The U.S. real estate market is facing a challenging year in 2023, as high-interest rates and a recession continued to weigh on asset values and fundamentals. According to CBRE, weakening fundamentals and higher cost of capital will generally lower asset values by an average of 10% across all sectors. In Q1, commercial real estate investment volume for the trailing 12 months fell 33% to $594 billion. Institutional and private investors were net buyers, while REITs and foreign investors were net sellers. Multifamily remained the leading sector with $25 billion in Q1 transaction volume, followed by industrial and logistics with $17 billion.
U.S. Commercial Real Estate Investment Volume by Quarter
U.S. Commercial Real Estate Investment Volume by Sector
In Q1 2023, Greater Los Angeles continued to be the preferred market for real estate investment, with a total investment volume of $51 billion, followed by New York with $42 billion and Dallas with $31 billion. Of the top 20 markets, Nashville had the smallest decline in transaction volume at 13%.
U.S. Commercial Real Estate Investment Volume by Market (Last 4 Quarters)
(USD Billions / % Figures Shows Change from Trailing 4 Quarters in Prior Year)
Cap rates expanded by approximately 125 to 150 basis points (bps) across all property types since early 2022, translating to a 15% to 22% decline in values based on actual transactions.
Historical Cap Rate and Forecast Across Sectors
Due to their strong fundamentals and positive long-term demand outlook, multifamily and industrial properties remained the most favored by investors. Grocery-anchored retail centers also performed well, while office investors preferred high-end Class A buildings.
After facing unprecedented challenges and spikes in costs over the past two years due to materials, labor, and margins, construction costs may moderate in 2023 as materials costs likely won’t rise. However, labor costs and margins likely will increase. Construction spending is expected to remain strong next year, driven by the record-high value of construction starts in 2022 and the $500 billion infrastructure program. Activity may slow down later in 2023 due to rising interest rates and economic slowdown, especially in the residential sector.
Annualized Construction Starts by Property Type
Commercial real estate will face a tough year in 2023 due to high-interest rates and possible recession. However, businesses are financially healthy and are expected to avoid laying off workers in a competitive labor market. Consumers are cautious but have fairly strong balance sheets with lower debt levels compared to previous recessions. These factors imply a moderate slowdown, with unemployment likely staying below 6%. Inflation is expected to fall by the second half of 2023, paving the way for lower interest rates and a new cycle that may last until the 2030s.
The real estate sector will still face rapid changes despite the economic challenges. Some buyers will be discouraged by higher capital costs, but large equity players who can invest capital fast will have opportunities. However, these investors will have a limited window: after the Great Recession, the pricing low point only lasted about six to nine months before cap rates started to shrink. The window of opportunity may be even smaller this time, as the recession is expected to be relatively short. ESG issues and the digital economy will also shape real estate demand. Hybrid work will benefit both employers and employees, but it will require adaptation from office owners and occupiers. Cities will also have to cope with new commuting habits and lower office demand.
The outlook for different sectors will vary, with data centers and industrial real estate likely to be the most resilient, followed by multifamily and retail. The office and hospitality sectors are expected to face more headwinds, and the life sciences sector should see a slowdown in activity after a COVID-induced boom. All sectors and locations will have to comply with decarbonization mandates from governments, occupiers, and investors.
Multifamily fundamentals weakened in Q1 2023 due to slow leasing, new deliveries, rising vacancies, and plateauing rents. Investment volume totaled $24.7B, a 63.7% year-over-year decrease and 25% less than the 2013-to-2019 average. Supply pressures are high but manageable, while construction debt is scarce and expensive, slowing down new starts.
Demand in the multifamily sector is expected to lag supply in the near term due to economic uncertainty, pushing vacancy toward 5%. 57 markets had vacancy rates exceeding 4.0%, up from 52 in Q4 and 43 in Q3 of 2022.
U.S. Multifamily Vacancy Rate and QoQ % Change
While the increase in vacancy rates extended across all multifamily classes, class A vacancies increased at a lower rate than class B and class C assets, which suggests that renters are not giving up their standard or living or moving to lower-cost housing despite the economic uncertainty. All three asset classes witnessed a deceleration in vacancy rate increases.
U.S. Multifamily Vacancy Rate by Class
Average monthly nationwide rent increased by 4.5% on a year-over-year basis. While this is down from the record 15.3% increase in Q1 2022, it is still well above the pre-pandemic average of 2.7%.
U.S. Multifamily Monthly Rent and YoY % Change
Multifamily rental demand continued to be high because of the difficult for-sale market, where home prices remain high and mortgage rates soared. According to CBRE, the average monthly payment for a new home in Q3 2022 was 57% more than the average rent, the biggest difference ever recorded. In comparison, the gap was only 8.5% before the pandemic. The current large gap suggests that renting will remain more affordable than buying and owning, even if home prices and mortgage rates go down next year.
U.S. Multifamily Cost of Ownership vs. Cost of Renting
Multifamily sector has demonstrated solid fundamentals and an average annual total return of 9.3% over the past decade. It also has access to Fannie Mae and Freddie Mac, which are unavailable to other sectors. These factors make multifamily one of the best asset classes to hedge against inflation. As the market stabilizes, more investors and lenders are expected to capitalize on this opportunity in 2023.
Commercial Retail Market
Commercial retail saw rents increase and vacancies fall across all retail sectors in Q1 2023. Vacancy rate fell to 4.8% in Q1 2023, a record low since CBRE began tracking the market in 2005. Rent growth fell by 50 bps year-over-year to 2.0% but remained above the 10-year average of 1.7%.
U.S. Retail Vacancy Rate by Property Type
Average asking rent grew by about 2.0% in Q1 2023 from the same period in 2022 but remained above the 10-year average of 1.7%. Neighborhood, community & strip centers continued to be the strongest performers, with rent growth of 2.7% over the prior year, while lifestyle & mall, and power center rents were unchanged.
U.S. Retail Average Asking Rent
In Q1, total retail sales dropped to 5.4%. Core retail sales, which exclude nonstore retail sales, increased by 0.5% from the previous quarter to 7.7%. Nonstore retail sales, which include e-commerce, decreased by 1.2% from the last quarter to 9.8%. Both core and nonstore retail sales grew slower than a year ago, by 3.5% and 0.6%, respectively.
U.S. Consumer Retail Sales Growth and YoY% Change
U.S. Retail Sales by Category
Q1 saw muted retail space deliveries for the quarter at 5.1 million SF, with a rolling 12-month total of 26.7 million SF, the second lowest on record behind only 2022. This trend of diminished development is expected to continue, with retail construction starts for the quarter totaling 4.8 million SF.
Retail fundamentals remain strong in 2023, thanks to limited new supply and positive net absorption. Retail deliveries have hit record lows for three consecutive years, while demand for retail space has outpaced supply. As a result, rents have increased, and vacancies have decreased across most retail subtypes. Moreover, more than 50 million SF of retail space has been repurposed since 2003, with 10 million SF in the last five years alone. This trend is expected to continue in 2023 as owners of underperforming malls and centers transform their properties into mixed-use developments.
Despite the challenges of high inflation, rising interest rates, and labor shortages, retail fundamentals are expected to stay solid in 2023 as brick-and-mortar retail sales keep growing from the previous year and as the high construction costs and the limited supply of retail space continue to persist.
Data Sources： CBRE Research, CBRE Econometric Advisors, J.P. Morgan Asset Management, CoStar Realty Information Inc., Bloomberg, WSJ.com, Zillow Group, Redfin, Bureau of Labor Statistics, & U.S. Census Bureau
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