Though interest rate reductions are anticipated, developers, employers and aspiring movers are contending with the Fed’s accumulated interest rate hikes, the last of which occurred more than six months ago. Similar to what we’ve seen in the industrial sector, the office and multifamily markets are experiencing similar headwinds.
The office space dilemma
The most visible CRE 2024 challenge may be traditional office spaces’ high vacancy rates, spurred by The Great Resignation and hybrid/remote work arrangements, as well as past overbuilding. The latter has attracted employers to newer spaces, leaving facilities built in the mid-1900s largely vacant. For instance, despite job growth throughout Texas, Houston, Dallas and Austin are among the three highest-ranking U.S. cities in terms of office space vacancy, with each at or near an 8% vacancy rate, per global real estate services provider JLL.
“They’re struggling. Some office customers are accepting that they’ve made a lot of money for many years, and now that they’re not, they just want to get out of the debt.”- Dan Easley, executive director of commercial real estate at BOK Financial®
Fallout from sagging occupancies and revenues can be seen in borrowers’ loan performance, as well. In Fall 2023, the quarterly Mortgage Bankers Association report showed:
- Fewer loans percentage-wise were either current or 30 days late.
- Higher overall office property loan delinquencies.
- A quarterly increase from 1.7% to 2.2% in loans that were either 90+ days delinquent or where properties had reverted to lender-owned status.
Not waiting for a recovery, some operators are repurposing office spaces to residences to help alleviate urban cities’ housing shortages. Even some single-user spaces are being rethought or transformed for multi-tenant use. An example is the former Sprint campus built in Overland Park, Kansas in the early 2000s in anticipation of a daily workforce of 15,000. Following layoffs and a 2020 acquisition by T-Mobile, which only needed a fraction of the multi-million-square-foot campus, it’s been rebranded to serve a variety of office users, including a co-working space.
The multifamily sector
Just as prevailing high interest rates have kept homeowners and seekers stagnant from a move perspective, they’ve also kept multifamily developers in check as projects that were thought to be affordable are not so now.
Multi-year construction delays are not uncommon, and fall 2023 figures from CBRE showed year-over-year multifamily investment declines—typically 50% or more—in each of 20 top markets. Overall, investment fell 62% from Q3 2022 to Q4 2023, from $75.8 billion to $29 billion. Over the same period though, unit deliveries and their occupancy (often known as absorption) have been strong, vacancies have remained relatively stable at 5% and rents have moderated. "The high absorption rates in Dallas, Austin and Houston reflect the overall strong Texas economy, where job creation is fueling growth in both population and living spaces," said Easley.
Optimism and further demand can come from a presumptive rate decline that could free up frozen projects, and from the 12,000 Americans who’ll turn 65 daily in 2024, many of whom will seek to relocate or at least downsize.
In the meantime, Easley urges a level of caution saying, “We know that multifamily is going to struggle, and that many notes will not qualify for an extension that was perceived three to four years ago based on pro-formas of the day and before many changes, including insurance that has doubled, as have taxes.”
Ever dynamic, the CRE marketplace is contending with expensive financing that has developers struggling to meet the rapidly changing—and often competing—needs of consumers and employers. Living spaces are in short supply, and the opposite is true for office and industrial properties. With interest rate reductions in the economic forecast, CRE developers and those aspiring to relocate will have renewed opportunities to build, convert or move. As markets recalibrate and adjust, Easley’s best advice for borrowers is to seek lenders with high credibility, who do what they say they’ll do and will work with you through any eventual challenges.
. © 2024 BOKF, NA.