By Bill Adams, MBA, CCIM, CRB, ALC
As we reached the end of Q3 2022, the Atlanta commercial real estate market was still experiencing higher interest rates from the threat of a recession, inflation, the latest Covid-19 variant and the war in Ukraine. At the time, the unemployment rate was also down to 3.3%, the Trailing-12 Consumer Price Index (CPI), the widely used measure of inflation, was at a still high 8.2% and the high CPI was driven by the cost of food, housing and transportation. Supply chain issues and the war in Eastern Europe were still the main culprits for inflation. Meanwhile, the Federal Reserve Bank increased the Federal Funds Rate by 75 basis point three times during this time. As of September 30, the Federal Funds Rate stood at 3.25% and many economists predict a recession in early 2023.
We will look at how office, hospitality, multifamily, industrial, retail and the land sectors have fared as we head into the last quarter of the year.
Of all the commercial real estate product types, the office market may permanently feel the effects of the pandemic. In 2020, with the onset of the Covid-19 pandemic, offices emptied out as workers and employers reacted to the virus. In the “white collar” world of the office, most workers made the transition from the office to working from home without a major disruption to their productivity and income. Some workers even moved to more remote locations with a lower cost of living.
Covid is still a threat to working in the office and many firms have reconfigured their office space to allow for more social distancing. Other companies are subletting space and reducing their footprint because less workers are in the building. In the meantime, many workers have gotten used to not commuting to work, having to dress up, paying for expensive lunches and the other parts of their former office routines. Studies have suggested that these workers are more productive working from home than they were before the pandemic. Despite all of this it’s interesting to note that Class A office buildings in the Atlanta market, along with other Central Business Districts throughout the country, are still attracting tenants. Meanwhile, Class B and C buildings are having trouble both attracting and retaining tenants and many of these structures will probably end up being part of an adaptive reuse project to housing, lodging or other use.
According to CoStar, at the end of Q3 2022, the Atlanta office market had an inventory of almost 335 million square feet of space, an increase of .7% over the last 12 months. There is 3.9 million square feet under construction with a net absorption of 1.4 million square feet over the last year. The office vacancy rate is 14.4%, a slight increase over the past 12 months, and the average rental rate is $27.55 per square foot. Office properties sold for an average of $177 per square foot, a 3% increase over the past year with a market capitalization rate of 7.5%. The threat of a recession and the increase in Covid cases are not good for this sector though and many companies will continue to reduce their office footprint.
The Atlanta hospitality market is beginning to return to normal as conventions and tourists begin to return to the city in greater numbers. As I mentioned last quarter, Atlanta was named one of the North American venues for FIFA’s World Cup in 2026, and that is speeding up plans to add more hotel rooms to the Atlanta market. In the fourth quarter, the city will host the Southeastern Conference football championship game and the College Football Championship semifinals.
Personally, on a recent trip to Chicago, I experienced a well-staffed hotel that continued with Covid-19 protocols. While I believe some business travel will continue, other meetings will be replaced by Zoom calls which will impact the hospitality market’s bottom line.
CoStar reports that there are 110,849 hotel rooms in the city, an increase of 1.5% over the prior year. There are a total of 4,774 rooms currently under construction, including a 1,000-room Hilton Hotel on the Georgia World Congress Center campus in Downtown Atlanta. The current occupancy rate is 67%, an improvement of almost 9% over the past year. The average room rate is $116.55, an increase of 33.7% over the past 12 months. Hotels sell for around $61.40 per room with a market capitalization rate of 8.6%. Both numbers are slightly lower than last year’s figures. Covid is still the biggest threat in this sector and a possible recession in 2023 could dampen both business and leisure travel.
The multifamily market continues to be solid in metro Atlanta. Some signs of weakness include a very low absorption rate and anemic rent growth. For new projects labor, materials and financing are a few of the challenges confronting developers. With home mortgage rates exceeding 7% at the end of September, fewer people will be able to qualify for a loan to purchase a home and this ought to stimulate demand for rental properties.
According to CoStar, there are 483,182 units in the market — a .2% increase in the last 12 months. To meet expected increased demand, 34,335 units are currently under construction — an increase of almost 37% over this time last year. Only 1,536 units were rented in the last year — a drop of 75% — and I expect that this is a supply issue rather than a demand issue. The vacancy rate is 7.6% and the average monthly rent per unit was $1,623 — an increase of 2.7%.
The multifamily complexes that sold averaged $139,000 per unit at a market cap rate of 4.7%. As mentioned above, higher interest rates will likely increase demand for rental apartments. A deep recession could lessen demand as some apartment dwellers might return home to their parents’ basement. Investor demand for multifamily properties is still high, however, higher commercial mortgage interest rates will likely increase capitalization rates for sellers.
The Atlanta industrial market is the area’s strongest commercial real estate sector. Demand for industrial space continues to outstrip supply. Metro Atlanta’s population growth and its transportation infrastructure drive this sector of commercial real estate. The trend toward “last mile” industrial has included the adaptive reuse of obsolete retail properties and will probably also include converting some Class B and C offices buildings to industrial use.
CoStar reports that the inventory of industrial space reached 762 million square feet, an increase of almost 6% over 2021’s inventory. To meet the demand for industrial buildings, 41.4 million square feet of space is under construction. Almost 23 million square feet of space was leased over the past 12 months.
The vacancy rate for the Atlanta industrial market fell to 3.4% with an average market rental rate of $8.16 per square foot. The average sales price of an industrial property is $120.00 per square foot, up from $105 per square foot last year. The market capitalization rate for industrial properties is 6.2%. A recession might be the only real threat to this sector of commercial real estate.
The Atlanta retail market has experienced limited new construction in the past several years. The supply of retail space remains constrained and with continued population growth, the retail sector continues to attract both tenants and investors.
One trend I see happening for some retailers is the move to smaller footprints. Those retailers that have a strong online presence may want to continue a strong brick and mortar presence, just a smaller one. Another trend I see continuing is the adaptive reuse of former retail sites into mixed-use, industrial and institutional uses.
According to CoStar, the Atlanta retail market has 368 million square feet of space. There is less than 2 million square feet under construction, thus the vacancy rate in the market is 4%, down from 5% last year. In a positive sign for this sector of the commercial real estate market, 3.9 million square feet of space was absorbed last year at an average rental rate of $20.81 per square foot. Retail properties sold for an average of $154.00 per square foot, up from $141.00 per square foot last year, at an average capitalization rate of 6.2%. The threat of a recession, higher credit card interest rates and inflation do not seem to be slowing retail spending.
The Atlanta land market is difficult to define because a developer may purchase an improved property and then demolish an existing building to develop the land. Such a transaction may be recorded as an industrial, office or retail sale when it is in fact a land sale.
Here is a sampling of current Average Sales Prices in the markets within about a 6-mile radius of Downtown Atlanta. The sales prices vary by location and the size of the property. As you know, the size of a property usually has an inverse relationship with the purchase price.
- Downtown Atlanta – $645 per square foot
- North Downtown/South Midtown – $42 per square foot
- North Midtown – $277 per square foot
- Buckhead – $165 per square foot
- West Midtown – $24 per square foot
- Castleberry Hill – $45 per square foot
- Grant Park/Old 4th Ward – $80 per square foot
- East Atlanta – $14 per square foot
- Little 5 Points – $64 per square foot
- Downtown Decatur – $55 per square foot
The commercial real estate market is always characterized by a certain level of uncertainty. Our job is to use our analytic tools, read the tea leaves and try to mitigate any perceived risks to our clients. While not without risks and challenges, the current Atlanta commercial real estate market remains attractive to both small and institutional investors. Despite higher interest rates, mid-term elections, inflation, geopolitical disturbances, and the threat of a recession, I expect that the Atlanta market will remain a great place to own commercial real estate.
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