Analysts predict that opportunities may emerge in the otherwise lackluster commercial real estate (CRE) market in the latter half of the year. However, the sector faces ongoing challenges, including vulnerabilities in the U.S. labor market.
CRE Market Struggles Amid High Interest Rates
The CRE market, valued at $23 trillion, has been grappling with chronic office vacancies, rising defaults, and falling valuations. The Federal Reserve’s policy of maintaining high interest rates to combat inflation has exacerbated these issues. In May, CRE delinquency rates rose to 5%, up from 3.6% a year earlier. This year, a fifth of the $4.7 trillion in outstanding U.S. CRE mortgages will mature, in a market where values have dropped about 30% since the Fed began raising rates.
The Impact of the Labor Market on CRE
Strong job growth has provided some relief to the struggling CRE market. However, a cooling labor market could threaten this support. The decline in the CRE market began as offices remained vacant after pandemic restrictions and a slower-than-expected return to the office. In the first quarter of this year, office job growth from 2022 increased at only a third of the overall employment growth rate. A record 20% of U.S. offices were vacant in the first quarter, and office construction has declined by 63% since the pandemic.
“Job growth, alongside interest rates, is probably the single biggest driver of growth in the real estate market,” said Richard Barkham, global chief economist at CBRE. However, recent unemployment data suggests that the jobs market is starting to lose momentum.
Potential Fed Rate Cut and CRE Woes
A cooling jobs market might prompt the Fed to cut interest rates, reducing borrowing costs for commercial buyers and boosting investor sentiment. However, if the central bank cuts rates due to a significantly deteriorated jobs market, the CRE market could suffer.
“If the Fed is cutting because bad things are happening in the economy, that’s going to be bad for CRE,” said Rebecca Rockey, deputy chief economist and global head of forecasting at Cushman & Wakefield. Torsten Sløk, Chief Economist at Apollo Global Management, noted that vacancy rates did not improve significantly even when job growth and the broader economy were strong. “If the Fed succeeds in slowing the economy down, then vacancy rates will move higher, and potentially very quickly,” Sløk commented in a blog post.
Signs of Optimism in CRE
Despite these challenges, some analysts see reasons for optimism. Rebecca Rockey mentioned that the office market might be nearing a bottom, although falling rents and a lack of transactions make it difficult to assess. “I think we’re close to a bottom, but there’s just not the price discovery to really know,” she said. “We’re going to continue this erosion of occupancy for the rest of this year.”
Al Brooks, head of commercial real estate at J.P. Morgan, noted that multi-family, retail, and industrial real estate sectors are performing well. “The commercial real estate outlook for the second half of 2024 is largely positive,” Brooks stated. Jeff Brown, founder and CEO of T2 Capital Management, pointed out opportunities in specific areas, such as student housing communities.
Wells Fargo economists also expressed cautious optimism. “If economic growth remains sturdy as we currently expect, then CRE demand should also stay afloat,” they noted.
While the CRE market faces significant hurdles, pockets of opportunity and a potential market turnaround offer some hope for the future.
