Economists' Outlook

Housing stats and analysis from NAR's research experts.

Commercial Weekly: Commercial Real Estate Outperforms Expectations in 2021 and is Poised to Strengthen in 2022

By many measures, the commercial real estate market exceeded expectations in 2021, as the multifamily and industrial property markets outperformed historical trends while improving vaccination rates drove foot traffic back to retail brick-and-mortars and led to increased personal and business travel. The strong growth in these sectors made up for the weak and tenuous recovery in the office market. Given the level of sales volume deals in the first 10 months, 2021 is poised to be the strongest year in terms of investment acquisitions, surpassing the peak sales volume of 2006 and the pre-pandemic level. NAR expects the demand for commercial real estate to strengthen in 2022 given the strong underlying demand fundamentals in the core property markets. While interest rates are expected to broadly rise by about 75 basis points, interest rates will still be low compared to historical levels and should not cause a severe decline in investment activity and the ability of companies to service their debt.

2021 in Review: A Historic Record for Multifamily, Industrial, Investor Acquisitions

The multifamily market had a historic year, with 1.07 million units absorbed since the pandemic, according to NAR’s December 2021 Commercial Market Insights Report. The vacancy rate hit a record-low of 4.5% as of December 18 while the median asking rent growth hit a record high of 11% year-over-year. Rental demand soared amid the recovery in household formation and with home prices rising at a double-digit pace. Major metro areas that experienced a short burst of out-migration saw renters coming back, resulting in a net positive absorption since the 2020 Q2 in the metro areas of New York, Washington DC, Boston, Chicago, San Francisco, and Los Angeles. However, more affordable secondary metro areas with less expensive rents  and generally strong job growth saw the largest increase in net absorption, led by Dallas, Houston, Charleston,  Wilmington, Savannah, and several Florida metro areas. 

With sustained demand for online shopping, the industrial property market also had a record year, with nearly 700 million square feet of space absorbed since the pandemic and with rents soaring to a historic high of 8.4% as vacancy fell to an all-time low of 4.1%.

The retail brick-and-mortars managed to survive broadly unscathed, except malls. Since 2020 Q2, 47.9 million square feet of space was absorbed, compared to just 29 million square feet of retail space absorbed in the 12 months before the pandemic hit.  Malls saw a decline in occupancy, but that was offset by the positive net absorption from neighborhood centers, strip centers, and free-standing/single-tenant stores.

Hotel occupancy and revenues also recovered with increased personal and business travel. As of December, occupancy was at 57% compared to 42% one year ago.

Only the office sector continued to shed office space use, even with strong job recovery and with the continued decline in the fraction of workers working from home, to just 11% from 35% in May. Since 2022, 142.5 million square feet of office space has been given back to the market, pushing the vacancy rate up to 12.5%. Many metro areas continue to give back office space, with the largest negative net absorption concentrated in the primary markets of New York, Los Angeles, San Francisco, Washington DC, Chicago, and Boston. However, absorption has increased over the past 12 months in Austin, Las Vegas, Nashville, San Antonio, Salt Lake City, Provo, Raleigh, and the Inland Empire. 

The strong demand for commercial real estate has led to declining cap rates, indicating a decline in the risk outlook (high cap rates means investors are only willing to purchase the asset at a low price). The median cap rate on investor acquisitions has continued to decline across all property assets, with the lowest cap rate for multifamily transactions, typically at 4.9%.

With improving market fundamentals, investor acquisitions of multifamily, office, retail, and industrial properties of at least $2.5 million totaled $523 billion in the first ten months of the year. NAR expects the full-year level of acquisitions to hit nearly $645 billion, surpassing the prior peak level of acquisitions in 2006 of $581 billion.

Commercial Sales Volume in Billion Dollars

2022 Outlook: Stronger Demand and Falling Vacancy Rates Except in Office Market

NAR expects the demand for commercial real estate to strengthen in 2022, with underlying demand fundamentals to dominate the impact of the slightly higher interest rates in 2022. The 10-year T-note is expected to rise modestly, by about 75 to 100 basis points to 2.5%, as the Federal Reserve Board engages in monetary tightening to bring back inflation to 2%. While interest rates are expected to broadly rise by about 75 basis points, interest rates will still be low compared to historical levels prior to 2018 (2.9% in 2018) and should not cause a severe decline in investment activity and the ability of companies to service their debt. The strong underlying fundamentals especially of the multifamily and industrial market will continue to drive investors towards these property assets.

NAR Commercial Real Estate Outlook

In the multifamily market, higher mortgage rates will boost rental demand as a mortgage payment becomes more slightly expensive. NAR forecasts that the vacancy rate will further tighten to 4.8% in 2022 (5.1% in 2021) and rent growth to average at 10% (7.8% in 2021). Renters have started returning to the primary metro areas, of New York, Chicago, Boston, Washington DC, Los Angeles, and San Francisco, in part attracted by the huge rent discounts during the pandemic. However, asking rents are picking up strongly which will tend to drive renters to less expensive secondary/tertiary markets or to outlying suburbs of these primary metro areas, especially with the opportunity to work from home. Rental demand is likely to continue to be strong in the West region and New England states where owning is more expensive than renting. Meanwhile, retiring baby boomers are likely to fuel demand in the Sunbelt markets, which will boost demand for commercial space (retail and small offices).

The demand for industrial space is expected to remain robust given that consumers have shown a preference for both online and in-store shopping. Given the convenience and quick delivery of online shopping, consumers will likely continue to use online shopping for standardized items and even for personal use items (dresses, shoes) where free returns are allowed. With brick-and-mortars also providing online shopping services to complement in-store shopping, the demand for last-mile delivery services will drive the demand for warehouses and distribution centers. About 460 million square feet of industrials space is under construction, or about 2.6% of the current inventory. NAR foresees that this construction will lead to slower industrial rent growth of 7.4% on an annual basis from the current rate of about 8.4% as of 2021 Q4 (6.7% in 2021). The vacancy rate is expected to slightly increase to 5% (4.9% in 2021).

In the retail brick-and-mortar market, growth will continue to be driven by smaller shops such as neighborhood centers, strip centers, and single-tenant stores. Consumer traffic is likely to become stronger in 2022 as malls continue to increasingly look towards experiential retail such as gaming lounges and kid activities to drive in-store traffic. Brick-and-mortars that have waded into providing online shopping continue to be creating in driving foot traffic to the stores, by providing in-store experiences/activities (e.g., exercise/yoga classes) and having consumers return items ordered online at a  brick-and-mortar store. Given the current low vacancy rate at brick-and-mortar stores and with the rise of experiential retail that will drive foot traffic to the malls, vacancy rates are likely to go down further to 4.6%. However, rising cases of the omicron variant poses a  downside risk to retail market’s recovery and could hinder foot traffic at the malls, especially in the first half of the year.1

Only the office real estate market will continue to see higher vacancy rates in 2022. At a broad level, the ongoing construction that is equivalent to 2.6% of the current inventory is expected to further raise the vacancy rate to 13.5% (12.2% in 2021) and cause a decline in office rent by 0.8% (-1% in 2021). However, as seen in the 2021 trends, the high office vacancy rates will remain concentrated in the primary metro areas of New York, San Francisco, Chicago, Los Angeles, Washington DC, and Boston. Meanwhile, secondary markets with lower cost of living (home prices or rent) and lower office rents will continue to attract businesses and workers into the area.  Based on the level of under construction activity, developers/investors are bullish on secondary markets like Dallas, Austin, Atlanta, Charlotte, Nashville, Miami, and Salt Lake City.

The timing of “the big re-entry” to the office is still dependent on the course of the COVID variants. However, it appears that the omicron virus is not as deadly as COVID-19 with vaccinations reducing the risk of death. Moreover, significant investments have been made to reduce the risk of transmission of the virus in the office environment through better air quality/air flow, reduced contact points (touchless elevators, foot pedals, plexiglasses, etc.), and cleaning protocols. Thus, businesses are better positioned to move ahead with their re-entry plans than when the pandemic first emerged in 2020.

Beyond the short-term effect of the re-entry on absorption, the long-term effect of the pandemic pertains to the need and use of office space (e.g., overall square footage and per employee square footage) and the allocation of office space for employees (fixed or hot desking/hoteling). CBRE’s 2021 Occupier Survey2 reported that in the United Sates, 62% of employers expect to adopt a hybrid schedule and for employees to go t the office 2.5 days a week. A higher fraction of U.S occupiers expect a contraction of their office space, at 44%, compared to 29% who expect an expansion and 27% who expect no change. Regarding the use of flexile space, 50% of occupiers expect to use flexible space to meet their office needs, such as using on-demand meeting spaces or using customized private suites with shorter terms than the traditional office leases (though leases can become shorter as building owners seek to compete with flexible operators to attract and retain tenants).

However, the adaptive reuse of office space for other uses such as for lab science and multifamily housing could increase investor interest for office properties, especially the older properties with floor plates and design that are suitable for such conversions. NAR’s study Analysis and Case Studies on Office-to-Housing Conversions3 shows a strong potential for the conversion of Class B office units into housing in New York, Chicago, Los Angeles, and Boston but less potential in Washington DC and San Francisco.

Author acknowledges Research Economist Brandon Hardin for providing and reviewing the retail market outlook.

CBRE 2021 Occupier Sentiment Survey,

NAR, Office to Housing Conversions,