Shaping the Future: Navigating the Changing Tides of Commercial Real Estate
Anticipated transaction volumes for the quintessential commercial real estate categories are poised to peak at nearly $200 billion, marking a 24% downturn from the half-yearly average of $265 billion, recorded over the five years preceding the COVID-19 outbreak. This estimate is based on preliminary data collected for the initial half of 2023.
This considerable shrinkage in property sales echoes the larger macro-economic climate, dominated by the highest interest rates observed since 2007. Amid economic instability, decelerating rent growth, and a pronounced bid-ask spread, all property types are grappling with challenges. Yet, faith in prospective rent growth remains the linchpin of property sale transactions, transcending any other financial measures.
As we navigate the midpoint of 2023, industrial properties are claiming the pole position in relative transaction volume. Cumulative sales for the first half of the year have surpassed 114% of the five-year pre-COVID-19 average, powered by reliable cash flow growth and seamless credit accessibility from diverse lenders.
Industry insiders spotlight an extraordinary 8% year-on-year rent growth for Q2 2023, nearly doubling the pace of other commercial property sectors.
Retail real estate, particularly strip centers, are also witnessing a surge in rent growth, with an average year-over-year increase of 4.2%. Current sector turnover mirrors long-standing trends, and a significant fraction of all-cash buyers, mitigating price depreciation from rising interest rates, is funneling additional capital into the sector.
Hot on the heels of retail, the hospitality industry expects the average daily rate (ADR) growth to moderate from high single digits to 3.8% year-over-year by December 2023. Despite recent rent growth, apprehensions linked to hotels' ties with the office sector and consumer spending might further temper annualized rent growth in 2024. Consequently, hotel transactions are progressing at 75% of their historical pace for the first half of the year.
Once a beacon for transaction volumes, the multifamily sector is facing a significant slump, triggered by a steady stream of new completions and increased borrowing costs. Half-year sales projections suggest that this once-favored asset type is currently trading at a mere 63% of its former volume. However, the availability of debt through government-sponsored enterprises (GSEs) and other government agencies is underpinning deal flow.
Office real estate, trading at a sparse 46% of pre-pandemic levels, confronts the most formidable obstacles in terms of future cash flows, thereby restricting lender interest. Current average rent growth in this sector is a paltry sub-1% year-over-year and is predicted to turn negative by year-end. While some investors may consider this asset class too risky, others discern opportunities amidst the escalating uncertainty and discounts.
Despite the ebb in overall sales activity, lenders and investment committees maintain a keen appetite to capitalize. The challenge lies in harmonizing cash flow appreciation to combat inflation with capital preservation, particularly given the historically high basis set at current entry points.
Opportunities are as diverse as the geography and sectors they lie in, illustrating the fluid and accessible nature of the market. By prioritizing cash flow durability in investment and lending decisions, capital allocators can discover unique strategies to remain engaged and active.