Despite the economic uncertainty and rising interest rates throughout the last year, the U.S. commercial real estate market experienced successes throughout 2022. For example, Atlanta saw a remarkable $30.7 billion in direct commercial investments between Q4 of 2021 and Q3 of 2022, outpacing major global cities such as Beijing, Tokyo and Singapore combined. However, a lot has changed in the past few months as investors monitor market trends and assess their next steps carefully before committing to any investments.
Economic uncertainty has presented ever-loftier borrowing costs and far wider bid-ask spreads, leaving many commercial real estate investors stuck on the side-lines. These daunting pressures have caused a noticeable decrease in investment activity as caution prevails and investors wait for the right time to jump back into the market. Despite these challenges, fundamentals around one of the historically strongest-performing asset classes—residential property development—haven't faltered. The housing shortage that had predated this period continues to offer a strong tailwind for residential investors who are carefully timing their entry back into the market.
This continued economic uncertainty makes it more important for investors to understand the different verticals of small-scale commercial real estate and overall macroeconomic trends and how they may be affected by various market conditions. A few verticals that have fared well include:
Single-tenant property owners
Commercial real estate investors have recently witnessed a large influx of single-tenant property owners facing elevated rates when refinancing. With interest rates on small-business loans reaching double digits, there is increased pressure on the owners to look for new, creative ways to finance their investments with better costs of capital. Sale-leasebacks are becoming more popular as an alternative for property owners, who will benefit from the long-term capital injection provided by this strategy. Commercial real estate investors must recognize the need for changing times and offer financing solutions that can be tailored to meet single-tenant owners' requirements while giving them greater flexibility and cost savings.
Class B multifamily
CRE investors have lofty hopes for Class B multifamily in the coming year. At the end of 2020, a
report from Freddie Mac highlighted that the U.S. still faced a shortage of 3.8 million housing units.
Class B multifamily could ultimately outperform due to its unique position relative to Class A and
Class C. While Class A multifamily is plagued by ample new supply; Class B could stand to benefit
from tenants looking to reduce their housing costs due to economic stress, creating a domino effect
on this particular class. In addition, an analysis by CBRE found that Class B outperformed during the
2008 recession compared to Class C, suggesting greater stability going forward. Commercial real
estate investors should keep their eyes peeled on Class B multifamily in 2023 and beyond.
Neighbourhood retail and food services
CRE investors should take note of the promising trend of neighbourhood retail combined with vital services underpinning robust gains throughout the last quarter. With an increase in spending on durable goods thanks to increased savings and government stimulus, these retailers are in a prime position to benefit from more cautious consumers who want to utilize their savings for staples and services. In particular, the National Association of Realtors reported an impressive 35% net absorption rate within these types of neighbourhood stores compared to 22% for retail spaces as a whole. This trend suggests that commercial real estate investors may find significant returns from
focusing on local retail hubs that offer a safe and reliable shopping experience this year.
One vertical set to face a challenging year is:
Class B and Class C offices
In the wake of an uncertain future for many businesses due to the changing remote/hybrid workplace, commercial real estate investors will want to keep an eye on the office sector in 2023. With possible waves of layoffs and a slowing economy, tenants looking to attract staff back to the office are opting instead for high-end Class A office buildings with enhanced tenant experience technology, green certifications or amenities that create desirable workspaces. Recent data from Commercial Edge has brought some positive news with regard to Class A listing rates being up 1.9% for 2022 compared to 2021. However, this optimism should be tempered as Class B listings have slid 0.4%, suggesting further challenges ahead in this segment of the market.
What does all this mean for CRE investors?
While the markets may appear frozen right now, it could be easy to feel like there won't be many opportunities in 2023. I expect that investors with readily available capital will be able to take advantage of some fantastic opportunities soon. Although this thaw might not begin for months, I anticipate that by the second half of the year, investors may be able to explore deals in recession- resilient verticals or those that hedge inflation. After several years of sustained growth in many markets, it is now more critical than ever for savvy investors to carefully consider the specific opportunities they are presented within the CRE sector. Heading into 2023, this dramatic re-balancing means to market, and sub-market selection will be key for those looking to optimize their investment strategy. To get ahead of the curve, investors should track conditions at the ground level and look out for emerging patterns – even if these may be tough to identify today. The foundations were laid last year, so stay patient; great returns can still be made.
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