Fed: CRE Activity Keeps Slowing and Loan Demand Down

The Federal Reserve’s Summary of Commentary on Current Economic Conditions, commonly called the Beige Book, made clear that the economy has begun slowing and that the upward revision of third quarter GDP growth to an annualized 5.2% isn’t likely to continue through the end of the year.

“On balance, economic activity slowed since the previous report, with four Districts reporting modest growth, two indicating conditions were flat to slightly down, and six noting slight declines in activity,” the report said. “Retail sales, including autos, remained mixed; sales of discretionary items and durable goods, like furniture and appliances, declined, on average, as consumers showed more price sensitivity. Travel and tourism activity was generally healthy. Demand for transportation services was sluggish.”

All this is bound to have an effect on multiple parts of commercial real estate, which it apparently did. “Commercial real estate activity continued to slow; the office segment remained weak and multifamily activity softened,” the report continued. “Several Districts noted a slight decrease in residential sales and higher inventories of available homes. The economic outlook for the next six to twelve months diminished over the reporting period.”

Here are some specifics from different Fed branches.

Boston: “Commercial real estate activity slowed modestly, and the outlook for office properties was increasingly dim. Outside of real estate, contacts on balance were cautiously optimistic for at least stable activity moving forward.”

New York: “Commercial real estate markets weakened for both office and industrial space, as vacancy rates edged up and rents declined across much of the District. Upstate New York office markets saw notable increases in vacancy rates, while the worsening trend in New York City’s office market continued after a pause during the last reporting period. The industrial market also deteriorated, with vacancy rates increasing and rents softening from long-term highs seen during the summer.” Construction declined in office and multifamily, but industrial increased with “high volumes under construction and new space set to come to market in the fourth quarter of 2023 and early 2024.”

Philadelphia: “Commercial real estate loans were flat, while auto loans fell modestly. … According to contacts, high interest rates continue to have a dampening effect on commercial real estate market transactions and on new construction. Leasing activity declined slightly accompanied by growth of concessions. The construction pipeline is not yet full for 2024. Activity fell slightly; however, infrastructure projects are keeping some firms very busy.”

Cleveland: “Nonresidential construction slowed in recent weeks. Multiple general contractors reported that their clients had delayed or reconsidered projects because of higher financing costs or economic and political uncertainty. Demand for commercial real estate was soft, in particular for older office space. In addition, one commercial realtor noted that demand for industrial, retail, and apartment space had begun to weaken. Nevertheless, many contacts expected conditions to improve in the coming months.

Richmond: “In the Fifth District, overall market activity in commercial real estate (CRE) was slow this period. Industrial and retail were both fairly stable with low vacancy levels and rising rental rates. In the office sector, owners were having to offer generous concessions, incentives, or tenant improvement allowances to secure new leases — so effective rental rates were much lower. In multifamily, rents were flat or down due in part to the amount of new construction coming to market. Banks were being very selective on financing any type of CRE investment. The lack of available financing dampened a broad range of activities within the CRE sector, including new development and refinancing. Contractors noted a slowdown in new work.”

Atlanta: “Commercial real estate (CRE) contacts reported diminishing conditions across the sector. In addition to the office segment, high-end multifamily and industrial real estate were noted as areas of distress. Contacts reported concerns regarding financing, as most lenders increased underwriting standards and reduced funding commitments. A growing wave of CRE loan maturities and declining asset values are significant downside risks to the CRE outlook.”

Chicago: “[S]ome contacts in construction, real estate, and finance reported taking down job postings, while others in those sectors were planning for layoffs. … Commercial real estate activity declined slightly, though vacancy rates and the availability of sublease space also fell. Prices and rents edged down. One contact reported that while leasing activity had held up, sales activity had fallen off. … Business loan demand decreased modestly, and loan quality was also down, with contacts highlighting struggles in the commercial real estate sector. One contact noted loan quality improvements in hospitality.”

St. Louis: “Commercial construction has slowed sharply since our previous report, particularly for new starts in the warehouse and industrial sectors. Residential construction has also seen slowing activity, with some projects sidelined or cancelled, especially for multifamily. One Memphis commercial real estate contact reported that new construction has all but stopped for developments aside from single-family housing. While the number of ongoing projects remains high, contacts with a strong existing project pipeline have reported slowing demand for future projects.”

Minneapolis: “Commercial real estate fell modestly. Office space remained challenging, with high vacancy rates because large tenants continued to seek smaller footprints. Multifamily vacancy rates have risen in many regions as new units come to market; however, new developments in this sector have slowed. Speculative development has also slowed for industrial space as vacancy rates ticked slightly higher, but from low levels. Residential real estate remained subdued, with year-over-year sales continuing to decline.”

Kansas City: “Though standards across loan types remained unchanged, several contacts expected further deterioration in credit quality over the next six months, particularly in the consumer and commercial real estate segments of their portfolios. Bankers cited higher debt service costs and declining borrower cash flow as key risks facing their CRE books, particularly for loans maturing in the near term. … Several developers and construction managers reported raw materials costs stabilized recently. They also noted greater ability to push against escalating costs from subcontractors. Public sector funding for municipal projects sustained demand for building materials, somewhat supporting materials prices. Contacts indicated that subcontractors were becoming more available for work, with holes in their backlog schedules for the first time in several years. Though construction labor was somewhat more available, growth in labor costs remain elevated.”

Dallas: “Activity in commercial real estate softened. Apartment leasing slowed and rents were flat to down. Office leasing remained minimal; vacancy rates were high, and concessions remained generous. With new supply outpacing demand, industrial vacancy rates ticked up and rent growth cooled. Heightened macroeconomic uncertainty, high capital costs, and diminished appetite to lend continued to deter investment across property types.”

San Francisco: “Real estate firms noted that higher input, building, and loan costs adversely impacted new construction projects. … Commercial real estate activity was varied in recent weeks. Office leasing activity was muted, and occupancy rates remained low. In contrast, demand for space in sectors less conducive to remote work, such as defense and lab-based sciences, was robust and occupancy rates were high. Elevated financing costs and economic uncertainty slowed commercial construction projects. A contact in Utah reported that construction continued as planned on existing industrial projects, but that rent growth in this sector began to ease.”