Why the commercial real estate landscape is both bright and dark

In the commercial real estate space today, it’s the best of times and the worst of times – depending on the investment property.

At one end, the office market continues to languish in the aftershock of a pandemic that dictated the tactic of physical distancing to ameliorate its spread. Yet at the other end of the spectrum, multifamily and retail have emerged as surprisingly resilient – and even flourishing – segments along the rocky landscape.

In a time of interest rate volatility against a backdrop of inflation, Jamie Woodwell (pictured), head of commercial real estate research for the Mortgage Brokers Association, has his work cut out for him as he tracks investor interest in a mercurial market. Mortgage Professional America reached out to him for a snapshot of the current state of the CRE market based on his expert insights.

He explained how a confluence of market forces have aligned, but it’s a wave of uncertainty that is selective in the way it bombards the various properties it impacts.

“The changes affect different deals, properties and loans in different ways,” he told MPA during a telephone interview. “One property may have no issues or no significant changes going on in relationship to the space market but then some questions are unknown in the equity market in terms of people not being sure where values are and higher rates in the debt market.”

A season of darkness in the office space

Take the office segment for example. Market forces have been especially unforgiving in the segment as the lingering practice of physical distancing from the peak of the pandemic has given rise to high vacancy rates in big markets. Many companies have continued to allow their employees to work remotely, exacerbating vacancies left in the wake of a worker exodus rooted in layoffs.

Those dynamics have left a trail of office vacancies in their wake, corroding rental income for property owners. One need only glance at news headlines to discern the detritus of distressed office buildings:

• In downtown San Francisco, Sixty Spear St. – an 11-story building that is 30% vacant and expected to be fully vacant by 2025 – was sold for $40.9 million, as reported by SFGate on Aug. 10. That’s a 66% discount based on the building’s most recent assessment of $121 million, the media outlet reported.
• In Seattle/Puget Sound, the office vacancy rate rose to 19.3% in the second quarter, JLL reports. Researchers attribute the high vacancy rate to larger tenants leaving spaces to consolidate footprints. Even as employers grow more firm in insisting on a mass return to the office, JLL reports, overall office demand has lagged with quarterly leasing volume down nearly 36% year-over-year.
• In Portland, Ore., a Colliers report detailed how the office vacancy rate reached 31.5% in the second quarter, as reported by TheRealDeal. Analysts wrote the market continues to face a “bleak outlook” at the midway point for 2023. “Over the next two quarters, more than 500,000 square feet of leased space is set to expire marketwide,” researchers wrote. “Should these tenants maintain office space following the expiration of their leases, they will likely look to downsize their real estate footprints.”
• In Cleveland, the office market gave back 56,688 square feet in negative net absorption in the second quarter, as reported by Newmark. This caused the vacancy rate to rise by 40 basis points to 21.9% from 21.5% in the first quarter. As economic uncertainty continues, coupled with the continued hybrid work-from-home vs. in-office conundrum, it is expected that availabilities will continue to rise along with vacancy,” researchers wrote in their report.
• In the capital of Texas, occupancy rates in Austin declined to push overall vacancy rates to increase by 620 basis points year-over-year to an all-time historical high, increasing to 21.6%, Newmark reported. Total leasing activity closed the quarter at 928,822 square feet, averaging 4,320 square feet per deal and reflecting an increase in deal size of 26.2% quarter-over-quarter but a decrease of 26.4% year-over-year, according to Newmark.
• The Big Apple has received one of the unkindest cuts. In the second quarter, Avison Young reports, Manhattan reached a decades long high availability rate of 19.9%. The 103.3 million square feet (msf) of currently available space grew from 102.4 msf in Q1 2023. Through the first half of 2023, Manhattan has experienced 12.2 msf of leasing activity – 39.5% below the pre-COVID average and 29.8% below this time last year. “In the office market, conversation tends to be very much focused on change in the space market and supply and demand of space and what that might mean for property income.”

Retail is on the sunnier side of the CRE landscape

But then one looks at other CRE segments, and it’s a very different story.

“If you look back at two-plus years ago, investors, lenders and others were completely shying away from retail as an asset class,” Woodwell said. “There was sort of a pall over retail. And then over the last couple of years, investors, lenders and others have really come to differentiate the types of retail that they are maybe less comfortable with and the ones they’re very comfortable with.”

He gave an example of the latter: “Grocery-anchored centers now are highly sought after,” he said. 

Multifamily is another bright spot

Multifamily is also bucking the trend, despite market forces that have corroded the office space. “There is still a great deal of optimism and faith in the multifamily space market,” Woodwell said. “There’s a lot of new supply coming online, and that’s impacting rents in markets. But from a loan perspective, it continues to perform quite well depending on when that property was first purchased or last financed.”

He explained the difference: “If it was purchased or financed 10 years ago, its value is 160% up from where it was 10 years ago,” Woodwell said. “There’s a lot of equity that’s been built into that. If it was purchased recently, it hasn’t seen the same level of appreciation. So again, different properties are in very different situations, depending on their particulars.”

In short, it’s the spring of hope and the winter of despair – all depending on where one traverses along the CRE landscape. Yet on balance, it’s an epoch of incredulity – with apologies to Charles Dickens.

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