The Impact of Slow Returns and Rising Interest Rates on CRE

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Episode Transcript:

Today, we're shining a spotlight on the intriguing relationship between architecture and the commercial real estate market.

In a significant development, architecture firms have witnessed a stark decline in business activities during September. This downturn may serve as a harbinger of even greater challenges for the commercial real estate sector in the coming year.

The numbers tell a compelling story. The AIA/Deltek Architecture Billings Index, a reliable indicator of the demand for nonresidential construction activity, nosedived to a concerning score of 44.8 in September. To put this into perspective, it's the lowest score we've seen since December 2020, right during the throes of the Covid-19 pandemic. The key point here is that any score below 50 indicates a worsening business climate, signifying a growing number of architecture firms grappling with decreasing billings.

This index is no crystal ball, but it does provide a glimpse into the future. It aims to predict construction activity nine to 12 months ahead. Kermit Baker, the AIA's chief economist, points out a significant trend. Not only are more firms reporting a drop in billings, but clients themselves appear hesitant to commit to new projects. Newly signed design contracts have slumped, casting a shadow on the industry. Consequently, backlogs at architecture firms have dwindled to an average of 6.5 months in the third quarter, the lowest level since the fourth quarter of 2021.

For commercial real estate, it's been a turbulent ride. The slow return to office is impacting not only office buildings but also the retail stores and restaurants that rely on office workers. Downtown areas are feeling the brunt of these changes. However, there's a double-edged sword at play. A sharp upswing in interest rates has further complicated matters, causing investments and deal-making to grind to a near halt in most sectors.

It's important to note that this decline isn't limited to a specific region. While all parts of the country are experiencing a decline, the West Coast is seeing the deepest impact. Return-to-office plans have been slower to materialize there compared to other areas. Among various real estate sectors, firms with a focus on multifamily residential projects have borne the brunt of this decline. The multifamily construction sector witnessed a boom over the past few years, leading to a record number of units flooding the market, which, in turn, has created pressure on rents.

Analysts and experts are sending out caution signals. While there's an acknowledgment that the market needs to absorb the current glut of multifamily construction, there's a looming question about what's next. "After that, there won't be much for a few years after," cautions Peter Boockvar, Chief Investment Officer at Bleakley Financial Group.

As the commercial real estate market grapples with these challenges, the role of architecture firms becomes even more critical.

This is Tyler Cauble, Signing off