By Todd C. Monahan, WCRE | CORFAC International
Every quarter, WCRE conducts surveys of the Southern New Jersey and Philadelphia commercial real estate markets, providing an in-depth analysis of various factors shaping its performance. In terms of a 2024 outlook, the commercial real estate landscape, particularly in the office sector, faces challenges contributing to an uncertain future.
The rise of remote work has led companies to reassess their office space requirements, putting sustained pressure on the office market. Employers have struggled to develop a coherent workplace strategy post Covid given remote work. However, 2023 saw more employers establishing hybrid work models and forcing employees back to the office several days per week. In turn, this has given employers more clarity on their office space needs and square footage. Many employers are changing the office design with more meeting space and collaborative work areas with less dedicated employee work spaces. For many employers, this has resulted in leasing less space but relocating to the best quality buildings, where state of the art air filtration, amenities and enhanced security provide the most modern and healthy work environments. The flight to quality will continue in 2024 enabling trophy assets to thrive and older more obsolete assets struggling to maintain occupancy levels. 2024 will be the year where the disparity between the haves and have nots widens.
In 2023 many over leveraged office assets failed to secure loan extensions or successful refinancing. This trend will continue in 2024 as more loans mature and lenders, reluctant to carry office debt, decline to finance or refinance office building loans. Our market has seen numerous defaults such as Center Square at 1500 Market (1.8M sf) the Wanamaker Building (1.8M sf), One South Broad (473K sf) and others. Several significant loan maturities loom, such as 1818 Market Street (979K sf), where Shorenstein has a loan maturing in March. Key metrics measuring the financial performance of key assets reveal financial distress and underperforming loans. Loan to Value (LTV), Debt Coverage Ratio (DCR) and Cash on Cash returns have put many owners of office building in precarious scenarios, unable to refinance or sell their assets.
Several owners have handed the keys back to the lender despite the lenders not wanting the assets on their books. This trend will continue in 2024 and 2025 with no obvious solutions in sight.
In contrast, the industrial property market continues to see high demand both for large box and smaller buildings due to an increase in manufacturing, along with e-commerce driven warehouse demand. Higher interest rates in 2023 impacted asset sales but user demand has not abated. We expect this to continue in 2024 as consumer demand remains strong, which directly impacts this asset class. And although the industrial vacancy rate decreased slightly in 2023, it remains historically low.
Resilient consumer spending continues to support retail space demand, with minimal new supply contributing to rent stability and low vacancy rates. However, a scarcity of retail space in desirable locations may impede leasing activity.
Despite facing headwinds, the U.S. economy has displayed resilience in 2023 and it appears a “soft landing” is very likely in 2024. The Federal Open Market Committee (FOMC) has refrained from further rate hikes, adopting a cautious stance on easing policy until sustained inflation aligns with its 2% target. Forecasts indicate a potential 225 basis points cut in the fed funds target range between Q1-2024 and Q1-2025. While lower interest rates may stimulate transaction activity and bolster valuations, projections indicate a slowdown in consumer spending, which will cool economic growth ever slow slightly.
Todd C. Monahan is executive vice president & managing director at WCRE | CORFAC International.