What Lies Ahead for the Commercial Real Estate Market for the Rest of 2024?

Pockets of opportunity in the lackluster commercial real estate market may surface in the second half of the year, analysts say. But cracks in the U.S. labor market offer yet another challenge for the $23 trillion sector.

Beset by chronic office vacancies, rising defaults and falling valuations, the CRE market has struggled in the face of the Federal Reserve's policy of maintaining high interest rates to combat inflation.

High interest rates helped push overall CRE delinquency rates to 5% in May, up from 3.6% in the same month a year ago. A fifth of the $4.7 trillion in outstanding U.S. CRE mortgages mature this year—in a market where values have plunged about 30% since the Fed began raising rates. 

Consistently strong jobs growth has provided the market some relief amid those challenges. However, a cooling of the labor market could undermine that support.

How the Jobs Market Affects Commercial Real Estate

The decline of the commercial real estate market began as offices sat empty after pandemic-era restrictions and amid a slower-than-expected return to office for workers. As of the first quarter, growth in office jobs dating to 2022 had increased at just a third of the rate of overall employment growth.

One-fifth of all U.S. offices stood vacant in the first quarter this year, the highest percentage in history. Office construction has declined 63% since the pandemic.

A resilient labor market has helped limit the damage.

"Along with interest rates, job growth is probably the single biggest driver of growth in the real estate market," said Richard Barkham, global chief economist with property manager CBRE.

However, recent unemployment data suggests that the jobs market is beginning to lose some of its momentum.

A Fed Rate Cut May Not Solve CRE Woes

A cooling jobs market could prompt the Fed to cut high interest rates, which would reduce borrowing costs for commercial buyers and boost investor sentiment.

However, if the central bank is pressed to cut rates because the jobs situation has deteriorated significantly, the commercial real estate market would likely suffer.

"If the Fed is cutting because bad things are happening in the economy,"said Rebecca Rockey, deputy chief economist and global head of forecasting at property manager Cushman & Wakefield, "that's going to be bad for CRE.”

Torsten Sløk, Chief Economist at Apollo Global Management, noted that vacancy rates didn't improve much while jobs growth and the broader economy were strong.

"If the Fed succeeds with slowing the economy down, then (vacancy rates) will move higher, and potentially very quickly," Sløk said in a blog post.

Some See Reasons for Optimism

Rockey said the office market appears close to nearing a bottom, though falling rents and a dearth of transactions make market assessment difficult.

"I think we're close to a bottom, but there's just not the price discovery to really know," she said, noting some owners continue simply walking away from offices they can't rent. "We're going to continue this erosion of occupancy for the rest of this year."

Despite the challenges, it's not all doom and gloom for commercial real estate.

Al Brooks, head of commercial real estate with J.P. Morgan, said in a recent report that multi-family, retail and industrial real estate continue performing well. "The commercial real estate outlook for the second half of 2024 is largely positive," Brooks said.

Jeff Brown, founder and CEO of T2 Capital Management, a private equity real estate firm, said opportunities exist in more specific areas of the market, such as student housing communities.

According to Wells Fargo, "there are plenty of reasons for cautious optimism that a turnaround is on the horizon."

"If economic growth remains sturdy as we currently expect, then CRE demand should also stay afloat," economists at the bank said.