Is Commercial Real Estate’s Boom Coming to a Halt?

Is Commercial Real Estate’s Boom Coming to a Halt?

In our last article, we noted that commercial real estate forecasts looked positive, despite economic challenges. Yet sales for the red-hot commercial real estate sector show signs of tempering after more than a year of month-over-month growth, according to a recent article in the Wall Street Journal. [1] It appears that with increasing interest rates from lenders, potential buyers and investors are thinking twice before putting more money into deals.

In April, property sales dropped by more than 15% from the year prior with hotels, industrial, senior housing and office logging the largest declines. While the decline is noteworthy on its own, analysts are concerned that this drop may indicate a dramatic shift in the market, as March sales were up more than 55% from their prior year.

The commercial real estate sales slump due to rising interest rates can be seen everywhere in large and small sites. Some high-profile inked agreements, such as the purchase of a Midtown Manhattan office tower for more than $850 million by Innovo Property Group, have been abandoned despite the losses incurred from doing so (Innovo said good-bye to an $85 million deposit!).

Investors are recalculating their investments with higher interest rates and finding that deals may no longer pencil out. And it isn’t just large deals that are falling apart; investors in smaller purchases also are walking away from letters of intent to purchase. Industry analysts and brokers in the WSJ piece say that hitting the “pause” button on such investments may be a sign of the times.

Though the Covid-19 pandemic negatively impacted commercial real estate, CRE rebounded in early 2021 thanks to lowered interest rates. Savvy investors projected a rally in the market and took advantage of these lowered interest rates to snap up properties they viewed as likely to resurge. Sales in multifamily and industrial properties grew and helped offset lingering losses in office commercial real estate due to employees transitioning to remote work.[2]

Now that interest rates and associated borrowing costs from banks are rising at a (relatively) rapid pace, and the Fed has indicated that it would risk a recession to stave off searing inflation,[3] investors are looking at their borrowing costs against their near-term projected returns and having to decide if the deal still works. Unsurprisingly, higher interest rates tend to have a trickle-down effect on new construction projects.

With a stall in new investments and purchasing, more commercial buildings can end up sitting vacant. High vacancy rates can hurt current investors and may even cause property owners to declare bankruptcy in extreme cases.

If there is a bright side to things, high interest rates and a more stringent lending environment may signal a shift to a buyer’s market, as sellers are interested in making concessions to complete a deal.

Despite these legitimate concerns in the near-term, industry experts still suggest commercial real estate investment as a “hedge” against inflation, largely because physical assets may retain their value better than non-physical ones, and because certain sectors like apartments can reset their rents repeatedly to minimize the impact of rising costs.[4]

Despite this setback in commercial real estate sales, the Chief Economist at the National Association of Realtors believes that solid growth for the sector (outside of office buildings) is likely to continue.  Apartment building sales in particular are forecasted to grow as shortages in the residential housing sector aren’t letting up.[5]

Though interest rates and inflation may bring a commercial real estate sales slump in the near term, the sector may still be a reliable place for investors to park their money…but due diligence on deals becomes paramount!

For more information about tax-advantaged real estate investments, please call 1031 Capital Solutions at 1-800-445-5908 or visit our website, 1031capitalsolutions.com.

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This is for informational purposes only, does not constitute as investment advice, and is not legal or tax advice. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. Please consult the appropriate professional regarding your individual circumstance.

The views of this material are those solely of the author and do not necessarily represent the views of their affiliates.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. Past performance and forecasts do not guarantee of future results. There are material risks associated with investing in real estate securities including illiquidity, general market conditions, interest rate risks, financing risks, potentially adverse tax consequences, general economic risks, development risks, and potential loss of the entire investment principal.

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[1] WSJ.com, Commercial Sales Properties Slow As Rising Interest Rates Sink Deals. June 7, 2022

[2] propmodo.com, Rising Interest Rates Slowing Down Commercial Deals. June 7, 2022

[3] Reuters, Fed Vows ‘Unconditional’ Inflation War, Says Soft Landing Still Possible, June 17, 2022

[4] pointacquisitions.com, How High-Interest Rates Affect Commercial Real Estate, May 9, 2022

[5] Nar.realtor. Commercial Real Estate Market Expected to Grow Despite Rising Interest Rates, March 4, 2022.