Given the uncertainties in both stock and bond markets this year and the increasing likelihood of a recession by year’s end1, it’s not surprising to see headlines focused on the real estate sector and its lagging performance. Let’s put context around these trends to evaluate the best course of action.
What is driving the poor performance in real estate markets?
Despite concerns, the overall real estate sector is slightly up for the year so far. That’s because the sector tracks both residential real estate and many forms of commercial real estate. Of all the real estate sectors, office properties are taking the biggest hit this year.*
As many people are still choosing to work from home for all or part of the week, office buildings have sat half empty on average since the beginning of the pandemic.2 This has forced building owners to lower rents and has raised their costs to attract new tenants, hurting profits. Financing costs for building ownership and maintenance have also skyrocketed as interest rates have gone up.
What is the outlook for the office real estate sector?
The office sector faces significant headwinds in the short term. A record $270 billion in commercial mortgages will need to be refinanced this year, at much higher interest rates.3 Property owners with floating-rate agreements have already felt the sting of higher rates and have been forced to sell their buildings at deep discounts. Fixed-rate payers who have yet to refinance may need to make similar decisions soon.
What happens over the longer term is uncertain. As the labor market gradually cools, employers might enforce stricter in-office attendance policies, which would be a boon for office real estate investments. It’s possible that office owners find their way out of these troubled times as they did in the 2007-2009 Great Recession. Despite losing over 70% in value during those years, the sector went on to return 16.1% per year for the next decade. By comparison, the sector has lost nearly 54% of its value since the pandemic began through May 2023.
Do I need to make changes to my portfolio?
Although the headlines might urge investors to act, often the best strategy is to stick with your long-term plan. Public real estate constitutes only 3%-4% of the total U.S. stock market 4, and office buildings make up less than 5% of public real estate.5 No matter the source of uncertainty, if you feel that the level of risk in your portfolio is too high, it’s time to review your plan with your trusted advisor.
