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The combined impact of elevated borrowing costs and persistent inflation create a complex and mixed outlook for U.S. commercial real estate assets, according to Cushman & Wakefield (New York Stock Exchange:CWK) mid-year macroeconomic outlook.
In addition to higher interest rates (which make it more expensive for borrowers to refinance) and delays in Federal Reserve rate cuts creating headwinds, the commercial real estate market has faced a significant pullback in occupancy rates and tighter lending standards. This, in turn, has resulted in more commercial foreclosures and highest delinquency on CRE loans. Office occupancy, in particular, has been affected by the post-pandemic trend of working from home.
“Cracks are forming beneath the surface, as consumers and businesses remain under pressure from the cumulative effects of higher interest rates and inflation,” said Rebecca Rockey, Deputy Chief Economist and Global Head of Forecasting at Cushman & Wakefield.
As for office space, net absorption is expected to be negative in 2024 at -63 million square feet and -7 million square feet next year, according to the report. Demand is projected to average 20 to 25 million square feet per year through the end of the decade.
“While office jobs will continue to grow, office demand is still adapting to hybrid work,” said David Smith, director of Americas Insights at CWK. “We believe we have advanced that process beyond what the weighted average lease terms imply, as approximately half of the space in the sublease market has an underlying expiration date in 2028 or beyond.”
As a side note, Search Alpha’s Quant system provides prime properties (New York Stock Exchange:CUZ) the highest rating among office REITs, followed by Kilroy Realty (New York Stock Exchange: KRC), City Office REIT (New York Stock Exchange: CIO), Commonwealth Equity (New York Stock Exchange: EQC) and SL Green Realty (New York Stock Exchange: SLG).
Meanwhile, demand for retail real estate remains strong, in part due to a strong pipeline of store openings by large retailers. About 850 more store openings than closures are planned so far this year, CWK said. Additionally, there is a lack of new supply, with less than 12 million square feet of commercial space under construction and more than 4.3 billion square feet of inventory. CWK does not expect new supply to rise to its 2010-2019 average until 202 at the earliest, suggesting retail space will remain largely scarce.
“The retail real estate sector stands out for its low vacancy rates, which benefits companies like Realty Income (New York Stock Exchange:O) and Accept Realty (New York Stock Exchange: ADC),” said SA contributor Brad Thomas.
Other Retail REITs: Kite Realty Group Trust (New York Stock Exchange: KRG), Kimco Realty (New York Stock Exchange:KIM), Getty Realty (New York Stock Exchange:GTY), Simon Real Estate Group (New York Stock Exchange:SPG), Brixmor real estate group (New York Stock Exchange:BRX), Acadia Realty Trust (New York Stock Exchange: AKR).
The outlook for the industrial real estate sector, however, does not look so good. “While e-commerce continues to rise as a percentage of retail sales, some of the creep effect (businesses building earlier and faster during the pandemic) will affect the demand outlook for 2024 and the first half of 2025,” CWK said. in the report.
In fact, effective rent growth in major industrial markets is peaking or has already peaked, CompStak said in its Q1 2024 Industrial Market Overview Report. The weakening market is also evident in a 12.9% drop in the average length of lease terms for bulk transactions across the major markets average. But even as some tenants and large industrial occupiers slow their growth, e-commerce’s share of total retail sales remains high and remains a strong driver of industrial demand.
Industrial REITs: Stag Industrial (New York Stock Exchange: deer), Innovative Industrial Properties (New York Stock Exchange:IIPR), Land Realty (New York Stock Exchange:TRNO), Rexford Industrial Realty (New York Stock Exchange:REXR), Foreword (New York Stock Exchange:PLD).