Archives for February 2024

Office landlords are increasingly willing to invest in and collaborate with local retailers, making upfront investments to sustain the space and bolster the overall building environment, according to a new report from Colliers.

This is vital for all parties, including jurisdictions with the capability of converting some space to residential, which could ease demand for affordable housing while enhancing the area’s livability.

The symbiotic relationship between the office and retail sectors emerges as critical in driving long-term growth, Colliers said.

“Together they can strategically leverage mutual benefits to navigate dynamic market forces,” according to the report, suggesting short-term tenancies as an option.

“These short-term arrangements with small business tenants require minimal landlord investment in converting spaces for subsequent use,” Colliers said. “And in some cases, salvage their financial investments.”

For retailers, this could create a more diversified tenant mix, potentially attracting foot traffic to well-established brands in a physical setting.

Given the struggle to bring workers back to the office, many existing retailers such as sandwich shops, dry cleaners, and daycare providers, are out of business, Colliers reported, and many of the goods and services that supported the office ecosystem have disappeared, limiting, and straining the remaining stores.

“The ideal scenario would be for office owners to invest and re-think the traditional retail market rent model in partnering with mature local retailers, particularly in food and beverage, to support those businesses and help bring back additional office tenancy,” Michael Lirtzman Head of Office Agency Leasing, US, Colliers, said in a prepared statement.

One example Colliers offers is an initiative in Arlington, Va., that expanded the diversity of businesses permitted within office buildings, to include breweries, urban farms, dog boarding facilities, virtual golf centers, commercial kitchens, labs, entertainment venues, and indoor recreation facilities, among others.

“These communal retail spaces can be considered an avenue for fostering personal interaction and revitalizing foot traffic patterns through alternative modes of walkability and transportation,” according to the report.

Source: “Office and Retail Can Find Value in Teaming Up“

There have been two camps on the immediate future of office properties. One — the larger it seems — say the pain will continue. The other sees better times, at least if the office is a Class-A or trophy.

Put Morgan Stanley into the first camp. In a recent note from the bank, according to Business Insider, which got a copy, analysts said that U.S. office buildings are facing a total 30% valuation drop from peak values. That drop would include the 20% down from peak already experienced, according to data Morgan Stanley credited to Real Capital Analytics.

Not that office is the only one dealing with problems. Morgan Stanley also addressed the elephant that’s filling the room to such a degree that people are absolutely talking about it: $2 trillion worth of maturity wave in the next few years.

But as Colliers U.S. CEO Gil Borok recently said, “There’s no question that there’s going to be distress coming. The signs are all there. But I also think that we will see banks and other lenders continue to work with borrowers to work through the situation and we’ve seen that historically. The sort of doom and gloom out there, it’s not to make light of it, but it is to say that there are pathways that will be less drastic than what we are hearing in the media today.”

That banks and other lenders will go to extreme lengths to avoid having massive defaults sitting on their balance sheets seems an easy call. What lengths and how much could be head off are the questions.

While that leaves things in question for much of CRE, office still remains a major problem that is up in the air. The “secular” problems facing the property type — to what degree workers will return and how easily employers could make them — are serious issues. Employees who do come into the office may not be there for full five-day weeks. That’s an issue.

The changes have already taken a toll. “Delinquency rates jumped to 6.5 percent of balances for loans backed by office properties and to 6.1 percent for lodging-backed loans,” said the Mortgage Bankers Association in a report. Retail-backed loan delinquencies were elevated but unchanged during the quarter. Multifamily and industrial delinquencies were up a touch. Office is where the dynamics are most strained.

“We are unlikely to see demand for office properties returning to pre-pandemic levels,” Morgan Stanley  wrote. “This means that property valuations, leasing arrangements, and financing structures must adjust to the post-pandemic realities of office work. This shift has begun and there is more to come.”

Source: “Office Agony Isn’t Over, Says Morgan Stanley“

While the U.S. economy remains resilient, the commercial real estate market’s performance during the first month of 2024 shows a nuanced landscape with sector–specific challenges and opportunities. The normalization of hybrid working arrangements continues to negatively impact office demand, increasing the market’s unoccupied office spaces. However, the fundamentals of the multifamily, retail, and industrial sectors remain robust, indicating a varied performance across the CRE market.

Below is a summary of the performance across various commercial real estate sectors at the outset of 2024.

Multifamily Properties

Mortgage rates remaining near 7% are strengthening the demand for apartment buildings. This trend stems from the fact that higher mortgage rates make home buying less accessible for many, leading people to seek rental options instead, thereby increasing the demand for rental apartments. The past year has seen a 120% jump in net absorption relative to the year before. Nevertheless, the effect is not visible in the vacancy rates due to the increased number of apartment units completed and delivered to the market. An influx of new housing supply could absorb the stronger demand, keeping the vacancy rates from declining. Specifically, the multifamily sector’s vacancy rate was 7.6% in the first month of the year.

Office Properties

The amount of unoccupied office space continues to rise, pushing the vacancy rate further up to 13.7%. Specifically, there are twice as many unoccupied office square feet as occupied compared to a year ago. With many businesses reevaluating their need for physical office space, vacancy rates will continue to increase in this sector, especially in the urban centers. However, the anticipated lower inflation and interest rates later this year may make rehabilitation or conversion of underperforming office buildings more viable.

Industrial & Warehouse Properties

The industrial sector continues to maintain its health, but there are emerging signs of a slowdown, with net absorption falling beneath levels seen before the pandemic. While online shopping and e-commerce pushed up the activity to record high levels at the end of 2021 and the beginning of 2022, net absorption is currently nearly 70% lower than a year ago. Nevertheless, rent growth continues to be the fastest among any other sector of the commercial real estate market. Specifically, rents for industrial spaces are nearly 6% higher than a year ago. The long-term outlook for the industrial real estate market remains positive, buoyed by factors such as the lasting impact of e-commerce and increased construction spending.

Retail Properties

At the onset of 2024, the retail sector has experienced a slowdown in demand. Compared to the early months of 2023, net absorption has seen a significant reduction, falling by approximately 30 percentage points. Despite lower absorption rates, the scarcity of retail spaces has contributed to maintaining low vacancy rates, which hover around 4%. With fewer new construction deliveries, the fundamentals of this sector will remain solid in 2024. When new supply is constrained, it can lead to tighter market conditions, potentially supporting rental rates and occupancy levels, key components of the commercial real estate sector.

Hotel Properties

The hospitality sector continued to advance at the beginning of 2024. Yet, despite gains in average daily rates and revenue per available room, hotel occupancy hasn’t fully recovered to the figures seen before the pandemic. The 12-month occupancy rate is still lagging by 2.9% behind the pre-pandemic benchmark.

Source: “February 2024 Commercial Real Estate Market Insights“

As apartment investors wade through the headlined, oversupplied markets, there is the chance they could capitalize on lesser-publicized markets, according to panelists at National Multifamily Housing Council’s Apartment Strategies Conference.

Speaking last week at the event in San Diego, Jay Parsons, SVP, Chief Economist, RealPage, said demand has not been a challenge.

“We’re bullish about more of it, especially in the Sun Belt and Mountain regions,” Parsons said.

“Consumer confidence is growing based on the University of Michigan Survey. There’s a real correlation between it and apartment demand. People are feeling better about things. A lot of the grocery store sticker shock is going away. Wages are rising more than apartment rents. It’s a unique cycle that we’re in.”

Parsons said lease-up rents are compressed. A recent survey of developers and contractors showed that about 80% of them are seeing delays in construction.

“It’s not because of supply chain or labor issues as it was before,” he said. “It’s about projects penciling out due to uncertainty of financing. These aren’t short-term delays – they are delaying projects significantly. I see us slogging through 2024 and then things improving in 2025.”

A John Burns report found that 80% of developers are developing less than last year and many are developing more than 20% less, Parsons said.

Huntsville is an apartment market that has been off the charts for supply and demand, Parsons said.

But still, rents have significantly compressed due to even more supply and demand — not necessarily for “off the charts” performance overall, he said.

Jeff Adler, Vice President, Yardi Matrix, said eventually there’s going to be another “up” cycle for the industry, but he sees 2024 and 2025 as difficult years for oversupplied markets.

Adler suggested looking for cities that can change their character.

“If you look back 10 years at markets such as Raleigh, Austin, and Nashville, they were not what they are now in terms of being destinations or homes to manufacturing and businesses such as technology hubs,” Adler said.

“A lot of times these [soon to be emerging, outperforming] markets are anchored to education and universities.

He said that places undergoing that kind of re-characterization now are Columbus, Ohio; Bentonville, Ark.; Knoxville, Tenn.; and Huntsville, Ala.

Source: “Navigating Apartment Markets’ Supply-Demand Issues“