A volatile US economy is keeping real estate investors on their toes, but also creating opportunities for those with higher risk tolerance, according to Lee & Associates’ latest market report. The office sector had begun to recover, but backslid in the second quarter with net absorption in the red at 16.3 million square feet. Multifamily remains strong as tenants shrugged off recession forecasts and extended the stretch of robust demand that began early last year.
“I think that both of these asset classes continue to persevere in a very dynamic market,” says Jeff Rinkov, the commercial real estate services firm’s CEO. “And while there are challenges, there are certainly opportunities for investors.”
Office Sector’s Recovery Slows
The office sector showed signs of recovery in Q2, but reversed 11.7 million square feet of tenant expansion it had gained in the three previous quarters. The contraction increased the vacancy rate by 30 basis points to a record 14.2%.
“Class A assets seem to be performing reasonably because there's been a lack of office construction,” notes Rinkov. “When new office space is delivered with preferential amenities and great location, those assets are doing well, while older, less functional B and C buildings are struggling. I think this is going to be an ongoing theme that will continue.”
Rinkov also says that top markets are continuing to grow, which is a reflection of migration patterns and a "flight to quality” as investors look for competitively priced real estate. He adds that smaller markets—including Boise, ID; Greenville, SC; and California’s Inland Empire—are performing better than expected. Overall, the trend continues towards smaller spaces, with many markets reporting that space consolidations are not yet over: the typical deal size remains about 15% less than the average from 2015-2019.
“I think this requires a robust, patient capital base, with a higher tolerance for risk,” says Rinkov. “It also requires a great operator that has a rejuvenation plan and quite a bit of vision.”
Multifamily Holds Steady, Sees Strong Net Absorption
Multifamily tenant demand remained healthy and second-quarter net absorption totaled 136,007 units in the US, as tenants appeared to shrug off recession forecasts. Rinkov says that the multifamily market has driven new construction to manageable rates and that while challenges remain, there are also opportunities for tenants. He believes that the market is “resetting,” with moderate rent growth and additional inducements in favor of tenants.
“In general, we are seeing really strong adoption and lower vacancy rates, which I believe is a phase of more normalization than a regression,” notes Rinkov
Looking ahead, Rinkov sees rising construction costs, labor rates and interest rates leading to a slower pattern of development. He expects this to give the market time to absorb the excess inventory in certain markets.
“I think we are on the path to a very healthy, robust market and hopefully there will be favorable monetary policies that will drive down capitalization rates and ease inflation concerns,” says Rinkov. “This will likely create a more fluid and more transactional multifamily market.”
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