There’s no doubt that the office sector is in trouble. According to Alena Botros of Fortune (subscription required), a recent study found that the staying power of remote work will be stronger than initially expected and lead to a $500B value loss in office values. Botros quotes the study’s authors as saying: “We calculate a reduction in value of the office stock between the end of 2019 and 2022 of $69.6 billion for NYC, $32.7 billion for San Francisco, and $5.1 billion for Charlotte,” authors wrote.”

Alena Botros reports again on the commercial sector through Yahoo! News, noting that Morgan Stanley analysts believe “peak-to-trough CRE price decline of as much as 40%, worse than in the Great Financial Crisis.” The reason for this assessment is two-fold: rising rates and remote work’s negative impact on the office sector and urban cores.

Indeed, CBRE reports on the office sector’s vacancy rate, which hit 17.8%. Further, despite job growth, Q1 2023 saw 16.5 million sq. ft. of negative net absorption, which is the weakest quarter for office demand in two years.

Source: CBRE (May 2023)

According to Yardi Matrix, there are some bright spots: “The office landscape continues to evolve, after the pandemic fundamentally altered how people interact with the workplace. Amid the disruption, new opportunities are forming, not least of which has been the growth of flexible space. Coworking is experiencing a resurgence due to the flexibility it offers tenants and the widespread adoption of hybrid work strategies.”

Further, Richard Berger of Globe St reports that “[s]trong demand for specialized space such as medical office buildings will help backstop availability in the office sector amid its challenges, even off-setting vacancy drops.” Of the office space coming online in 2023, 14% is expected to service medical professionals.

Interest rates

According to Freddie Mac, the 30-year average mortgage is 6.57%, up from 6.27% just last month. According to Dana Anderson of Redfin, they’ve seen mortgage rates above 7%, with a homebuyer’s average monthly mortgage payment setting a record-high of $2,614. Redfin’s Economics Research Lead Chen Zhao explains the current state of interest rates:

“People may be wondering why rates are surging as we come up against a potential debt crisis. Right now, the way investors are reacting is the driving force. Mortgage rates have increased over the past two weeks because it looks more likely that the U.S. government will avoid hitting the debt ceiling…That may seem counterintuitive, but optimism is driving rates up because an economic crisis would lead to the Fed lowering rates as they try to prevent a recession. Financial markets felt the risk of default was unusually high for the last month or so, which caused rates to stay lower than they otherwise would have been. Now that Democrats and Republicans have come to the negotiating table and are making some progress toward  a deal, rates are going up.” 

Source: Redfin (May 2023)

According to the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey, mortgage applications decreased 4.6% week-over-week last week, highlighting a drop in demand due to rising rates. Joel Kan, MBA’s Vice President and Deputy Chief Economist comments: 

“Since rates have been so volatile and for-sale inventory still scarce, we have yet to see sustained growth in purchase applications. Refinance activity remains limited, with the refinance index falling to its lowest level in two months and more than 40 percent below last year’s pace.”

Jiayi Xu of Realtor.com comments on mortgage rates, noting that higher interest rates have led homebuyers to seek more affordable homes and markets. This will reduce the supply of starter homes, pushing more to the rental market.

Multifamily update

Leslie Shaver of Multifamily Dive reports on sales volume for this asset class, which shows that after dropping 64% year-over-year in Q1 2023, multifamily sales fell 74% year-over-year in April to a volume of $7.1 billion. As of April 2023, average cap rates for multifamily sat at 4.8%, and with interest rates currently higher than cap rates, investors are taking a break on acquisitions.

According to CoStar, Cincinnati and other Midwest cities were among the top markets that reached positive apartment sales territory over the last year. Sales growth has worn off in the Sunbelt and is now booming in the Midwest. “Sales over the past 12 months are up 133% in Cincinnati with $768 million in apartment deals, according to CoStar data as of May 22. That volume percentage is the highest among markets with at least 75,000 units.”

Patrick Clark and Prashant Gopal of Bloomberg report that higher rates and inflationary pressures on expenses have left multifamily owners in a tough position financially. According to Trepp data, the debt payments that exceed income in financed multifamily buildings include over $47 billion in loans. “Making matters worse, property taxes are escalating swiftly and the destructive path of climate change is sending insurance costs skyward. And building values are falling, complicating owners’ efforts to sell or refinance their way out of trouble.”

Robert Dietz of the National Association of Home Builders (NAHB) reports on missing middle multifamily (2-4 units) and how starts of this asset class have remained flat. In Q1 of 2023, there were 4,000 missing middle unit construction starts, and as a share of all multifamily production, development of these units was only 4% of the total share for Q4 2022.

Source: NAHB (May 2023)

In commenting on the real estate syndication space for multifamily, Will Parker, Konrad Putzier, and Shane Shifflett of the Wall Street Journal (subscription required) report that:

“Many syndicators are racing to either raise funds or sell properties before tipping into foreclosure. Most hold balloon-payment loans that require repayment when they come due this year or next. Those syndicators face large payouts at a time when getting new, more affordable property loans will be difficult. Even firms with multibillion-dollar portfolios have used syndication to buy apartment buildings that no longer make enough money to cover debt payments, bond documents show.”