Commercial Real Estate Overview 2023
In 2023, inflation and interest rates emerged as the twin pillars shaping the economic landscape and, therefore, the commercial real estate sector. In an effort to reduce inflation, the Federal Reserve implemented multiple interest rate hikes throughout the year. One of the most direct effects of rising interest rates was the increased cost of borrowing, which affected the profitability of new developments, the feasibility of certain projects, and the overall volume of real estate investment. This resulted in a sustained rise in vacancy rates and slower rent growth across nearly all commercial real estate market segments for much of the year.
Office Properties in 2023
The office sector was the hardest hit sector in commercial real estate, suffering the largest losses in 2023. Despite reduced remote working opportunities, vacancy rates in the office sector surged to unprecedented levels, approaching a peak of 14%. As leasing velocity slows, net absorption is expected to remain negative throughout 2023, creating a significant surplus of available office space.
Apartment complex in 2023
With mortgage rates above 7.5%, apartment demand in the multifamily sector rebounded late in the year after nearly a year of stagnation. But a construction boom caused vacancy rates to continue trending upwards, reaching 7.4% at the end of the year, which resulted in rent growth slowing to 0.6%. Still, rents continued to rise, albeit more slowly than a year ago.
Retail Properties 2023
Rental growth has also slowed in the retail sector, but despite challenges from rising consumer prices, the sector performed better in 2023 than pre-pandemic, with rent growth accelerating, increased absorption of retail space and vacancy rates remaining at a 10-year low of 4.1%.
Industrial Real Estate in 2023
In 2023, the industrial sector maintained its position as the standout segment with the strongest growth among all categories in the commercial real estate market. Although rents did not rise as sharply as in 2022, the cost of renting industrial space saw a notable increase of 6.6% year-on-year. However, vacancy rates and net absorption were further moderated by a 31% increase in floor space over the past year.
Future predictions: 2024
While 2023 has seen notable increases in vacancy rates and slower rental growth that have impacted all aspects of commercial real estate, a better year for commercial real estate is on the horizon. Although market headwinds will continue, lower interest rates are expected to mitigate these challenges in 2024. The Federal Reserve has already halted interest rate hikes since July last year, but interest rate cuts are likely to continue in the first quarter of 2024. This could reduce the cost of borrowed capital and, as a result, stimulate investment in the commercial real estate market. Therefore, market activity is expected to recover next year.
It is important to remember that activity levels vary across sectors.
Office Properties 2024
Starting with the hardest-hit sector, the office sector, 2024 is unfortunately expected to be another tough year for this commercial real estate segment. Activity is unlikely to recover anytime soon. Hybrid workplace policies are becoming a permanent feature, despite the decline in the number of full-time remote employees. As a result, office demand is likely to remain sluggish and never return to pre-pandemic levels. Occupancy rates in 2024 are likely to fall further from their current historic lows, signaling the continued transformation of this sector, with office space split into three categories: top-class properties with modern amenities, properties in need of upgrading or conversion, and older properties that are becoming obsolete. But the office sector was already bifurcated before the pandemic. The pandemic simply accelerated this transformation in this commercial real estate segment.
Apartment complex in 2024
With a record number of apartments under construction in 2023, rent growth in the multifamily sector will slow further in 2024 as many units come onto the market and expand available inventory. This is expected to provide some relief for many renters struggling with both rising rents and rising borrowing costs for those looking to transition to homeownership. Currently, one in two renters spend more than 30% of their income on rent, making them already cost-burdened. Still, demand in the multifamily sector will remain strong as many buyers remain out of the market despite mortgage rates expected to fall below 6.5% in 2024.
Retail Properties 2024
The retail sector is poised to remain strong in the commercial real estate market throughout 2024. Although annual net absorption is projected to decline, limited supply means vacancy rates are expected to stabilize at around 4%, maintaining the lowest rate compared to other commercial real estate market segments. However, performance will vary across retail space types. Malls will continue to underperform and undergo further transformation. However, neighborhood and strip centers are expected to perform steadily and are expected to see the highest rent growth among all types of retail space in 2024.
Industrial Real Estate in 2024
Industrial real estate will continue to perform well in 2024. Undoubtedly, net absorption will decline further from pandemic highs and stabilize at pre-pandemic levels. That said, rent growth will remain robust, likely exceeding 5%. Rent growth for warehouse and distribution space will be even higher due to the continued growth of e-commerce. Retailers need more warehouse and distribution space, but there is significantly less space under construction.
Hotel Properties 2024
Despite post-pandemic travel demand and accumulated savings, hotel occupancy rates have not fully recovered to pre-pandemic levels and are not expected to reach those levels in 2024. The outlook for 2024 remains positive, driven by stable leisure travel and strength in business, group and international travel. However, the sector will continue to face challenges due to economic uncertainty and changing consumer behavior. Average daily rate (ADR) and revenue per room (RevPAR) growth are expected to slow further in 2024, with occupancy rates falling below 65%.
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