CRE's Worse Days May Be Over But 'We’re Not Out of the Woods'

The worst of the COVID crisis may be in the rearview for the commercial real estate market, according to one industry insider.

“I still think the worst is behind us, and that the commercial real estate market is strengthening,” said John Chang of Marcus & Millichap in a recent video. “But we’re not out of the woods yet.”

The apartment sector had a stellar second quarter, Chang said, with net absorption coming in at 218,000 units—the strongest single quarter absorption on record back to 1993.  Quarter-over-quarter rent growth was 4.1%, the biggest gain since the dot-com boom, and vacancy fell 3.8 basis points nationally.

“The strong quarterly results reflect the release of pent-up household formation and a broad-based housing shortage,” he said. “By the look of things, the shortage will probably become even more acute over the next couple of years, supporting strong apartment performance momentum.”

Industrial vacancy came down 30 basis points to 5% in Q2, despite the addition of 60 million square feet of space. Chang also predicts more than 300 million square feet of industrial completions this year⁠—a figure that’s tempered by the more than 100 million square feet of absorption during the quarter.

The outlook for industrial demand remains strong, according to Chang, but another important consideration is the supply chain backup, which suggest companies will try and stock up for the holiday season.  That will drive warehouse-based demand.

Retail is a “bit trickier,” Chang says. “A lot of retailers closed shop during the pandemic but we didn’t see the expected dramatic vacancy surge. Yes, vacancies went up about 70 basis points last year…but that’s pretty sedate compared to the 170 basis point climb during the financial crisis.”

The limited pace of retail construction helped performance, as did adaptive reuse in the sector. Overall, the sector held up “better than expected,” with average rents making their first real gain in over a year.

The office market is also improving slowly, with absorption barely positive in Q2. Since the pandemic began, tenants gave back around 200 million square feet, and the current office vacancy rate stands at 16.2%, matching the peak of the financial crisis.

“We’ll have to see how effective companies are in bringing their workforce back to the office before we have a real sense of the office market outlook, but it does look like the worst is behind us,” he said.

Headwinds could emerge⁠—most likely due to the Delta variant. The states with the highest infection rates are the least likely to implement lockdowns, Chang said, but “a broadening surge of infections could slow the return to working in the office.”