Is Commercial Real Estate Cooling?

With Fed rate hikes continuing indefinitely, many are asking what the future holds for CRE. Are we finally at the end of the bull market? While it seems a recession is more and more likely, just how will this impact CRE?

Perhaps the biggest question in the minds of professionals is whether or not commercial real estate is cooling down. Has a slowdown already begun? Just how will capital markets affect real estate? Let’s wade into these waters to get a better handle on what the rest of this year and 2023 will look like.

Interest Rates

It’s no secret that commercial real estate is a highly leveraged industry. Interest rate hikes are not our friend. And it would seem that recent rate hikes will continue for a while. Because the cost of capital is rising, investors are more hesitant. Higher interest rates mean smaller margins and greater risk. It’s quite likely that over the next year or more, success in CRE will require more capital and more effort than the previous few years.

However, there is currently somewhat of a disparity between capital markets and property markets. While rising interest rates are making it more difficult to fund new projects, we still see strong fundamentals. Most commercial properties are still outperforming expectations. Commercial real estate may be cooling, but it seems quite gradual.

Other factors are holding up. For example, job growth is still strong. CRE compensation is still rising, as demand remains strong. And liquidity is still profound at this juncture, leading some to theorize that an inevitable downturn will not be nearly as severe as the 2008 recession. Not all recessions are the same, and if we are entering one, it might be a mixed bag.

Market Sectors

2022 has not been a bad year for CRE. Though it all depends on which asset class you are looking at, commercial real estate in general looks rather strong considering the headwinds it is facing. Indeed, the remainder of 2022 looks promising, in spite of some commercial real estate cooling in the forecast.

Retail Properties

In densely populated areas, retail spaces like strip malls are performing well. Class B and C malls are struggling, but that’s nothing new. These buildings may present an opportunity for adaptive reuse as fulfillment centers or industrial space.

Multifamily Properties

Current vacancy rates are lower than they were in 2019 for multifamily, with rents at near-record highs. Nationally, the US is facing a housing shortage estimated to be between 2 million and 5 million units. Add to this the advent of Gen Z renters entering the market, and there is a strong argument to be made for modernizing and updating apartment space even during these uncertain times. Even Baby Boomers are selling their homes and renting in apartment spaces at increasing levels.

Office Properties

Offices are evolving, and companies may need to rethink how much office space they need. In an age of hybrid work and work from home, it is likely that demand for office space will decrease and change. How companies use their spaces will likely change, too.

Industrial Properties

Industrial space is still experiencing a boom, thanks to growth in ecommerce. Warehouses and fulfillment centers continue to be in high demand. Even though most commercial properties will likely see some level of slowing during a recession, if consumers continue to purchase online, odds are industrial space will remain in demand.

What’s Next?

There’s no denying that CRE deals are slowing down. Commercial real estate is cooling down like everything as interest rates climb. But as the balance shifts from a sellers’ market to a buyers’ market, there is immense opportunity to capitalize on new deals. The strength of multifamily and industrial are very promising.

Cheap debt is a thing of the past for the foreseeable future. As such, more-speculative deals aren’t as attractive. But with the shift, sellers are more likely to make favorable concessions to retain potential buyers. Bargains will once again enter the marketplace.

Office space will need some time to adjust to new formats and uses. Commercial real estate cooling will likely continue for a time as the overall economy reacts to rising inflation and rate hikes. But analysts are optimistic about new opportunities and long-term viability.

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