How CRE Fared in 2023's Non-Recession

It was widely believed that the US would be in a recession by now, but that is not the case – it’s one of several 2023 forecasts that didn’t play out exactly how many thought it would.

As the year comes to an end, Marcus & Millichap looked at commercial real estate’s asset classes to determine which ones underperformed compared to expectations set going into 2023 and which overperformed.

The 5.2% GDP growth in the third quarter really reiterated just how far off those recession predictions were, said John Chang, Executive Vice President of National Research and Advisory Services for Marcus & Millichap in his firm’s recent news video.

“At this point, we’re estimating 2023 will deliver economic growth in the 2.5% range, which is actually a really strong showing,” he said.

Additionally, the US will add about 2.7 million jobs in 2023 with a still low unemployment rate.

“At the same time, retail sales have aligned perfectly for a soft landing with total purchases increasing by just 0.2% on an inflation-adjusted basis,” Chang said.

The headline CPI number started the year at 6.4% and stood at half that level, just 3.2%, as of October.

Core PCE, the inflation metric most closely monitored by the Federal Reserve, also fell significantly from 4.9% at the start of the year to 3.5% in October.

Both inflation measurements are expected to decline further by the end of the year, he said.

The other widely expected event that failed to materialize was a wave of commercial real estate-driven bank closures, according to the video.

“Although a few banks were shuttered, none of those closures were caused by a wave of bad real estate debt,” Chang said. “One of the ideas driving the bank failure dialogue was the widely held expectation that commercial real estate would face significant distress, and many believed a wave of delinquencies would hit the market.

“And yes, a few properties did shake loose, and some investors did hand the keys back to lenders, but the distress was more of a trickle than a wave.”

He said that both the Federal Reserve and the FDIC rapidly backstop banks and their guidance on commercial real estate extensions and workouts appears to have staved off a lot of the commercial real estate risk, at least thus far.

The CMBS delinquency rate of just 4.6% likely beats most people’s expectations.

“From a property fundamental standpoint, the market did better than expected but not as good as we would’ve liked,” Chang said.

Apartment vacancies are expected to end 2023 at 5.7%, about 80 basis points above year end 2022.

But considering a record 420,000 new units were added this year, inventory growth of 2.2%, an 80-basis point rise in vacancy isn’t bad, according to Chang.

“Office is another property type that probably exceeded expectations is office, not because it performed well, but because expectations were so low,” he said.

Marcus & Millichap anticipates the office vacancy rate will close 2023 at 17.6%, up 140 basis points from last year. Large, older urban office buildings have fared worse than smaller, newer office buildings located in the suburbs and smaller cities.

As for retail, Marcus & Millichap anticipates the vacancy rate will close 2023 about 10 basis points higher than last year at 4.7% — that’s for all retail, including both multi-tenant and single-tenant properties.

Focusing in on just multi-tenant retail, the year-end vacancy rates should land around 5.2 or 5.3%, which would be the lowest year-end multi-tenant vacancy rate on record back to at least 2007, Chang said.

“At the beginning of 2023, I don’t think anyone expected record retail sales, nor were they expecting the multi-tenant vacancy rate to end 2023 at a record low,” Chang said.

“Now unlike office, people’s expectations for industrial properties this year were quite high and ultimately we’re expecting to see annual absorption of around 175 million square feet, which will give us a vacancy rate in the upper 4% range, about 120 basis points above the close of 2022.”

Like apartments, industrial construction was a major factor with a record 400 million square feet delivered in 2023.

“But looking under the surface, over half of the newly added space falls in just 10 markets,” Chang said. “Most areas of the country saw little development.”

Looking back on 2023, Chang said that both the economy and commercial real estate generally outperformed expectations.

“It certainly wasn’t the best year on record, but all things considered, it looks like we dodged a bullet,” Chang said.