Research Brief

Where CRE Fundamentals Stand And What It Means For Investors

Opportunity Exists In CRE, Even In Hard-Hit Sectors

• Local market dynamics can outweigh strong macro trends; some markets have stable or improving office vacancy rates, despite broad-based headwinds
• Opportunities in impacted CRE segments highlight the importance of looking beyond national trends

Retail and Industrial Outperforming as Sectors

• The multi-tenant retail sector now has vacancy below the 1Q 2020 level in 24 major U.S. markets
• Industrial properties are also recording lower vacancy in 40 of 48 tracked metros, spurred by 52 consecutive quarters of positive net absorption

Investors Should Look Beyond The Headlines

• All property types have locations, segments, and asset types that have exceeded national performance trends
• Opportunities exist in the market despite economic headwinds if investors stay alert and active

*From 1Q 2020 to 1Q 2023
Sources: Marcus & Millichap Research Services, CoStar Group , Inc., RealPage Inc

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What Emerging Workforce Trends Mean for Investors

Labor Market Still Showing Signs of Strength

• The unemployment rate in April fell back to 3.4 percent, while the labor shortage fell to 3.7 million
• A decrease in immigration and of older workers in the labor force are helping sustain the shortage

Diminishing Wage Pressure To Aid Inflation Fight

• Despite the shortage of workers, wage growth has fallen off recent highs to 4.3% annually
• Construction wages are 15.3% higher than before the pandemic, creating additional delays in construction

What This Means For Investors

• As wage growth is a major concern of the Fed, a slowdown may signal that it is time to pause rate hikes
• Certainty in the interest rate climate would help investors, developers and lenders achieve stable financing outcomes on projects and plans

*Through April; job openings through March
Sources: Marcus & Millichap Research Services, BLS

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What The FED Meeting and Banking News Means For Investors

Federal Reserve Raises Rates But Changes Tune

• The Federal Reserve once again raised the overnight rate by 25 bps at the May meeting, to 5.00%-5.25%
• Language in The Fed’s press release suggested the Fed is entering a “wait-and-see” approach as opposed to expecting additional hikes

Regional Banks Still Face Risks As Major Sale Occurs

• After customers withdrew $100B in Q1, First Republic Bank was seized by regulators and auctioned to JPMorgan Chase
• 61% of First Republic’s lending was in SF housing, 13% was multifamily and 6% was other CRE

Rate Stability To Aid Lenders and CRE Investors

• If the Fed stops raising rates, lenders and banks can begin to stabilize their lending standards
• Long-term demand drivers remain sound for the majority of CRE types

*Through May 04
Sources: Marcus & Millichap Research Services, Federal Reserve, CME Group

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Perception Gap Emerging in the CRE Market

Economic Indicators Show Strength Despite Recession Risk

• 1Q GDP data shows a 1.1% annualized growth rate in 2023, in line with the Blue Chip consensus forecast of 1.2% this year
• The U.S. economy also added more than 1 million jobs in the first 3 months of 2023, despite high-profile tech layoffs

KPI’s Are Strong for Most Asset Types

• When compared to pre-pandemic averages, most property types are recording stronger fundamentals in 2023
• Annual rent growth through 1Q exceeds the pre-pandemic average for all the major asset types besides office, with retail and industrial vacancy also lower in 1Q 2023

Office Presents Headwind, But Overall Outlook Bright

• Office vacancy is up nearly 370 basis points from its 1Q 2019 level, with rent growth below the pre-pandemic average
• The perception of a broad-based CRE reset being pushed by the media does not align with the current data, forming the perception gap in the market

*5-year period from 2015-2019; ADR growth for hotel
Sources: Marcus & Millichap Research Services, CoStar Group, Inc, RealPage, Inc.

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What Supply and Demand Trends Mean for CRE Investors

Office and Retail Pipelines are Thin This Year

• Both office and retail inventories are expected to grow by no more than 1% in 2023, but differing demand environments are propelling divergent outcomes
• Office space demand has been low since 2019, while retail demand has surged, helping the segment record two years of downward moving vacancy and solid rent growth

Multifamily and Industrial Developers are More Active

• Multifamily and industrial developers are forecasted to increase inventory by greater than 2% this year
• There is good reason to believe the loan environment and construction shortages will delay some projects, diminishing the impact of 2023 construction on existing properties

Construction Pipelines Appear to be Tapering

• With the interest rate on construction loans around 8%, new CRE construction starts are declining
• The supply and demand outlook for apartments, retail, industrial and most niche property types remains promising

*Forecast for 2023
Sources: Marcus & Millichap Research Services, CoStar Group, Inc, RealPage, Inc.

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Where Is The Risk In Today’s CRE Market?

Some Investors Face Greater Headwinds Than Others

• Some CRE segments could see heightened distress this year, but risks are not broad-based
• Aggressive investors strategies, underwriting and debt profiles will face challenges; urban office properties also face outsized risk

Some Financing Strategies Have Compounded Risk

• Investors that maximized floating rate leverage, going as high as 80% face substantial risk
• Investors with floating rate debt who did not get a rate cap or hedge may need to sell or recapitalize assets

Systemic Behavioral and Societal Changes Pressure Office

• The hybrid work schedule could drive a significant office vacancy increase that snowballs into a broader problem for the market
• Office properties make up roughly 26% of the loans maturing this year, and distress in these assets could create ripples that impact other urban property types

*Sources: Marcus & Millichap Research Services, Mortgage Bankers Association

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