The worst may be over for commercial real estate (CRE) assets, yet a full recovery is still some distance away, according to a recent report from Goldman Sachs.

The analysis, shared by analyst Caitlin Burrows on Friday, indicates that while the annual decline in CRE transaction volumes has likely bottomed out, significant challenges remain for a meaningful country-wide rebound, though some cities are exceptions.

CRE Market Has Bottomed, According To Goldman Sachs’s Burrows

Goldman Sachs notes that leading indicators suggest the CRE market has seen the worst of its downturn.

Drawing comparisons to the Global Financial Crisis (GFC), Burrows explained that it took eight quarters of year-over-year declines in transaction volumes before the market saw a positive shift in the ninth quarter. Currently, the CRE market has experienced eight quarters of declines, starting from the third quarter of 2022.

There have been some optimistic signs from leading indicators. Goldman Sachs highlighted that the OECD's U.S. Composite Business Confidence Index, which leads U.S. office leasing volumes by about two quarters, has shown steady improvement in recent months.

However, while the market may be at or near the bottom, a recovery phase akin to past cycles might still be a few quarters away.

Burrows emphasized that a positive turnaround will take more time due to persistently high interest rates and ongoing structural issues within the office segment. “It is likely to take longer to inflect positive,” she noted, pointing to the prolonged period of higher interest rates as a key factor.

City-Specific Market Improvements

The report also pointed to improving market conditions in major cities like New York and San Francisco.

“Manhattan has experienced strong leasing activity,” Burrows noted. She also mentioned that San Francisco is seeing “AI-driven demand,” which could help bolster the market.

San Francisco saw a significant increase in office tour activity in May, with a 73% month-over-month and 30% year-over-year rise, primarily driven by demand from TAMI tenants (technology, advertising, media, and information).

But Cautious Ahead Is Still Needed

Goldman Sachs highlighted ongoing challenges for the CRE market, citing that “higher rates for longer are likely to limit the pool of transactions.”

Bank credit to CRE continues to struggle due to already substantial exposure. The office segment remains particularly challenged, facing significant “structural headwinds.”

Before the COVID-19 pandemic, offices accounted for about a quarter of overall CRE transaction volumes. Post-pandemic, this share has plummeted to 15%, reflecting a substantial shift in market dynamics.

Furthermore, the CRE market exhibits considerable heterogeneity, resulting in divided asset valuations. High-quality, healthy assets in favored submarkets are experiencing strong leasing momentum, positively impacting valuations. In contrast, low-quality and distressed assets continue to face pressure on valuations, reflecting ongoing market disparities.

CRE-related exchange traded funds (ETFs), such as the Pacer Industrial Real Estate ETF INDS and the VanEck Office And Commercial Real Estate ETF DESK are both down by 10% year-to-date.

Yet, even within the troubled office CRE market some stocks have shown a strong performance with Net Lease Office Properties NLOP SL Green Realty Corp. SLG and HIW Highwoods Properties, Inc. HIW rising 30%, 27% and 16% year to date, respectively.

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