Return to School, Return to Work: What’s Next for Commercial Real Estate?

While our children are going back to school, let’s take a look at some challenges impacting commercial real estate for the balance of 2022.

With the recent Federal Reserve’s interest rate hikes, the cost of debt will certainly affect investors’ bottom line. That said, our current borrowing power is STILL VERY LOW!  Do you remember when interest rates were in the double digits? We are far from that today.  Real estate is still for sale and there are still some very good deals available. As asset pricing adjusts to the new financing norms, sellers are coming to grips with the current asset pricing versus what they thought they could get just 90 days ago.

As markets continue to search for price stabilization, expect to see shorter-term leases, reduced capital improvements and negotiating leverage continue to tip to tenants.  Vacancies best suited to be used in “as-is” condition will lease first. Some Landlords will do minor improvements upfront to be more competitive. Individual markets perform at their own pace. According to Moss Adams Real Estate Advisory, “we haven’t reached the bottom yet so expect this to continue until there’s a turning point.”

Return to Work

It should be noted Return to Work is real. The office sector has been anxious, in part, because of the conversation and the confusion about what occupancy is going to look like and what hybrid is going to look like.

The reality is that CEO’s are committed to the office and companies have to be in the office at some point. There’s less hoteling than one might think. Office leasing in Albuquerque is currently doing well, especially in those buildings where landlords have continued to upgrade finishes throughout their building.

While central banks attempt to cool off overheated sectors of product, broad-based tenant demand will likely step down a notch because monetary policies are blunt instruments that don’t distinguish well between sectors. Just about every expense category associated with operating a property will experience upward pressure making net leased sale opportunities most attractive.

The ‘I’ word

Inflation may be more supportive of tightening cap rates as pricing adjusts in the downward direction. The Commercial Real Estate sector is “moderately well positioned” to face prolonged inflation, according to one industry watcher, thanks to what he calls its “demonstrated ability to protect (and expand) profit margins in inflationary periods.”

Price discovery and investment activity will likely decrease amid higher costs and tighter credit availability according to Omar Eltorai, director of research at Altus Group. However, he notes that lease structures allowing owners/operators to capture the upside of inflation, as well continued strong demand for commercial assets, will help keep CRE operating performance steady even as inflation rises.

A strong finish

In conclusion, the second half of 2022 will be challenging given how rapidly conditions are changing as volatility in the 10-year Treasury yield is likely to persist and that every piece of news is a mixed blessing.

Leasing will remain strong as CEO’s continue to bring workers back to the office. What Commercial Real Estate moves will you make in 2022? Now is the time. Although interest rates, construction costs and operating expenses are on the rise, there are still some profitable CRE deals available.