Commercial real estate in the new normal
There have been many ebbs and flows occurring in the commercial real estate market over the last several years, and although the market has seen significant recovery from the economic impact of the COVID-19 pandemic, it's important now to look at the long-term implications of a changing economic climate.
This includes rising interest rates, inflation, supply chain disruptions, and geopolitical uncertainty.
The real estate industry raised significant capital and continued to gain momentum through 2021. It is also considered to be a significant hedge against inflation for investors and a way to diversify their portfolios in a continually changing economic climate.
Here are a few things current and prospective investors should keep an eye on in the commercial real estate market in 2022 and beyond.
Trends in property value
While certain commercial properties will grow exponentially in value, others may see a decline. For example, some market trends are suggesting that industrial properties will be on the rise while office spaces may see stagnation for a while longer. Below are several considerations for commercial properties and their investment value.
• Industrial properties - Many retail businesses have closed their traditional brick-and-mortar stores or have significantly increased focus in the e-commerce arena. This may put pressure on warehouses, manufacturers and distribution facilities to increase storage space for goods before they can be shipped to consumers.
• Office spaces - Following the pandemic, many offices closed their doors temporarily and since then have either gone fully remote or are operating on a hybrid model. While this does not necessarily mean the demand for office space is dead, it does implicate a downward trend for office space utilization.
• Hospitality - As cases of COVID-19 have slowed in some areas, leisure and business travel have begun to rise again and are expected to grow, according to the CEO of Marriott International.
• Residential - NAR Chief Economist Lawrence Yun shared that the residential housing shortage will result in significant rent growth over the next two years, continuing to rise by more than 10%. Additionally, urban multifamily properties saw a decline early in the pandemic, but are now starting to see a resurgence.
Financing and capital
During a recession, the market typically sees the availability of capital decrease. Contrarily, the impact of the pandemic has seen investment funds remain available for real estate properties, particularly in strong sectors such as the industrial space.
Many institutions such as insurance companies and pension funds are raising more debt capital and are continuing to invest heavily in the commercial real estate market. However, big banks are more frequently limiting their approvals on loans for riskier deals (e.g., assets with vacancy, development risk and higher loan to value ratios) as they navigate more stringent regulatory lending frameworks.
Finding and keeping tenants
A particularly important aspect of investing in a commercial property is the ability to find and keep tenants over time. One shift in the market that is improving the tenant experience is prioritization of sustainable properties and green investments.
A growing focus on environmental, social and governance (ESG) compliant investments has resulted in more quickly compressed yields as well as the opportunity for investors to develop new or reconstruct existing properties to meet higher environmental standards.
Renovation vs. new construction
An abundance of commercial real estate firms are turning toward retrofitting properties and existing assets to maximize value as opposed to building new properties, especially as constructions costs have risen. As a result of supply chain disruption, prices of raw materials used in construction rose by 77% in 2021.
As trends continue to fluctuate throughout 2022 and beyond, it's important for investors to apply due diligence and stay ahead of changes as much as possible.
As a financial institution that always has its eye on the real estate market on behalf of our customers, Republic Bank has expert bankers and financial advisers ready to help navigate the waters. Reach out to our team to learn more.
• Emilio Di Cesare is senior vice president/commercial banking at Republic Bank.