Stability in commercial real estate during times of change

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As the saying goes, “The only constant is change.”

The past three years have certainly demonstrated that we must all be financially prepared for unexpected changes to stay on course with our goals — and to stay ahead of potential issues. From rising interest rates, to inflation, and continued supply chain issues, the business landscape continues to be in a state of flux.

The Fed has continued its efforts to tame inflation with seven increases in the Fed’s funds rate in 2022 taking the rate from its low of 0 – 0.25% to its current level of 4.25 – 4.50%, marking the fastest, sharpest increase in lending rates since the 1970s.  While the effects of these rate increases are not fully clear at this time, recent market data suggests inflation is retreating but not to the Fed’s target of 2%. The Fed continues to suggest a higher fed funds rate is needed.  Employment strength persists, the housing market continues to experience high rates and prices and new home construction has slowed.  Long-term clarity on the debt market is still evolving.

Understanding the commercial real estate marketplace and its performance is a topic our business customers frequently inquire about. Our portfolio at ESL and the Greater Rochester marketplace overall continues to perform and remain strong. The local market continues to show overall resilience in performance albeit there is no question construction costs have risen significantly in the last 12 months, supply chain issues remain but are improving. Finding and retaining quality labor is a top priority to business owners and timelines on development projects have increased almost across the board. However, the business landscape trajectory continues to be positive as new developments are absorbed in the marketplace, and stabilized asset performance remains strong.

The multifamily market continues with exceptional strength achieving double digit rent growth in 2022 with more anticipated in the second half of 2023. For the most part, occupancy levels were at some of the highest levels ever in 2021 and further increased in 2022. Projects that came online were absorbed well and justified additional costs through higher-than-originally-projected rents.

We continue to closely monitor the market holistically as it reacts to the changing interest rate environment and the effect of higher rates leading to any value reduction through cap rate compression; we have started to see a little of this recently but not enough to note any trends as of yet.

While overall absorption levels and new household formations have recently slowed, the impact on occupancy levels is not anticipated to be material as the housing supply is still low and new construction starts have dipped.

Retail occupancy levels trended up in 2022 with some of the adaptive re-use of multiple big-box and mall anchor locations. Flex space remained healthy but saw some uptick in vacancy as some of the office component space struggled. However, part of the available inventory was successfully moved to accommodate the exceptionally strong industrial marketplace demand which had overall vacancy levels of around 5% at the end of 2022. Vacancy rates in the industrial market are forecasted to remain low as new construction is anticipated to slow in 2023. The office market continues to evolve post-pandemic to adapt to the changing overall employee experience through remote work, hybrid plans, and full in-office experiences. Overall vacancy levels hovered around 18% at year-end 2022.

While the market continues to wane on recessionary fears and the state of commercial real estate continues to evolve, businesses must remain ever-vigilant on market changes, turning to lenders for information and guidance to navigate the frequent changes we have seen. Lenders, like ESL, will continue to use this lens as our compass to address the questions, concerns, and needs of our customers. Regular communication is instrumental as we must work together to determine the best course of action as needs arise and market variables change, which, as we’ve seen time and time again, is to be expected.