These are spooky times in Commercial Real Estate, full of concerning statistics that will truly give you a scare. Green Street presents its 2023 House of Horrors, highlighting the current areas to be weary of when navigating today’s market. Don’t worry though, there are plenty of treats out there for investors who want them. 

“Property Prices are down almost 20% from their ’22 peak.” 

Real estate prices are still too high, and prices would need to fall another 15% to bring pricing in line with its historical relationship to corporate bond yields. Green Street’s recent Commercial Property Outlook publication takes a deep dive into macro trends, operating fundamentals, and relative valuation, providing an extensive explanation for future private and public market price declines. 

“Residential mortgage rates are the highest they’ve been in over two decades (~7.6%).” 

Lower MBS demand and higher yield volatility increases the risk that mortgage originators might have to hold loans on their balance sheet for some time before they can be sold into the secondary market. In turn, mortgage originators are charging home buyers a higher rate. Together, these factors translate into a higher mortgage rate for home buyers.  

“Unsecured REIT debt costs have risen to 6.6%, up 160 bp from the beginning of the year.” 

According to Commercial Mortgage Alert, REIT-bond issuance activity fell sharply in the third quarter as borrowing costs soared and issuers explored other financing avenues. Typically, REITs tend to prefer unsecured debt due to the cheaper price and greater flexibility, but rising rates and volatility in the capital markets have made agencies the most economical option for some. Although the 2023 year-to-date issuance is well ahead of last year’s sluggish pace, it’s still less than half the nine-month output of the two previous years. 

“The City of San Francisco is projecting a >$500 million structural deficit in Fiscal Year 2025-26, growing to ~$1 billion by the end of the decade.” 

Transaction volumes across sectors have plummeted in San Francisco. Downtown submarkets (Financial District, SoMa) have seen the largest declines in foot traffic as well as the largest increase in crime and homelessness, contributing to limited interest from buyers. Of all sectors, office – which has seen total vacancy rates (including sublease vacancy) rise to 30%+ – has been impacted the most.  

“Office property values have fallen 31% from last year.” 

Although many aspects of daily life have returned to pre-pandemic norms, office utilization has yet to follow suit. The reality is that utilization is still at least ~35% below ’19 levels, anecdotes of downsizings are still making the headlines, and leasing demand remains relatively anemic. Due to current averages and negative sector sentiment, Green Street’s report Office Insights: Fourth Time’s a Charm or Post-Labor Day False Alarm? analyzes the different variables at play and the impact future levels might have on office demand. 

“Major insurers in the state are requesting the ability to raise rates on average by 30-40% but retain the ability to raise rates more aggressively.” 

The disruption across the U.S. has made insurance a key variable in real estate underwriting as the rise in insurance costs the last few years has far outpaced other forms of expenses as well as the rate of inflation. A combination of concerns on the frequency of climate events, higher replacement costs, and regulatory pressure in the insurance market could keep insurance costs on an uncomfortable trajectory, especially in states such as California (quoted above), Florida, and North Carolina. 

“California’s Air Resource Board (CARB) has proposed a diesel truck registration ban for new drayage trucks starting January 1, 2024.” 

New climate regulation in California could be a threat to the region’s supply chain dominance and thus industrial demand. As Los Angeles, the Inland Empire, and Orange County collectively account for a quarter of total U.S. industrial investment opportunity, and Los Angeles and Long Beach ports handle ~35% of total U.S. container shipping volumes (according to this month’s Property Insights Report: Counting the Trillions), this policy could be detrimental to the industrial sector. 

It’s not all ghost stories and nightmares out there though, as many areas of Commercial Real Estate are alive and thriving. Consumer sentiment has improved over the past year as inflation has decreased from 9%/yr to 2.5%/yr. Retail sales growth has been healthy, as have broader measures of consumption. 

Major markets such as Boston, New York, and Atlanta are leading in M-RevPAF and DCF Expected Returns across multiple core sectors. The Single-Family Rental and Industrial sectors across the U.S. have experienced a steady decrease in nominal cap rates over the past 3 months. The Senior Housing sector has displayed recent increases in property prices. Data Center vacancy is tight, and fundamentals haven't been this good in a long time. Industrial forecasts remain to be among the best. Manufactured Home Park and Single-Family Rental sectors are expected to experience much higher growth than Apartments over the next few years.  

Although Commercial Real Estate conditions may look dark and scary, there are plenty of investment opportunities if you know where to look. Green Street’s proprietary analytics tools and forward-looking thought leadership provides early warning signals for CRE market performance, empowering you with reliable data to confidently mitigate risks and seize opportunities that drive returns through all market environments.  

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