Archives for 2024

Although the pandemic feels like it happened long ago, many sectors of the economy are still struggling to recover from its lasting effects, and the office real estate sector is certainly one of them. The pandemic caused significant disruptions, and the sector continues to face challenges as companies, employees, and investors adapt to new workplace realities. The shift to remote work and changing workforce preferences triggered a downturn that saw vacancy rates soar and demand plummet, as many companies began rethinking their long-term office space needs. While the sector is still struggling with ongoing challenges, there is hope on the horizon as demand begins to increase and net absorption turns positive in several large urban centers.

Let’s take a closer look at the timeline of the office sector’s journey through the pandemic and beyond.

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Although business owners and managers are beginning to make firmer decisions about their companies’ real estate needs, most are still prioritizing flexibility in their lease terms.

That’s according to a recent survey by commercial lease-management software company Visual Lease, in which 61% of real estate executives surveyed said flexibility was very important given the current market and commercial real estate trends.

Bill Harter, principal solutions advisor at Visual Lease, said companies in the market for space today primarily want expansion and contraction options in their leases.

“Ultimately, it’s the ability to make modifications to the leases at some future points in time, based on market conditions, rather than taking a long-term commitment,” Harter said.

A lease of up to 10 years has historically been a common-term length for office deals, but tenants today want something with a shorter term and the option to extend a lease for, say, another three years after that shorter term expires.

That’s because it’s still tough for many companies to determine exactly how much office space they need, even four years after the onset of the Covid-19 pandemic, which upended office-use norms in most industries.

Landlords are still generally willing to negotiate with tenants on term flexibility, Harter said. In the past four years, tenants have had more leverage as office owners have seen companies downsize or exit buildings entirely, and leasing demand has thinned as companies have delayed making decisions.

Although office-leasing activity has been picking back up, flexibility remains paramount for occupiers, Harter said. Companies overall want to be able to reevaluate their lease portfolio more frequently than they’ve been able to in the past.

“That said, landlords are trying to put that line in the sand,” Harter added. “They want to have some sort of commitment, but this is a typical give-and-take of market-based negotiations.”

Beyond flexible leases, tenants today also want more visibility into things like a building’s operating costs and a landlord’s financials.

Visual Lease’s survey found that 56% of real estate executives surveyed said they plan to add space in 2025, while 36% expect to remove space in their strategies next year.

Notably, 55% of the executives said it was extremely or very likely their companies will defer necessary upgrades or relocations in the coming year because of economic uncertainty. That’s down from 71% who said the same last year, though it remains a significant share.

Harter said the return-to-work movement is still uncertain for a number of companies, making it tough to move forward on what can be an expensive real estate decision. Other companies are waiting to see the outcomes of this week’s elections before making firm business decisions, including on their real estate.

Source: “Flexibility remains paramount in office-leasing decisions”

Commercial real estate transaction activity is picking up, even ahead of the Federal Reserve’s interest-rate cut last month.

The U.S. commercial real estate market saw almost $60 billion in transaction volume in the second quarter, a 31% bump from the the first three months of the year, according to CoStar Group Inc. (Nasdaq: CSGP). And in a third-quarter survey of industry participants by commercial real estate data company Altus Group, the percentage who picked “deploying capital” as a primary focus over the next six months surged 11 percentage points, to 31%, from the previous quarter, when it was 20%. Meanwhile, the percentage of respondents who said they were pausing or de-risking their portfolios dropped 5 and 6 percentage points, respectively.

Art Jones, senior director of commercial real estate research at Principal Asset Management, said the past couple of years have been a capital-markets type of recession, which the industry is beginning to emerge from. But a capital-markets recession is usually driven by a weak economy, and that hasn’t been the case here.

“We haven’t had that economic distress that usually coincides with value corrections,” Jones said. “It’s the first time on record in 40 years that this has happened.”

While office buildings have started trading — frequently at basement-bargain prices compared to their last sales — there’s been a disconnect between buyer and seller pricing expectations across the industry.

Access to capital also has been a challenge, especially to obtain debt, as lenders reconsider their commercial real estate loan exposure and have pulled back from the sector. Year-over-year commercial real estate loan growth across U.S. banks slowed to 2.2% in the second quarter, compared to 2.9% the prior quarter, according to S&P Global Market Intelligence.

With the recent rate cut and the expectation that more cuts will come before year-end and into 2025, that’s giving investors more confidence to move forward on deals, Jones said.

“The dry powder in various strategies is lining up to start investing in the next year,” he said. “We think it’s going to be a slow end to 2024, but the strategies are lining up to pick up in the next year.”

Which property types will prove popular with CRE investors?

There will be disparity among sectors as the expected increased investment and deal activity plays out.

Among them, the office segment remains a sector that’ll be tricky for investors to navigate in the coming quarters and years.

Jones said for the past year to 18 months, high-net-worth individuals and family office funds have been most active in buying office properties at discounts of 50% or greater.

“There hasn’t been a lot of distress selling in core equity,” he said, adding more distress and value correction is still to come. “That repricing, and some of the interest-rate corrections, [are] going to help.”

Still, a lot of debt funds and regional banks were oversubscribed to office real estate even before the pandemic, so it’s unlikely those capital sources will be re-entering the market in a substantial way in the near term, Jones said.

Conversely, despite some of the overbuilding that’s occurred in both apartments and industrial, those are two property types high on investors’ radar. That’s also because of broader economic themes — a continued national undersupply of housing and e-commerce demand that’s expected to remain strong for the foreseeable future, Jones said.

Apartment deliveries are up 9% from 2023 and 30% from 2022, according to Principal, but the wave of new supply is beginning to slow as fewer projects break ground.

New industrial construction also has slowed, having fallen 55% below the market’s 2022 peak, according to Principal. Those who track the industry say the slowdown in apartment and industrial will allow demand within those property types to recover and — especially in residential — could even create a shortage in a couple of years.

Other, somewhat more niche sectors, drawing investors’ interest include data centers — although that market is highly competitive and expensive, Jones said — industrial outdoor storage and single-family rentals.

Mark Rose, CEO of Avison Young, said in a recent interview with The Business Journals in the short term, property types that have been attractive — grocery-anchored retail centers, Class A office space, outdoor storage, cold storage, self-storage and data centers — will continue to be popular with investors. But even more challenged properties, such as regional malls or office buildings that need to be repositioned, will start to make more sense for investors to pursue.

“It’s like anything else … [if] everybody is piling into the same assets, it never ends well,” Rose said. “A combination of quantitative and qualitative returns is something we still need to focus on. Everything that was working is going to continue to work at lower financing costs. Everything that hasn’t been working — in particular, the office sector — you have the fundamentals starting to catch up incrementally.”

Investors today know the sectors they want to deploy capital into and, with the recent rate cuts and more economic certainty, can begin formulating strategies that will be deployed in the coming quarters.

“Those two things are really going to allow them to figure out where pricing is,” Jones said. “That’s been lacking in the past two years.”

Source: “CRE investors prepare for a busier year of buying, selling in 2025”