The residential real estate market is doing better than most people expected after interest rates more than doubled last year. Nationally, prices fell each month from July 2022 to January 2023 (though never by more than 1% per month). However, the prices came back 0.2% in February. Ironically, February was the first month Year-on-year price drop, interrupting a 131-month record of continuously rising prices. It’s too early to tell, but it appears that despite higher rates, the housing market is stabilizing.
However, it’s not so pretty for commercial real estate, especially office.
office slump
Back in October last year, i noted that “Broadly speaking, the outlook for commercial real estate, especially office buildings, is not good. And large office buildings in particular are doing poorly and will struggle in the coming years. The reasons were of three types. First, the pandemic and the lockdown forced many businesses to close, many permanently, and this led to a general decline in existing stock and reduced demand for office space.
Second, working from home has become more prevalent in recent years, and Covid has only accelerated this. One prominent economist even went so far as as to say Full-time office work is “dead”. While there are many companies Employees have been ordered to return to officeAt least in the short term, the increase in work-from-home arrangements has clearly put pressure on the demand for office space.
Ultimately, there is a significant increase in crime in many cities. While the issue of crime primarily affects the retail sector, it also hinders offices, especially in areas of the city where employers pay a premium due to the popularity of those areas. As the popularity decreases, so does the premium.
Nevertheless, it is retail (discussed below) that has been most affected by crime, with many major retailers closing shop in various cities. Significantly, Walmart has closed half of its stores. chicago and all its stores portland, Target announced that it is retaining $400 million loss Due to shoplifting, Walgreens has closed 10 locations san francisco,
And speaking of San Francisco, it has been hit particularly hard by all three of these trends. The office has been particularly hard hit, as in this chart for office vacancies san francisco standard clearly explains.
It was not difficult to predict, because i noted last yearThe way commercial leases are structured makes all of this inevitable,
“The reason we can know for sure that this problem is about to get worse is the way commercial leases are structured. Unlike a normal lease on a house or apartment unit, commercial leases are typically 3-5 years long and sometimes longer.
“Downtown commercial real estate was already declining prior to 2020, but the pandemic exacerbated that decline. Many companies that signed leases in 2017, 2018 and 2019 are stuck with those leases for a few more years. But all signs point to the vast majority of them leaving once the lease expires.
“So, if you think the vacancies are high now, I would advise you to gear up.”
This office slump in San Francisco will likely come in 2025 when 2 million square feet of office space leases expire. (In 2023 and 2024, that’s 800,000 and 1.2 million, respectively.)
Although the situation may be worst in San Francisco, offices across the country have been affected. CBRE Notes he “Question 1 [of 2023] saw 16.5 million square feet negative pure absorption” (italics mine). This is not a positive sign at all.
this chart Moody’s shows that after a brief and shallow recovery from the pandemic in 2021, the office vacancy rate has begun to rise again and is now nearing 20%, a nearly 15% increase since early 2018 Is. Moreover, rents have risen, declined dramatically during Covid before rising in 2021, have started to move back towards zero while inflation is still high.
Maybe another way to picture it is to look at Alexandria Real Estate Equities, Nation’s largest office REIT has performed over the past two years, by a factor of more than two. At least this much can be said that it is not right. Its share price has almost halved from its peak of $223 per share in December 2021 $124.18 at the time of this writing,
Other office REITs have performed similarly over the past year or two.
And unfortunately, this trend is likely to be with us for some time. Given how leases are structured and the hard reality of the three factors driving this decline (pandemic, work from home and crime), the pandemic appears to be the only one that has ended or is likely to end soon. Is. and there is still given Strong chance of recession There isn’t much reason for optimism, either later this year or in 2024.
This condition can be seen further CBRE had conducted a survey earlier this year Out of 250 real estate professionals. More than half expect CBD office (central business district) and suburban office cap rates to rise by 25 basis points or more (that is, such buildings will cost less). And virtually no one expects cap rates to go down.
The only other sector with a similarly dismal outlook is the retail sector.
Is there even a retail recession?
Thankfully the pandemic is over, and retailing is not something that can be easily done from home. Unfortunately, as previously mentioned, crime problems affect the retail sector the most. Apart from this, retail is also facing the problem of Amazon. E-commerce as a percentage of total retail sales has grown from less than 5% in 2010 to 14% in 2020 and Projected to be 23.5% by 2025, Amazon accounts for over 40% of online retail sales.
In addition, inflation has affected the American pocketbook and some people have had to buy less. This can be hidden by raw sales reports because, for example, if you buy three widgets worth $10 in one year and then the next year, the widgets are $15, you only buy two. Sales for both years would still be $30. But inflation doesn’t mean that the profit margin on any given widget is bigger.
a survey found that 72% of Americans reported “buying fewer items” when grocery shopping in 2022, compared to 64% in 2021. Still, retail sales (in terms of dollars spent) declined in four of the last five months and are mostly flat since early 2021.
Yet, as far as vacancy rates are concerned, the retail sector is performing much better than the office, not great though, It has recovered from the growth seen during Covid, but has stabilized around 50 basis points above 2018. Rents have been rising steadily after a major fall during Covid, but still lag inflation by a large margin.
We can also look at the largest retail REITs to get an idea of their relative performance. Realty Income Corporation It’s topped the charts here, and while 2022 and 2023 haven’t been good for it, it’s down only 15% from its peak in August of 2022 and up a little over 20% since its pre-Covid peak, which Alexandria Much better than real estate. Equity.
commercial real estate downturn
While residential real estate (including apartments) and industrial are doing well despite high interest rates, other sectors haven’t been nearly as lucky.
While we are looking into a shallow recession in retail, the office has suffered.
The long-term future for retail looks dubious as Amazon and other e-commerce companies continue to eat away at brick-and-mortar establishments’ share. However, at least for the time being, the retail business appears to be somewhat stable.
However, office properties are a different story. The condition of such properties is getting worse and worse. And such trends are likely to take some time to reverse.
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Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
