Commercial property mid-year outlook: ‘cracks are forming beneath the surface’ (NYSE:CWK)
ArLawKa AungTun
The combined impact of elevated borrowing costs and persistent inflation create a complex and mixed outlook for U.S. commercial real estate assets, according to Cushman & Wakefield’s (NYSE:CWK) mid-year macro outlook.
In addition to higher interest rates (which make it more expensive for borrowers to refinance) and delayed Federal Reserve rate cuts creating headwinds, the commercial property market has been facing a sizable retreat in occupancy rates and tighter lending standards. That, in turn, has resulted in more commercial foreclosures and higher delinquencies on CRE loans. Office occupancies, in particular, have suffered from the post-pandemic work-from-home trend.
“Cracks are forming beneath the surface, as consumers and businesses remain under pressure from the cumulative effects of higher interest rates and inflation,” said Rebecca Rockey, deputy chief economist and global head of Forecasting of Cushman & Wakefield.
On the office space, net absorption is expected to be negative in 2024 at -63M square feet and -7M square feet next year, the report said. Demand is projected to average 20M-25M square feet per year through the back of the decade.
“Although office jobs will continue to grow, office demand is still adjusting to hybrid work,” said David Smith, head of Americas Insights at CWK. “We believe we are further along in that process beyond what weighted average lease terms imply, as about half the space on the sublease market has an underlying expiration date in 2028 or beyond.”
As a side note, Seeking Alpha’s Quant system gives Cousins Properties (NYSE:CUZ) the highest rating among office REITs, followed by Kilroy Realty (NYSE:KRC), City Office REIT (NYSE:CIO), Equity Commonwealth (NYSE:EQC) and SL Green Realty (NYSE:SLG).
Demand for retail real estate, meanwhile, continues to be strong, partly due to a robust pipeline of store openings by large retailers. There have been some 850 more store openings planned than closures so far this year, CWK pointed out. In addition, there’s a lack of new supply, with less than 12M square feet of retail space under construction, and over 4.3B square feet of inventory. CWK doesn’t see new supply ramping up to its 2010-2019 average until 202, at the earliest, suggesting retail space largely will remain scarce.
“Retail real estate stands out with low vacancy rates, benefiting companies like Realty Income (NYSE:O) and Agree Realty (NYSE:ADC),” said SA contributor Brad Thomas.
Other retail REITs: Kite Realty Group Trust (NYSE:KRG), Kimco Realty (NYSE:KIM), Getty Realty (NYSE:GTY), Simon Property Group (NYSE:SPG), Brixmor Property Group (NYSE:BRX), Acadia Realty Trust (NYSE:AKR).
Industrial real estate prospects, though, aren’t looking so hot. “While e-commerce continues to increase as a percent of retail sales, some of the pull-forward effect – firms building out sooner and faster during the pandemic – will weigh on the demand outlook for 2024 and the first half of 2025,” CWK said in the report.
Indeed, effective rent growth across major industrial markets is either topping out or has already peaked, CompStak said in its Q1 2024 Industrial Market Overview Report. The market’s softening is also evident in a 12.9% drop in average lease term lengths for bulk transactions across the major market average. But, even as some tenants and large industrial occupiers slow their growth, e-commerce’s share of total retail sales remains elevated and a strong driver of industrial demand.
Industrial REITs: Stag Industrial (NYSE:STAG), Innovative Industrial Properties (NYSE:IIPR), Terreno Realty (NYSE:TRNO), Rexford Industrial Realty (NYSE:REXR), Prologis (NYSE:PLD).
