Transaction volume was still 14% greater than the five-year pre-pandemic average.
Transactional Cap Rates
Transactional cap rates increased to 6.4% during the first quarter of 2024, approximately 60 basis points greater than at the same time during the previous year. However, prices were more stable than other commercial real estate sectors, largely reflecting positive underlying fundamentals and fewer distressed assets.
Retail
The retail market normalized in early 2024, following a period of tightening during the past three years. Demand for retail space stabilized at an elevated level, although financial headwinds among households led to a moderation in consumer spending.
While operating conditions in the sector remained favorable, shifts in consumer spending patterns led to substantial variation in property performance.
Increased Savings
An unprecedented savings rate and stimulus measures fueled elevated consumer spending after the onset of the pandemic. In aggregate, US households accumulated excess savings of approximately $2.1 trillion, partially due to government stimulus efforts.
Some of these savings were exhausted relatively quickly, particularly among low-income households that relied on government benefits for necessary expenses.
Even as savings wound down, sticky spending habits persisted while higher-income households increased spending on discretionary items and services as investment returns boosted their consumer confidence.
Credit Card Debt Surges
Financial pressures began to accumulate during the second half of 2023 and into 2024, particularly among younger households. These challenges include rising credit card debt and the resumption of student loan repayments. Inflation also remained challenging.
The Consumer Price Index (CPI) increased by 3.5% in March 2024—less than the peak of 9.1% in June 2021. For some consumers, wage growth partially compensated for price increases. In fact, wages increased by 4.7% YOY.
Sustained elevated prices of essential goods, including groceries, continued to weigh on household budgets. As household finances normalized, consumer spending growth slowed, curtailing retail demand. Spending on goods increased by only 1.1% YOY as of February of 2024, while spending on services increased by 3.0%.
E-commerce
E-commerce accounted for a growing share of retail sales since the onset of the pandemic, including expenditures through omnichannel platforms and digital or physical hybrid shopping experiences. E-commerce led to weaker demand for certain types of physical retail, including Class B and C regional malls.
Other product types were more resilient to online cannibalization, including pharmacies and grocery stores. In fact, operating conditions among necessity-based retailers outperformed the overall retail market. Retailers who offer unique or distinctive experiences, including many outdoor shopping centers or food and beverage outlets, were also less likely to be replaced with online shopping.
CBD retail locations, which historically relied on daytime foot traffic from office workers, also performed poorly in certain parts of the country. This trend was particularly pronounced in regions with a higher proportion of remote workers, such as the major West Coast cities.
Tracking with broader trends across all commercial real estate sectors, sales volume of retail properties slowed. Total sales volume decreased by 36% YOY during the first quarter of 2024. The single-tenant segment accounted for nearly 30% of all transactions, the largest share of any retail category, and sales in this segment slowed less than the overall retail sector.
Total Retail Transactions
The decrease in total retail transactions was the smallest decline across all major property sectors, partially reflecting entity-level trades which boosted overall sales volume.
More stable sales volume also reflected greater investor confidence in the sector, owing to favorable underlying fundamentals in some segments, as well as the asset value correction in the retail sector that occurred over the last two decades.
Lodging
The lodging market was swept up in a wave of pent-up demand for travel in the aftermath of the pandemic, which persisted into 2024. Shifts in work arrangements and consumer behavior contributed to changes in travel patterns during the past three years, leading to varied hotel operating conditions across property types.
Total travel volume consistently exceeded the pre-pandemic level in 2023 and into 2024. Air travel throughout in mid-April 2024 was more than 5% greater than at the same time during the previous year, even as consumer spending moderated in non-travel categories, highlighting robust travel demand.
Business Versus Leisure Travel
Elevated travel volume largely stemmed from an increase in leisure travel, while the business travel recovery remained sluggish. While many companies returned to the office, at least on a part-time basis, short-term business trips were eliminated by some firms.
In-person meetings between work teams and client groups largely shifted to remote alternatives, partially as a cost-cutting measure as well as to reflect the diverse locations that employees and customers may now be in.
Work-from-home arrangements enabled the rise of bleisure travel, which combines both business and leisure in one trip. For example, a remote worker may choose to work certain days while on vacation to spend more time in a certain location.
Domestic travel demand softened in favor of international destinations. At the same time, inbound international tourism was limited by ongoing geopolitical volatility, particularly in the Middle East and Eastern Europe, and economic challenges in trading partner nations, including China.
Reduced levels of international tourism particularly impacted hotel conditions in gateway markets, including Honolulu and San Francisco.
Operating Conditions
Operating conditions eased slightly during the first quarter of 2024. The occupancy rate softened to 58.9%, approximately 120 basis points less than at the same time during the previous year. The average daily rate (ADR) growth also slowed to less than 3% YOY, slightly less than the rate of inflation.
Luxury
On an absolute basis, occupancy was strongest in the luxury segment, but luxury hotels in urban areas were still very weak relative to the pre-pandemic level, partially stemming from the reduction in business and convention travel.
Investment Market
In the investment market, sales volume slowed by 43% YOY and increasingly skewed toward limited-service hotels.
This pace of decline accelerated from the prior year in contrast to most other commercial real estate sectors. The slowdown in transactions partially reflected liquidity challenges, but also stemmed from investor wariness of the sector amid speculation of a looming recession.
Apartments
In the residential space, the perfect storm of obstacles hit the apartment sector. While positive underlying demand fundamentals supported apartments through early 2024, the ongoing wave of new supply still led to weaker operating conditions in many markets across the country, particularly Sun Belt cities.
Highlighting the substantial impact of new development, operating conditions across different geographies closely correlated with the extent of new supply relative to existing housing stock. Beyond supply-side headwinds, increased operating costs also compounded ownership difficulties, leading to significant risk in some cities.
Multifamily Trends
Multifamily starts rapidly accelerated in 2021 and 2022 amid a surge in renter demand, which led to a substantial increase in apartment completions during the past two years. In fact, the professionally managed apartment stock increased by 6% since 2021. This represented an absolute increase of nearly one million units, an outsized share of which were concentrated in the Sun Belt, including Austin, Phoenix, and Houston.
Demand for rental housing remained elevated across the nation through early 2024, partially stemming from low affordability in the for-sale market. Even robust demand was insufficient to absorb all the new units. Operating conditions eased in most cities across the country in early 2024 as supply surpassed demand, although there was substantial regional variation.
The vacancy rate increased to 4.5% during the first quarter of 2024. This was a modest increase of 60 basis points compared with the prior year. Rent growth moderated to 1% YOY compared with a peak of 15% during early 2022.
Many Mountain region states and Sun Belt markets where construction activity was even more elevated than the rest of the nation saw rent declines during this period. Conversely, rent trends in supply constrained coastal cities were generally more favorable.
Beyond geography, operating conditions were also bifurcated by type of property. Limited opportunities for financially feasible workforce housing development translated to tight conditions in the Class C segment. Professionally managed Class C apartments continued to produce positive rent gains, even as rent growth flattened in the midrange segment and declined in the high-end segment.
Management and Operations
On the management side, operating costs posed a substantial challenge to investors. Apartment operating costs increased by 7% YOY as of January 2024. Insurance expenses were the primary driver of operating cost increases, with average premiums up by 28% YOY. Administrative, maintenance, and other costs also contributed to rising expenses. Insurance costs were particularly challenging in states with high climate risk, including Florida.
Weaker than expected rent growth and higher operating costs created uncertainty in the investment market. True asset values were difficult to ascertain, leading to a bid-ask gap and a rapid deceleration in transaction activity. This was further compounded by elevated debt costs and financing challenges.
While investment volume slowed, government sponsored enterprise (GSE) liquidity as well as stronger demand fundamentals buoyed acquisitions relative to other property segments. Apartment sales accounted for 34% of all US commercial real estate transactions during the first quarter of 2024, the largest share of any sector.
The sector accounts for the largest share of potential distress given the greater number of assets while apartment distress remained limited. More than $470 billion of multifamily loans are expected to mature during the next two years, the largest share of any sector.
While some borrowers may be able to extend or modify existing loan terms, the majority will mature during a challenging financing environment and with limited opportunities to pass on higher expenses to tenants in the form of increased rents.
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