In this episode of The REconomy Podcast™ from First American, Deputy Chief Economist Odeta Kushi and Senior Commercial Economist Xander Snyder discuss what the encouraging fourth-quarter sales trends mean for the outlook for commercial real estate in the year ahead.
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More importantly, though, is that prices are stabilizing across asset classes. So, we mentioned that the declines are still happening in some cases. There are moderate increases in other asset classes. But the fact that they're not falling so drastically provides buyers with greater confidence of entering a deal and knowing that that's a good price to get the building at. And it provides lenders with greater confidence about asset valuations, which in turn lets them provide a greater quantity of credit to the commercial real estate industry.” – Xander Snyder, senior commercial economist at First American
Odeta Kushi - Hello and welcome to episode 110 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Xander Snyder, senior commercial economist at First American. Hey Xander.
Xander Snyder - Hey, Odeta.
Odeta Kushi - Today, we're going to turn our gaze back to the world of commercial real estate, specifically looking at transaction volume or sales activity in the fourth quarter. Now, transaction volume is a measure of the total amount of commercial property that's been exchanged in a given time period, and it can be measured in dollars, units, or number of properties.
Xander Snyder - Yeah, and it turns out that we received fairly good news from the fourth quarter data on commercial real estate transaction volume. Now, throughout the first three quarters of 2024, sales activity remained relatively stagnant, growing by only about 1% compared to the first three quarters of 2023. But the year ended on a high note, with fourth quarter transaction volume increasing by about 33% on an annual basis to $120 billion. So, the spike in transaction volume in the fourth quarter resulted in full-year transaction volume ending up by about 9% compared to 2023.
Odeta Kushi - How interesting. So, despite activity being essentially flat for most of the year, the spike in the fourth quarter transaction volume brought full year volume up to almost double-digit growth.
Xander Snyder - Yes, what's more, the increase in transactions was relatively broad-based. The increase in sales volume in the fourth quarter was driven by growth in multifamily, industrial, and office sales. Multifamily sales grew by 63% in dollar terms for the quarter year over year. Industrial by 29%, retail by 8%, and interestingly, office sales grew by 36%.
For the full year, the growth rates were a little lower. Multifamily sales grew by 21% compared to 2023, industrial by 5%, and office by 20%.
Odeta Kushi - 36% annual increase in office sales is definitely something I want to circle back to. But first, what about the remaining major asset classes? How did they do?
Xander Snyder - Well, retail sales increased by 8% in the fourth quarter, but for the full year was actually down by 8% compared to 2023. Hotel sales also fell in 2024, full year, by about 12%.
Odeta Kushi - Somewhat surprised by the full-year decline in retail sales, hasn't retail been performing relatively well in the post-pandemic period?
Xander Snyder - Yeah, well, part of the reason retail has been performing as well as it has been, at least from the perspective of an owner or operator, is that there's limited retail space available to lease and very little in terms of new construction being added to the stock. So, the lack of rentable space puts upward pressure on rents. And the lack of new construction means that there isn't a whole lot of retail space to buy or sell. So, if you're a retail owner at this point, benefiting from the limited availability of retail space, you're probably happy owning the property and won't be bringing it to market.
Odeta Kushi - Makes sense. It's hard to buy something there isn't a lot of. Now coming back to office transactions, this increase was a new trend, right? I think given the challenges that office real estate has endured in the post-pandemic era with the broader adoption of remote work, many would be surprised to see that number growing by double digits.
Xander Snyder - Yeah, it was a new trend. Office sales in the fourth quarter of 2024 were about $22 billion to give you a sense of scale. And that's the highest it's been in two years. Since the first quarter of 2023, so for seven quarters until last quarter, office sales have hovered between roughly $12 and $16 billion. And again, it was $22 in the most recent quarter.
Odeta Kushi - And did sales activity increase in both urban and suburban office markets?
Xander Snyder - Yeah, office sales increased in both urban and suburban markets. Breaking that down a little bit, urban office sales in the fourth quarter increased by, get this, 104% compared to the fourth quarter of 2023. Suburban office transaction volume increased by less, by about 9% compared to a year ago.
Odeta Kushi - Whoa, 104%. That's pretty significant. Is it time to cue Survivor’s ‘Eye of the Tiger’ for CBD's Office's comeback story?
Xander Snyder - I see you're keeping Mark’s ‘80s reference streak going. Well done. Well, I don't know if we're quite ready for ‘Eye of the Tiger.’ Maybe Journey’s ‘Don't Stop Believing’ is more appropriate. Will you take Journey?
Odeta Kushi - Okay, okay. I'll take Journey.
Xander Snyder - Yeah, so in dollar terms, the dollar value of suburban offices transacted has been and remains consistently higher in post-pandemic world than central business district offices or CBD or urban. And, as a point of comparison, the average quarterly volume for suburban offices between the first quarter of 2023 and the third quarter of 2024 was about $10 billion. Whereas that same average for CBD offices was less than half, it was about $3.5 billion.
Odeta Kushi - I see, so at least part of the reason growth in CBD transaction volume was over 100% is because CBD office sales were much lower than suburban sales a year ago. Sort of what we call base effects. If the base period is unusually low, even a small increase can result in a large percentage change, making the growth look stronger than it actually is.
Xander Snyder - Yes, exactly. In the fourth quarter of 2023, CBD transaction volume for offices was about $4.5 billion. Suburban was about $11.5 billion. A year later, the higher rate of growth for CBD office transaction volume was still lower than suburban offices. It was about $9 billion compared to $12 billion. So, despite that 100 plus percent growth, there are still more suburban offices transacted in the fourth quarter of 2024 than CBD offices.
Odeta Kushi - I have to ask, was there some sort of obvious catalyst behind the increase in office sales? Is it related to the onset of interest rate cuts in the first quarter, maybe?
Xander Snyder - Well, I don't think that there was a single catalyst, rather a confluence of factors. Perhaps the most important of those factors is that office property prices have declined substantially over the last two and a half years. And just for the sake of a mental exercise, even if your property is only 30% occupied, you can still make an investment make sense if you can buy the building cheaply. Compared to pre-pandemic, CBD office prices have fallen by 47%. By comparison, suburban office prices have been somewhat more resilient, falling by only about 5% compared to pre-pandemic.
Odeta Kushi - The decline in CBD office prices by almost half is quite striking. Yet office prices aren't quite done falling, though the rate of decline is moderating. On an annual basis, CBD office prices fell by a little more than 9% in the fourth quarter of 2024, and suburban office prices fell by about 2%, still negative, but less severe than mid- to late 2023 when CBD office prices were falling by over 30%.
Xander Snyder - Right, exactly. So, coming back to your question, I think one of the main drivers, albeit not the only one, of office transaction volume increasing by so much in the fourth quarter is that these price declines have occurred at this point. And they've occurred to a sufficient degree that certain investments are beginning to pencil out that wouldn't have if they cost 30% or 40% more to get into.
Odeta Kushi - I know a big question for office has been how far prices would need to fall to offset the reduced demand for office space and higher borrowing costs. The fact that office transaction volume increased as much as it did in the fourth quarter is probably a sign that prices have fallen enough to make this occur more often. Would you say this logic broadly applies to other asset classes as well? You have said before that the CRE recovery won't just be an interest rate story, but also a price story.
Xander Snyder - Yeah, I mean, I really think the main dynamic in the commercial real estate world generally right now, so beyond office properties, excuse me, is that these falling prices have begun to attract buyers back to the market. It's already happening. There are a few caveats. For one, retail and industrial prices are already back to growing and positive territory again, so they're no longer falling. More importantly, though, is that prices are stabilizing across asset classes. So, you we mentioned that the declines are still happening in some cases. There are moderate increases in other asset classes. But the fact that they're not falling so drastically provides buyers with greater confidence of entering a deal and knowing that that's a good price to get the building at. And it provides lenders with greater confidence about asset valuations, which in turn lets them provide a greater quantity of credit to the commercial real estate industry. And we saw evidence of this in the fourth quarter. Recent data from the Mortgage Bankers Association, or MBA, shows that commercial real estate lending origination activity picked up meaningfully in the fourth quarter, increasing by about 84% compared to the fourth quarter of 2023. Now, for the full year 2024, lending origination activity increased by nearly 40% compared to 2023, driven primarily by higher investor, lender, and CMBS originations, or commercial mortgage-backed security originations.
Odeta Kushi - Interestingly, that same MBA report shows that CRE mortgage originations from banks were up by 20% in 2024 compared to 2023. This is notable since another metric of bank lending trends showed that CRE lending standards tightened in the fourth quarter of 2024. This metric is the Fed Senior Loan Officer Opinion Survey, or SLOOS, as we affectionately refer to it and it has indicated tighter CRE lending standards and declining demand for CRE loans since early 2022. While that trend did not yet reverse in the fourth quarter, it is moderating, suggesting that CRE lending standards at banks may soon begin to loosen and that demand for these loans may begin to grow.
Xander Snyder - So, yes, there are two slightly conflicting data points here, but I do expect that the supply of commercial real estate credit will grow in 2025 as buyers return to the market because they will be chasing assets whose prices are no longer falling like this proverbial knife which has been happening over the last two and a half years.
Odeta Kushi - No one wants to catch a falling knife. So, does that mean that the CRE recovery is well and truly here?
Xander Snyder - Well, I think the answer is a qualified yes. The fourth quarter was definitely a promising quarter. And though transaction volume still remains below where it was pre-pandemic, it really seems like we are now firmly in positive growth territory. A lot of this is being driven by stabilizing prices and interest rates, and that's making it easier to acquire assets. However, it's worth noting that there has been meaningful upward pressure on a number of commercial real estate operating expenses. So, in addition to financing costs, things that you need to pay in order to run the building. So, things like insurance premiums or repairs and maintenance costs, material costs. So, this means that even if deal activity picks back up and we see more demonstrable signs that the next cycle has really begun, it's still going to be a more challenging operating environment than what prevailed pre-pandemic. So, I think there's going to be a much greater focus in this next cycle on managing expenses and operator capability. Additionally, with inflation, again, kind of proving stickier and harder to beat than many had imagined, we may be looking at interest rates that don't get cut this year. Maybe we get 25 basis points. Maybe they just stay where they are. Maybe the Fed even hikes a little bit in the future. We don't know. But higher rates could certainly slow the recovery down.
Odeta Kushi - All right, so a qualified yes abound with caveats in true economist fashion, but still optimistic. I think I will take it. Thank you, Xander, for coming on the show to talk about this nascent CRE turnaround. And thank you all for joining us on this episode of The REconomy Podcast. If you have an economics-related question you'd like us to feature in the future, you can email us at economics@firstam.com. And, as always, if you can't wait for the next episode, you can follow us on X. It's @OdetaKushi for me and @XanderSnyderX for Xander. Until next time.
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