Commercial Real Estate Is Both Exciting And Terrifying

Fact: Commercial real estate could be described as a volatile market today. It can be a good or bad time, depending on your investment. 

Silver Lining: Even though office space and rentals in general are getting hammered, retail offices and multifamily properties have stood strong.

Offices continue to be affected by the pandemic’s aftershock, which has led to a physical separation of the market to reduce its impact. Multifamily housing and retail are two segments that have risen to the top of such a rocky terrain.

Jamie Woodwell, head of Commercial Real Estate Research for the Mortgage Brokers Association (pictured), has a lot of work to do as he monitors investor interest in this market. Mortgage Professional America (MPA) asked him to provide a current snapshot of CRE market conditions based on expert insight.

He told MPA in a phone interview that the changes affected different properties, deals, and loans differently. Concerning the office space industry, one property might not have any issues. However, there may be significant changes in equity markets. People are not sure of the values and rates.

The World Of Office Leasing Is A Little Dark

Consider the office sector. The market forces in this portion of commercial real estate have been particularly unforgiving, as physically separating from the height of the pandemic led to high vacancy levels in large markets. The number of companies that allow employees to work from home has increased, resulting in a higher number of vacant positions.

These dynamics have led to a trailing of vacant offices, eroding owners’ rental incomes. You only need to look at the headlines of news publications to see how distressed office buildings are affecting rental income.

• SFGate reported on August 10 that Sixty Spear St., an 11-story, 30%-vacant building in downtown San Francisco, was sold at $40.9M. The property is expected to become fully vacant by 2025. The media outlet said that this is a discount of 66% compared to the most recent valuation for the building, which was $121 million.
  
• JLL reported that the office vacancy rates in Seattle/Puget Sound rose to 19.3% during the second quarter. The high vacancy rate is attributed to large tenants consolidating footprints and leaving space. JLL says that the overall demand for office space has been lagging despite employers’ increasing insistence on mass office returns. Quarterly leasing volumes are down by nearly 36%.
• TheRealDeal reported that a Colliers’ report in Portland detailed that the rate of office vacancies reached 31.5% during the second quarter. The market is still facing a “bleak future,” according to analysts at midway in 2023. Researchers wrote that over the next two years, more than half a million square feet of market-wide leased space will expire. If these tenants continue to lease office space after their leases expire, they will likely reduce their footprint in real estate.
• According to Newmark, the office market returned 56,688 sq ft of negative net absorption in Cleveland during the second quarter. The vacancy rate increased by 40 basis points to 21.9%, up from 21.5% in the previous quarter. Researchers wrote that as economic uncertainty persists, along with the hybrid work-from-home vs. office conundrum, we can expect to see vacancies and availability increase.
• Newmark reports that occupancy rates have declined in Austin, pushing the overall vacancy rate to a historic high of 21.6%. This is a 620-basis-point increase year-over-year. According to Newmark, total leasing closed at 928.822 square feet, with an average deal size of 4,320 square feet. This represents a 26.2% increase quarter-over-quarter but a 26.4% decrease year-over-year.
• Big Apple is one of the worst-hit cities. Avison Young reported that Manhattan had a high availability rate for decades in the second quarter. In Q1 of 2023, the 102.4 million square feet (MSF), or currently available space, was higher than 103.3 MSF. Manhattan’s leasing activity has been 12.2 million square feet (MSF) in the first half of 2023 – 39.5% lower than the average pre-COVID and 29.8% less this time last. In the office sector, the conversation is largely focused on the changes in space markets and the supply and demand for space.

Not Mr. Right BUT Mr. Right Now – Retail Is A Safe Heaven

The story is very different when looking at the other CRE segments.

Woodwell stated that “if you go back to two years or more ago, the retail asset class was completely avoided by investors, lenders, and other stakeholders,” Woodwell explained. There was a pall around retail. Over the past couple of years, investors, lenders, and other stakeholders have begun to distinguish between retail types they may be less confident with and those they feel very comfortable with.

He gave as an example: “Grocery anchored centers are now highly desired,” he stated.

Multifamily Commercial Real Estate Is Strong

The Multifamily market also breaks the mold, despite the market forces that have damaged the office space. Woodwell stated that there is still optimism and confidence in the market for multifamily spaces. New inventory is coming online, impacting the rent in certain markets. From a lending perspective, the property continues to do well, depending on whether it was purchased for the first time or financed last.

Woodwell explained: “If the property was bought or financed ten years ago, its value has increased by 160% from its previous level.” There’s equity built in. It’s not the same if it was bought recently. “So again, properties can be in different positions depending on the particulars.

It’s both the spring of optimism and the winter of depression, depending on where you are on the CRE landscape.