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Commercial Real Estate Prices to Remain Low for the Foreseeable Future

Property values might start rising up to two years following a sales activity rebound.

Commercial Real Estate Prices to Remain Low for the Foreseeable Future

Property values might start rising up to two years following a sales activity rebound.

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Good morning. Despite predictions of a commercial real estate price bottom on the horizon, historical trends differ. The multifamily sector is battling high-end oversupply amid sluggish rent growth and increased luxury builds. Conversely, Dallas-Fort Worth's shopping center transactions are booming due to strong demand and limited availability, leading to rising rents.

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Market Snapshot

S&P 500
GSPC
4,554.89
Pct Chg:
0.1%
FTSE NAREIT
FNER
687.30
Pct Chg:
0.3%
10Y Treasury
TNX
4.332%
Pct Chg:
-1.3%
SOFR
1-month
5.32%
Pct Chg:
0.0%

*Data as of 11/28/2023 market close.

TAKING A CUE FROM HISTORY

Commercial Real Estate Prices Unlikely to Reach a Bottom Any Time Soon

The U.S. commercial real estate market is facing a continued sales decline due to high-interest rates and investor caution. While some experts have called for a bottom soon, history tells a different story in property prices.

Where we are now: Investors are currently adopting a wait-and-see approach due to the uncertainty brought on by higher borrowing costs. This cautious stance has slowed down the price discovery process in commercial real estate. Historical patterns suggest that it may take time for sales activity to pick up and for prices to stabilize. CoStar's research delves into previous commercial real estate market downturns, providing insightful projections on the expected recovery timeline.

Office sector: Looking back at the 2007 downturn, office real estate transaction volumes peaked and then significantly declined, taking two years to hit a low. Despite a 63% increase in transaction volumes over the following two years, office prices per square foot continued to drop, indicating that increased transaction flows can exacerbate price declines.

Industrial and Retail sectors: Similar trends were observed in the industrial and retail sectors. The industrial market saw a 61% decrease in deal flow, followed by a significant increase in transactions but a continued decline in overall value. Retail properties experienced a recovery in transaction counts, but it took even longer for retail prices to reach their lowest point, demonstrating a lag between transaction recovery and price stabilization.

Multifamily resilience: The multifamily sector deviates from these patterns. Due to its short lease structures, this sector is more responsive to economic changes. In the last downturn, transaction volume slowdown and price declines in multifamily occurred simultaneously, with prices stabilizing much faster than in other sectors. This rapid adjustment could offer insights into the broader commercial real estate market's future trajectory.

➥ THE TAKEAWAY

Where is the bottom? The past may be a precedent. The current state of the commercial real estate market suggests that prices may not bottom out soon. Based on historical data, it could take up to two years after a rebound in sales activity for property values to start increasing. The multifamily sector's quicker response in past downturns might provide some clues, but overall, the market is likely to experience continued price adjustments in the near future.

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TRENDING HEADLINES

  • European empire: Blackstone's (BX) CEO Schwarzman is actively targeting real estate opportunities in Europe as central banks ease rate hikes. But only in places he would “visit twice.”

  • RIP Legend: Billionaire investor Charlie Munger, known for his success in the markets and as Warren Buffett’s closest friend for six decades, passed away at the age of 99 on Tuesday.

  • Can’t stand it anymore: Amazon (AMZN) is seeking roughly 50 KSF of office space in Miami as Jeff Bezos plans his move from Seattle.

  • Boardroom battle: Choice Hotels International (CHH) is reportedly buying shares of Wyndham Hotels & Resorts (WH) to gain influence in favor of a potential acquisition.

  • Building boom: Berkeley approved zoning changes allowing for taller buildings near the UC Berkeley campus to address the city’s housing shortage, potentially adding 2,650 units.

  • To hire or not to hire: Many expect 2024 to be a rebound year for CRE hiring, but uncertainty and lack of commitment in the industry are leading to limited hiring and personnel challenges.

  • Revitalizing the Shore: Long Branch, NJ is experiencing a wave of commercial redevelopment, with new lux condos, mixed-use, and apartments built in the wake of Superstorm Sandy.

  • Beating the heat: Miami's office market saw increased deal volume and 2.4 MSF under construction in Q3, with significant projects including Highland Park Miami and 830 Brickell.

  • Facing the music: Greenland's Pacific Park faces foreclosure as it defaults on $350M in loans, endangering the completion of much-needed affordable housing.

  • Are we at the bottom? PGIM Real Estate's report predicts that CRE values will not converge with buyer and owner expectations until property values fall another 10%.

  • Picking and choosing: Apple (AAPL) remains quiet about its planned Research Triangle Park campus, but has filed permits for construction at temporary offices in Cary and Durham.

  • What comes next? An analyst who accurately predicted 8% mortgage rates is now eyeing Treasury yields and mortgage rates, which are causing a homebuying slowdown.

  • Foreclosure frenzy: Lender Aareal Bank sues Meringoff Properties over unpaid mortgages totaling $149.3M at 462 Broadway in Soho.

  • Tampa Bay living: The Related Group started construction on Tower II of The Ritz-Carlton Residences in Tampa, which consists of 94 condos and 6 villas, with 60% of units already sold and prices starting at $1.7M.

  • If you can build it there: NYC City Planning initiates a plan to allow gambling in NYC, preventing the City Council from vetoing casino proposals, while still requiring local approval from advisory committees.

UNDER CONSTRUCTION

High-End Apartments Facing Greatest Risk Of Oversupply

The multifamily industry faces an oversupply of high-end apartments, intensified by slow rent growth and a surge in luxury construction.

By the numbers: Recent data from a CoStar report indicates that high-end apartments, which constitute a significant portion of new constructions, are most vulnerable to oversupply. About 70% of the nearly one million units under construction at the end of the third quarter were high-end. The gap between mid-range and high-end rents is notably widening, with a difference of approximately $550 per month.

Concession obsession: The significant rent gap poses challenges for developers, who often resort to offering concessions to entice tenants from lower-tier properties. On average, high-class building rents are about $2,074 per month, necessitating substantial concessions, such as three free months, to be competitive. Presently, 30% of rental listings are offering concessions, the highest rate in two years.

Under construction: Specific regions, such as Downtown Miami and Charlotte's South End, are experiencing variations in rent growth, with luxury rents decreasing and lower-tier rents increasing. Markets like St. Augustine, Downtown Austin, and Downtown Atlanta, each with a construction pipeline representing over 40% of their inventory, are also facing rent growth declines. The Sun Belt region has the largest concentration of units under construction.

➥ THE TAKEAWAY

Zooming out: The oversupply of high-end apartments is not only a current issue but also a looming future challenge. Companies like UDR and Camden Property Trust anticipate this trend to continue into 2024, particularly in markets that have witnessed heavy construction in 2023. This situation suggests that the multifamily industry, especially in high-end segments, may need to adapt strategies to manage the growing supply,

QUICK HITS

📖 READ: How much does the national average rent of $1.7K get you in terms of apartment square footage? Memphis (zip code 38109) tops the list with 1,996 SF per $1,700 in rent.

🎧 LISTEN: On this episode of The Tape, Matt Miller and Paul Sweeney talk with Ira Jersey, Chief US interest rate strategist for Bloomberg Intelligence, about Treasury auctions and the bond market.

🖥️ WATCH: According to HSBC CEO Noel Quinn, China’s CRE sector has bottomed out, but eager investors looking for great overseas deals shouldn’t jump in just yet.

SHOPPING SPREE

Investors Flock to Purchase D-FW Retail Centers, Drawing $1.3B in Nine Months

Investors poured $1.3 billion into DFW retail in nine months

Source: TRD/Getty Images

Investors are showing a strong interest in retail properties in Dallas-Fort Worth (DFW), particularly shopping centers, marking a notable recovery in this segment of the commercial real estate market post-pandemic.

No vacancy: DFW's retail sector experienced a surge in leasing activity, with only 4.3% vacancy at the end of the third quarter. The leasing of 1.2 million square feet of retail space exceeded new supply, leading to an average 8% increase in shopping center rents year-over-year. This trend reflects the sector's resilience and growing investor interest despite past concerns over the impact of e-commerce.

Hot commodity: Over $1.3 billion has been invested in DFW shopping centers this year. Major transactions include CTO Realty Growth's $61 million acquisition of Plaza at Rockwall and Precision Investments’ purchase of the Shops at Eastside in Richardson. Other notable sales were Prestonwood Park in Plano and Northview Plaza in northeast Dallas. High-profile retail centers like the Village at Allen and Park Village in Southlake are currently on the market.

➥ THE TAKEAWAY

Reverse of fortune: Soaring construction costs and pricey debt have curtailed speculative retail development, leading to a notable scarcity of retail spaces for expanding businesses since 2008. This 15-year hiatus in new developments, juxtaposed with a robust increase in demand and significant investment interest, has propelled retail to the forefront as one of the most dynamic and thriving segments in the Dallas-Fort Worth commercial real estate market.

CHART OF THE DAY

Despite positive years for CRE in 2021 and 2022, Phoenix investment sales were down 68% YoY in Q3. Right now, 2023 looks like it will barely outperform 2020, which was one of Phoenix’s worst years since 2013. Multifamily construction, in particular, has fallen dramatically.

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