” Forty seven percent said current building layouts are not conducive to change and 44% said environmental regulations are also a concern.
The survey participants noted that they believe flexible workspaces (65%), improved ventilation (63%) and work-from-home/hybrid spaces (61%) will be the top trends over the next few years as owners try to coax more workers back to the office.
Retail Properties
More retail stores actually opened than closed in 2022 and 2023. Although some chains are closing locations or shutting down completely, others such as dollar chains and discount stores, are picking up the pace. General merchandise retailers, such as Target and Walmart, and auto parts businesses, are also anticipated to stay strong.
And while it’s true many malls have become obsolete, high-end malls are alive and well, with retail sales increasing to nearly $819 billion in 2022.
Industrial Buildings
Industrial starts fell in 2023 to 204.3 million square feet, compared to 614.1 million in 2022 and 586 million in 2021, in part due to interest rate hikes and stricter lending standards. But the sector is anticipated to remain strong, spurred by increasing growth of e-commerce sales, as distribution networks must be large and decentralized in order to deliver goods quickly.
The top three industrial markets are all in California (the Inland Empire, Los Angeles and Orange County). On the East Coast, the top markets are Boston, New Jersey and Bridgeport, Conn.
Multifamily Rentals
The multifamily sector experienced “subdued but positive demand” during the first half of 2023, according to Fannie Mae. The ongoing housing inventory shortage, along with high interest rates and home prices, were contributing factors.
The agency anticipates that an expected economic slowdown combined with over one million units currently being built will slow down this sector in the short term. Fannie Mae’s analysts believe the nationwide vacancy rate will be around 6% by the end of 2023 to peak at 6.25% in 2025 before dropping back to 6% in 2025.
Mortgage Concerns
CRE mortgages are secured through liens on the property and are often only five year terms, although they may range up to 20 years. Over the next 5 years, more than $2.5 trillion in commercial real estate debt will mature. Nearly three quarters of those loans are from local or regional banks. As many of those loans were financed when base interest rates were near zero, there is growing concern about what the impact will be on those banks when the loans need to be renegotiated at the current higher rates. As of September 2023, delinquency rates for commercial real estate loans were increasing but still historically low.
Some analysts, including J.P. Morgan, expect that rather than force borrowers into foreclosing, lenders may offer “short-term forbearance or even modify their loans” instead of repossessing a property that they would have to manage or sell.
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