Integra Realty Resources: Commercial real estate has reached a positive turning point

Posted on by Jordan Jensen

Integra Realty Resources in its 2024 Mid-YearCommercial Real Estate Report said that the commercial real estate sector remains a resilient one despite the challenges of higher interest rates and construction costs.

The report also points to a stabilization in property prices as another sign of better times to come in the CRE market.

“While the commercial real estate market continues to face challenges, our 2024 Mid-Year Report demonstrates the industry’s remarkable adaptability,” said Anthony Graziano, chief executive officer of Integra Realty Resources.

In the report, Graziano said that the industry is seeing a stabilization in property prices and a modest increase in values this year. That, Graziano said, marks a significant turning point for commercial real estate and the professionals working in the business.

“Our analysis highlights key trends such as adaptive reuse in the industrial sector, resilience in multifamily markets, innovations in retail spaces and the evolving dynamics in the office sector as it adjusts to new work patterns,” Graziano said.

The mid-year release includes about 230 local reports covering nearly 60 U.S. markets across four property types: office, multifamily, retail and industrial. Interested in accessing the reports? You can find them at www.irr.com/research.

Here are some key Insights from IRR’s 2024 Mid-Year Report, listed in an official press release from the company:

OFFICE MARKET:

  • Elevated Vacancy Rates and Negative Absorption: Express this to continue across all regions, driven largely by remote work trends. Integra also said that businesses will continue to migrate to tax-friendly states.
  • Resilience in Specific Sectors: Medical office and biotech in most regions are experiencing stability since these sectors are the least susceptible to economic volatility and work-from-home trends.
  • Major Value Trends: Limited capital availability and significant value declines in large urban markets are driving down office property prices, with these prices sometimes nearing land value. Tenant improvement costs are reducing effective returns, and the market is facing challenges in pricing because of low demand. Institutional investors are exiting long-term office holdings, with a narrow buyer pool mainly consisting of private equity acquiring downtown buildings at steep discounts. New Class-A buildings, though, are leasing well, given the low supply pipeline.
  • Investment Metrics from the second quarter of 2023 to the second quarter of 2024:
    • Cap Rates: Nationally, CBD Class-B properties’ cap rates rose to 8.68%. Suburban Class A and B properties increased by 44 basis points. The East saw the largest increase for CBD Class B properties at 9.02%, while the South saw the smallest increase for Suburban Class A properties at 7.82%.
    • Market Rents: Nationally, Class A rents rose to $32.99, and Class B to $23.49. The South saw the highest growth for Class A properties at $28.83, while the West saw a decrease for Class B properties to $28.95.
    • Vacancy Rates: Nationally, Class A vacancy rates increased to 20.32%, and Class B to 20.96%. The West saw the highest increase for Class A properties at 20.63%, while the South saw the smallest increase for Class B properties at 21.30%.

MULTIFAMILY MARKET:

  • High Interest Rates: The sharp interest rate hikes in 2022 disrupted value-add buyers with projects based on low interest rates and aggressive rent growth. This led to a slowdown in new developments and investment volumes across all regions, even in high-demand markets like Chicago, Los Angeles and Atlanta.
  • Strong Demand and Low Vacancy Rates: Many markets reported balance in upcoming construction supply and continued strong demand resulting inpositive rent growth in cities like Grand Rapids, Detroit, Indianapolis, New Jersey, Philadelphia, Boise, Denver and Phoenix.
  • Regional Resilience: The South and West are delivering major construction pipelines from 2021, but slower rent growth and higher vacancies are emerging. Markets with new supply exceeding 3% to 5% of inventory are expected to see unsustainable values in the short term. The market anticipates moderation in borrowing costs to address negative leverage on pre-2022 deals.
  • Investment Metrics from Q2 ’23 to Q2 ’24:
    • Cap Rates: Nationally, Urban Class A properties rose 42 basis points to 5.61%, while Suburban Class B properties increased by 37 basis points to 6.29%. The East saw the highest increase for Urban Class B properties at 6.48%, while the Central region had the smallest increase for Suburban Class B properties at 6.80%.
    • Market Rents: Nationally, Class A properties increased by 0.11% to $1,950, and Class B by 0.01% to $1,307. The East saw the highest growth for Class A properties to $2,281, while the West saw a decrease for Class B properties to $1,736.
    • Vacancy Rates: Nationally, Class A vacancy rates increased by 75 basis points to 6.65%, and Class B by 55 basis points to 4.84%. The South saw the highest increase for Class A properties to 7.16%, while the East saw the smallest increase to 6.16%.
  • Market Cycles: Since the fourth quarter of 2023, the multifamily market has shifted from Hypersupply to Expansion and Recovery, especially in the Central and East regions, indicating improving conditions. The market expects 2025 to mark the end of significant multifamily deliveries exceeding 3% of existing supply.

RETAIL MARKET:

  • Demand Mixed, changing with continued Low Vacancy Rates: Retail tenant demand remains robust despite challenges in high-supply markets for Big Box and Jr. Box stores. In contrast, newer urban centers, upscale mixed-use developments, and community shopping centers are thriving. Markets like Chicago, Columbus, and Indianapolis report low vacancy rates and positive retail absorption, though consumer spending headwinds may impact the retail landscape.
  • Rising Rents are evident in the South (e.g., Atlanta and Miami) and select Western cities (e.g., San Diego and Phoenix) driven by population growth and increases in population density and higher earning migration.
  • Mixed-Use Developments: Increasing in the Central and East regions, with cities like Kansas City, St. Louis, and Hartford focusing on diversified retail spaces and revitalization.
  • Investment Metrics from Q2 ’23 to Q2 ’24:
    • Cap Rates: Nationally, Community Retail properties rose by 10 basis points to 7.25%, and Neighborhood Retail properties increased by 9 basis points to 7.26%. The East saw the highest increase for Community Retail at 7.40%, while the South saw a decrease to 7.19%.
    • Market Rents: Nationally, Neighborhood Retail rents rose by 0.83% to $19.86, and Community Retail by 0.69% to $21.98. The South saw the highest growth for Neighborhood Retail rents, up 1.18% to $17.43.
    • Vacancy Rates: Nationally, Neighborhood Retail properties increased by 29 basis points to 10.89%, and Community Retail by 22 basis points to 10.32%. The Central region saw the highest increase for Neighborhood Retail at 13.17%.
  • Market Cycles: Nationally, Expansion rose to 35.5%, while Hypersupply increased to 19.4%, Recession decreased to 14.5%, and Recovery dropped to 30.6%. In the East, Expansion fell to 0%, with Hypersupply rising to 38.5%, while the South saw Expansion grow to 59.3%. Demographic shifts into the South are driving retail expansions, although most regions are adapting retail assets to meet new tenant demands. E-commerce continues to influence smaller in-store footprints but hasn’t diminished overall retail demand.

INDUSTRIAL MARKET:

  • Strong Demand and Rising Rents: E-commerce and supply chain needs continue to drive demand and push rental rates higher, particularly in Charlotte, Miami, Boise, and Phoenix although speculative construction and leasing velocity slowed in most markets by Q1-2024.  The strength of most industrial markets outpaced all other assets, including even multi-family, but the sector is not immune from volatility.
  • Higher Vacancy Rates from New Supply: Prior increased speculative development has led to higher vacancy rates in markets like Chicago, Indianapolis, Dallas, and Los Angeles. Conversely, areas with limited new construction, such as Cleveland and Detroit, maintain low vacancy rates and limited price volatility.
  • Strategic Locations: Demand and rental growth are sustained by strategic locations and infrastructure improvements, especially in Chicago, Kansas City, Raleigh, and Northern New Jersey. Regions with industrial land constraints and a strong manufacturing workforce, like those benefiting from automotive and onshoring expansions, continue to thrive.
  • Adaptive Reuse: The conversion of older industrial buildings and underutilized properties into modern industrial facilities is gaining momentum, driven by the scarcity of industrial land in major cities. This trend is helping to support market prices for remaining inventory.
  • Investment Metrics from Q2 ’23 to Q2 ’24:
  • Cap Rates: Nationally, Warehouse cap rates increased by 23 basis points to 6.42%, while Flex Industrial properties rose by 17 basis points to 6.93%. The East saw the highest increase for Warehouse properties at 44 basis points to 6.92%, while the Central region had the smallest increase at 7 basis points to 7.13%.
  • Market Rents: Nationally, Warehouse rents rose by 3.06% to $7.57, and Flex properties increased by 2.91% to $12.00. The East experienced the highest growth for Flex properties, up 3.88% to $13.02.
  • Vacancy Rates: Nationally, Warehouse vacancy rates increased by 181 basis points to 6.30%, while Flex Industrial properties rose by 100 basis points to 6.96%. The West saw the largest regional increase for Warehouse properties, up 247 basis points to 6.49%.
  • Market Cycles: Since Q4 ’23, the national industrial market saw Expansion decrease to 45.2%, Hypersupply increase to 43.5%, Recession remain at 4.8%, and Recovery increase to 6.5%. In the East, Expansion remained stable at 38.5%, with a decrease in Hypersupply to 38.5%.