July 2023 Commercial Real Estate Market Insights

Leasing velocity slowed down in commercial real estate during the year's second quarter. While there is still much uncertainty about the total impact of the bank failures earlier in the year, there are rising concerns and speculation about where commercial real estate is headed. Since commercial real estate relies heavily on small banks for capital, a pullback in lending among these banks could further impact commercial real estate. However, data shows that commercial real estate lending activity is increasing weekly. Meanwhile, delinquency rates for commercial loans have increased since the end of 2022, but they remain below 1%. Nevertheless, delinquencies are expected to rise further in the year's second half.

As a result, most commercial real estate sectors continue to experience slower rent growth and higher vacancy rates compared to the previous year. In the office sector, there are more available spaces for lease than ever. Despite multiple efforts to repurpose unused office spaces, the slow return-to-office movement continues to hurt this sector. In the multifamily sector, rent growth has slowed even further compared to the beginning of the year, but the vacancy rate remained virtually the same in the second quarter compared to the previous quarter. Although leasing activity continues to slow down in the retail sector, the vacancy rate remains near 4%, the lowest rate in any other sector in commercial real estate. Finally, the performance of the industrial sector has eased from the 2022 record highs, but rent prices for industrial spaces grew more than 8%, significantly faster than pre-pandemic.

Here is how each commercial real estate sector performed in the second quarter of 2023:

Multifamily Properties

With multifamily construction overperforming in the last couple of years, the completion of these additional units has increased the vacancy rate in the multifamily sector. In the meantime, in the last 12 months, net absorption of apartments was half of last year's level, while 22% more units were delivered during that same timeframe. Thus, this demand-supply mismatch has increased the vacancy rate to 6.9% from 5.3% a year ago. Consequently, rent growth has dropped to 1.1%, below the pre-pandemic level. Nevertheless, the multifamily sector will remain strong compared to the other CRE sectors, owing to favorable demographics, a strong job market, and low housing affordability due to higher mortgage rates.

Office Properties

Even though more people are going to their offices more often, the office sector still faces challenges. The office vacancy rate reached a new record high at 13.1% at the end of the year's first half. With hybrid work arrangements allowing for a mix of in-person and remote work, a lot of office space is left empty. Meanwhile, in their effort to reduce their occupancy cost, tenants have decreased the average square footage per person leading to lower demand for space. The office sector is transforming to adapt to changing working arrangements and needs.

Industrial Properties

The industrial sector of commercial real estate has slowed down this year from record highs during the pandemic, but it continues to be stronger than the pre-pandemic level. Net absorption was nearly 40% lower at the end of the year's first half compared to the previous year. But, along with lower demand, significantly more industrial spaces were delivered in the market. As a result, the industrial vacancy rate rose to 4.7% and rent growth eased to 8.9%. However, rents for industrial spaces continue to increase faster than before the pandemic.

Retail Properties

Due to the emergence of e-commerce, the "traditional" retail sector has been challenged over the past decade, with the pandemic decreasing activity even further. However, the retail sector was able to remain stronger than pre-pandemic. The vacancy rate has been unchanged for the last three quarters at 4.2%, the lowest vacancy rate among all the sectors- With inflation easing further and interest rates to stabilize later this year, the demand for retail space is expected to remain robust.

Hotel Properties

Hotel demand advanced even further, increasing occupancy and encouraging higher-priced room rates. The hospitality sector saw a further increase in hotel revenue, which was previously affected by COVID-19 restrictions and quarantine measures. The revenue per available room (RevPAR) is now over 13% higher than it was before the pandemic. As both business and leisure travel pick up, the demand for hospitality spaces is expected to keep increasing throughout 2023.

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