Adapting to New Times: Commercial Real Estate Steady Amid Changing Landscape

On a local level, the commercial real estate market continues to adapt accordingly while steering through a set of complex challenges like increased costs, labor shortages, and the ever-changing needs of clients. Despite these rather large obstacles, industry experts expect a strong finish to the year with more opportunities ahead in 2023 and beyond.   

A Changing Environment 

While trends in commercial real estate are in a state of reevaluation, Chris Mensinger, senior vice president at Colliers International, said the review of workspace is top of mind for most companies as they bring people back into the office.  

“Collaborative space is a term that we are hearing daily,” Mensinger said. “As many companies work to balance the dynamics of a workforce that is split between wanting to get back into the office and a group that has found satisfaction in working from their homes, the question is often how do we encourage the innovation that often happens when you get people in a room together?”  

Because some businesses have found that having their employees work from home can be done successfully, they have scaled back their office footprint. Jack Warren, commercial real estate broker for Investors Realty, said the Omaha market has seen more sublease space come available this year than in any other year, according to collected data.

“At the end of quarter two in 2022, there was roughly 840,000 square feet of sublease available on the market,” Warren said. “That is nearly 80% higher than the amount of available sublease space at the end of quarter two in 2021 just one year ago. Many new leases are still getting signed and considerable amounts of this available space is getting backfilled.”

Brickline at The Mercantile (Photo Courtesy of Colliers)
Brickline at The Mercantile (Photo Courtesy of Colliers)

Companies are also investing in their space and their brand to attract talent, according to Alex Epstein, executive vice president at OMNE Partners. On the investment sector side, he said clients are raising cash for potential buying opportunities as capitalization rates increase with interest rates.

To counteract the effects of COVID-19 on businesses from a tenant perspective, Kirk Hanson, principal at ACCESS Commercial, said drive-thru lanes have been an emerging site criterion. Commonly paired with app ordering, drive-thru lanes support convenient traffic flow, enabling contactless and efficient customer service to consumers. 

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Recently, Hanson said big-box retailers have announced plans to add large-scale, innovative fulfillment centers to better support e-commerce sales. 

“With these warehouses being more automated, it would combat rising labor costs while providing more efficient e-commerce logistics,” Hanson said. 

Greenfield development, or development on untouched land, is emerging again since the overbuild of retail space in 2008. With residential neighborhoods rapidly urbanizing suburb areas, Hanson said greenfield developments are meeting consumer demand.

Additionally, he stressed that cap rates continue to be at all-time highs. 

“Commercial real estate is a primary alternative investment for stakeholders chasing yield, in turn producing top dollar for commercial properties,” Hanson said. 

There is no denying that there’s still an appetite for new Class A construction in Omaha. 

According to Martin Patzner, vice president/office specialist at Cushman & Wakefield/Lund Co., the local market is in a good position for the next 12 to 18 months, especially as development is rapid along West Dodge Road. 

Patzner said developments such as Heartwood Preserve and Avenue One will evolve and fill out over the course of the next 10 to 15 years and become more like Aksarben.

“Right now, people are looking to relocate into newer spaces, solely based on creating a new experience for employees who are coming back to the office after working remotely for so long,” he said. “Certain amenities, like fitness centers and covered climate-controlled parking, are definitely a box that all major employers are looking to check.”

Due to the pandemic, many companies are now redesigning spaces to become more accommodating for hybrid employees, or flex workers.

“We are seeing more breakout offices with connectivity so people can easily jump on a Teams call together if needed,” Patzner said.

Along with upgrading technology in these changing times, he said tenants no longer need dedicated IT server rooms, as everyone is moving to the cloud, which means the extra space is being recaptured for other usages, like storage. 

1117 Nicholas St. a retail property with space available for lease. (Photo Courtesy of Cushman & Wakefield/The Lund Company)
1117 Nicholas St. a retail property with space available for lease.
(Photo Courtesy of Cushman & Wakefield/The Lund Company)

Confronting the Challenges 

Like all industries, the commercial real estate scene has its share of difficulties. Currently, one of the challenges the commercial real estate industry is facing is the ability to facilitate conversations and plan for business leaders to help them determine their square footage needs in a changing work environment. For example, the look and feel of the office space, enclosed offices vs. open space, shared workspace vs. dedicated work areas and parking needs for a staff size that fluctuates daily. 

According to Mensinger, all of these questions force the commercial real estate industry to look at the services it currently provides and adapt. 

“We may need to bring in more resources to help our clients reevaluate their needs,” Mensinger said. “Building owners are seeing more short-term renewals as tenants work through this process.”  

Also regarding office space, Warren said the market continues to face the obstacle of companies’ desired lease term vs. high construction costs. 

“Employers are still navigating future workplace strategies, which impacts size and lease term decisions,” Warren said. “The COVID-19 pandemic proved that having employees work from home could be done successfully for certain companies.”

With future workplace strategies still uncertain, Warren said tenants would like the flexibility of shorter lease terms, but high construction costs emphasize the need for longer lease terms. These high construction costs are still prevalent today due to inflation and global supply chain issues.

As costs increase to make the numbers work for projects, the rent must increase, too.  Epstein said the demand will continue to support this equation unless development slows.

“When rates and costs increase at the same time, it makes it a very tough problem to solve,” Epstein said. “Other challenges in the industry remain people. There’s so many open positions and for companies to expand they need the ability to find the human capital to support the growth.”

Hanson noted that construction materials have had the most abrupt and steepest cost increase. High costs, coupled with supply shortages and delays, have been causing slower and more expensive development timelines.

“Expansion is slowing for many businesses due to the cost climate, as well,” Hanson said. “Rents are at all-time highs and triple net leases are becoming standard contract structure, affecting the financial ability for some tenants to expand. National labor shortages have been a major contributor to slowing growth, as well, with not having the necessary staff hired to manage and run new locations.” 

Construction costs have truly changed the dynamic of office leasing, and while there has been an overall increase in rental rates, this still has not offset current construction prices. 

“Three to four years ago, Omaha used to be known as a turnkey market where tenants could negotiate a lease where a lot of the improvement dollars were negotiated into the lease,” Patzner said. “Today, tenants are having to use a lot of out-of-pocket money above and beyond their tenant improvement allowances. They are probably matching 100% of what their landlord is giving them. As a result, we are seeing some tenants make some longer-term decisions vs. shorter-term leases.”

Patzner said tenants that are moving are also attempting to find spaces that require little or no cosmetic improvement to keep the overall cost down.

Mastery Logistics office remodel done by USG Construction. (Photo courtesy of OMNE Partners /Seldin, LLC.)
Mastery Logistics office remodel done by USG Construction.
(Photo courtesy of OMNE Partners /Seldin, LLC.)

Industry Outlook 

Looking at the remainder of the year, there are many issues impacting the industry’s outlook. Ongoing supply chain disruption, impacted building supplies and the increase in interest rates give those invested in the commercial real estate world pause. 

“While the long-term impact of the changing world has yet to be fully recognized, we will all likely need to have a bit more patience as deals may take a bit longer to come together and companies may need more planning time to determine their needs,” Mensinger said. “I do believe that in the end people and companies do best in environments that are supportive, allow for productive interaction with others and are adaptive.”

In the Omaha office market, Warren said the sector is expecting to see more sublease space come available, which is challenging for landlords but creates more opportunities for users. 

“There are users in the market, some of which are quite large, so we anticipate continued leasing activity which will mitigate any severe impact to occupancy rates,” Warren said. “High construction costs make existing buildings more attractive, so we expect sales to remain strong, even with higher interest rates.”

With markets seemingly adjusting to the interest rate increases and inflation remaining short-term, the rest of the year is looking bright. Heading into 2023, Epstein said the industry may see some of the headwinds set in from a potential recession due to the possibility of Fortune 1000 companies and others preparing for layoffs as recessionary pressures increase.

For the remainder of 2022, Hanson projected cautious expansion plans being developed for 2023. The changing dynamics of supply and demand, interest rates, inflation and overall affordability will cause more diligent monitoring of commercial real estate investments into the next year. With record high occupancies and limited property availability, Hanson anticipated the continuation of competitiveness in leasing and purchasing retail spaces. 

“Innovation and technology continue to play a crucial role in our industry and will accelerate this next year to combat challenges,” Hanson said. “Platforms and smart tools providing high-quality data, both historical and real-time, are rapidly evolving allowing brokers to provide clients with insight into property patterns, trends, demographic data and potential value analytics essential to generating strong leads and closing deals.”

He noted that sustainable technologies are also quickly becoming a necessity with climate change and many states are starting to implement sustainable requirements on commercial buildings, causing an increase in demand for advancements from both investors and tenants.

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According to Patzner, there is a general misconception that the office sector is slow in Omaha right now, but that’s not the case at all. He expects activity to continue for the remainder of 2022, especially for small to medium-sized users. It is some larger, national companies that Patzner said are still on somewhat of a pause and don’t exactly know what direction they are going to go.

“Some companies in town are still in that hold mode and trying to figure things out for a long-term basis,” Patzner said. “At the end of the day, companies have to be flexible with their workforce. The great thing about Omaha is commercial real estate is very well leveraged so there is not a whole lot of panic even when we do have slower periods.”

As trends continue to change and new challenges arise, experts in the commercial real estate sector note that adaptability is the name of the game for the foreseeable future. Fortunately, professionals alluded to the local market remaining vigorous with little signs of slowing for the time being.