Southern California’s commercial real estate sector is entering 2026 with a cautiously optimistic outlook, shaped by a combination of rising interest rates, evolving tenant preferences, and ongoing urban redevelopment efforts. Market participants are navigating a slower transaction environment marked by more disciplined underwriting and adjusted pricing expectations.

Michael Lorch, Senior Vice President and Chief Lending Officer at Axos Commercial Bank, described the current market as fundamentally sound despite higher borrowing costs. He noted that cap rates previously based on low debt costs have shifted as interest rates have risen beyond 6%, narrowing the gap between buyers’ and sellers’ valuations and reducing transaction volume. However, lenders are increasingly selective, focusing on asset quality, sponsor credibility, and clear exit strategies. Lorch added that if the Federal Reserve reduces rates in the latter half of the year, deal activity could pick up quickly, particularly benefiting investors who maintained strong lender relationships during a muted period.

Industrial and multifamily sectors are leading performance, supported by robust demand for logistics facilities and urgent housing needs, respectively. Diane C. De Felice, a shareholder at Brownstein Hyatt Farber Schreck, highlighted that sustainability and energy efficiency have become central to both tenant demand and investment decisions. Corporate occupiers now prioritize buildings with environmental, social, and governance (ESG) attributes—such as LEED or WELL certifications—that reduce operating costs and improve workplace environments. For investors, integrating carbon management into building operations has become essential for risk mitigation and valuation, with inefficient properties facing increased obsolescence.

Retail real estate is showing signs of stabilization, particularly in necessity-based and experiential formats. Conversely, the office sector continues to grapple with structural headwinds linked to changing work habits. Hybrid work models have led major tenants like KPMG to downsize and redesign their footprints, emphasizing collaboration spaces over traditional layouts. Greg Skalaski, Executive Vice President at Shawmut Design and Construction, pointed to opportunities in adaptive reuse, especially in Downtown Los Angeles, where converting obsolete office properties into mixed-use or residential developments could reverse vacancy trends. He emphasized that success in this area depends on coordinated public-private partnerships, streamlined permitting, updated codes, and targeted incentives that can attract private capital and revitalize urban cores.

Flexibility, amenities, and access to transit remain high priorities for tenants in a competitive market. Skalaski noted that locales such as Century City and Culver City demonstrate how well-designed amenities and technology infrastructure, combined with walkable environments, support low vacancy rates by enhancing employee experience and encouraging in-office presence.

Overall, Southern California’s commercial real estate market is adapting to a complex landscape of economic and social changes. While challenges persist, especially in the office sector, developers and investors are exploring innovative approaches to asset utilization, sustainability, and tenant engagement to foster long-term resilience.