Mid-Year Commercial Property Outlook: ‘Cracks Are Forming Under the Surface’ (NYSE:CWK)

The combined impact of rising borrowing costs and persistent inflation creates a complex and mixed outlook for U.S. commercial real estate assets, according to Cushman & Wakefield’s study (NYSE:CWK) the macro outlook at mid-year.

In addition to higher interest rates (which make it more costly for borrowers to refinance) and the Federal Reserve’s delayed rate cuts creating headwinds, the commercial real estate market is facing a sharp pullback in occupancy rates and tighter lending standards. That, in turn, led to more commercial foreclosures and greater delinquents regarding CRE loans. Office jobs, 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, Cushman & Wakefield’s Deputy Chief Economist and Global Head of Forecasting.

In terms of office space, net absorption is expected to be negative in 2024 at -63 million square meters and -7 million square meters next year, the report said. Demand is expected to average 20-25 million square feet per year by the end of the decade.

“While office jobs will continue to grow, office demand is still adapting to hybrid work,” said David Smith, head of Americas Insights at CWK. “We believe we are further along in this process beyond what the weighted average lease terms imply, as approximately half of the space in the sublease market has an expiration date in 2028 or beyond.”

As a side note, Seeking Alpha’s Quant system offers 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).

Meanwhile, demand for retail real estate continues to be strong, thanks in part to a solid slate of store openings by major retailers. About 850 more store openings than closings have been planned so far this year, CWK pointed out. Additionally, there is a dearth of new supply, with less than 12 million square feet of commercial space under construction and more than 4.3 billion square feet of inventory. CWK sees no new supply until the 2010-2019 average to 202 at the earliest, suggesting retail space will remain largely tight.

“Retail real estate stands out for its 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).

The industrial real estate outlook, however, does not look so hot. “While e-commerce continues to grow as a percentage of retail sales, some of the pull-forward effect — firms growing earlier and faster during the pandemic — will affect the demand outlook for 2024 and the first half of 2025,” CWK said in the report.

Indeed, effective rent growth in major industrial markets is either exceeding or has already peaked, CompStak said in its Q1 2024 Industrial Market Overview Report. The market decline is also evident in a decline with 12.9% of the average lease term for bulk transactions in 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 high 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).