Persistent Inflation and Its Effects on CRE

While inflation is still a challenge for the Federal Reserve, there are many positive signs for the commercial real estate industry. The headline Consumer Price Index rose 3.2 percent for the year ended Feb. 29, a figure 20 basis points lower than the Dec. 31, 2023, rate. 

Lower energy and food costs helped slow the rate of inflation and global supply chains remained active in spite of regional and global conflicts. If we eliminate food and energy costs from the Consumer Price Index, the core CPI dropped slightly to 3.8 percent in February, slightly lower than the rate in December. Pricing pressures in the core CPI indicate that the economy is stronger, and inflation is higher than the Federal Reserve would like. These inflationary pressures, along with higher wage growth, have caused investors to stop expecting a rate decrease in April or May, as had been hoped.

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Despite these inflationary concerns, there are positive signs in the commercial real estate market in 2024.  Higher wages have increased the rate of household formation and the demand for apartment rentals. In the year ended in February 2024, the average hourly earnings for U.S. employees increased 4.7 percent, a rate well ahead of inflation. Government spending has continued to grow, causing labor and wage gains in many sectors of the economy. These trends are causing many experts to predict that 2024 will see a doubling in household formations as compared to 2023 and will create strong demand for multifamily housing. Nationally, almost 500,000 new apartment units are expected to hit the market in 2024, an all-time record.  he strong pent-up demand for housing units is expected to easily absorb the new construction, slowing the annual vacancy increase and causing rent gains of up to 1.5 percent nationally.

The inflation rate for services remained steady at 5.4 percent in February, showing a strong demand for both consumer and business services. The Institute of Supply Management Services Index rose slightly above 3 percent in February, which shows that the economy is still expanding. This expansionary trend is a good sign for the industrial real estate market, as industrial businesses continue to grow to meet the demand for their services. Nationally, experts predict the U.S. will absorb close to 200 million square feet on industrial space this year, pushing rent growth higher than the current average rate of 3.4 percent annually. In addition to industrial space, we are also seeing growth in the medical office market. The U.S. government is expected to continue to increase health-care expenditures in 2024. The expansion of health-care policies, coupled with the aging of the population, is expected to increase the number of medical office visits. Healthcare providers are expected to expand their footprints in order to meet these increasing demands.

An expanding economy, coupled with strong wage growth, has caused the Federal Reserve to take a cautious approach, and it is expected that they will not take action to lower rates until they see significant signs that inflation is under control. Despite this cautious approach, there are many encouraging signs for the commercial real estate market, a sector that has been hit hard over these past two years.

Stephen A. Sobin is president and founder of Select Commercial Funding LLC, a nationwide commercial mortgage brokerage company. He is a proud member of the Inter-Capital Group and the Commercial Finance Broker Network, both nationwide alliances of commercial mortgage professionals.