On July 17, 2024 I attended a webinar hosted by First American Title about the commercial real estate (CRE) market in transition. Here are some important takeaways.
In the overall economy, inflation peaked in the summer of 2022 and has been steadily declining since then, although it has not yet reached the Fed target of 2% annually. The 2020-2022 inflationary spike was primarily a result of sharp growth in the cost of goods and supply chain disruptions caused by the COVID-19 pandemic. Cost of goods are now in deflation.
Services and housing costs are still high, but moderating. Since rent costs have an outsized impact on the cost of living, CPI indicators are still high but will also come down as rent costs cool. Wage growth is cooling along with inflation, but experts do not expect another spike in wages since less people are voluntarily leaving their jobs and unemployment remains low. As a result of these positive economic indicators, most experts predict the Fed will cut rates once in 2024 and up to four times in 2025.
While things are looking good in the overall economic picture, the CRE environment still looks rocky. Nationwide, CRE deal volume in 2024 is at less than 50% of deal volume in 2019. Financing still remains hard to find, which will present a particular problem as many CRE loans are maturing in late 2024 and into 2025. As of mid-2024, 14% of all CRE loans were underwater, and that rate reaches as high as 45% for office properties. More than $260 billion in office loans are due to mature by the end of 2026.
While prices are currently declining in all CRE asset classes, the longer term outlook for industrial and multi-family properties is promising. A short-term oversupply in these classes should soon morph into a long term need. Retail properties face an uncertain future due to the e-commerce trend.
Oversupply in the office category is clearly more ingrained, although there are significant regional differences. Some markets like San Francisco and Dallas show little sign of recovering from steep vacancies, while others like Miami and Boston are less impacted. While one might assume that high vacancy rates result from low demand, in many markets that is not the primary factor. Instead, much currently vacant office space is outdated and doesn’t meet the changing technology needs and amenity desires of modern tenants. So in some markets high vacancies result not so much from a shortage of tenants as from a shortage of space that they want. Also, about 60% of currently-active office leases were signed before the pandemic and are likely to be downsized when they come up for renewal due to work-at-home trends, making it harder to chip away at the overall vacancy rate.
As best I can tell from the tea leaves, the CRE industry should probably expect rough sailing for the next 6-12 months as we wait for positive economic trends to take a stronger hold and bring interest rates down. Longer term, we should expect the pace of recovery to be largely dependent on the asset class and regional market in question.
