2023 Commercial Real Estate Forecast

With the current U.S. inflation, interest rates, and housing costs rising, many Americans are wondering if a recession is coming.

In January of this year, we spoke with Edward R Lawrence III, Senior Research Analyst at Colliers International, to discuss that issue and what to expect from the commercial real estate market in 2023. Here is what Ed had to say in response to our questions:

Maura A. Snabes

SVP, Corporate Counsel,
corporate settlement solutions.

Edward R. Lawrence III

Senior Research Analyst,
Colliers International.

The pandemic accelerated the trend of working from home and hybrid work. This has caused a huge impact on the commercial real estate market and primarily the office, industrial and retail sectors.

In the office marketplace, there are 2 trends we've seen. First, employers are moving toward higher quality amenities and Class-A office space, in what we’re referring to as a “flight to quality” shift. Sadly, there are also a large number of anchor tenants that are going to be rolling, particularly in downtown markets. It appears as though the suburban market will fare better than the major metropolitan areas. Ultimately, office buildings in downtown metro areas are being converted into residential, especially Class B and Class C space. Conversion brings its own set of challenges.

In terms of the industrial sector, a couple of factors have arisen and have a big impact. One of them is a large demand for last-mile distribution centers and decentralization of warehouses based upon the proliferation of e-commerce. For this reason, industrial brokers have been quite busy over the last two and a half years since the pandemic started and are still not slowing down. Now, rising interest rates will likely curtail some of that growth. So there may not be a softening of this sector, but perhaps a slowdown in the industrial real estate market may occur.

As the pandemic changed consumer habits, and there have been labor shortages, retail has generally struggled a little bit across the nation. And it's still being determined whether there will be any relief in 2023. For that reason, to minimize retail supply and improve the utilization of these products, many larger retail properties are being converted to industrial or multifamily use.

Speaking of the multifamily submarket, this market has done very well over the past few years and there is still a strong demand. In 2023, it's likely that there will be a small correction, during which rental prices for multifamily units may start to level out. But, ideally, they won't necessarily go down. Again, with higher interest rates, there will probably be a slight decrease in the amount of investment money flowing into multifamily and after that, it is most likely that multifamily would definitely experience an upturn in the third and fourth quarters of this year, along with the other commercial markets I’ve mentioned.

Within the CRE market, there are a few promising subsectors and Life Sciences is undoubtedly one of them. It should come as no surprise that more money is continually being invested in medical research and development. This investment will undoubtedly aid in boosting the industrial market since this sector involves more sophisticated manufacturing facilities, which drug manufacturers lease at a high volume. In addition, for those who are looking for the more typical lab space, it will serve to boost the office market.

As investors, we always look to make sure that the property we are buying is being exploited to its fullest and best potential. But there are challenges involved, with cost being the biggest.

It would be in the best interests of communities to consider offering financial incentives to the owners of these sorts of buildings to help cover the costs associated with converting them to residential use. Based on the higher expense of doing the conversion, Gensler Architectural Firm estimates that only around 30% of the country's office buildings would make sense to convert to residential. However, that isn't stopping a landlord's investigation to ascertain— through architects and engineers—what the cost of conversion would be and what kind of lease rates or rental rates we might accomplish if they were converted to flats.

We hope that this trend will continue and that mayors and economic development authorities in these significant metropolitan areas across the country will attempt to collaborate in order to provide incentives. Even though it may hurt now in terms of the investment, it will undoubtedly pay off for everyone in those areas over the next five, seven, or ten years, not only by removing outdated buildings in urban areas and making them more useful and providing income from the additional tax revenue, but also by doing the right thing and providing affordable housing.

Brokers and commercial real estate companies that serve as consultants and counselors to their clients will emerge from this situation much stronger. On the other hand, brokers that specialize only in transactions may find it more difficult. Therefore, the best practice is to understand as much as you can about the macro implications and what's going on with the economy in order to be able to advise your clients. Additionally, there can be off-market chances for commercial real estate investors who still have the resources and ability to invest, where there might be some outstanding deals and advantageous purchasing opportunities.

Whether you are a commercial lender, realtor or broker, you should always surround yourself with a team of knowledgeable professionals. This would include engineers and architects who can advise clients on the best and highest use of the property, creating the highest aesthetic appeal for luring employees back to the workplace; attorneys who can assist with conversion and condominiumization, and obtain the legal variances and approvals that may be required; and a knowledgeable title company to research the property and have the expertise to handle complex commercial transactions, like CSS.

Since it will be up to brokers in the multifamily and investment sectors to go outside the box and truly start working as a team with their clients to figure out how to generate funds, it will be important to rely on connections in the banking sector, because those professionals can offer brokers a lot of advice and support on how to obtain capital, possibly in unconventional ways. I do anticipate an upward trend in non-traditional or unconventional financing for commercial borrowers while the interest rates edge higher and conventional lending tightens. Different methods can be used to raise money or ensure that potential purchasers have the resources necessary to close deals if both the buyer and the seller are driven to do so. This may involve seller financing of deals or obtaining funds through separate investors.

The construction industry's success is dependent on three factors: materials, labor costs, and profit margins. Unfortunately, it's unlikely that supply tensions will ease significantly in 2023. Labor costs may increase, and the industry job market may become more competitive.

Despite this, the future of commercial development is not all doom and gloom. We can expect a small increase, but it won't reach pre-pandemic levels.

Although this won't immediately help brokers or lenders, it's essential to remember the $500 billion Federal Reserve program for infrastructure. Based on anecdotal evidence in my area, this program has benefited the entire Commonwealth of Pennsylvania, as well as western Pennsylvania. It's likely that this money is being distributed nationwide, benefiting many civil engineering businesses and ultimately helping the construction industry.

It is well known that real estate investors enjoy taking risks. However, because of the uncertainty in the economy, we are aware that our sector is undoubtedly harmed. Due to this, the first two quarters may be difficult and there will be a little bit of paralysis in the market at least until we know more about what the Fed will be doing in regard to interest rates.

The office market has a significant impact on retail and even to some extent on multifamily housing. If people are coming into offices, there will be a more active downtown area. People will eat out for lunch and will be keener to get into new apartments and condo projects downtown, among other things. The post-pandemic/hybrid work situation remains a challenge for the general health of commercial real estate. Urban areas could greatly benefit from workers coming into the office two, three or four days a week.

The last challenge will be facing inflation. Over the past few months, inflation has begun to decline, something that directly impacts the costs of construction and operation, especially for office, industrial, and retail properties. We can only hope that pattern holds as real estate assets can be significantly affected by it. But, time will tell.

The sale-leaseback is frequently based on the property owner's need for additional funding or desire to take advantage of a healthy market, so that they may maximize the value of the asset out of which they are currently operating. Therefore, I'm not certain if that market still exists at this time–this is simply my speculation. It might make sense to knock on the doors of certain owner-occupants and ask if they would be open to a sale-leaseback if there are few traditional acquisition or purchase prospects available for investors and they have money to invest.

The utilization of registered leases by the federal government is currently low. This suggests that the trend for government leasing is similar to what we are observing in the office sector overall. In addition, the government is reevaluating how it uses its workplace space, but to date we have not seen a significant increase in requests from state and federal agencies as a result.

In conclusion, the best advice is to be prepared for a less-than-ideal scenario for 2023 and anticipate the potential outcomes. While the current situation may not be ideal, there is a possibility for a silver lining in the form of a soft landing and a stronger emergence in the third and fourth quarters, which could provide positive momentum going into 2024.

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Maura A. Snabes

SVP, Corporate Counsel,
corporate settlement solutions.

Maura has been the corporate legal counsel for a title company since 1994 and has been with Corporate Settlement Solutions since 2002, as SVP, Corporate Counsel.

She is a Certified Exchange Specialist® as certified by the Federation of Exchange Accommodators and is the founder and co-owner of Corporate Title Exchange Services which was founded in 1995 and which is a qualified intermediary for forward, reverse and build-to-suit tax-deferred exchanges. She regularly gives seminars on 1031 exchanges and other real estate matters to real estate and tax professionals in Northern Michigan.

Maura is highly involved with the community and is a member of the State Bar of Michigan; Charlevoix-Emmet Bar Association; Phi Alpha Delta Law Fraternity; Antrim-Charlevoix-Kalkaska Association of Realtors, is chair of the Professional Designation Board of Review for the Michigan Land Title Association (MLTA) and is a member of the MLTA Legislative Steering Committee. She is also a licensed Michigan real estate broker, Michigan Certified Land Title Professional (CLTP), ALTA National Title Professional (NTP) and is an ICLE contributor.

Maura and her husband live in Charlevoix, Michigan and have three grown children. She enjoys singing, traveling and participating in and watching competitive sports.

Edward R. Lawrence III

Senior Research Analyst,
Colliers International.

In his current role, Ed leverages his 15 year of experience as Vice President of Office Brokerage to provide research support to Colliers’ brokerage teams and clients.

This includes organizing a platform of comprehensive commercial real estate data, partnering with marketing to present materials to win new business and providing value to existing clients. He earned a B.A. from Denison University in Granville, OH and an M.B.A. from Waynesburg University. In his spare time, Ed serves as a board member for Service Coordination Unlimited (SCU) and enjoys spending time with is wife, Lisa and their two son, Eddie (23) and Charlie (16).

2023 Commercial Real Estate Forecast

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