The commercial real estate industry, notably office space, had a rocky 2023 due to the rise of inflation and interest rates. As professionals from retail to warehousing look for better things ahead – the question is, how long is the wait?
Regi Powell, commercial sales director with PJ Morgan Real Estate, echoed a refrain familiar to many in the industry with one word, “challenging.”
“In 2024, I think there will be challenges for investors who paid top dollar for a property at a low interest rate and now face a loan adjustment,” Powell said. “This should create some opportunities not seen for a while in the market. I expect most of this to come in the multi-family sector.”
The prevailing sentiment runs along similar lines: high interest rates have had multiple detrimental effects on the CRE market as owners struggled to finance projects, causing shortages in some sectors and driving up rent. Yet just as prevalent is the optimism within the CRE industry that the worst is behind them.
“The market believes there will be improved interest rates, which should help the CRE market,” Powell said. “It will also help the sales prices on a property be more in line with projected incomes. Multi-family will see extra supply in available rental units in the short term and this should slow rent growth, which has outpaced most of the country over the last year or two. Retail and industrial will be playing catch-up on the supply side.”
Office Space Hurting
Laura Bell, owner and founder of Commercial Realty Group in Lincoln, said office space is a particularly thorny category and is likely to remain so for the foreseeable future.
“What are we going to do with the number and size of available spaces on the market and businesses needing much less space or no office at all since many employees are working from home?” she said. “Does it become more medical spaces? Does it become housing? We need more affordable housing for people to live in, both to rent and to purchase, so that is one option.”
Bell said with all other challenges in the market, one thing the CRE industry has not had to contend with is a lack of interested buyers.
“There are opportunities to represent and assist people looking to buy, sell and lease commercial real estate and make things happen for them,” she said. “The challenging aspect is there are more buyers than there are properties available to purchase.
“Also, interest rate increases slowed otherwise interested buyers, although rates have come down some which is great. Lower interest rates are a cause for optimism. Problematic is the concern from many regarding the economy and high inflation that would continue to slow the commercial real estate industry, although I personally believe it will get better.”
Jared Froehlich, commercial real estate advisor with NAI FMA Realty in Lincoln, broke down the office market situation further, saying lower-graded properties are likely to experience a particularly rough year.
“Class B and Class C office space will continue to be a problem across the country,” he said. “These property types have been struggling and will likely continue to struggle to attract tenants. Companies needing office space are seeking out the nice, new Class A office with the best amenities.
“Furthermore, many office users have downsized their office needs and as those lease expirations have been coming up, we are seeing office relocations. Over the past few years, we’ve seen a trend where office users are moving away from the downtown markets and are moving toward suburban markets. We’ll likely continue to see that trend.”
Short on Space
Kristi Andersen, vice president with CBRE, said within the leading CRE sectors – retail and industrial – the market is suffering from a lack of new space, again, hampered by financing of development.
“Retail and industrial markets will continue to be tight and premium space will be hard to find as new retail construction is not keeping up with the demand,” she said. “The industrial vacancy rate remains below 2%, but there are currently nine additional industrial properties totaling over 1.5 million square feet under construction and expected to deliver in 2024.
“On the retail front, consumers are demanding more ‘eatertainment’ options and local developers are delivering. New putt-putt golf, pickleball and other concepts have recently entered the market, with more coming.”
Anderson said the challenges in the local market are relative, however, and overall Omaha is doing much better than other parts of the country.
“If we compare Omaha to other commercial real estate markets, I would give us an A,” she said. “We continue to outperform most other parts of the country and remain resilient.”
Give and Take
The situation leads many building owners to think and act differently in positioning their properties to attract and retain tenants.
“Class A office owners are better-positioned due to the lack of new construction in that sector,” said Chris Mensinger, senior vice president with Colliers. “Class B office buildings with large floorplates typically used as call centers have historically been a strong market in Omaha. Many of these users now have lower square footage needs since the movement towards hybrid work environments.
“Owners of these buildings in the past had been concerned about demising floors for small users. The owners who have been willing to do so have had more deals in the last year as we see smaller users locking in that rental rate. I think that trend will continue in 2024.”
Landlords are also looking to tenants to do more to help offset the costs of enhanced amenities or other concessions.
“While tenants’ needs may have changed over the last few years — figuring out their square footage, a change in floorplan layouts and the desire for upgraded amenities — so has the cost of construction and the cost of borrowing,” she said. “Landlords and tenants are both managing the balance of cost: While landlords have been generous in tenant improvement contributions, tenants are realizing they may need to be able to make longer-term commitments in order to capture those contributions.”
Reason for Optimism
Between the pent-up demand and economic markers nationally, the planets in commercial real estate appear ready to align.
“The main reason for optimism is what I’d call a new normal being established,” said Alex Epstein, executive vice president of OMNE Partners. “Once interest rates become more settled, I think prices will start to adjust to that and then we’ll see activity as people adjust to the new normal.
He noted that interest rates may be on their way down. All told, Epstein said, the area remains a good place to do business both for the CRE industry itself and for the companies that occupy those properties.
“Omaha is resilient and more insulated from the pain being felt in San Francisco or Chicago. I think there’s plenty of opportunity here,” he said. “If interest rates have reached a peak and do start to steadily compound, that would definitely cause activity to go up. Omaha has remained very healthy through all of this and is still a great place to do business.”