By Tim Courtney, Chief Investment Officer
While the stock market overall has been marked by up-and-down performance over the past couple of years,1 it’s clear that the commercial real estate market has taken a significant hit.2 Prime office properties, many located in the heart of our largest cities, are being sold for pennies on the dollar.3 Beyond the low sale prices, once-bustling office-building floors can now often be found eerily quiet, and previously reliable rent payments have proven to be far less consistent and significant than anyone might have imagined pre-pandemic.
While the famous slogan in real estate is “location, location, location,” even locations that were once deemed highly desirable are experiencing this downturn, a clear testament to how the pandemic has changed the way we work and where we do it.
This unexpected development offers crucial lessons to investors. First, we must understand that even market sectors that seem invincible can quickly change. It wasn’t long ago that office properties were generally considered very appealing and consistent investments, as real estate managers even overweighted portfolios with them.4 Yet, the widespread shift to remote or hybrid work and the resulting oversupply of office space have sent prices tumbling.
Second, leveraging money always carries risk. The allure of falling interest rates in previous years5 led many investors to borrow heavily to invest in more real estate, a strategy that worked while rates continued to fall. However, with interest rates now rising5 and office occupancy rates falling,6 many people are finding it increasingly difficult to service their debt, forcing them to sell off their properties at a loss.
Finally, these events underscore the importance of having a diversified investment portfolio. While it might have seemed unimaginable a few years ago for commercial real estate to be so negatively impacted, the unprecedented shutdown of our economy and ensuing workplace trends made this situation a reality. Pinning all your hopes on a single asset class such as real estate, especially one as specific as commercial/office property, can leave you exposed to unforeseen market shifts.
The current state of commercial real estate serves as a stark reminder of the unpredictable nature of our dynamic economy. While we can’t foresee every shift and turn the market will take, we can prepare for them prudently by diversifying.
At Exencial, we’ll continue to monitor the commercial real estate market and its implications for broader markets. Whether currently underutilized office buildings will be repurposed or filled once again with workers at some point remains to be seen. We think it still makes sense to maintain real estate as a portion of your portfolio. If you have any questions, please contact your Exencial advisor.
- MarketWatch (5/23/23) — S&P 500 Index
- CNN (3/27/23) — Commercial real estate is in trouble. Why you should be paying attention
- Fox Business (5/17/23) — San Francisco fire sale: Downtown high rise selling at a 73% discount
- Pensions & Investments (10/3/22) — Office sector loses ground, but firms still own a lot of it
- Forbes Advisor (5/3/23) — Federal funds rate history 1990 to 2023
- Forbes (11/29/22) — Office buildings are still less than 50% occupied. Who should worry?
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