US real estate prices have historically exhibited similar trends across subsectors, mainly reflecting growth and monetary policy cycles. However, since the Federal Reserve began raising interest rates in 2022, prices have diverged between the residential and commercial real estate sectors.
Recent price trends
In the residential real estate (RRE) sector, prices have continued to rise despite restrictive monetary policy. After a period of moderation following the first interest rate rises, price increases have regained momentum. The exception is new home prices, which represent around 10% of transactions and which have been decreasing for several months.
In contrast, since early 2023, prices in the commercial real estate (CRE) sector have been falling. Many observers fear that this will affect the rest of the financial system, as was the case during the 2007-09 crisis. The office sector has seen price declines exceeding 15% year-on-year. Retail space and rental apartments have also seen large price drops, although the trend appears to have reversed recently. In contrast, prices of industrial and logistics sectors have held up.
The divergence between RRE and CRE prices reflects supply and demand differences in the two sectors. At the end of 2023, the availability of residential properties for purchase or rental was historically low. In contrast, office sector vacancies were almost a fifth of the total. In the retail sector, where weakness in demand had emerged well before the pandemic, vacancies have stayed above 10% for over a decade.
The outlook for residential real estate
The outlook for activity and prices in the RRE sector remains favourable, supported by positive demographics and pandemic-driven changes in US households’ preferences. Strong employment growth and new household formation support housing demand. At the same time, supply is low, reflecting the adverse impact of the pandemic on the construction sector workforce and increased input prices and financing costs.
It therefore seems unlikely that house prices and rents will fall much in the near term, despite mortgage rates having risen to a 24-year high, depressing housing affordability. That household debt service and financial obligation ratios are close to the lows since the early 1980s supports the outlook for RRE.
The outlook for commercial real estate
The outlook for the CRE sector is multifaceted. Projects related to the production and logistics sectors will benefit from the fiscal measures introduced by the Biden administration, such as the Inflation Reduction Act, to stimulate US industrial production. The need to improve supply and distribution networks following the growth of online purchases at the expense of in-store purchases, will increase demand in the logistics and infrastructure sector.
The office sector remains the most vulnerable, especially in non-prime locations.2 The pandemic-driven structural decline in demand for office workspace, reflecting the shift to employees working from home and the subsequent rise of hybrid workplaces, led to declining occupancy rates. Furthermore, the growing preference for living further from urban centres makes central locations or locations far from transport networks less attractive.
Finally, the retail sector will remain under pressure due to the growing trend of consumers making purchases online. Even if the stability of economic growth helps to reabsorb part of the unused commercial spaces, it will take time before demand is sufficient to stimulate a price increase.
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