CRE Tidbits: Keys to Current Office and Industrial Real Estate Investing

The pandemic, soaring interest rates, and bank crisis have left the CRE industry in a state of concern. iSourceOut sifted through the current situation of the office and industrial real estate sectors and dug out insights for investors. ?

What makes an office enticing vs. ‘hardest hit’ by vacancy during a crisis??

The commercial real estate market has been facing challenges since the pandemic hit, and the recent bank crisis has only intensified concerns for investors and owners.??

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According to CommercialEdge's National Office Report, office asset prices have decreased since the start of 2022, with an average of $269 per square foot in Q1 vs. $214 per square foot in Q4. Yardi Matrix also reported that in the top 50 markets the vacancy rate was?16.5%, and the transaction volume only reached $83.6 billion in December 2022. When the bank crisis started in March 2023, delinquency rates rose to 3.09%, according to Credit IQ.??

Although concerns linger over investing in office spaces, many markets are seeing flourishing transactions. Dallas, San Francisco, Houston, Atlanta, Pittsburgh, Charlotte, and Boston have stood out as top performers, with impressive growth and incredibly resilient employment rates. A crucial element in the success of these investments is the inclusion of sought-after amenities and services, such as on-site childcare.?

CBRE's study also emphasized avoiding the identified factors shared by “hardest-hit buildings” (HHBs) to mitigate risks. HHBs are buildings that experienced the most occupancy loss by square footage during the pandemic, from Q1 2020 to Q4 2022. Many of these buildings are struggling to recover today. ?

HHBs tend to be in areas with higher crime rates, fewer nearby restaurants, and measure between 100,000 and 300,000 square feet. Though age isn't the determining factor, about 70% of HHBs were built between 1980 and 2009. Surprisingly, 40% of downtown office buildings also fall into this category, and many HHBs are clustered in the Northeast and Pacific regions. ?

With these in mind, CBRE recommended owners and investors revive and repurpose HHBs to attract tenants. It also warned that removing HHBs, or not at least addressing their problems will escalate the situation in the already problematic office sector.?

What's with industrial CRE's resiliency???

Despite incurring losses too, the industrial investment sector has proven remarkably robust compared to other commercial asset classes. In February 2023, the average rent for in-place leases was $7.12 per square foot, according to data from CommercialEdge. This is an increase of 6.9% year-over-year. ?

Even amid the pandemic and banking crises, the sector has maintained meager delinquency rates, sitting at a mere 0.33% as of March 2023. So, what keeps industrial commercial real estate (CRE) investments so resilient??

Craig Meyer, JLL's president of industrial for the Americas, told Wall Street Journal (WSJ) that in contrast to people-centric retail and office properties, warehouses are resilient to vacancy because they are critical to the logistics of goods. Checking the situation, the office vacancy rate is high because many employees prefer working from home or hybrid. People shop online rather than in malls for convenience and safety against COVID-19.??

Distribution centers benefit from the surge of e-commerce as retailers need storage spaces near their customers. According to Cushman & Wakefield, this led to the construction of new warehouses and increased leasing for years following the start of the pandemic in 2020. However, these activities declined in Q3 and Q4 of 2022 as online shopping also cooled down and fear of recession heated. The vacancy rate also increased by 3.1% and 3.3% during those periods, but less alarming than the 5% in 2020.??

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As of Q4 of 2022, the asking rental rate for warehouses increased to $8.81 per square foot based on Cushman & Wakefield's data. WSJ's report stated that today the high leasing rate offers economic relief to warehouse owners and investors.?

In terms of hot markets for industrial CRE investors, CommercialEdge noted the top ones in February included Southern California, New Jersey, and Charlotte. The three markets posted the largest sales volume with $855 million, $209 million, and $186 million, respectively. Inland Empire also had an impressive 15.6% rental raise rate year-over-year, along with Los Angeles (11.6%) and Orange County (9.2%) in February.?