It’s clear the commercial real estate marketplace is changing, thanks to economic shifts, financial concerns and regulatory changes across property types. Appropriate knowledge of such shifts will allow brokers, originators and borrowers to identify opportunities in times of challenge.
For the same reasons, stakeholders involved with commercial real estate must update their strategies. They will need innovative ideas and methods to deal with the altered commercial landscape if they wish to remain successful.
Industry overview
This year is sizing up to be a mixed bag of challenges and opportunities in the commercial sector due to an unstable economic climate, shifting consumer preferences and new regulations. The most promising trend could be that interest rates should stabilize and offer a more certain environment for borrowers and investors. With the Federal Reserve positioned to maintain a cautious and steady course, the cost of acquisition and refinancing might settle into a clear pattern and provide much-needed clarity to the market.
One of the hot trends this year is expected to be the transformation of office space. While this idea may sound like it’s right out of 2022, the process of rethinking how the average office can be used may kick into a higher gear this year. Despite some large companies, such as Amazon, requiring employees to be in the office five days a week, hybrid work models will survive and demand for traditional office spaces in secondary markets should continue to decline. Increasingly, businesses will have to switch to properties that allow flexibility in the workplace or refit office buildings into mixed-use projects that meet demands for either residential or retail space.
Meanwhile, the industrial property market is expected to remain solid. Look for continued e-commerce growth, which will fuel demand for last-mile logistics centers. Furthermore, demand for cold storage facilities is increasing with surges in online grocery sales, further lifting industrial property prospects. Reshoring and nearshoring also could strengthen supply chains and increase industrial demand.
Multifamily properties should have a decent year, with rent increases of about 1.5% nationally, according to Yardi Matrix. The considerable number of projects under construction will support supply increases this year, but the number of new projects should taper off in the future.
Due to high interest rates and the general cost of housing, many potential homebuyers have been unable to purchase properties, increasing demand for rentals. With stable cash flows, multifamily properties stand to gain from this segment, especially in regions facing shortages in affordable housing.
The Sun Belt rental market is expected to do well because of the favorable climate and growing job opportunities. Meanwhile, the “build-to-rent” communities are also turning the corner as an option for those who enjoy single-family home lifestyles without necessarily carrying the burden of ownership.
Winners and losers
Due to changing tenant needs, increased financial risk and fluctuations in demand, commercial mortgage originators should expect difficulty financing office and retail projects. While the office sector appears to be gradually stabilizing, office properties are expected to continue struggling, particularly in non-core markets outside the major metropolitan centers. These areas are more susceptible to downturns due to lower office space demand and fewer large corporate tenants.
Funding an office project may require more innovative solutions or financing options. For instance, property owners could reposition or redevelop older assets, including renovating obsolete office buildings into mixed-used or residential properties.
Retail properties also are at a crossroads. While smaller, neighborhood retail centers anchored by necessary services continue to thrive, large shopping malls are still struggling. Investors should be cautious of large retail projects as foot traffic and consumer habits change. Specialty retail centers reaching even more select markets — high-end luxury brands or experiential stores — will find further growth.
On the other hand, the industrial and multifamily sectors have potential for considerable growth. Strong demand for warehousing, influenced by e-commerce and supply chain resilience, should continue to grow. Cold storage and specialized logistics facilities are particularly attractive investment options as the efficiency of supply chains becomes more important. Sectors to watch include:
- Industrial properties: Demand will remain strong due to e-commerce and supply chain needs; cold storage and last-mile logistics are very promising niches.
- Multifamily developments: Demand will continue in suburban communities and Sun Belt cities; adaptive reuse and build-for-rent communities will grow in popularity.
- Office spaces: Stagnation is likely to continue in the sector, especially in secondary markets. The industry will focus on incorporating amenities to attract tenants.
- Retail properties: The sector will experience a mixed performance but neighborhood centers will remain strong. There is optimism for experiential retail and medical tenancy.
Future strategies
To thrive in this new landscape of commercial real estate, brokers, borrowers, investors and originators all need to be flexible and able to adapt to change. They should focus on high-demand sectors, such as industrial and multifamily.
Cold storage and build-to-rent communities will be strong niche areas moving forward. To attract tenants in an uncertain market, offer flexible lease terms for office and retail properties. Short-term leases and renewal options provide desired flexibility.
Capitalize on conversion opportunities, such as transforming underutilized office and retail properties to mixed-use or residential properties. Adaptive reuse can potentially breathe life into old properties and yield attractive returns. Monitor regulatory, environmental, social, and governance (ESG) trends. Stay updated on interest rates, zoning and environmental policies impacting property values and financing.
This will be a transformational year for commercial real estate, with both opportunities and headwinds. Borrowers and investors should focus on resilient, adaptive sectors, including industrial and multifamily. The office sector and parts of retail must find new, innovative ways to stay competitive. Therefore, adaptive reuse, flexible leasing and more amenities must be introduced.
Understanding these market dynamics and leveraging technology -driven solutions will be important for commercial mortgage originators. Those who can best help investors navigate the nuances of a transitioning market while providing products and services to meet their specialized financing needs will be well positioned.
