Mid-Year 2023 Sacramento Commercial Real Estate Outlook

Sacramento’s commercial real estate market experienced a sizable pullback in investment activity amidst rising interest rates and shifting property market fundamentals so far this year. Though uncertainty persists and challenges loom, opportunities abound for the savvy and sophisticated investor or tenant in this current period of correction.

The commercial real estate industry is dynamic. Now, more than ever, it is imperative to have reliable data and comprehensive information during these turbulent times. The following content outlines commercial real estate market trends through the first half of 2023 in the Sacramento region. Links to recent market reports are included for your reference. In addition to property sector updates on office, industrial, retail, and multifamily, there is specific commentary on capital markets, life sciences, and hotels. If you have any additional questions or would like further information, please feel free to contact me directly.

Capital Markets: Regional CRE Sales Volume Down 63% Y/Y as Prices Fall and Cap Rates Rise

• Sales activity is down across the board through the first half of 2023 in the Sacramento region and nationally. Though there is an incredible amount of uncertainty, there are some attractive buying opportunities in the market if you know where and how to look.
• The Federal Reserve raised interest rates by a quarter percentage point to a 22-year high on July 26 while inflation fell to a 3.0% annual rate in June, the lowest level since March 2021. The consensus opinion is that the Fed will likely raise rates one more time this year and keep them at this elevated level through much of 2024.
• Sacramento's commercial real estate sales volume of $773 million through the first half of 2023 declined 63% from 2022. Industrial sales made up 39% ($301M) of regional sales volume while multifamily sales fell precipitously from 45% in the latter half of 2022 to 24% ($187M) in the first half of 2023.
• Retail was the only sector in Sacramento to post an annual price increase (+2.9%) while multifamily recorded the largest year-over-year price drop of -36.3%. Industrial cap rates jumped significantly, rising 208 bps year-over-year to 5.74% in the first six months of the year.

Office: Challenges Persist as Vacancy Rises Again

• The office market vacancy rate rose 350 bps year-over-year to 20.0%, the highest level since Q4 2012. This vacancy rate is only 170 basis points below the all-time high from Q4 2011. Based on the market's current trajectory, a new record high vacancy could be set by Q1 2024.
• Quarterly net absorption of -279k SF dropped YTD net absorption to -744k SF. While this is a 44% improvement from the second half of 2022, cumulative net absorption since Q2 2020 has fallen to -4.38 MSF and additional consolidation from the State of California and CalSTRS will likely keep demand in negative territory through the remainder of the year.
• Large blocks of space were returned to the market vacant during the second quarter from Centene/HealthNet (-179k SF), Sutter Health (-88k SF), Optum360 (-57k SF), and California Dental Association (-36k SF). UC Davis Health occupied 194k SF in Rancho Cordova this quarter, moving into a full building it leased back in Q1 2020.
• Sales activity continued to stagnate with only 19 transactions closing during the second quarter totaling $48.5 million. Owner-user deals comprised of 46% of YTD volume. The average price of $135/SF this year was driven down by the disposition of 2868 Prospect Park Drive in Rancho Cordova in the second quarter for $75/SF at a $12M loss.

Industrial: Wave of New Speculative Supply Hits the Market as Tenant Demand Cools

• After a record run of growth since mid-2020, Sacramento's industrial market is seeing tenant demand moderate substantially while new supply comes online. The vacancy rate rose 67 points during the second quarter to 4.4% as 1.5 MSF of new supply delivered. Of note, the vacancy rate would be 3.1% without Metro Air Park's new construction vacancy.
• YTD net absorption of 779k SF is roughly half of new supply's total as demand from large occupiers has dropped significantly over the last six months or so. There is 2.23 MSF of new product under construction (1.6% of existing inventory) and new deliveries will noticeably slow by mid-year 2024.
• Market average warehouse asking rents decreased quarter-over-quarter for the first time since Q2 2020. The $0.75/SF NNN regional average fell 2.3% from Q1 2023, however, rents are still up 6.8% year-over-year and are 32% above Q1 2021's level. Starting rents for new construction space jumped considerably in the last year and are now into the $0.90/SF+ NNN range.
• New supply delivering this year could take some time to lease up and there is an estimated 3.14 MSF scheduled to deliver this year. All new product delivered in 2020 or 2021 is fully leased and 2022 new supply is up to 76% leased. While headwinds are emerging and demand is slowing, the market's fundamentals are still on solid footing with well below 5.0% vacancy, rising rents, and positive absorption.

Multifamily: The Return of the Renters Amidst a Rising Tide of Supply

• After being one of the hottest housing markets during the pandemic, Sacramento has seen a sizable slowdown in apartment market demand since the summer of 2022, placing downward pressure on occupancy and rent growth at a time of unprecedented construction activity.
• Regional average effective apartment rents posted its first year-over-year decline since Q2 2010, falling 2.0% from Q2 2022. After peaking at 15.5% annual rent growth in Q3 2021, rent growth has fallen for seven consecutive quarters. Landlord concessions are on the rise as the percentage of units offering concessions have more than tripled over the last 12 months to 14.5%, its highest point since Q2 2014.
• Regional occupancy declined 233 basis points year-over-year to 94.5%, its lowest rate since Q2 2013. This occupancy level is 358 basis points below the all-time high set at the end of 2021 and occupancies were above 95% for the last decade leading up to 2023.
• Quarterly absorption of 616 units reversed the trend of five consecutive quarters of negative demand. Quarterly supply of 1,197 units is the highest amount on record and there are 4,098 units (2.6% of inventory) slated to complete by Q2 2024.
• YTD sales volume is down 81% year-over-year due to the current capital markets situation and a dramatic slowdown in lending. There is incredible downward pressure on pricing as NOI's are impacted by falling revenue and rising expenses. Cap rates have expanded substantially since year-end 2022.

Retail: Stable Fundamentals Continue but Demand Shows Signs of Cooling

• Sacramento's retail market vacancy rate has been on a slight upward rise over the last year, ending Q2 2023 at 8.0%, up 30 basis points year-over-year but essentially level with the pre-pandemic rate from Q1 2020.
• Leasing activity has been healthy with 1.06 MSF leased year-to-date, up 17% from the first half of 2022. However, YTD net absorption has been negative and three of the last five quarters have posted negative absorption.
• Fitness, restaurants, and discounters remain active and well located space in high-end centers are in low supply. Open air retail centers in suburban areas like Folsom and Roseville are seeing a significant amount of foot traffic. Westfield Galleria in Roseville posted record high visitor levels in early 2023. Redevelopment plans are in the works for Sunrise Mall and challenges remain at Arden Fair Mall since Nordstrom and Sears closed.
• New supply has been minimal with only 146k SF of YTD completions. There is about 268k SF under construction across the region with most projects proceeding with encouraging pre-leasing.
• Regional retail/food services sales of $40.5 billion in 2022 increased 3.3% compared to 2021. The regional consumer is generally on stable financial footing and has been eager to spend. However, rising inflation and moderate wage growth should result in moderating retail sales this year. Sacramento's positive population growth should largely sustain well operated retailers and restaurants in the year ahead.

Life Sciences: Growth Trajectory Takes a Breath but Strong Value Proposition Remains

• While there has been a notable slowdown in life sciences transaction activity this year, startups are still expanding, new to market and existing occupiers are growing local operations, and incubators remain full.
• In early May 2023, Aggie Square topped out construction of the first of two buildings totaling 728k SF in the $1.1 billion innovation district on the south end of the UC Davis Medical Center. Additional projects at The Port and BioSpace in West Sacramento by Fulcrum and Blue Rise Ventures are purpose-built developments for companies requiring cGMP or lab space. Colliers Sacramento is tracking 3.4 MSF of existing life sciences inventory in the Sacramento region, in addition to 5.5 MSF from seven proposed and purpose-built life sciences developments to capture growth from both existing and new to market companies.
• Regional life sciences employment increased 2.3% in 2022 to 14,578 jobs and is projected to grow another 4.9% this year. In addition to having UC Davis, a world leader in food and agriculture research, Sacramento's talent pipeline is expanding with 21,000 Biological & Biomedical Sciences degree completions in the region from 2012 through 2021.
• Despite a pullback in venture capital funding and a general deceleration in the biotechnology sector, the region's innovation cluster is on the rise. Local expansions and funding rounds over the last year include Lab@AgStart, ThermoGenesis, Macro Oceans, GeminiBio, Biome Makers, and Bio Consortia.

Hotel: Construction Activity Continues at an Elevated Rate as Hospitality Recovery Reverts to Normal

• There are 998 hotel rooms under construction across the region, amounting to a 3.4% increase in existing inventory. This is in addition to approximately 1,400 new rooms delivered in the last three years. Some hotels are being built via adaptive reuse while others are being repurposed to apartments.
• The average occupancy of 63.7% over the last 12 months is down 240 basis points from the year before. The region's occupancy is around the national average and has recovered from 51% in the early months of the pandemic. However, occupancy is down drastically from the low-70% range from 2019.
• The 12-month average daily rate of $155.53 increased 7.3% year-over-year. Rates are forecast to increase another 5.0% over the next 12 months. Furthermore, the 12-month revenue generated per room of $99.01 is up 4.8% in the last year and is projected to rise 3.9% in the year ahead.
• Over the last 12 months, the region recorded 24 hotel sales at an average of $193,000 per room and a cap rate of 8.3%. Sales activity has been notably muted in 2023 compared to a significant year of trades in 2022.

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For additional information, please contact:

Bob Shanahan

Research Director | Sacramento & Reno

[email protected]