Commercial real estate trends, once a powerhouse investment opportunity, is facing a reckoning. This sector, comprising office spaces, retail outlets, and industrial properties, is entangled in the evolving economic conditions and changing workplace norms. Let’s delve into commercial real estate trends to see how to face the prospects of investing in this sector.
What is Commercial Real Estate?
Commercial real estate includes properties that are used for business purposes. This category is diverse and comprises:
- Office spaces: These include skyscrapers and smaller buildings intended for occupation by businesses.
- Retail properties: These include shopping malls, storefronts, and other spaces that host businesses that sell goods and services.
- Industrial properties: These are spaces like warehouses and manufacturing facilities that are used for production, distribution, and storage.
Rising Interest Rates and Commercial Real Estate Trends
Recently, interest rates have gone up sharply, making it costlier for owners to buy or refinance properties. This has come after a long period of cheap debt that fueled a buying spree.
According to Green Street, a data analytics company, in the US, where interest rates started rising in March 2022, the values for institutional-quality offices have plummeted by 27%. Apartment building prices have fallen by 21%, and malls by 18%. In Europe, office prices are expected to experience a drop of over 25%, and nearly 13% in the Asia-Pacific region.
This decline is attributed to the fact that as interest rates rise, the cost of borrowing increases, which leads to a decrease in the number of transactions and the value of properties.
Changing Workplace Norms and Office Properties
The global pandemic brought about a monumental shift in the way people work. Remote working became the norm, and this has directly impacted the demand for office spaces. With a significant number of companies embracing remote or hybrid working models, office spaces, particularly in big cities like New York, London, and San Francisco, have witnessed reduced occupancy rates. For instance, a new skyscraper in Hong Kong is only a quarter leased. Such low occupancy rates are prompting some landlords to abandon their properties as they face financial strain.
Are Office Properties a Good Investment?
Given the current scenario, investing in office properties seems precarious. But, may present opportunities for some investors. This is because the best time to be brave is when others are fearful.
With high negative sentiment in the market for office buildings, have we reached the lowest point? Or, should investors wait for a further round of defaults before investing?
Major institutional owners like Blackstone, Brookfield, and Pimco have halted payments on some buildings, citing better use for their cash and resources elsewhere.
The recovery of commercial real estate values, especially for office spaces, is expected to be slow. Analysts predict that it could take up to 10 years for US office prices to recover to pre-crisis levels.
Additionally, the situation is highly dependent on geography. Different cities are impacted in varying degrees by localized conditions.
Office Investment: Allied Properties
One office property landlord for investors to watch is Allied Properties. The company is known for having high quality buildings in desirable locations in Canada’s major cities like Toronto. The company is best known for developing old warehouse space in Toronto King West neighbourhood into vibrant offices. The area is now characterised as a sought-after location for both offices and new residential buildings.
However, Allied Properties has also developed new buildings which are adding new risks to its portfolio. One such building is The Well. This building is a new development in partnership with RioCan REIT which was supposed to feature Shopify as an anchor tenant. But, since Shopify plans to work mostly remote, they decided to end their lease. This left The Well with lots of empty space.
Allied Properties is better positioned than most other large office landlords. Its relatively low leverage before the pandemic helped it survive. But there is no way for it to escape the core trends of the office market. Work from home is real and a trend that will continue. The degree to how much office employees will work from home is debated, but certainly a trend that is here to stay.
At some level, Allied Properties becomes an attractive investment again. For investors, is this when the shares are yielding 8%, 10%, 12% are more? With a current yield of 8.50%, the shares seem like fair value. But for investors looking for a deal, they should demand a greater yield over the cost of borrowing. Office market investors may get a chance for higher yields in the coming months and years.
Conclusion
The current state of commercial real estate is akin to shifting sands. The rise in interest rates coupled with changing workplace norms has led to a downturn in property values, particularly in the office space segment. Before considering investment in commercial real estate, it is crucial to analyze the long-term trends and understand the local market conditions. With the landscape so variable, thorough research and cautious decision-making are more important than ever.
