Tenants and lessees often consider lease renewals to be perfunctory and routine. They may not be aware how the renewal process can give landlords the upper hand in setting terms of this new contract.
In fact, as soon as lessee signs the original contract, future negotiating leverage shifts to the landlord. Landlords knows that unless the lessee outgrows the space or has another strong reason to relocate at the end of that lease, they’ll gravitate toward re-signing and staying in that leased space. Landlords understand that businesses owners value continuity, and relocating is costly, disruptive to their business, and distracting for their employees.
The most recent commercial real estate (CRE) data show that we’re in a period of slow but steady transition. Throughout the Denver Metro area, the demand for industrial space has slowed and we’re likely in early stage of emerging from the depths of a depressed office real estate market.
We’re not out of the woods, yet though. Fed action is at least partially responsible for a dramatic decline in 12-month sales volume, which decreased almost 25.75 percent for industrial properties and 21.5 percent for office properties compared to Q3 2022. The CRE market is clearly in a wait-and-see mode at this time as it relates to future Fed interest rate increases.
For the most part, Metro Denver commercial real estate owners and investors have the luxury of waiting out a short-term economic downturn since markets here have been, and will likely remain, relatively strong compared to many areas of the U.S.
Rising Federal Reserve interest rates haven’t significantly impacted commercial real estate deals and markets yet. We have every reason to believe that even if the Fed continues its attempts to slow the economy, markets here will only decelerate, not necessarily decline.
Recent actions by the Federal Reserve Board appear to be on their way to having the intended effect – an economic slowdown, especially in the commercial real estate (CRE) market. The Fed’s Board of Governors has raised the federal funds policy rate by 225 basis points since the first of the year to 2.5% and that rate may reach 3.5% or higher by year end.
Let’s look at some of the national CRE implications of these rate increases before we zero in on what really matters – the Metro Denver market.
Slowdown in Commercial Construction and Transactions
Higher interest rates increase borrowing costs and, therefore, CRE construction project costs. These increases are coming on top of the higher costs already factored in over the past two years related to labor shortages, supply chain bottlenecks, and the cost of building supplies in general.
Is the U.S. in a recession? Whether the correct answer ultimately proves to be “yes,” “no,” or “not yet,” it’s an academic issue that’s not keeping us up at night.
There’s no doubt, though, we’re entering a period of economic slowdown in the commercial real estate market caused by:
- Inflation’s impact on consumer demand and, therefore, business activity.
- The series of Federal Reserve rate increases that are increasing the cost of lending, diminishing buying power, and reducing the number of qualified buyers for commercial real estate.
With interest rates steadily climbing, we’ll likely see the commercial real estate investment markets cool off, along with more parity between office space opportunities (the sector has struggled of late) and industrial space investment activity (which has been hot for several years).
However, interest rates shouldn’t be the only factor in a CRE investment decision, of course. Location and industry-specific trends (e.g., the life sciences boom in the Denver-Boulder corridor) also help determine demand, supply, and therefore the market price of a property.
