Midwest real estate market update: Navigating a sluggish year with glimpses of optimism
Posted By: REJournals on October 10, 2024. For more information, please click here to read the source article.
The real estate market in the Midwest has experienced a year marked by economic uncertainty, a restrictive lending environment, and lower transaction volumes. Assessing the year up to the final quarter of 2024, the capital markets have been nearly frozen, stalling development and transaction activity across multiple property sectors.
While smaller, owner-user properties have been somewhat resilient, larger and institutional properties have felt more pain. Higher interest rates throughout much of the year have kept many investors on the sidelines, waiting for more favorable conditions before re-entering the market.
This “wait-and-see” approach has been pervasive in both commercial and residential sectors. Buyers and sellers have struggled to agree on prices, while lenders, concerned with protecting their portfolios, have tightened restrictions and added more covenants to loan agreements. However, with the election weeks away and signs that interest rates are slowly declining, there is optimism that the market may begin to loosen as we move into the fourth quarter.
Although 2024 has been sluggish so far, recent metrics indicate that the Midwest real estate market may be poised for a gradual resurgence. Let’s take a closer look at the regional trends and market performance over the past nine months, as well as what we can expect in the final quarter of the year.
A Year of Challenges: Key Economic Factors
Several key economic concerns have significantly impacted the Midwest real estate market this year:
- Economic Uncertainty: Economic fluctuations, including inflationary pressures, have left many businesses and investors uncertain about the future. This has prompted a more cautious approach to investing, with companies delaying expansion plans and real estate acquisitions.
- Restrictive Lending Environment: Throughout the year, lenders have been reluctant to provide capital, particularly for new construction projects. With higher interest rates and increased financial scrutiny, borrowers have faced more restrictive covenants, making it more difficult to secure financing.
- Higher Interest Rates: For much of the year, interest rates remained high, which increased the cost of borrowing and dampened demand for real estate purchases. Though the 10-Year Treasury yield has recently dipped to 3.7%, signaling that rates may continue to decline, the challenges caused by prolonged higher rates has already slowed the market’s momentum.
- Election Year Pause: With the election just weeks away, there has been a pause in market activity as investors and businesses await greater political clarity. Many are holding off on decisions until they see what the post-election landscape will look like in terms of policy and economic stability.
Midwest Metrics: Key Property Sector Insights
Despite these challenges, there have been some noteworthy trends in the Midwest real estate market. Based on the available data for the first three quarters of the year, we can observe varying degrees of performance across different property types: retail, office, industrial, and multifamily sectors.
- Retail: The retail sector has seen negative absorption so far in 2024, reflecting a general decline in retail space expansion. The average rent for retail properties has stabilized at around $21 per square foot, and vacancy rates hover at a modest 18%. Retail is still in a phase of recovery post-pandemic, with consumers increasingly shifting toward online shopping. However, brick-and-mortar establishments have surprised to the upside in their stability and continued consumer patronage.
- Office: Office space continues to be one of the most challenging sectors. Absorption rates have remained negative, and average rents have fallen slightly, standing at approximately $24 per square foot. Vacancy rates for office space are around 23%, with the sector experiencing a uncertain recovery as hybrid and remote work models persist. However, there is some optimism that demand for office space may begin to pick up in the coming months as companies finalize long-term workplace strategies. Amazon is leading this charge with the recent announcement of five-day work weeks for all of its employees.
- Industrial: The industrial sector has performed more strongly than most others, with positive absorption and rents averaging around $7.75 per square foot. Industrial properties have remained in demand, driven by the continued expansion of e-commerce and logistics. Vacancy rates for industrial properties are among the lowest across the sectors, at just 14% and single digit vacancy rates in high-demand locations. Industrial construction is expected to remain a bright spot, although high construction costs still pose challenges for new developments.
- Multifamily: The multifamily sector has shown some resilience in 2024, with positive absorption and rents averaging $1,450 per unit. Vacancy rates are a low 8%, reflecting sustained demand for rental properties despite the broader economic uncertainties. Stable trends in the multifamily market can be attributed to a steady demand for housing, particularly as rising mortgage rates have kept many would-be homebuyers in the rental market longer than expected.
Looking Ahead: What to Expect in Q4 2024
As we approach the final quarter of 2024, there are signs that conditions may begin to improve across the Midwest real estate market. Several factors are contributing to a more optimistic outlook:
- New Construction – The Midwest has a smaller pipeline of new construction, which has the effect of curtailing supply and contributes to lower vacancy risk.
- Declining Interest Rates: the 10-Year Treasury yield, a barometer for mortgage interest rates is now at 3.7% and further reductions expected. Borrowing costs may become more affordable, helping to unlock more transaction volume and new development opportunities. If this trend continues, it could provide a much-needed boost to both the commercial and residential real estate sectors.
- Election Certainty: The conclusion of the election in the coming months will likely bring greater certainty to the market, regardless of which party prevails. Investors and businesses will have a clearer understanding of future policies and can make more informed decisions about acquisitions, investments, and expansions.
- Cap Rates Moving Downward: Over the last quarter, there have been indications that cap rates may be starting to move downward, which could help bridge the bid-ask gap that has persisted between buyers and sellers. If sellers become more flexible in their pricing expectations, we may see an increase in transaction activity, particularly in the retail and office sectors.
- Chugging Along: While the market may not be firing on all cylinders, it’s certainly grinding along, with certain sectors like industrial and apartments continuing to perform reasonably well. As more favorable economic conditions take hold, the Midwest real estate market could regain some of its lost momentum, even if recovery is uneven across different property types.
Cautious Optimism Amid Lingering Concerns
2024 has been a challenging year for the Midwest real estate market, with sluggish transaction volume, higher interest rates, and restrictive lending conditions. While the outlook for the remainder of the year appears more promising, several concerns still linger. Recessionary fears have subsided somewhat, but there is still talk of a possible downturn that could impact both demand for real estate and access to capital.
At the same time, construction costs, though moderated from their 2022 highs, remain elevated compared to pre-pandemic levels. This continues to pose challenges for developers, particularly in the industrial and multifamily sectors where demand for new space is still strong.
However, as we enter the final quarter, there are reasons to be cautiously optimistic. With interest rates declining, election uncertainty soon to be behind us, and positive trends in key sectors like industrial and multifamily, the Midwest market could see renewed activity in the months ahead. Despite these challenges, the region continues to chug along, proving its resilience in the face of economic headwinds.
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