By Elizabeth Rogers
While some real estate owners, investors and developers have been struggling to stay afloat during a period of soaring inflation, steady interest rate increases, and falling demand in particular sectors, some are rethinking their strategies and making decisions that are shaking up the landscape of the commercial real estate (CRE) market.
Among the myriad market factors and influences shaping CRE, a handful of key trends stand out. Understanding these key factors-and appreciating how and why they are impacting CRE decision-making-helps us gain important insights into not only how these trends and challenges will continue to impact the CRE market into 2023 and beyond, but also how CRE owners, developers and investors may need to evolve to remain competitive. Let's look at some key CRE trends.
Office, or no?
Every market segment has felt the impact of COVID-19 and the pressures of an ever-changing post-pandemic marketplace, but few would disagree that the office sector has been disproportionately affected. While employer-tenants grapple with remote v. in-office work requirements and labor shortages, landlords are faced with persistently high vacancy rates, and requests from tenants to amend and restate lease terms to include less space, reduced rents and sometimes, more amenities. With national office vacancy rates rising to an eye-opening 16.3 percent in October, it's clear the workforce has become accustomed to remote and hybrid work options, and growing numbers of businesses are deciding that they no longer need a sizable office footprint. Complicating the matter is the fact that many businesses are discovering that remote and hybrid work options can help with recruitment and retention, further reducing incentives to return to pre-pandemic in-office norms.
Retail recovery
On the retail side, things look very different. Unlike the office sector, retail is trending upward. There were predictions that due to post-pandemic health concerns, in-person shoppers would be reluctant to return to brick and mortar locations, but the opposite seems to be true. After long and varying periods of lockdown, people appear happy eager, even to return to in-person shopping. Admittedly, this shift back to in-person shopping is paradoxical, as pre-pandemic shoppers were trending toward the convenience of on-line shopping experiences. Although e-shopping continues to be a popular option, certain types of traditional brick-and-mortar locations are not going away; however, consumers are requiring some changes. In Michigan, we've seen the sale and planned repurposing of some once popular, large, enclosed malls, and retailers are pivoting to embrace unique brick-and-mortar locations and prime spaces at lifestyle centers, neighborhood pop-ups, and within premium regional shopping environments. Concurrently, hybrid online-and-in-person models are proliferating, as brick and mortar retailers become more adept at integrating online ordering and in-person pick-up options into their operations in ways that are synergistic rather than competitive.
Delayed development
As the Federal Reserve continues to increase interest rates to combat inflation, developers are feeling the pain of more expensive borrowing in addition to the unavailable or extremely delayed availability of certain building materials, and the increased costs for those same materials that were significantly less expensive just two years ago. In response, on the residential side, some builders have implemented programs to buy down interest rates and woo buyers who otherwise would delay new home construction. On the commercial side, some of the more liquid developers forge ahead with their original plans, leveraging readily available cash to negotiate lower prices for building materials since they can be purchased in bulk and without financing terms; some are going after more tax credit financing, brownfield funding and local incentives; and, because of their experience and reputations, some are cherry picking from private owners and out of receivership, partially completed developments that have been stalled due to financing and other constraints. Finally, some developments have just been sidelined until market conditions permit re-engagement.
Before the plunge
Overshadowing CRE is the prospect of a potential recession. By all indicators, it likely will not be as significant as the 2007 recession, but we would be remiss to ignore the familiar warning signs and ominous macroeconomic indicators that are signaling a downturn. There is a growing sense that we are on a roller coaster poised at the crest of the hill just before the descent. While a drop is inevitable, we don't know yet whether it will be the equivalent of an uncomfortable dip that rights the economy, or a nightmarish plunge.
With market changes, come adjustments. Since CRE always has been cyclical, particularly successful developers, owners and investors have learned to be nimble and creative. They are especially adept at setting trends and reinventing themselves in troubled markets. For the flexible, there always are opportunities available. Some owners with high office vacancy rates are rehabbing those spaces into multi-family units, while savvy tenants with office leases are taking advantage of this climate and renegotiating their leases for more favorable deal terms. Investors looking to fund deals still are able to find them, and municipalities and quasi-governmental entities always are looking to support developments that serve the interests of the public and cause underutilized spaces to blossom into completed projects.
Whether you are a well-heeled developer looking for fire sales, an owner looking to change the zoning and use of your existing space, a tenant seeking more favorable lease provisions, or a borrower facing an inevitable workout request, it is important to consult with a trusted legal professional with experience in handling complex real estate transactions. Just like our successful developer, owner, investor clients, we keep a few hats and rabbits on hand just in case we need them.
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Elizabeth Rogers is a partner in the Real Estate Practice Group with Jaffe in Southfield.
