As 2022 ends, there are a number of questions about what’s ahead for the commercial real estate industry in 2023. Al Brooks, head of CRE at JPMorgan Chase, recently shared his thoughts on CRE’s outlook in the coming year with Commercial Observer. While the industry could face some challenges, retail is at a crossroads and office space’s future remains up in the air, Brooks found some bright spots CRE can look forward to next year.
Keep reading for Brooks’ 2023 CRE forecast.
Rising interest rates could impact CRE
Target federal funds range is 3.75 percent to 4.0 percent as of the November Federal Open Market Committee meeting — this level was last seen in 2008, Brooks wrote. As the Federal Reserve expects additional interest rate increases in 2023, CRE owners could be negatively impacted. Higher interest rates combined with record-high inflation could lead to a recession next year, according to Brooks. A full recovery might take years rather than months and impact all asset classes.
Online shopping boost is great news for industrial CRE
E-commerce continues to increase, meaning the need for warehouses and industrial space will too.
E-commerce’s need to get products into consumers’ hands sooner is what’s driving a lot of innovation,” said Victor Calanog, Head of CRE Economics at Moody’s Analytics. “All the way from investments in last-mile distribution complexes to drones.”
Given that E-commerce accounts for less than 20% of retail sales, there’s still room for the industry to grow. “E-commerce will likely serve as a tailwind for the logistics industry — and industrial warehouse and distribution properties — for at least 10 years,” Calanog added. “The industry has begun to respond and deliver record amounts of new warehouses. Ultimately, whether or not industrial performance metrics fare well will depend on the mix of supply and demand.”
If industrial CRE were to face a road bump, it might be its longer leases, which generally make up about 2 to 3 percent inflation.
Retail CRE’s fate in 2023? It depends.
The COVID-19 pandemic impacted retail CRE significantly as many locations were forced to close their physical locations. How these properties rebound will depend on where they are and what they sell, according to Brooks. People still need to food shop, fill their prescriptions and get haircuts, giving these type of retail properties a reason to be optimistic. Retail properties in neighborhood shopping centers located in well-populated residential areas should continue to perform well.
Meanwhile, cities are looking to redevelop B- and C-class mall spaces. They initially tried to revive these properties for sales tax purposes, but after decades of effort, they will likely be converted into mixed-use centers that will include apartments, restaurants and movie theaters. City-based retail properties haven’t had as much success rebounding, however.
“Urban retail tends to boast higher rent levels than other retail,” Calanog said. “But it has continued to be weighed down because fewer people are working in downtown offices.”
Office space CRE’s fate is to be determined
The office sector has also felt the pandemic’s impact as many workers have been slow to return to the office, opting to work remotely if their employer allows it, or at best coming in a couple days a week. Brooks noted that no U.S. region saw its vacancy rates fall below their pre-pandemic fourth quarter of 2019 levels, however, per Moody’s analytics.
Businesses could have more luck getting employees back if they are in the right location and offer enticing amenities like floorplans for collaboration, private outdoor spaces and onsite services such as childcare.
“Looking ahead, we are not in the ‘office is dead’ camp, but we think cash flow growth will be challenged in the office sector,” noted Anthony Paolone, Senior Analyst and Co-Head of U.S. Real Estate Stock Research at JPMorgan Chase.
What’s ahead for CRE in 2023
“Our forecasts suggest that unless the Fed changes course, 2023 will be characterized by slower GDP growth as monetary policy continues to tighten and global economies adapt to inflation,” Calanog said. “That translates to less credit and lending activity, and continued volatility for asset pricing.”
However, Brooks noted that CRE’s cyclical nature will continue.
“Property owners and investors with fortress balance sheets understand how to take advantage of those ups and downs,” he wrote. “There may be overleveraged building owners during an economic downturn. That presents prepared owners and investors with an opportunity to grow their portfolio at a lower cost.”