Understanding the Commercial Real Estate Market Cycle

Understanding the commercial real estate market cycle is a fundamental element of understanding the broader real estate market. However, before discussing the real estate market cycle, we should look more closely at what we mean by the real estate market.

There are many elements that make up the real estate market. This blog is focused on commercial markets as opposed to residential markets. Specifically, our market definition includes office, industrial, retail, and hospitality markets. Also the markets are further differentiated into urban and suburban markets, building class (A,B,C) and locale (city and regional markets).

The 4 Phases of the Commercial Real Estate Market Cycle

Commercial real estate markets follow a predictable 4 phase cycle. A Harvard blog post labeled the four real estate market cycle phases as:

1. Phase 1: Recovery
2. Phase 2: Expansion
3. Phase 3: Hyper Supply
4. Phase 4: Recession.

Phase 1: Recovery

Here the markets are on an upward trend; essentially coming out of the last down turn. In many urban and suburban markets, buildings are suffering from high vacancies, declining rentals, and some cases of bankruptcies and foreclosures. Unemployment is relatively high, and demand has diminished. Economic growth resumes, and property transactions increase, particularly in distressed properties.

Phase 2: Expansion

The markets are showing signs of recovery. Tenant demand is rising, along with rental rates. Real estate developers are beginning to buy and build new properties. Space absorption is increasing, and the general commercial markets are steadily improving. These trends vary by city and sub-markets, but in general this is a period of recovery. Vacancy rates decrease significantly due to strong demand and investor confidence is high, driving investment into the market.

Phase 3: Hyper Supply

This is the period in the cycle when markets boom, and become overheated. Most recently, this phase occurred during the COVID pandemic with many markets becoming over built, and supply exceeding demand. This was caused for various reasons, including businesses no longer needing offices after switching to remote work, decreased traffic because of lockdowns, and more. The result is declining rents and growing vacancies.

Phase 4: Recession

This is the bottoming of the market. (Remember the recession of 2008?) Foreclosures abound, bankruptcies depress the property markets, tenancy contracts, and many properties stand vacant for months. But the markets finally bottom out, and the general economic scene shows signs of recovery. The cycle repeats itself, with tenant demand increasing, rents rising, and occupancy improving with improved employment trends.

External Factors in the Commercial Real Estate Market

Several external factors can influence the commercial real estate market cycle. Economic policies, such as interest rate changes, can significantly impact the market. Technological shifts, like increased remote work, can alter demand for different property types. Global events, like the 2020 pandemic or geopolitical tensions, can disrupt the market and accelerate or delay the cycle as well.

Urban vs. Suburban Markets

Urban and suburban markets often experience different cycles. Urban markets tend to be more volatile, with more dramatic swings in vacancy rates and rental rates. Suburban markets, on the other hand, often experience more stable growth. The COVID-19 pandemic accelerated the shift towards remote work, leading to increased demand for suburban office and industrial space. Class A properties in urban centers may be more susceptible to market downturns than Class B and C properties in suburban areas.

What Stage is the Commercial Real Estate Market Currently in?

The current commercial real estate market is primarily in a hyper supply phase. This is evident in the office sector, where overbuilding and increased vacancy rates are significant challenges. While other sectors like industrial are performing relatively well, the overall market is impacted by the excess supply in these certain segments.

Many believe that the market may be heading towards a recession very soon, but the Federal Reserve did just cut interest rates for the first time in four years, which is a good sign for the commercial real estate market.

The commercial real estate market is currently very complex. While some sectors, like industrial, continue to thrive, others, like office, are facing significant challenges. As the market evolves, it’s crucial for businesses to adapt to these changes and optimize their real estate portfolios.

To effectively manage commercial leases and ensure compliance with complex accounting standards, leveraging a premium real estate lease accounting software is important. By automating lease accounting processes, businesses can gain valuable insights, reduce risk, and improve financial reporting accuracy. Contact us with any questions or request a demo today to see how Visual Lease’s software works.