Adjusting to Structural Change: the Outlook for Commercial Real Estate in the Twelfth District

Communities and businesses play a crucial role in shaping the Federal Reserve’s monetary policy. To inform our decision-making, the San Francisco Fed hosts discussions with the people we serve so we can hear their stories and perspectives on how economic data translates into real impacts in the Twelfth District. Our “Beyond the Numbers” series shares some of those insights with you.

During the pandemic and continuing into the post-pandemic period, Commercial Real Estate (CRE) has been buffeted by significant economic headwinds. Given the sector’s size and significance for both the Twelfth District and national economies, the SF Fed has been closely tracking the economic activity associated with the production, financing, and management of space for business, multifamily residential, commercial, and industrial activity.

After two previous roundtables in 2023, we recently convened our third roundtable. Mary Daly, President and CEO, and Laura Choi, Executive Vice President of Public Engagement, sat down with industry representatives. They were interested in how the various CRE asset classes are faring and focused on whether industry trends that had emerged in the last few years were continuing. Finally, they also discussed how roundtable participants viewed likely future developments. 

Different Outlook Across and Within Asset Classes

During previous roundtables, industry representatives emphasized the importance of differentiating between and within CRE asset classes when analyzing the sector. The participants in this most recent roundtable echoed this fundamental insight.

Throughout the period of turbulence in CRE, the office class has been a leading concern. Participants in this latest roundtable noted that the office asset class remains stressed. They pointed out that the demand for high end office space has picked up. However, the story is much different for lower quality office space. As one participant noted, “[L]ower end office space is rough.” Some owners have gone so far as take buildings down.

Participants also discussed the apartment market. Here they pointed out it was important to differentiate by location. Demand and rents have been increasing in coastal cities while cities, especially in the Sun Belt where the markets were particularly robust, have experienced marked weakness.

Some Clearing in the Market

President Daly and Laura asked participants for their view of the overall market, especially in relation to making transactions and the availability of financing. Industry executives distinguished between two property categories: one, properties that are performing and approaching refinance; and two, non-performing properties. In the second category it is difficult to secure financing, especially for office space.

It is a different matter, the participants emphasized, for the first category of properties. Here they noted that the market is beginning to clear. In 2023, there was a general reluctance to complete deals to avoid getting in too early and making mistakes. However in 2024, the participants felt the environment was better. There are more interesting opportunities available as prices seem to be near the bottom. Uncertainty does remain. As one executive underscored, it will take three years for the market to clear completely and now, “it is a matter of figuring out when the three-year period started.”

Adjusting to Structural Change in the Future

Asked about future developments in the sector, the leaders pointed to the structural change in the office class as one of the lasting effects of the current industry stress. The transition to remote work has permanently changed the office market, and the roundtable participants did not think demand for office space, especially on the lower end, will come back to pre-pandemic levels.

Nonetheless with the market beginning to clear, the roundtable participants had a more positive outlook generally. There are still sources of significant stress, but they felt they could be managed without leading to systemic stress on the overall economy. As one participant concluded, the real estate business is still in the hospital but it is “out of the operating room.”

The Value of Roundtables

The SF Fed’s conversations with CRE executives have been one of the most valuable sources of information about the state of the sector. Through these roundtable conversations, leaders and economic analysts at the SF Fed have been able to combine insights gleaned from economic data with a real-time perspective from practitioners in the field and achieve a richer understanding of the sector.

With such valuable data from stakeholders, the SF Fed is better able to fulfill its mission to develop monetary policy for the benefit of all Americans. This is the reason we will continue to listen and learn from business and community leaders across the Twelfth District.

The views expressed here do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.