Sector and city performance to remain uneven - Capital Economics
US Commercial Property

Sector and city performance to remain uneven

US Commercial Property Chart Book
Written by Kiran Raichura
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Fiscal and monetary stimulus have kept economic growth solid and will support a continued recovery. While this bodes well for occupier demand, structural factors have weighed heavily on the office and retail sectors. That weakness is set to persist this year. On the other hand, industrial has benefited from structural forces, while apartments, which have been faring poorly, are beginning to show the early shoots of recovery. Nevertheless, even in the apartments sector, where investment totals set a new quarterly record in Q4, there will continue to be a wide range of performance, with cheaper Southern cities faring particularly well and more expensive northern coastal cities less so.

  • Fiscal and monetary stimulus have kept economic growth solid and will support a continued recovery. While this bodes well for occupier demand, structural factors have weighed heavily on the office and retail sectors. That weakness is set to persist this year. On the other hand, industrial has benefited from structural forces, while apartments, which have been faring poorly, are beginning to show the early shoots of recovery. Nevertheless, even in the apartments sector, where investment totals set a new quarterly record in Q4, there will continue to be a wide range of performance, with cheaper Southern cities faring particularly well and more expensive northern coastal cities less so.
  • Economic indicators show that the economy held up well in recent months despite enforced business closures, probably reflecting the effect of fiscal stimulus measures. With more stimulus to come and the Fed set to keep interest rates at historic lows, GDP and employment look set for solid growth this year.
  • National Occupier Market indicators were mixed. Vacancy rates rose again in offices, retail and apartments on the back of weak demand. But industrial property saw absorption strengthen again in Q4, causing vacancy to fall. These divergences are reflected in the outlook, with industrial rents growing steadily but the other sectors seeing falls, though there are nascent signs of recovery in apartment rents.
  • City Market Indicators highlighted that the most expensive cities have suffered the largest employment falls and reductions in demand, in both offices and apartments, generally underperforming the US average. That has also translated to rents and capital values. Boston and Seattle are notable outperformers in offices, while less expensive Southern cities stand out in the apartments sector. (See Chart 1.)
  • Investment Market Indicators pointed to a strong rise in activity in Q4. All sectors saw an increase, but this was most pronounced for apartments, where deal totals set a new quarterly record. The divergence in occupier markets was reflected in yield and capital value performance, with the office and retail sectors seeing further price declines in Q4 and the more expensive office and apartment markets faring worst in those sectors. Further capital value falls are likely in those markets in the first half of the year.
  • Economic Data and Forecast Summary

Chart 1: Apartment Capital Values (%)

Source: MSCI

Economic Indicators

  • Renewed virus restrictions, prompted by a resurgence in infections, weighed heavily on the economy in the fourth quarter (2). Indeed, annualised GDP growth slowed to 4.0%, down from 33.4% in Q3 (3). However, with virus cases dropping back, $900bn of fiscal stimulus working itself through and the prospect of further fiscal support, economic activity is likely to pick up in the coming months
  • Tighter virus restrictions are taking their toll on job growth, which increased by just 49,000 in January, leaving employment still 10 million below its pre-virus level (4). But the recovery will gather pace as the vaccine rollout allows more of the economy to reopen and demand is boosted by fiscal support. In fact, there are already signs that the stimulus is having a positive impact on the economy, as retail sales gained 5.3% m/m in January after three consecutive months of decline (5).
  • The virus-induced weakness in activity and employment is weighing on core CPI inflation, which fell to 1.4% in January (6). But base effects will drive both core and headline inflation back above 2% over the coming months. Despite this, the Fed is expected to allow a period of sustained above-target inflation, in line with its new average targeting strategy, and keep interest rates close to zero. In contrast we expect the 10-year Treasury yield to climb to 1.5% by the end of 2021, driven by higher inflation compensation (7).

Chart 2: COVID-19 Infections & Deaths

Chart 3: Real GDP

Chart 4: Non-Farm Payroll Employment (Millions)

Chart 5: Retail Sales (% m/m)

Chart 6: CPI (% y/y)

Chart 7: Interest Rates (%)

Sources: Refinitiv, Capital Economics.

Office Market Indicators

  • Net absorption worsened further in Q4, falling to minus 9.8m sq. ft. (8). That REIS figure was again well below the minus 28.4m sq. ft. reported by brokers. Indeed, CBRE data shows a total reduction in occupied space of 80.1m sq. ft. in the last three quarters, which far surpasses the 46.4m sq. ft. seen in the GFC. Those falls are likely to come through in the REIS data in the coming quarters. Meanwhile, Q4 completions reached 7.4m sq. ft., meaning that annual levels accounted for just 0.8% of inventory (9).
  • The net result of these factors was that vacancy rose by 30bps q/q, taking the annual uplift to 90bps (10). This data doesn’t take account of sub-lease vacancy, which continues to grow rapidly. And vacancy has continued to rise rapidly in both suburban and downtown locations. Notably downtown vacancy has already far exceeded the level seen in the GFC (11).
  • Asking rents are still up on an annual basis but fell by 0.2% q/q in Q4 (12). Net effectives were down by 0.7% y/y though, reflecting that increased incentives have been the main tool used by landlords so far. We expect rent falls to accelerate this year. The combination of rental weakness and rising vacancy means that offices NOI growth fell sharply over the year, with downtown locations hit hardest (13). Both sub-sectors are likely to see more pain as tenants leave excess space behind and rents adjust downward.

Chart 8: Office Net Absorption (M sq. ft.)

Chart 9: Office Completions (% of Inventory)

Chart 10: Change in Vacancy Rate (Bps)

Chart 11: Suburban vs. Downtown Vacancy (%)

Chart 12: Rental Values

Chart 13: Net Operating Income (4Q mov. avg., % y/y)


Office Market Indicators

  • Office employment growth was widespread in Q4, but in most of the top cities, the level of jobs remained down compared to Q4 2019 (14). The largest and most expensive cities have generally been hardest hit. In fact, except for Chicago, absorption was negative in all six major cities this quarter, with Los Angeles (LA) and San Francisco (SF) seeing their largest quarterly falls in occupancy since Q3 2009. The Q4 outturn fed through to annual falls in absorption, which reached 1% of inventory in SF (15).
  • Consistent with the national picture, completions fell back in 2020, except in LA where the level was the same as the previous year (16). As a result of the growing demand-supply imbalance, vacancy rates rose across the board in Q4, though the annual increase was most pronounced in SF (17). We expect vacancy to continue to rise this year, thanks to further falls in absorption.
  • Those rises in vacancy are already feeding through to rents, where year-on-year growth rates are slowing and have already turned negative in NYC and Washington D.C. (D.C.). Boston is the major exception, as it continues to benefit from life sciences demand, although we still expect rents to decline this year (18). Those differentials were echoed in capital value performance, with Boston and Seattle seeing rising values on both a quarterly and annual basis, reflecting positive investor perception (19).

Chart 14: Office-Type Employment (%)

Chart 15: Net Absorption (Rolling 4-qtr, % of Inventory)

Chart 16: Completions (Rolling 4-qtr, % of Inventory)

Chart 17: Change in Vacancy Rate (Bps)

Chart 18: Asking Rents (% y/y)

Chart 19: MSCI Capital Values (%)

Sources: MSCI, REIS

Apartment Market Indicators

  • Renewed lockdowns combined with the expiration of government income support hit rental demand in Q4, causing the net absorption rate to fall to an 11-year low of 0.14% (20). However, the rise in vacancy was relatively modest. REIS reported a 20bps quarterly rise, to 5.2%, up from 4.7% a year earlier (21).
  • One factor preventing a larger rise in vacancy has been a reduction in completions. REIS reported just 34,400 units completed in Q4, which would be the lowest since the start of 2014, although there are likely to be upward revisions (22). The fall in completions has not been accompanied by a drop in apartment starts, which is consistent with our expectation that completions in 2021 will be a similar level to 2020.
  • Alongside the rise in vacancy, there has also been a rise in rent arrears, which has worsened since the expiration of government income support late last year (23). But the issuance of new stimulus checks in January and the prospect of further support mean arrears should ease back in the next few months.
  • According to REIS, rental growth dropped to -3.0% y/y in Q4, while other measures have also shown a slowdown (24). However, more timely data from Apartment List show asking rents rising in December and January, which fits with our view that rents should begin to recover as the economy picks-up. Nevertheless, apartment net operating income again fell sharply in Q4, dropping by 5.2% q/q (25).

Chart 20: Net Absorption Rate (% of Inventory)

Chart 21: Apartment Vacancy Rates (%)

Chart 22: Apartment Completions (000s units)

Chart 23: Rent Paid by End-Mth (Diff. from last yr, % pts)

Chart 24: Rental Values (% y/y)

Chart 25: MSCI Net Operating Income (% q/q)

Sources: Census Bureau, MSCI, Refinitiv, REIS

Apartment Market Indicators

  • Employment growth slowed in all cities in Q4, after the sharp bounce in Q3. This meant that metro employment levels were still lower in Q4 2020 than in Q4 2019 (26). And absorption remained soft in Q4, turning negative on an annual basis in D.C. and SF (27). Only Boston outperformed the US average, reflecting the net-migration away from larger and more expensive cities last year.
  • Helpfully for current landlords, completions dropped back sharply in a few cities, although Q4 figures are likely to be revised higher as more data becomes available. Therefore, the 2.4% increase in inventory in D.C., which already looks high, is likely to be worse still (28). Those new deliveries have already caused D.C.’s vacancy rate to jump sharply (29). And while the rises elsewhere look more muted, this dataset doesn’t capture the effect of sub-leasing, which points to a further rise in vacancy in Q1.
  • Indeed, sharp falls in rents show the true extent of the pain that landlords have faced in the most expensive cities. Even though quarterly rent falls slowed, they still reached 5.5% q/q in SF and 4.4% q/q in NYC. That pushed annual declines to 14.7% and 11.9% respectively (30). Those declines have been reflected in MSCI capital values, with SF seeing another 2.8% q/q drop in Q4. Conversely, cheaper Southern cities dominate the best performers in Q4, showing a rise in capital values (31). That trend is likely to continue in the first half of the year, although we think the more expensive cities should improve in H2.

Chart 26: Metro Employment (Total, %)

Chart 27: Net Absorption (Rolling 4-qtr, % of Inventory)

Chart 28: Completions (Rolling 4-qtr, % of Inventory)

Chart 29: Change in Vacancy Rate (Bps)

Chart 30: Asking Rents (%)

Chart 31: MSCI Capital Values (%)

Sources: Refinitiv, REIS, MSCI

Retail and Industrial Market Indicators

  • Virus restrictions – and the associated drop in in-store spending – have forced struggling retailers out of business, leading to a fall in occupied retail space. Indeed, net absorption in neighbourhood and community (N&C) centres was negative for a third consecutive quarter in Q4 (32). The pandemic has also caused a sharp decline in completions of new retail space which fell to the lowest level since Q1 2011.
  • Falling demand for space pushed vacancy higher in Q4, with the rate for both N&C centres and regional malls rising to 10.5% (33). While vacancy has been trending upwards for several years, rents only started to fall in 2020. Regional malls have been hit hardest over the past year, with rents falling 1.8% y/y (34). But we expect retail rent falls to accelerate to minus 2.7% in 2021, with regional malls faring worse still.
  • The picture for distribution warehouses is more positive, as the shift to online spending is driving demand for storage space. Indeed, net absorption increased in Q4 (35). The sharp decline in new completions this quarter should be treated with caution as REIS also reported falls in Q2 and Q3, which have since been upwardly revised. That said, it may reflect disruption to development caused by virus restrictions (36). The reduction in completions helped the vacancy rate to edge back in Q4 to 10.5%, having risen steadily since Q3 2017. This prevented further declines in rental value growth, which remained at 1.2% y/y (37).

Chart 32: N&C Net Absorption (M sq. ft.)

Chart 33: Vacancy Rate (%)

Chart 34: Retail Asking Rents (% y/y)

Chart 35: Industrial Net Absorption (M sq. ft.)

Chart 36: Industrial Completions (M sq. ft.)

Chart 37: Vacancy and Asking Rents

Source: REIS

Investment Market Indicators

  • Investment activity rebounded strongly in Q4, reaching $145.4bn, nearly half of which was transacted in December (38). This was only 11% below Q4 2019, but still left the annual total nearly 30% down. All major sectors saw a bounce, but at $56.7bn apartments set a new quarterly record (39). Indeed, apartments accounted for over 40% of deals in Q4. By contrast, offices, where activity was down 41% in 2020, accounted for just 20% of all Q4 activity (40). With investors keen to put capital to work and some mid-size cities seeing in-migration, we’re likely to see industrial and apartment demand stay strong in 2021.
  • It was a mixed picture for yields in Q4. While office yields were broadly flat, NOI yields for industrial and apartments fell on the back of the strong investor demand for assets. Retail (gross) yields also dropped, by around 10 bps, but this was surprising given the still-poor outlook for the sector (41).
  • Indeed, retail capital values still fell by 2.2% q/q, taking the annual drop to 12.6%, which dwarfed the price falls in the other major sectors (42). At the other extreme, industrial capital values, led by distribution warehouses, were up by 2.7% q/q. The worst performing sub-sectors this quarter were regional malls and hotels, where values fell by 3.9% and 7.4% respectively (43). We think there is more pain ahead for retail assets, but hotels should begin to perform better as the economy re-opens in the second half of the year.

Chart 38: Real Estate Investment Activity ($ bn)

Chart 39: Investment Activity by Sector ($ bn)

Chart 40: Share of Investment by Sector (%)

Chart 41: NOI Yields by Sector (%)

Chart 42: Capital Values by Sector (%)

Chart 43: Capital Values by Sub-Sector (%)

Sources: MSCI, Newmark Knight Frank

Data and Forecast Summary

Main Economic & Market Forecasts

%q/q ann. (%y/y) unless stated

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021













CPI Inflation









Core CPI Inflation









Unemp. Rate (%), Period Ave.









Household Spending









Average Hourly Earnings









Case-Shiller House Prices









Fed Funds Rate, End Period (%)









10y Treas. Yld., End Period (%)









3-month LIBOR (%)


5-year Swap Rate, End Period (%)


S&P 500, End Period









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Sources: Refinitiv, Capital Economics

Kiran Raichura, Senior Property Economist,
Sam Hall, Assistant Property Economist,