Higher interest rates and inflation are having a mixed impact on the demand for commercial real estate. The pace of absorption has slowed in the industrial and retail markets as consumers cut back on spending amid high inflation. Meanwhile higher mortgage rates and continuing return of workers to the office have increased the pace of absorption of multifamily units and office space.
As rising mortgage rates make a home purchase less affordable, occupancy of multifamily units in the past three months as of May 2022 rose to about 75,600 units, an increase from 62,000 units in 2022 Q1.
While workers continue to return to the office and with sustained job growth, 13 million square feet (MSF) of office space was absorbed on a net basis in the past three months as of May, up from just 3.4 MSF in 2022 Q1
As consumers pare back on spending, net absorption of retail store space decreased to 20.4 MSF in the past three months ended May 2022, slightly lower than the 22.6 MSF net absorption in 2022 Q1. General retail and strip centers, which provide basic goods and services compared to malls, have driven the demand, accounting for 80% of the net absorption.
Net absorption of industrial space also slowed to 83 MSF in the past three months as of May 2022. In the industrial property market, logistics (warehouse, distribution, fulfillment centers) have been the growth driver, accounting for nearly 90% of net absorption.
On a positive note, the big cities continue to come back to life. After the New York metro area suffered a decline in occupancy in the second quarter of 2020, the New York metro area absorbed 30,778 apartment units, the largest increase in net absorption of apartment units in the 12 months ended May 2022, surpassing Dallas-Forth Worth. New York, Los Angeles, Chicago, Boston, Washington DC, and San Francisco also saw positive net absorption of retail space over the past 12 months ended 2022 Q2. However, the office market is slower to recover. Since 2020 Q2, New York has the largest loss in occupancy of 28.3 MSF, followed by Los Angeles (10.9 MSF), San Francisco (10.2 MSF), Chicago (9.6 MSF), and Washington DC (8.6 MSF), as well as Boston though the loss is smaller (-1.9 MSF).
The impact of higher interest rates on the economy is causing some heightened risk aversion among investors. Investor acquisitions over the 12 months ended May 2022 have waned somewhat compared to the 12-month acquisitions ended 2022 Q1, although the investment volume is still above the pre-pandemic level. Total acquisitions for multifamily, office, industrial, and retail properties totaled $582 billion in the 12 months ended May 31, or 7% below the $628 billion of acquisitions in the 12 months ended March 2022.
On the whole, the commercial real estate market is still poised to do well despite higher interest rates and inflation. Mortgage rates are boosting rental demand while e-commerce continues to boost the demand for logistics space. Retail rent growth is still below the rate of inflation which means positive gross margins for retail tenants. The continuing return of workers to the office, even If some return on a hybrid model, is lifting demand for office space.