Wednesday’s announcement by the Federal Reserve of another ¾ point interest rate increase continues the central bank’s grim war with inflation. Higher rates are doing damage across the economy, which has never stabilized after the COVID-19 shock. But commercial real estate, vital to cities’ economic and fiscal well-being, hasn’t taken a big hit—yet.
Ever-higher interest rates are slowing the economy, and if the Fed keeps this up, it will induce a recession (which seems to be its goal.) Although some detected a softening in Chairman Jay Powell’s remarks on today’s rate hike, stock markets dropped sharply in reaction to Powell saying it was “premature” to consider suspending increases, saying “we have a ways to go.” That doesn’t bode well for the economy, or for jobs and demand, or for commercial real estate.
Cities and urban experts are especially worried about the impact on commercial real estate, which still has not recovered from the COVID-19 pandemic. That induced a rise in working from home (WFH) and a parallel drop in office occupancy, and there are signs those impacts are becoming somewhat permanent. The much-watched Kastle Office Occupancy barometer, measuring keycard swipes in ten major real estate markets, has been trending slowly upward, but the ten-city average still hasn’t broken 50%.
Forbes’ Jonathan Ponciano points out the Fed has now pushed interest rates to their “highest level since the Great Recession.” The Fed is reacting to continuing high inflation, even though many economists argue inflation is being driven by factors outside the Fed’s control, including food and energy price hikes caused by Russia’s aggressive war in Ukraine.
The Fed-induced slowdown has put downward pressure on office building rents and also thrown a shadow over future office construction. Cities depend on office work to provide jobs, both directly and for lower-paid workers who provide services like restaurants, security, and cleaning. The office sector also pays taxes, rents to landlords, and interest payments to banks.
These pressures on commercial offices worries many observers. Some scholars predict a commercial real estate “apocalypse,” seeing downward pressure on real estate values, and cheaper and shorter-term leases reflecting reduced demand as landlords scramble for tenants. Their analysis for New York City predicts “long-run office valuations that are 39.18% below pre-pandemic levels,” which could lead to a “fiscal doom loop” for city budgets.
It isn’t just scholars who are worried. In August, the Federal Deposit Insurance Corporation (FDIC) noted a concern about banks with large commercial real estate (CRE) concentrations, and said examiners will “be increasing their focus on CRE transaction testing,” especially on new loans and risks to bank balance sheets.
Thus far, we aren’t seeing a CRE meltdown. On the one hand, there’s downward pressure on property prices because as Eliot Kijewski of Cushman and Wakefield points out, “buyers’ inability to access credit at the once-historically low interest rates is chilling the investment market.”
But loan repayments aren’t collapsing. The Mortgage Bankers’ Association reports third-quarter delinquencies on commercial and multifamily lending actually fell slightly, part of a downward trend in 2022. Retail and lodging loans continued to be the worst, but even there delinquencies are moving down.
Delinquencies aren’t worsening because tenants’ rent payments haven’t collapsed, allowing landlords to pay their loan charges. CommercialEdge reported that September average office rents were down “2.4% year-over-year,” with a lot of geographic and sectoral variation—not increasing, but not a collapse.
There’s anecdotal data that clients are are pursuing high-end Class A office space, although they may be moving from existing, less desirable offices. Those older, less modern offices they are leaving are the big worry hanging over the sector and over cities.
Commenting on some positive moves by large New York companies into expensive new Class A offices, the New York Post quoted Jeff Peck of Savills saying “the subtext is who is going to absorb the spaces they’re leaving?” He noted that economic troubles for less affluent tenants will lead to demand for reduced rents and that “will cause real pain to these Class B minus buildings.”
That’s the essential commercial real estate and city budget problem from the Fed’s recession drive. Smaller businesses and non-profits will stop growing or shrink (or go out of business) in a recession, lowering demand for their office space. Some of those older buildings can be repurposed into residences, but that process takes time and requires more nimble policies from cities to encourage the transition.
And as Powell noted, the Fed likely isn’t done raising rates and pushing for a recession. That will bring losses in jobs, businesses, and overall well-being, with the impacts falling hardest on low-income and vulnerable workers, and disproportionately on Blacks and other minorities.
So we don’t yet have a commercial real estate “apocalypse.” But the Fed ‘s push for a recession means cities and the commercial office sector likely have further to fall.
TORONTO – One expert predicts Ottawa‘s changes to mortgage rules will help spur demand among potential homebuyers but says policies aimed at driving new supply are needed to address the “core issues” facing the market.
The federal government’s changes, set to come into force mid-December, include a higher price cap for insured mortgages to allow more people to qualify for a mortgage with less than a 20 per cent down payment.
The government will also expand its 30-year mortgage amortization to include first-time homebuyers buying any type of home, as well as anybody buying a newly built home.
CIBC Capital Markets deputy chief economist Benjamin Tal calls it a “significant” move likely to accelerate the recovery of the housing market, a process already underway as interest rates have begun to fall.
However, he says in a note that policymakers should aim to “prevent that from becoming too much of a good thing” through policies geared toward the supply side.
Tal says the main issue is the lack of supply available to respond to Canada’s rapidly increasing population, particularly in major cities.
This report by The Canadian Press was first published Sept. 17,2024.
OTTAWA – The Canadian Real Estate Association says the number of homes sold in August fell compared with a year ago as the market remained largely stuck in a holding pattern despite borrowing costs beginning to come down.
The association says the number of homes sold in August fell 2.1 per cent compared with the same month last year.
On a seasonally adjusted month-over-month basis, national home sales edged up 1.3 per cent from July.
CREA senior economist Shaun Cathcart says that with forecasts of lower interest rates throughout the rest of this year and into 2025, “it makes sense that prospective buyers might continue to hold off for improved affordability, especially since prices are still well behaved in most of the country.”
The national average sale price for August amounted to $649,100, a 0.1 per cent increase compared with a year earlier.
The number of newly listed properties was up 1.1 per cent month-over-month.
This report by The Canadian Press was first published Sept. 16, 2024.
MONTREAL – Two Quebec real estate brokers are facing fines and years-long suspensions for submitting bogus offers on homes to drive up prices during the COVID-19 pandemic.
Christine Girouard has been suspended for 14 years and her business partner, Jonathan Dauphinais-Fortin, has been suspended for nine years after Quebec’s authority of real estate brokerage found they used fake bids to get buyers to raise their offers.
Girouard is a well-known broker who previously starred on a Quebec reality show that follows top real estate agents in the province.
She is facing a fine of $50,000, while Dauphinais-Fortin has been fined $10,000.
The two brokers were suspended in May 2023 after La Presse published an article about their practices.
One buyer ended up paying $40,000 more than his initial offer in 2022 after Girouard and Dauphinais-Fortin concocted a second bid on the house he wanted to buy.
This report by The Canadian Press was first published Sept. 11, 2024.
