As we reach the halfway mark of 2023, the commercial real estate industry is an unfinished painting, comprised of varying colors and brushstrokes—from looming interest rate hikes and rent increases to shifting vacancy rates, there is a general sense of uncertainty highlighted on the mid-year canvas. However, there is also tenacity, resilience, and varied levels of activity across all sectors as the economy begins to cool and settle.

To share their insights into the industry's current and future outlook, SIOR members across different markets identified the areas poised for strength and those facing challenges within their regions and beyond, as well as the anticipated trends that will continue to dye the commercial real estate landscape during the remainder of the year.

A Foggy Horizon: Current Challenges

“Without a doubt, the effects from the increasing cost of capital are having a dramatic impact on several sectors within the CRE industry,” reports Michael Connor, SIOR, an office specialist and vice president at Hanna Langholz Wilson Ellis, Pittsburgh, Pa. To curb the impact of increased capital, tenants interested in upgrading their spaces are choosing to renew or refurbish rather than invest in an entirely new space. Consequently, the fear of rising interest rates continues to play a huge role in both office and industrial markets across the board. “Pressure on lenders to clean up their balance sheets continues to be a challenge,” notes SIOR Past-President Mark Duclos, SIOR, president at Sentry Commercial in Hartford, Conn.

Connor notes that general uncertainty for the office sector in Southwestern Pennsylvania continues to be the greatest challenge. One area of uncertainty is, from a users’ perspective, “how to best structure an effective return-to-office policy while minimizing attritions from employees.” He adds that while some Class A offices are likely to endure, Class B and C office spaces might struggle to gain tenants despite a likely drop in asking rates. Bob Gibbons, SIOR, founder at REATA Commercial Realty in the Dallas–Fort Worth market, agrees, saying this will be especially true for “class B & C product that aren’t in a highly desirable, walkable locations.”

Tim Vi Tran, SIOR, president for The Ivy Group in San Jose, Calif., also agrees, quoting the uncertainty of interest rate hikes, coupled with job losses (especially in the tech sector), as contributing factors. “The office market is prime for a major shakeup,” he states, particularly due to the nature of continuing work-from-home scenarios and an overall lower demand for office spaces. He specifically calls out downtown Central Business districts such as San Francisco, Oakland, and San Jose. “Some cities,” he continues, “are looking at the possibility of converting office spaces to much-needed residential.”

Overseas to the east, Australia also finds itself grappling in the office sector. “Lower quality assets in CBDs will struggle to retain and attract tenants,” predicts Kyle Hutchin, SIOR, principal at Franklin Shanks in Sydney. Construction cost pressures will likely mean that refurbished and non-fitted spaces will be viewed less favorably than those with higher-quality spec fit-outs.

On the industrial side, some markets are reporting that tenant demand is shifting towards smaller buildings. “Large buildings are seeing less activity,” says John Barker, SIOR, president at Red Rock Developments in Charlotte, N.C. Other industrial experts, such as Duclos, note that available inventory is sparce, which presents challenges for both tenants and occupiers. In a recent article on the SIOR Pulse Blog, Duclos discussed the rise of flexible warehouse spaces in Hartford, Conn., predicting ongoing shortages of industrial spaces in the foreseeable future.

Regarding the European sector, Tobias Schultheiß, SIOR, managing partner at Blackbird Real Estate in Königstein, attributes Germany’s industrial inertia to a shortage of materials and increased construction costs. “The combination of high inflation and interest rates, combined with low (but much more expensive) financing activity, is the reason for a standstill situation in the commercial and residential real estate markets in Germany,” he explains. Similarly, the Australian market has also seen a significant increase in construction costs, “both on materials and labor,” according to Hutchin.

Clear Blue Skies: Areas of Strength

When it comes to most local western markets, vacancy rates remain low in the industrial sector due to ongoing tenant demand. “Industrial is still very strong in our market and vacancy rates are low,” reports Marlene Spritzer, SIOR, vice president at Lee & Associates in Raleigh, N.C., “but the demand is cooling slightly.” Evidently, most don’t see this decrease as any cause for concern, especially considering the lack of available property thus far. “Nationally and locally, vacancy rates will remain low due to decreased new development and ongoing tenant demand,” affirms Duclos.

While the office sphere is seeing higher vacancy rates, there are still reasons to remain optimistic, specifically for Class A spaces. “An overwhelming majority of office users will continue to prioritize Class A options at higher price points,” explains Connor, “even when compared to more competitive deals in less-desirable office properties.”

Additionally, more diverse communities may have a higher chance of weathering the oncoming storm for property types across the board, with asking rents starting to climb back as well. Spitzer believes the effects won’t be as drastic in the Raleigh-Durham market. “Flex space rates are increasing dramatically here,” she relays. “We have about 5 million sq. ft. of office subleases and the number is rising.” At the height of uncertainty, the Raleigh-Durham office market is proving to be quite adaptable. Gibbons reports a similar phenomenon for the Dallas–Fort Worth region, citing significant in-migration from other parts of the country as a significant leading factor. “We still see the impact of hybrid work models which reduce demand for office space,” he says—but that isn’t as much of an issue for smaller local and regional companies.

Laurie Tylenda, SIOR, associate broker at CBRE Upstate NY, agrees. On account of the greater Albany area, she shares, “While our office leasing is not yet what it was pre-COVID, we do have a fair amount of activity,” further elaborating that some submarkets for Class A space have tightened in the past few months. “Flight to quality continues to be a trend here,” she adds.

Interestingly, some international markets are faring quite differently compared to their western counterparts. “In China the office market, as well as the industrial market (including both manufacturing and warehouse space), continue to perform well,” states Bjarne Bauer, SIOR, managing partner at NAI Sofia Group Shanghai. Likewise in Australia, the industrial market is booming. “Australia currently has the lowest industrial vacancy rates in the world, now estimated to sit nationally circa 0.6%,” touts Hutchin, “with demand expected to continue outstripping supply for the next few years.” The office sector remains resilient as well, with flight to quality driving tenants back to premium spaces.

Greener Pastures: Embracing Innovation & Looking Ahead

As the paint dries on the first half of the 2023 canvas, SIORs draw from a wealth of industry knowledge to offer insights on what lies ahead.

“We will continue to see industrial asset be the darling in the owner/user space,” predicts Tran. Bryan Gardner, SIOR, an industrial specialist and executive vice president at McIntyre Real Estate Services in Reno, Nev., also expresses optimism, stating, “We are starting to see a more normalized supply chain.” With the ports operating more efficiently, companies can start to lessen the need for overflow “Just in Case Space,” allowing them to allocate those resources elsewhere.

For countries such as China, the market will likely remain extremely competitive. Citing unrivaled cost structure, logistics, and administrative stability, Bauer explains that “China provides for a better production environment” compared to locations such as Mexico, Vietnam, and Thailand.

Meanwhile, Schultheiß is expecting to see more activity in the investment market in Germany, with “another massive driver of change” being ESG (environmental, social, and corporate governance) regulation. Buyers only consider non-ESG compliant properties when presented with substantial price discounts, Schultheiß observes, which gives ESG-compliant properties a competitive edge and indicates the industry's mounting focus on sustainability.

For office assets, “more challenges await the capital markets sector overall,” says Connor. As the concept of the office continues to evolve, he expects to see a rise in “phantom vacancy” or “shadow space.” Alternatively, Tylenda points out that as the return-to-office rhetoric gains momentum, some companies will have to reconsider their space requirements, especially after downsizing during the pandemic. In light of this, the demand for flex spaces is expected to remain a prevailing trend. And according to Barker, not just office but “all markets will need more balance in product size offerings” in the second half of 2023.

Undoubtedly, amidst lingering apprehensions in various sectors, there's still a renewed sense of hope. SIORs are resiliently adapting their businesses, steering towards new opportunities with the shifting tides.

Businesses are prioritizing flexibility, risk avoidance, and adopting an asset-lite approach, Bauer observes. Gibbons and Tran express similar perspectives, emphasizing their intensified marketing efforts and a willingness to explore new and inventive approaches to showcase their experience and meet evolving needs. Meanwhile, other SIORS are focusing on technology: “We are continuing to look at Proptech to further enhance the services we provide,” Gardner remarks.

At the end of the day, the grass is always greener where you water it. As tenants face challenges in bringing their ideal spaces to life, SIORs are championing increased efforts to support and empower them. “One area where we have materially fine-tuned our practice,” Connor shares, “is playing a stronger role in helping clients.” He describes that his practice now assists clients through the entire site selection process, including the preliminary design, budgeting process, and throughout construction well after a lease has been executed.

“Internally, we are continuing to build and strengthen our client relationships,” echoes Tran. “We’re in this for the long haul.”

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