I don’t think the commercial real estate market in Austin, or the rest of the US for that matter, has bottomed out yet; at least not so soon after COVID. In my opinion, the two primary reasons for the delay in the continued growth of the economy and commercial real estate market as a whole, are inflationary factors and interest rates.
The inflation rate of 4.12% is down from a high of 8.9% in June 2022, but it’s still higher than most of what we have seen since 1991.1 The current interest rate average of 6.25 % rate is the most we have seen since 2008. Both are high enough to make investors and businesses take pause at where they put their cash and how they leverage it.
More specifically, when we look at the health of the commercial real estate market, it starts and ends with occupancy and rental rates. These are the two primary factors that determine the value of commercial real estate; whether it’s office, industrial, retail, or multi-family. Occupancy is currently being determined by the flex scheduling companies are having to address as employees can perform many of their job duties from a home office. I have spoken to many companies about this subject and their answers vary greatly as to what percentage of time they expect their employees to work from the office each week. Some companies want 100% participation at the office while others are shooting for 60% participation.
For office space, this is the key issue that determines their occupancy. If occupancy ends up on the lower end of that spectrum, landlords will have no choice but to lower rental rates and offer other incentives to get companies back into office space. The lowering of rental rates will lead to lower values on the real estate, which will cause distress for some property owners, but at the same time offers investors an opportunity to acquire those distressed assets at a discount. Don’t expect as much distressed activity as was seen from the Great Depression, Dot-Com bust or S&L crisis; primarily because many investors have learned their lesson from those painful times and simply aren’t as leveraged as before. Also, lenders now have more tools with which to work and get creative with distressed property owners to keep their property since most lenders do not want to take back real estate.
This discussion mainly affects office space since manufacturing/warehousing and retail users rely on more than just the employee base for occupancy. Manufacturing and warehousing rely equally on employees and their physical building to conduct business. I like to say, “companies can’t successfully manufacture or distribute products from their home”. Likewise, but for different reasons, retail users also equally rely on employees, but also the physical building as a place to display product.
To get more employees back to the office, CEOs of large companies like Amazon, Salesforce, and JP Morgan are putting return-to-work mandates in place and plan to enforce them. The atmosphere is right to do so with the rise in demand for skilled labor while availability of skilled labor remains relatively low.2 Many are expecting stability in commercial real estate in late 2024 or early 2025. By then, many existing long-term leases will be close to expiring and we will fully know how much space companies will “give back” to the landlord as superfluous space due to the shrinking pool of “go-to-work” employees.
On a positive note, employment is on the uptick as of May 2023, adding 339,000 jobs nationwide, according to the Bureau of Labor Statistics, with gains occurring in professional and business services, government, and healthcare; all areas that will need office space.
A final word about commercial real estate investing — commercial real estate investment has been, and still is, a good idea; especially in Central Texas where we have experienced sustained growth year-over-year for decades. If you would like to discuss this more, please give me a call at 512-736-5933 or email me at firstname.lastname@example.org
1 Federal Reserve Bank of St. Louis. Federal Funds Effective Rate, 17 June 2023.
2 Miriam Hall. “Top-Down Mandates Increasingly Seen As Only Way Workers Will Return To Offices En Masse”, BizNow.com, 8 June 2023.