The commercial market is undergoing major changes. Certain sectors of commercial real estate (CRE) are seeing record-high demand driving strong rental growth, high absorption rates, and competitive cap rates, while other sectors are trying to combat lowered demand and dropping values driven by short-term conditions and even long-term trends.
The National Association of Realtors (NAR) recently published its Commercial Market Insights September 2021 report, sharing several interesting findings about the CRE industry today. Here are six insights from the report commercial investors need to know.
Office is hurting
Office space continues to be hit hard as it battles many businesses switching to a work-from-home business model. The office industry has lost 144.39 million square feet of occupied space since Q2 2020. From Q1 2020 to August 2021, the vacancy rate for office has increased 2.6%, now at a record high of 12.4%.
Office is also the only sector in which asking rents are declining. Pre-pandemic rental rate growth for the sector was 2.8% but now is down roughly 0.4% year over year. And the office sector's elevated vacancy rate and negative absorption isn't expected to let up anytime soon. New construction is expected to deliver around 1.8% of current office supply to the market in 2022, which will put additional pressure on an already oversupplied market.
The top markets for office space as of Q3 2021 are:
- Provo, Utah
- Boise, Idaho
- Omaha, Nebraska
- Chattanooga, Tennessee
- Myrtle Beach, South Carolina
- Daytona Beach, Florida
- Palm Beach, Florida
- Austin, Texas
- San Antonio, Texas
Industrial, multifamily are leading the way
The industrial and multifamily sectors are dominating the CRE industry today. The average asking rent for industrial property per square foot rose 6.9%, a 1.9% increase from its pre-pandemic levels. Multifamily average asking rent prior to the pandemic was up around 1.6%. As of September 2021, average asking rents increased a whopping 10.7% year over year.
Vacancy rates are also near record lows, with industrial sitting at 4.6% as of September 2021 and 4.9% for multifamily. Net absorption of apartment units is at its highest level in a decade. The sector has absorbed 689,226 units during the past year as of September 2021. These industries are by and large outperforming all expectations amid a global pandemic, dominating returns and real estate development across the nation.
Retail is recovering
The long-term trend favoring e-commerce has also loomed over the retail sector, but pandemic-related challenges for many retailers accelerated this trend and financially bankrupted many retailers. But it appears things are starting to look up for this sector. Asking rents are up 1.9% as of September 2021, while net absorption headed in a positive direction.
However, not all retail assets are considered equal in their road to recovery. Net absorption was highest for general retail space, followed by neighborhood centers and strip centers. The majority of retail space returned to the market (negative absorption rates) was led by malls, followed by power centers, both having negative absorption rates in the millions over the past year. Tulsa, Oklahoma; Atlanta; and Jacksonville, Florida, are the top-performing markets for retail, achieving growth of 8.2%, 7.4% and 6.9% respectively.
Cap rates are trending down
Cap rates are on a steady decline, with average cap rates sitting between 5.4% and 6.9% across all sectors, including office. Lower cap rates mean higher asking prices. This isn't too surprising. Given the amount of dry powder in the private market, investors need to put idle capital to work, particularly in today's inflationary environment, and are willing to pay more to do so. Industrial saw the biggest decrease in cap rates, a testament to its strong performance over the past year and a half.
Big cities are back
Major cities, including New York, Boston, Chicago, and several others, saw a mass exodus at the start of the pandemic, but it appears people are starting to slowly return to these markets. The Sun Belt region in the U.S. is definitely still dominating positive migration, new construction, and rental growth among all sectors, but cities that recently saw tenants flee are finally seeing positive net absorption rates. Boston and Seattle are now seeing double-digit rental rate growth as of September 2021.
Hotels are still on shaky ground
Hotels were showing strong signs of recovery at the start of summer as travel made a huge comeback. But the surge in delta variant COVID-19 cases has caused a lot of that progress to be erased. Occupancy rates dropped from 62% in July to 56% in August, while average daily rates (ADR) also fell from $143 in July to $119 in August.
The Millionacres bottom line
Many of the insights shared in the report echo noticeable trends in the CRE market that are reported here on Millionacres and by many other industry experts. It's likely the hotel, retail, and office sectors will continue to have a volatile few months or even quarters ahead as the country navigates recovery, while dominating industrial and multifamily will continue to lead the way.