Now’s the Time to Start Thinking About Next Year’s Fundamentals

The Federal Reserve Bank’s series of interest rate hikes has been the major story for commercial real estate for the past year, sending shock waves through the community used to a decade of ultra low rates. 

The negative effect that the rate increases have had on the capital markets and valuations have been CRE’s chief focus during this period but now it is time to start thinking of where fundamentals will be next year, especially as the Fed is widely expected to pause its monetary policy for the remainder of 2023. 

In general we have been very lucky up until last year. Over the last five years, occupancy has been healthy and there have been rental gains, CBRE points out, noting that in certain sectors net operating income is expected to benefit as the leases expire. 

This is most likely to happen in the industrial sector as income growth offsets the expected almost 100-basis-point increase in cap rates during this cycle. The result will keep capital values positive for the period from last year through 2024. 

In contrast to industrial, multifamily will see occupancy levels return to historic levels to benefit less from lease changes, CBRE predicts. 

And both retail and office may experience greater value loss. In general, the momentum retail has experienced recently in occupancy and rent gains won’t be enough to meet rising cap rates. An exception may be retail centers in prime locations. 

Meanwhile, the office sector has been battered by what occurred starting during COVID-19 as employees began– and continued—to pivot and work from home. Many continue to do so in hybrid, or part-time, or full-time schedules. 

The overall economy’s gyrations, including interest rate hikes and spending changes, also affected this sector. In this market, falling occupancy and lower effective rents mean NOI will decline as leases roll over into 2024. Leases are predicted to fall as much as 8% from 2019 numbers.