December 2023 Commercial Real Estate Market Insights –

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A Recap of Commercial Real Estate in 2023

In 2023, inflation and interest rates emerged as the twin pillars steering the economic landscape and, consequently, the dynamics of the commercial real estate sector. In pursuit of lower inflation, the Federal Reserve implemented multiple interest rate hikes throughout the year. One of the most direct effects of these higher interest rates was the increased cost of borrowing, affecting the profitability of new developments, the feasibility of certain projects, and the overall volume of real estate investments. As a result, for most of the year, nearly every commercial real estate market segment encountered a continuous rise in vacancy rates and a deceleration in rent growth.

Bar graph: Inflation, 2020 through 2023

Office Properties in 2023

The office sector remained the most significantly affected segment within commercial real estate, enduring the biggest losses in 2023. Even with the reduction in remote work opportunities, the office sector witnessed an unprecedented surge in vacancy rates, almost reaching a pinnacle of 14%. Amid shrinking leasing velocity, net absorption has remained negative throughout 2023, with a substantial surplus of available office spaces.

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Multifamily Properties in 2023

With mortgage rates surpassing 7.5%, the multifamily segment witnessed a revival in apartment demand in the second half of the year following a nearly year-long slowdown. However, due to the construction boom, vacancy rates continued their upward trajectory, reaching 7.4% and consequently reducing rent growth to 0.6% at the end of the year. Nevertheless, even though slower, rent prices kept rising from the previous year.

Table: Top 10 Metropolitan Areas with Strongest Multifamily Absorption

Retail Properties in 2023

Slower rent growth has also been observed in the retail sector. However, notwithstanding the challenges posed by elevated consumer prices, this sector performed in 2023 better than pre-pandemic: rent prices rose faster, absorption of retail spaces increased, and vacancy rates remained at a 10-year low of 4.1%.

Table: Retail Absorption by Type, Q4 2015, 2019, and 2023

Industrial Properties in 2023

In 2023, the industrial sector maintained its status as the standout segment with the most robust growth among all categories within the commercial real estate market in 2023. Even though rent prices did not escalate as rapidly as they did in 2022, the cost of renting industrial spaces saw a notable increase of 6.6% compared to the previous year. But, with a 31% increase in square footage delivered over the past year, both vacancy rates and net absorption moderated even further.

Table: Top 10 Metropolitan Areas with Strongest Industrial Absorption

Predicting the Year Ahead: 2024

While 2023 impacted all facets of commercial real estate, marked by an increase in vacancy rates and a deceleration in rent growth, a better year is on the horizon for commercial real estate. Although market headwinds will persist, the anticipation for 2024 is that lower interest rates will mitigate these challenges. The Federal Reserve has already paused its interest rate hikes since last July, while rate cuts will likely follow as soon as the first quarter of 2024. This could reduce cost for borrowing capital and, consequently, stimulate investments in the commercial real estate market. Thus, market activity is poised to pick up next year.

It’s important to remember that the activity level will differ across sectors.

Office Properties in 2024

Starting with the most significantly affected sector, the office sector, it’s unfortunate that 2024 is projected to be another challenging year for this commercial real estate segment. Activity is unlikely to pick up anytime soon. Despite a reduction in the number of full-time remote employees, hybrid workplace policies are becoming a lasting feature. Consequently, office demand is expected to stay subdued, probably not reverting to pre-pandemic levels. Occupancy in 2024 is likely to decline further from the current historic lows, signaling a continued transformation of this sector and splitting office spaces into three categories: top-tier properties with modern amenities, properties requiring upgrades or conversions, and old properties that will become obsolete. But the office sector was already bifurcated even before the pandemic. The pandemic simply intensified this transformation in this segment of commercial real estate.

Multifamily Properties in 2024

With a record-high number of apartment buildings under construction in 2023, rent growth will decelerate further in the multifamily sector as many of these units will be added to the market in 2024, thereby expanding available inventory. This is expected to bring some relief to many renters grappling with both increasing rental prices and rising borrowing costs for those looking to transition to homeownership. Currently, one in two renters is already cost-burdened, spending more than 30% of his income on rent. Nevertheless, demand in the multifamily sector will remain solid as many buyers will remain out of the market even though mortgage rates are expected to drop below 6.5% in 2024.

Retail Properties in 2024

The retail sector is poised to maintain its strength in the commercial real estate market throughout 2024. Despite a projected decrease in net absorption for the year, the vacancy rate is anticipated to hold steady at around 4% due to limited supply, maintaining the sector’s status with the lowest rate compared to other commercial real estate market segments. Nevertheless, performance will vary across different types of retail space. Malls will continue to underperform, undergoing additional transformations. However, neighborhood and strip centers are expected to experience steady performance, with the strongest rent growth among all types of retail spaces in 2024.

Industrial Properties in 2024

Industrial will continue to perform well in 2024. Undoubtedly, net absorption will moderate further from the pandemic highs and stabilize at pre-pandemic levels. Nevertheless, rent growth will remain strong, likely above 5%. Rent increases for warehouse and distribution spaces will be even higher, driven by the continued growth of e-commerce. While retailers must add more warehouse and distribution spaces, significantly fewer spaces are under construction.

Hotel Properties in 2024

Despite the pent-up demand for traveling and pent-up savings in the post-pandemic period, hotel occupancy hasn’t fully rebounded to the pre-pandemic levels, and it is not expected to reach those levels in 2024 either. The outlook for 2024 remains positive, driven by stable leisure travel and stronger business, group, and international travel. But, this sector will continue to face challenges due to economic uncertainty and the shift in consumer behavior. Both the average daily rate (ADR) and revenue per room (RevPAR) growth will moderate further in 2024, while the occupancy rate will likely remain below 65%.

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