Are You Trying to Gain Some Clarity From a Variety of Forces Impacting the Commercial Real Estate Industry?
If you follow trends in commercial real estate and work in the industry, there has certainly been a barrage of disconcerting news over the last several months. Let’s take a look at some of the recent information and forces in play to get a handle on what is happening. According to the Urban Land Institute (ULI) semiannual real estate three-year economic forecast, CRE transaction volume (as measured in dollars) in 2023 is expected to drop by a total of 41.8%. In fact, according to some sources, overall transaction volume has already decreased by 40% in Q1 2023 vs. Q1 2022, due mainly to wider bid-ask spreads, decreased inventory, and the higher cost of debt. CRE loan originations in Q1 2023 were at a nine year low, 56% lower than Q1 2022. The largest asset class decreases in transaction volume were multi-family at 58% and office at 44%. According to Green Street, overall property pricing was also down 15% from the unusual highs of Q1 2022. Office pricing in particular was hit very hard and was down 27%, and likely has a ways to go. By some estimates, office pricing may decrease by as much as 49% by 2029. The beleaguered office sector is one of the main reasons why Commercial mortgage-backed securities (CMBS) delinquency rates have increased to 4.2%, the highest level since 2018. Indeed, you just have to peruse the major real estate news outlets to see consistent reminders of the stress in the office sector as more and more borrowers are handing keys back to lenders for under-water office assets. The main sentiment is that pricing overall will need to continue to decrease in order for transaction activity to start to get back on track toward a sense of normalcy. ULI indicates this may take until 2025…OK, deep breath here.
The above notwithstanding, there are some brighter spots and opportunities. Although the industrial sector is cooling, it is still performing well, with cold-storage and industrial outdoor storage (IOS) facilities in particular in high demand and out-performing other industrial type assets. Also, within the net-lease space, gas stations/c-stores, car washes, and auto parts and repair facilities appear to be doing well, and retail in general is benefitting from strong consumer demand. The distress in office assets is also spurring the formation of various real estate funds focused on taking advantage of the coming further reduction in pricing to get good deals, and to potentially re-position office assets into residential. If these assets start to trade, it may quicken the overall pricing corrections needed to get things flowing. In addition, although the cost of debt remains high, many investors have large war chests and are capable of getting deals done if the right one presents itself.
The June jobs report released by the Bureau of Labor Statistics showed a cool down from May with 209,000 jobs added in June. Excluding the losses seen during the first year of the pandemic, this is the smallest seen since December of 2019. Other indicators of slowing economic growth include the unemployment rate increase uptick, and wage gain slowdown, the result of which should continue to curb inflation, which is the main goal of the Fed.
Colorado’s labor force increased by 4,500 in June to 3,249,100. The share of Coloradans participating in the labor force remained at 68.7 percent in June, identical to the month prior. The U.S. labor force participation rate was 62.6 percent in June and was unchanged from the month prior.
So overall, what does this all mean? There’s no crystal ball, but history can tell us a few things. When interest rates start to steady out and confidence builds, combined with pricing corrections and ready sources of capital waiting to be deployed, things start to move. The question is: ‘when’ will this happen? Most of the brokers and real estate investors I have canvassed indicate guarded optimism and that moving into 2024 will start to see some things shake out. Although there is still some pain to endure, there are always opportunities, there are always players ready to make deals, and based on what has happened thus far, we have a better understanding of where things need to go in order to fire up the industry. So stay positive, focused, and ready – let’s go.
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