Commercial real estate activity remains elevated in 2022, which is a promising sign considering record-highs were reached last year. Market activity is being paced by three property types, multifamily, industrial, as well as a strong rebound in retail. A new Mid-Year Report from Coldwell Banker Commercial shows investors were eager to unlock cash flow and pushed cap rates to record-lows in 4Q21 and 1Q22 across most sectors. It is anticipated that demand for real estate will continue to be strong for high-growth markets. These positive signs comes despite widespread supply chain disruptions, inflation and political uncertainty around the war in Ukraine.
There is a flight to quality assets in major metros like New York, Boston, or Los Angeles, yet focus on smaller markets continues to be a central focus. While rising interest rates will eventually put upward pressure on cap rates, it has not slowed acquisition activity in smaller markets. Professionals with Coldwell Banker Commercial are still seeing tremendous amounts of capital pouring into secondary and tertiary markets in search of improved yields and growth opportunities.
The trifecta of corporate relocations, industrial expansion of large national brands, and greater retail openings in local neighborhoods is creating real growth potential that can support long-term demand for hard assets. So, despite today’s record-high prices, most investors, except for local developers, are more concerned about protecting existing wealth over thinning cap rate spreads. The need to put capital to work combined with a belief that rents can go higher to create positive leverage, and the natural hedge against inflation have been overriding rate hike fears.
Researchers at Coldwell Banker Commercial report that a lack of supply is still driving demand. Even though buyers may be weary of high prices, their appetite for CRE assets remains strong. That said, sellers are not listing enough properties to satisfy the demand. Many still prefer to hold onto their assets, which are producing income due to rising rents, rather than grapple with the question of what to buy next. In generally, those willing to sell tend to be institutions and retirees, while private and regional investors have elected to remain in a hold pattern. Coldwell Banker Commercial notes that construction pipelines have been hampered by severe labor shortages and still-rising material costs across the country.
With more capital chasing too few deals, investors across the spectrum ranging from high-net-worth individuals and family offices to REITS, are widening their searches into towns just outside of bigger cities. That’s driving activity into markets like Austin, TX and Phoenix. as well as smaller metros like Coeur d’Alene, ID and Charleston, SC.
Industrial, multifamily and medical offices continue to be the most active property sectors. Extremely tight supply and near-zero vacancy rates have forced sales and rents to rise to record highs, according to research by CoStar. Strong demand for online purchases of grocery and medicine, an uptick in last-mile delivery needs, and the shift toward just-in-case inventory continues to drive the need for industrial space.
Multifamily is seeing a similar trend. Data posted on Trading Economics shows the rapidly rising mortgage rates, which doubled since January, worked to quickly stop sales of existing homes, resulting in a 21.1% drop from January. It also pushed demand for apartments and residential development land to unprecedented levels. With occupancy expected to remain above 95%, rent growth is expected to outpace construction cost increases over the next year.
The retail sector continues to undergo an evolution, with traditional big box spaces being transformed into fitness centers, restaurants, and experiential entertainment across the country. Appetite for both sales and leasing has accelerated as COVID has become an accepted part of everyday life. Well-located NNN locations are receiving quotes that are double pre-pandemic pricing. Coldwell Banker Commercial research reveals there’s shortages of restaurant and retail shop space in many markets as franchisees look to open up independent businesses. While Class C and functionally obsolete centers may not fully recover, Class A and B centers are experiencing soaring demand — with a constant line of people inquiring if any openings will eventually come to market.
While the office sector has started to improve, there remains considerable uncertainty about when (or if) it will fully recover as many companies implement hybrid work models and look for ways to cut back on square footage. To entice workers back to the office, companies must consider redesigning the space for comfort and collaboration with built-in lounges, eateries, gyms, and open meeting space. Downtown locations will require longer than the suburbs to recover as they sift through overbuilt stock and older buildings that are now being rehabilitated. Some of the hardest-hit cities, like NYC, Chicago, and San Francisco, are converting office buildings into condos, apartments and multistory warehouses. Conversely, suburban office markets are faring better with lower available inventory and strong owner-user demand.
Coldwell Banker Commercial research shows construction costs are starting to impact office leases.The cost to construct new space and the time it takes to bring in materials have increased significantly over the past few months, driving rents up to double or triple their pre-pandemic values. While this has not impacted leasing demand for retail and restaurant space, it has started to cause turmoil for office leases around major metro markets. Some decisions are being put on hold as companies consider alternative plans, while others must renew leases because they cannot move right now. Coldwell Banker Commercial’s professionals report the majority of tenants are staying and renewing – but for much shorter terms (1-2 years) – while they seek permanent space elsewhere.
Meanwhile, developers are hitting pause. While landlords have been able to raise rents significantly in 2022, enthusiasm is starting to wane among local developers as borrowing costs and high material prices are reaching a breaking point. Residential construction activity is beginning to slow, even though market fundamentals and demand drivers remain strong. With new construction yield spreads getting thinner, developers are turning to passive investments in smaller markets and taking longer to close deals. Small markets have been offering safer returns as new residents propel the local economies with the additional wealth amassed from the move. Coldwell Banker Commercial’s experts believe there is ability to continue raising rents, given households must live somewhere. The question is, which markets can keep the momentum going?
Coldwell Banker Commercial expects to see continued growth in industrial, multifamily, retail and suburban office assets, a conclusion supported by the tremendous amount of capital pouring into emerging secondary and tertiary markets. Developers and office users are starting to worry about thin yield spreads, yet the momentum created by job gains, suburbanization and entertainment needs will create real consumer demand and growth that could offset some of the rising capital costs. Now that the easy money era has ended, investors, developers and owners will need to rely on higher rent growth to drive investment return. To be sure, there will be interesting months ahead as the second half of 2022 unfolds.