Commercial Real Estate Recovery Kicks Into High Gear

Consumers are resuming pre-pandemic activities, such as working at the office, dining out, and attending sports events, which is boosting all commercial sectors.
Construction site against blue sky

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Despite the financial pressures of rising interest rates and high inflation, consumers are returning to their pre-pandemic lifestyles, providing a boost to commercial real estate across all sectors, experts said Wednesday at the National Association of REALTORS®’ quarterly Real Estate Forecast Summit.

Mortgage rates for commercial loans have already risen 150 basis points so far this year, but further increases in 2022 are likely to be less sharp, said NAR Chief Economist Lawrence Yun. A slowdown in rate hikes could provide stability as the commercial market continues to recover from taking a deep hit during the pandemic. Yun pointed to the difference between the federal funds rate, which the Federal Reserve raised to 0.5% earlier this month, and the average interest rate on commercial mortgages, which is around 5%. “The market is anticipating multiple rounds of increases,” he said. “Any further rises in the federal rate are already factored in.”

Yun also predicts that inflation will remain high due to elevated oil prices. However, there are positive signs in the recovering job market, which is approaching pre-pandemic levels. In fact, it’s performing better than that in the Mountain and South regions of the country. “The job market is very important for commercial,” Yun said, “especially for retail and office.”

Positive Signs in all Four Sectors

Demand for rental housing is being buoyed by a net increase in household formation, indicating more younger adults are moving out of their parents’ basements. Occupancy rates have increased over the last year for multifamily, industrial, retail, and office properties, and investors stepped up acquisitions in all four sectors in the fourth quarter of 2021.

Yun expressed continued uncertainty about the office sector: A significant number of employees are still working remotely or utilizing a hybrid office model. But while gateway cities like New York, San Francisco, and Boston have been experiencing negative net absorption since the second quarter of 2020, smaller metros like Austin, Texas; Palm Beach, Fla.; and Durham, N.C., have seen positive absorption in the same time period. “The office sector is somewhat wobbly,” Yun said. “But if you look closely, you will see divergence in some areas. It’s not the same everywhere.”

REITs Show Strong Investment Potential

Real estate investment trusts have proven to be an excellent hedge against inflation, outperforming the S&P 500 in periods of low, moderate, and high inflation, said Nicole Funari, vice president of research at the National Association of REITs. Funari attributed part of this resilience to the increasingly diverse REIT portfolios. Emerging sectors, such as infrastructure (e.g., cell towers), data centers, and self-storage facilities, accounted for only 6% of the industry market cap in 2000. As of December 2021, these sectors accounted for 41%. “We have remarkable growth in new sectors,” said Funari. “The diversity of properties has led to very strong performance.”

Funari also said areas of REIT investment that struggled during the pandemic are now picking up speed. The lodging, health care, and office markets—which all saw negative returns at the height of COVID-19 restrictions—posted positive returns from December 2021 to March 2022 of 9.9%, 7.6%, and 4.6%, respectively. Funari saw further good signs for REITs, noting that acquisitions are up across all sectors in the fourth quarter of 2021. She pointed to self-storage as a particularly hot sector.

Resurgence in Retail

Brandon Hardin, an NAR research economist, reported that retail is showing excellent signs of growth, posting sizable gains in employment and wages in the first quarter of 2022—and actually exceeding 2019 levels. Increased income opens the potential for more consumer spending, Hardin noted, adding that data early in the year is already demonstrating this growth. Retail sales showed a sharp year-over-year increase in February, led by gas stations at 37%, food and beverage at 33%, and clothing stores at 30%. “Consumers are feeling better about returning to pre-pandemic activities,” Hardin said. “People are going out to dinner, going out to watch sports.”

Hardin also noted an increase in net absorption for retail space—including beleaguered shopping malls—which rose to a total 96 million square feet as of last Sunday. Further, e-commerce sales began to plateau from the fourth quarter of 2020 through the fourth quarter of 2021 due to consumers returning to pre-pandemic activities but also the ingenuity of brick-and-mortar stores, Hardin said. Many businesses have begun to build “safety inventory,” meaning they have extra stock on hand rather than operating with the bare minimum necessary to cover sales. “They’re moving from ‘just in time’ to ‘just in case,’ ” Hardin said. “This puts them in a better position with consumers.”