The unprecedented market conditions brought about by the pandemic on the commercial real estate market haven’t resulted in the wholesale abandonment of leased space as some had predicted. That said, things aren’t completely back to normal yet, either.
While office and retail occupancy has steadily become healthier, the airtight industrial market continues to be challenging for manufacturers when it comes to finding suitable space. Add the sustained labor shortage and higher inflation and the chance of the situation being fixed with expanded capacity isn’t likely to happen soon.
“In the Omaha MSA (metropolitan statistical area) market, we are seeing very low vacancy rates in the retail and industrial sectors, specifically,” said Mandi Backhaus, associate broker with The Lerner Co. “This speaks to the high demand and activity, but a portion of this can also be attributed to construction having slowed down from the time of the pandemic and trickling into the present day. Elevated material costs along with labor shortages are still a concern in some scenarios.”
A Nationwide Crisis
It has long been acknowledged that trends in business and industry tend to reach the heartland well after the coasts, and in the case of current commercial real estate market trends, that’s something to be thankful for. Valued at some $20 trillion, the commercial real estate industry has a strong influence on the economy. Thus, across the nation, economists are sounding the alarm of an impending real estate crash as valuations plummet, workers and shoppers increasingly deal in remote environments and rising interest rates stunt new development and investment.
The shaky national picture stems from a combination of factors – inflation, interest rates and the implosion of banks earlier this year foremost among them – and that perfect storm has the industry taking on water. The Mortgage Bankers Association reported real estate lending dropped 56% in the first quarter compared to the first quarter of 2022, to its lowest level in almost a decade, due to lower demand and the volatile economy.
More concerning, according to a Business Insider report in May, borrowers will have a hard time paying back debt due to curtailed cash flow. JPMorgan estimates of the roughly $450 billion in commercial real estate loans due to mature in 2023, as much as 20% are likely to default.
Ryan Ellis, CEO of PJ Morgan Real Estate, said while the situation on the ground in Omaha isn’t quite that bad, there are plenty of choppy waters in the local market conditions to go around.
“There seem to be supply chain issues with certain materials and products still; however, we are now seeing a compounded problem of quality of materials,” he said. “We are seeing that more than ever; materials are delivered with problems or damage and the turnaround time to replace those items can be months. Suppliers are telling us they are working with limited workers, amplifying both the quality and lead time issues we are seeing in the market.
“The biggest challenge we have today is managing the total cost of projects. All of the factors that go into that are construction costs, site constraints, regulatory processes and timelines — all of those things add time and money to a project. Inflation has dramatically impacted cost of building/remodeling to the point that some of our clients have decided to hold off on projects for now. They are hopeful to resume them in the future, but they are determining that in the current environment, some projects are not financially viable.”
Hybrid’s the Word
Office space in Omaha continues to defy three years’ worth of predictions of its imminent demise, due to work-at-home arrangements. Experts note that work-at-home was already being experimented with in the Midlands – albeit in a much more limited capacity than during the pandemic – and still the trend has yet to take a meaningful bite out of companies bringing workers back to the office.
“The office sector has certainly been an interesting one to evaluate over the last few years,” Backhaus said. “In Omaha, we have seen various companies adjust their workplace structure and how they utilize their spaces, which has resulted in alterations of the segment as a whole. However, it can be said not all of this is due to the pandemic alone; we are seeing a generational shift in the workplace, and as we know, humans are ever evolving with how we work, live and play.”
Companies are navigating changing workspace preferences among workers.
“There had been some speculation that the demand for office space would completely evaporate due to the pandemic. For the most part, this has not been the case for our local market,” said Jared Froehlich, commercial advisor with
NAI FMA Realty. “Many companies have brought employees back to the office or adapted to a hybrid work model. Turns out that it’s important to see and interact with your colleagues in person rather than solely on Zoom.”
Froehlich said there is a lot of uncertainty about what will happen to space after leases expire.
“Office shadow space – leased but unoccupied space – is the biggest unknown,” he said. “To entice employees back, some companies have spruced up their existing space or relocated to higher-quality space as leases come due. In Lincoln, the greatest increase in office vacancies has been seen in the downtown office market as a few larger employers have chosen to stay remote or go to hybrid work.”
New Uses for Old Spaces
With all of this effort and concession, today’s office spaces are being used in different ways than they were pre-pandemic. Kristi Andersen, vice president of CBRE, said even as occupancy rates have steadily improved, companies are thinking differently about how their space looks and functions.
“Our latest figures for the second quarter show an office vacancy rate of 9.5%, which is about 110 basis points lower than the same time last year and 320 basis points lower than the COVID-19 high-mark vacancy rate in 2021,” she said. “We are seeing some tenants repurpose the way they use their space. Some have created more areas for hoteling or for employees to plug in when they are in the office instead of having a dedicated office space. We believe the hybrid approach – some days home and some days in the office – is here to stay.”
Not surprisingly, market conditions have worked to tenants’ favor in the office sector, said Froehlich.
“Office tenants have become a bit bolder in their demands of landlords, especially in the central business district, the downtown market,” he said. “These larger office tenants now have a safety net in the form of other available offices to lease and the opportunity to move to a hybrid model requiring less space.”
Retail space statistics are perhaps most surprising, given the steady pressure online shopping has placed on the sector for more than a decade. That, combined with the aforementioned economic pressures, might suggest the sector’s death knell, but locally that hasn’t been the case.
“We have seen great activity with local retail,” Ellis said. “The cost of remodeling spaces is definitely a factor and restaurants in the area are still looking to do new concepts but need to work with landlords to help manage the high costs to remodel and outfit a full kitchen and restaurant.”
He noted retail is thriving in both suburban retail centers and urban neighborhoods, notably in Little Bohemia.
“In Omaha, there is still a steady [retail] absorption rate and vacancy remains under 5%,” Backhaus said. “Foot traffic is increasing in shopping centers, and retailers are continuing to target the Omaha market to enter or expand their presence. We’re also seeing many new food, fashion and entertainment concepts focusing on the Omaha MSA.”
If there’s anything upon which all can agree concerning the local CRE market it is this: industrial space is red-hot and there’s not enough of it.
“Average rent prices are up and vacancy in the Omaha industrial market is once again below 2%. In other words, it is very hard to find industrial space, specifically warehouse space,” Andersen said. “Much of the demand is being driven by public warehouse operators and food processing companies.
“We are seeing more industrial space built to keep up with the demand. There is currently over 1.2 million square feet of industrial space under construction, with almost 800,000 square feet, 64.6% of it, located in the Sarpy/west submarket.”
Future in Fundamentals
Whatever market challenges lie ahead, the fundamentals of commercial real estate continue to apply, Andersen said.
“We continue to see a flight to quality where companies are seeking new office spaces in higher quality buildings that are amenity-rich in amenity-rich areas,” she said. “They may need less space because of the hybrid work model, but they are taking a step up in quality in an effort to entice employees back to the office and recruit new talent. We’re seeing more companies offer food, bring your dog to work days, special events, et cetera, to engage team members.”
Landlords need to pay attention to trends.
“Those landlords that are adapting to the need for smaller spaces, easy-to-move-into spaces and buildings and neighborhoods rich with amenities are seeing activity in their buildings,” Ellis said. “It’s a wild world out there in commercial real estate right now.”