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Commercial Real Estate: Washington State and National Update

  • August 13, 2024

The national commercial real estate (CRE) market remains “in a holding pattern” as of July with macroeconomic trends both buttressing and buffeting CRE sectors.

According to second-quarter data, commercial real estate is “benefiting from a moderate economy, particularly in multifamily as employment remains robust. On the other hand…interest rates are applying significant pressure,” writes Moody’s in a trend announcement. Data suggests “a period of continued stability in most sectors despite ample vulnerability should things sour in the broader economy.”

Which commercial real estate sector is buttressed by current economic conditions? Which is buffeted by them?

In this article, we’ll cover each of the major CRE sectors – multifamily, industrial, retail, and office – we’ll also cover new policies proposed in the state of Washington for commercial-to-residential conversions.

Multifamily Supported by Continued Demand for Housing

While not booming, multifamily real estate, such as apartment buildings, saw rents increase by 0.3% in the first half of 2024, according to Moody’s. Vacancy rates remained flat, sitting now at 5.7% for the sector as a whole.

Multifamily effective rents, though, have declined by 1.1% year over year. Moody’s noted that the decline follows an inflationary period that drove rents up substantially – they are now up by nearly 20% since the fourth quarter of 2019.

As Coastal Community Bank reported last week, according to the Building Industry Association of Washington (BIAW), the state needs at least 251,894 new housing units to meet current demand. The supply-demand mismatch has driven up rents and home prices for people across the state. According to Zillow, the state’s median rent is $2,100. Although median rents are rising now, they are still $100 lower than a year ago.

Industrial Coming Off Record Years; Retail in a Holding Pattern

Influenced by rising interest rates and lower demand, new construction projects for industrial facilities have slowed. Construction in this sector saw considerable growth during the past three, culminating in a new peak for construction volume in 2023.

Now, demand is falling “more rapidly than supply,” Moody’s reported. “Vacancies have been on the rise for several quarters.”

While the vacancy rate is still significantly lower than the pre-pandemic average, it has increased by 120 basis points to 6.5% nationally. Moody’s forecasts subdued construction activity for the retail sector for the rest of the year.

Retail vacancies remain flat at 10.4% thus far in 2024. Despite inflationary pressure, “spending has not ground to a halt,” Moody’s stated. “Consumers plan to travel and attend concerts this summer, indicating a shift in preference towards experiences over goods.”

Worker Use of Office Space Drops Like a Rock

Office buildings made history in the second quarter of 2024 by reaching a record vacancy rate of 20.1%. Moody’s reported that “effective rents have now been negative or flat for four straight quarters as the market continues to adjust.”

Conditions for offices are likely to worsen before they improve. According to a study, “What will be the impact on office demand from working from home?” published by Moody’s, office vacancy rates will likely “peak in early 2026 at approximately 24% nationally.”

Low unemployment is part of the work-from-home, low-office-usage story. About “28% of respondents indicated they would be highly likely to seek new employment if required to return to the office,” said Thomas LaSalvia, Moody’s CRE senior director. In an economy with strong employment – unemployment now sits at 4.0% and GDP growth at roughly pre-pandemic levels – employees can be more choosy about where and how they work.

Washington Considers Policy to Encourage Housing

According to The Seattle Times, about 14% of offices are empty or available for sublease across the Puget Sound region, including Seattle, Tacoma, and the Eastside. That’s the highest share since 2010.

On March 28, 2024, Washington Governor Jay Inslee signed a bill introducing a sales and use tax deferral program for the conversion of commercial buildings into affordable housing. The tax incentives went into effect June 6, 2024.

According to professional services firm Moss Adams, to obtain approval, certain requirements must be met:

  • The investment project is set aside primarily for multifamily housing units, and the applicant commits to renting or selling at least 10% of the units as affordable housing to low-income households.
  • The applicant commits to any additional affordability and income eligibility conditions adopted by the local government.
  • The project will occur on underutilized commercial property and is, or will be at the time of completion, in conformance with all local plans and regulations.
  • The area is located within an area zoned for residential or mixed uses and wasn’t acquired through a condemnation proceeding.
  • Cities may impose other requirements.

“If a conditional recipient maintains the property for qualifying purposes for at least 10 years, then the deferred sales and use taxes won’t need to be paid,” Moss Adams writes.

As we covered in our post last week, commercial-to-residential conversion can become profitable projects even without tax breaks. According to Fannie Mae, converting commercial properties into apartments serves housing demand and can avoid the cost of building new multifamily structures.

In California, one of the most expensive states for construction costs, thousands of hotel rooms have been converted into apartments at about 35% of the cost of new construction, Fannie Mae recently reported.

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