The Rollercoaster 1st Half Year of 2023 in the Commercial Real Estate Market!

–Howard Freedland

It is hard to believe that it is June, and since we are within a few days of closing the first half out, let’s look at the state of the state in Commercial Real Estate. I’m Howard Freedland, and this is your Echo Commercial First Half Report 2023.

Before we get into it, I need to mention something important. In my experience, the ability to deliver tough news is much more important than knowing how to deliver good news. After all, anyone can say “We Win!” pretty easily (I am, actually, just learning how to do this – I am a Detroit Lions fan). Consequently, knowing how to deliver tough news is more important.

My delivery is direct and factual.  I am not going for hyperbole…I am trying to put our reality into perspective.  It is the only way that I know how to make good business decisions going forward. So, after a few years of booming prosperity, we have met some challenges. You will read about some of them below, but please, read until the end. The outlook is brighter than the past has shown.

1. In the first quarter of 2023, Commercial Real Estate investment declined by 57%, year over year. Global volatility, falling valuations, banking turmoil and broader macroeconomic headwinds have dramatically slowed CRE investment volume. According to CBRE, annual investment volume fell by 57% to $78B in Q1.

Institutional and international investors were the largest real estate purchasers, whereas private investors and REITs were sellers, on average.  Many firms, even those investing in favorable markets like multifamily and industrial, are waiting out the storm. Much of the reason is related to the fed funds rate exceeding 5% at the end of May, with two more increases expected by the Fed before the end of the year. More on that later.

2. According to Green Street’s Commercial Property Price Index, May prices dropped by 15% over the past year, following a peak in Q1 of 2022. According to data from the price index, institutional quality building prices have dipped below pre-pandemic prices for the first time. Rising interest rates, lower occupancy, and uncertainty in financial markets, have largely dampened commercial prices.

According to RCA’s property price index, commercial prices continued to fall in March of 2023. Apartment prices saw the steepest decrease at 10.3% YoY, while retail fell 5.8%. Suburban offices fell by 5.6%, while central business district office pricing fell by only 2.9%. The RCA property price index fell by 8% over one year.

3. Florida, however, has seen stagnation and even escalation in certain sectors in CRE. Industrial Multi-Family rent rates have grown this year, while retail and office have slowed their roll. But, look out for the silver lining…

Effective December 1, 2023, the State of Florida’s sales tax rate on commercial real property lease payments (including base rent and additional rent) will be reduced from 5.5% to 4.5% for payments received for occupancy periods beginning on or after December 1, 2023. Examples of taxable commercial real property rentals include commercial office, retail space, warehouses, convention and meeting rooms, and self-storage units. My projections for the back half of 2023 and into 2024 will be next week’s focus.

4. As high capital costs and ongoing inflation stifle transaction activity, the commercial real estate industry has largely shifted toward biding time until borrowing costs decrease, and investments offer a more attractive expected return.

Furthermore, lending dropped significantly in the first half of this year. The CRE Lending Momentum Index declined by 33% quarter-over-quarter and 53% year-over-year. That is a staggering reaction to bank failures, quantitative stagnation (I would put tightening, but that has only happened recently) and much higher interest rates.

Deep Knowledge Investing’s Gary Brode states “Others are saying that we’ve had a historic decline in the money supply which will lead to disaster. Technically, this language is correct, but ignores magnitude. Yes, M2 is down, but look at the chart below to see this “historic” decline. Do you see the problem?”

This has led to valuations falling as transaction volume stagnates or declines, depending where in the country you are looking. REITS, or Real Estate Investment Trusts, are selling more that buying, and investors with cash are hanging out until prices finally start to subside.

5. Many are preparing for impending refinancing doom. I wrote two weeks ago that The Mortgage Bankers Association (MBA) estimates that “of approximately $4.4 trillion of outstanding commercial and multi-family mortgages, $728 Billion (16%) matures in 2023, with another $659 Billion (15%) maturing in 2024. Approximately 25% of this is in the office sector.  When these come due, the refinancing will be at a significantly higher rate than what the holders are paying, and decisions will have to be made.

Ok. Take a breath. That…was…a lot. I get it. With every boom, there is a decline. And, with every challenge, new, creative real estate investment positions arise, which leads to more growth. Going forward, I see interesting opportunities available, and will shed some light on them in my predictions for the next six months in South Florida CRE. Next week, I will put the back end of 2023 in perspective with my expectations for growth, the economy and liquidity, and will discuss how to make the most out of the opportunities that will arise.

Howard Freedland is our Echo Commercial Properties Real Estate Specialist. As an independent wine broker, Howard has executed international deals with corporations and conglomerates. While working with Echo Fine Properties, Howard is a part of a team currently managing the interests of national and international companies wanting to secure land and property in South Florida. All of his prior business experience has brought him to this point as a professional, effective real estate leader. You can contact him on 561.889.2735 or [email protected].

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