Commercial real estate vacancies remain a 'major structural challenge' for select metro hubs: Broker

Marcus & Millichap CEO Hessam Nadji discusses the state of commercial real estate as vacancies remain a major structural challenge for major cities.

Video Transcript

- Commercial real estate prices fell in the first quarter. That's according to Moody's Analytics. It's the first time since 2011 that theory prices have declined. Joining us now for what lies ahead for commercial real estate, we want to bring in Hessam Nadji, CEO of Marcus & Millichap, an investment brokerage company that specializes in commercial real estate. Hessam, it's great to see you again. So Moody's out, say that they saw prices decline in the first quarter. Is that consistent with what you're seeing within your portfolio?

HESSAM NADJI: Good afternoon. Great to be with you on the program. Yes, it is. We are intermediaries and advisors to buyers and sellers. We don't actually own the properties ourselves. But because of our real time sense of what's happening with seller expectations and buyer expectations as the largest investment brokerage sales force in the country, really North America, including Canada, we have a real sense of the gap between that kind of bid ask spread.

And it's as wide as it's been really since the Great Financial Crisis because of the interest rate shock. The interest rate shock has been profound, 500 basis points in a year, is enough to cause a disruption in valuing real estate and really creating a lot of uncertainty and confusion.

So I'm not surprised to see Moody's index show a price decline. If you look at publicly traded REITs, they're down about 20% year over year. Public markets always react, maybe overreact on the way down than on the way up. The private market isn't quite as quick to respond. And so price corrections are somewhere between 10% to 15%, based on what we've seen so far.

But you have to remember. A lot of sellers are not bringing properties to market because the healthy fundamentals of properties, good occupancies, good rents, cause no real urgency to bring product to market when there is a disruption like this. On the flip side, we have some enduring loans and some distress that are bringing some inventory to the market as well.

You know, Hessam, we've been watching those office occupancy rates really closely because some companies have just struggled to get workers back to the office. It's been particularly glaring when you look at vacancy rates in places like San Francisco, as well as New York. What are you hearing from sellers on that front, and how do you see those spaces evolving? Because some companies just aren't going to bring their employees back.

It is a major structural challenge for our office clients across the country what's amazing is that some metros like you mentioned New York, San Francisco, Downtown Seattle have seen urban vacancies go up significantly, while others, for example, Las Vegas, or West Palm Beach, or Miami have seen vacancies stable or even come down because of in-migration of both companies and workers.

So it's not a general trend that is behaving the same across the country. Suburban markets tend to be doing much better than urban markets. And the pandemic really delivered a structural change to the way that the workers want to come back to the office or not. We're seeing a lot of incentives and a lot of initiatives by companies to bring employees back. But nonetheless, occupancy is on a daily average or barely above 50% across the country. Again, a lot of market variation.

So this is making office sort of the new retail because shopping centers and brick and mortar retail over the last 10 years was basically facing a shock from e-commerce. It has reinvented itself and repositioned itself. So retail is now actually ironically doing very well, while office properties struggle more than any other product type.

- Yeah. Hessam, it's been interesting to see the strength that we have been seeing in retail. What do you think is behind that? And also, when we talk about retail, what about the industrial side of the retail story? How does that look at this point?

HESSAM NADJI: You know, what has brought retail back is a lack of new construction for the last 10 plus years because retail was so overbuilt, and so much obsolescence was coming to market that there had to be different uses for lots of retail properties and different retenanting. And what really brought retail back was the experiential retail type of format with food, fitness, health, and beauty-related activities, and of course, entertainment.

That was quite strong prepandemic. It was devastated during the pandemic and has come back roaring since then because of pent up demand on the consumer side. With office buildings, it's going to be much harder to reposition them or in fact, even knock them down and repurpose them. Conversion of office to multifamily, multifamily is another very strong sector, is somewhat of an opportunity, but it's very expensive. And so the question is still out there as to what will happen to excess office space, especially older office buildings that aren't as compelling as the newer ones.

On the industrial front, ironically, e-commerce has created a whole new wave of warehousing and distribution facility needs that are modern and have just in time kind of an inventory management and transportation links. So industrial has been doing extremely well, primarily because of e-commerce.

- Specifically on retail, we have seen these mixed use cases pop up more and more. These large areas that were left vacant because a department store like JCPenney closed down. What do you do with that? We've seen apartments moving in. How much of that model do you see picking up? Because if you're looking at the residential side of things, we are still seeing it pretty limited in terms of inventory.

HESSAM NADJI: You're absolutely right.

- Multifamily, in particular, is doing extremely well. Occupancies are down a little bit year over year but still around 95%. And there's a lot of buzz around over building 400,000 or so apartment units this year. But if you look under the hood, those 400,000 units are really concentrated in about 10 major markets. The rest of the country is sharing 200,000 units of new apartment rentals, which is a rounding error. We have a housing shortage in this country that's acute. And with interest rates having gone up and home prices haven't gone up so much, there is even less affordability and more demand for apartment rentals.

There is a shortage of inventory outside of those 10 metros. And by the way, those 10 metros are like Atlanta, Dallas, Austin, Phoenix, that tend to have a lot of growth. But sometimes, they get ahead of themselves and build too many units. Overall, multifamily is performing very well, and the housing shortage is actually helping the demand stay very strong.

- Hessam Nadji, always great to get your perspective. CEO of Marcus & Millichap. Thanks so much.