Trends & Forecasts

From bank closures, rising interest rates, transaction declines, moderating rent growth, and migrating populations, the first four months of 2023 have certainly set the tone for the year, and several trends have emerged.

What’s Going On With the Fed?

The Fed has been raising the short-term federal funds rate since March 2022 to combat high inflation. In March 2023, the target federal funds rate was raised from 4.75 percent to five percent. Despite indications that the rate hike may be slowing down, there is expected to be another .25 hike in the coming quarter.

Inflation remains a dominant concern, and the Fed aims to restore price stability for American families and businesses.

The Fed’s actions seem to have had some success in curbing inflation, as it showed signs of easing towards the end of 2022 and during the first quarter of 2023. Living costs, as measured by the Consumer Price Index, rose by six percent over the past 12 months until February 2023, which is a decrease of 3.1 percent from the peak inflation level recorded in the 12 months ending in June 2022. However, despite these developments, after the FOMC meeting in March 2023, experts acknowledged that the process of bringing inflation back down to the Fed’s long-term target of two percent is likely to be challenging and may encounter obstacles along the way.

The Fed’s plans are impacting CRE, especially for short-term funding. The current challenges facing the commercial real estate industry are not just limited to the recent increase in interest rates. The bigger problem is the rate at which rates have been increasing, causing financing costs to be twice as much as six months ago. As a result, borrowers are now faced with the difficult choice of either selling their properties at higher cap rates or refinancing at much higher interest rates than their current debt. It is expected that cap rate expansion will persist for most real estate asset types, but it could reach its highest point later this year and then start declining in 2024, when the Fed’s rate-hiking cycle is expected to come to an end.

CRE Sectors Overview

Several CRE sectors still performed well despite current economic uncertainty.

The retail sector is experiencing increased demand and has been unphased by talk of recession or rising inflation. Investors are still active in the market, contributing to the record-high sales volume. Retail deals were up by four percent year-over-year in December 2022, with the highest net absorption in five years and a four percent rise in rental rates. Local consumer spending and store adaptation to e-commerce boosted the asset class, and major discount stores’ expansion plans are expected to further strengthen the sector in 2023.

Despite the decrease in rent growth, multifamily properties remain a highly sought-after CRE investment asset. According to Costar Group, this is evident from the national sales volume, which amounted to $197 billion between Q1 2022 and Q1 2023, surpassing the historical average of $87.9 billion. This indicates that the multifamily asset type has demonstrated its resilience, even during periods of low demand.

There was a 16.6 percent increase in RevPAR for hospitality during February 2023, and the remainder of the quarter was positive. This can be attributed to the healthy demand growth driven by the COVID-19 pandemic.

Banking Crisis

Two bank failures occurred during Q1 2023, which has stressed the financial sector and is of ongoing concern for businesses and investors nationwide. Silicon Valley Bank was closed by California regulators on March 10th, 2023, and the bank was then taken over by the Federal Deposit Insurance Corporation (FDIC) that same day. This event is the second-largest bank failure in U.S. history, with approximately $209 billion of asset deposits in limbo. In addition, Signature Bank, the third largest bank failure in U.S. banking history, was closed by New York regulators on Sunday, March 13th.

Obtaining debt is expected to become more difficult due to the dramatic nature of these events. Investors are waiting to see how the Fed will react in the upcoming month.

Trends

Moderating Rent Growth

Almost all major metropolitan areas in the U.S. are experiencing a decrease in apartment rents after a period of growth from mid-2021 to the first half of 2022. This slowdown is expected to continue until the end of 2023 due to more supply than demand. Nevertheless, seasonality trends may reverse the overall year-overyear rent growth.

In March 2023, the year-over-year growth rate for rental rates across the country decreased significantly, reaching only three percent. This is the lowest level of growth since April 2021. Rental rates have been falling since September 2022 and continued to do so until February 2023, when a slight increase was observed. As of January 2023, the national median rental rate was $1,942.

Sustainability Goals

Building construction and operation accounts for nearly 40 percent of greenhouse gas emissions in the U.S. This has caused a significant shift toward more sustainable practices throughout all CRE markets.

Adaptive Reuse

The real estate industry has observed a significant rise in adaptive reuse projects. Investors and buyers recognize that adaptive reuse can take various forms and present endless possibilities. It is anticipated that 90 percent of real estate growth in the next decade will involve the adaptive reuse of existing buildings instead of new construction.

Where Are People Moving To?

According to the U.S. Census Bureau’s Vintage 2022 estimates, many residents who had left major metropolitan counties during the pandemic are returning. New York and San Francisco counties are among the top two counties experiencing this trend. The overall increase in migration is attributed to students returning to universities and schools reopening. Many other counties, such as Maricopa County in Arizona and Dallas County in Texas, have also seen population growth. A noteworthy trend is the reversal of migration changes between small and large counties during the pandemic, with many small counties now experiencing positive migration.