SIOR Pulse Blog

SIORs on the Present and Future for Office and Industrial

Written by SIOR HQ | Jan 5, 2024 1:39:41 PM

Office and industrial—two commercial real estate sectors with very different circumstances currently, yet both operating in the same uncertain economy. We sounded out five industry leaders in office and industrial brokerage on what they’re seeing and what they expect in 2024 within their markets and sectors.

Below, you’ll read insights from SIOR CEO Robert G. Thornburgh, SIOR, CCIM, CPM, FRICS,; Matt Sultenfuss, SIOR, managing partner of Avocat Group in Tampa; David C. Lockwood III, SIOR, CCIM, CRE, EVP and COO, Colliers, Columbia, SC; Vanessa A. Herzog, SIOR, CCIM, SVP and principal, Lee & Associates in Tacoma; and Ryan Moen, SIOR, principal and co-founder, Versa Real Estate Services, Oakbrook Terrace, IL.

On current office and industrial leasing demand. Sultenfuss (office and industrial): The difference between the industrial and office markets is drastically different than what it was before the pandemic. The pandemic brought a huge rise in e-commerce demand, which is a big reason why the industrial market has been booming. Industrial vacancy in general is extremely low across the US. In turn, we’re seeing tons of new construction in the tertiary markets that are an opportunity for companies to evaluate as their larger urban market leases come due. 

The office market, on the other hand, has been greatly affected, with many companies nationwide having shifted to a remote or hybrid work policy, meaning the number of employees who come into the office is much less than pre-pandemic levels. For this reason, these companies are downsizing to smaller offices, or combining locations. Tampa, where we are headquartered and Florida in general, hasn’t been hit as hard by this shift, as many companies are relocating from up north in return for lower rental rates.

Lockwood (office): The trend of “flight to quality” has continued and Class A space continues to be leased. In most markets, there is positive absorption of Class A space even in a period of time we see many companies renewing their leases with slightly less space than previously leased. The Class A space, which is successful, is the space that is heavily amenitized and with surrounding support services such as restaurants, bars, entertainment, etc. 

Herzog (industrial): We are seeing a slowdown in leasing demand, and a slowdown in decisions from tenants. Sublease space is at its highest in a decade. Rates are holding, but we are beginning to see some softening. High interest rates, slow jurisdictional response (COVID, working remotely) combined with still high construction costs are causing both landlords and tenants to shy away from heavy tenant improvements. Those TIs that are getting included result in the higher shell rates, which is artificially projecting shell rate increases in the area. Normalizing? Not to a normal standard yet, but we expect to see that later in 2024.

Moen (office): Leasing volume has been steadily increasing. Net absorption is still relatively flat as the volume of sublease availability coming on the market is suppressing it. We are also benefiting from office utilization slowly increasing week by week, as well as continued high employment rates which also affects demand for office space. One noticeable change is that many office occupiers have shifted their real estate strategy to signing shorter-term leases with good existing conditions.  

Post-pandemic office users are seeking spec suites/fully furnished spaces or second-generation space with good existing built-out conditions versus raw white box space. Higher construction costs have been a material part of this focus. Pre-built spec or furnished spaces allow office users to keep their lease term shorter and also with less capital expense required. Particularly in Class A buildings, many owners have a spec suite program in place to capture this demand.   

With that said, office owners are still combating the higher vacancy and availability rates. We are seeing more competitive rental rates along with aggressive concession packages to entice tenants to their buildings. Larger tenants are gravitating to higher rent Class A buildings with abundant amenities as employers continue to entice their employees to return to the office with more frequency.

On how demand in 2024 will compare with 2023. Sultenfuss (office and industrial): I anticipate that industrial markets will continue to thrive in 2024, and the office markets will continue seeing the effects of remote and hybrid work. However, I predict that industrial landlords will offer better concessions in the near future, as new construction continues to be delivered increasing vacancy rates for the short term. We have seen a massive decline in speculative industrial development over the past six to 12 months, which in my opinion will cause vacancy rates to go back down in 2024 and 2025. On the office side, more pre-pandemic leases are coming up on their expirations, and I envision that a large portion of these companies will downsize.

Lockwood (office): I believe that as many corporate offices in larger cities return to the office with a balance of in-the-office workers and remote workers, we will continue to see companies desire to upgrade their space and thus move to higher-quality buildings. At the same time, there is a strong push to reimagine older obsolete office buildings with alternative uses which removes those buildings from the inventory of office stock.  While we continue to see an overall high vacancy rate right now, I believe we will see the vacancy rate begin to trend downward in 2024.   

Herzog (industrial): 2024 will still be unpredictable as the economy continues to shift and the elections are looming.

Moen (office): I anticipate leasing volume to continue to stay steady or slightly increase for 2024 provided there are not any meaningful economic changes that would deter corporations from leasing space. Through 2024 the office market will still combat higher availability rates. Those rates have already seemed to be nearing a peak if they have not done so already as many office users have put their excess space on the market for sublease or exercised termination options to cancel the lease.

On how brokers are advising clients in the current market. Sultenfuss (office and industrial): As a tenant representative, I have a fiduciary responsibility to act in the best interest of my clients. When an office client comes to us for direction because they have an expiring lease, we help them assess their current space and whether they’re using it efficiently. Most of our clients still want a nice, Class A office space, but they just need less of it. This is where the Flight to Quality plays in. If our client doesn’t need all their space and can save money by downsizing to an office of higher quality than their current one – that’s what we advise them to do.

The industrial side is a little different. It’s based less on the amount of space, and more on location. If we have an industrial client who is happy with the space they’re in, and the location is good for business, we’d encourage them to renew, but fight for the most aggressive rental rate and best concessions possible. However, if one of our industrial clients is looking to relocate or add a location, then we pull out our geographic analytic tools. We dive into things like demographics, traffic data, consumer profiles, and more – for any given region of interest.

Lockwood (office): I believe owners should be carefully planning improvements to their properties if the improvements translate into higher rents for the properties. I believe these decisions will be slow to occur and based on the credit markets.  If we begin to see some moderation of the interest rates which enable lenders to fund more improvements, I believe the continued interest from tenants will be in better quality and updated Class A or high Class B space.

Herzog (industrial): For landlords, I am advising them to be creative in financially structuring the lease costs, watch the competition closely, and move strong for good credit. Try to have your available space looking as move-in ready as possible (no dirty sinks and no cobwebs – thank you). If you don’t have a certificate of occupancy, do what you have to and obtain that so the space is ready to occupy. Be prepared for tenants to prolong the process of making decisions.

Moen (office): Tenants: In today’s market, landlords are competing aggressively with strong concession packages to win their tenancy. Whatever their situation is (renewing, downsizing, expanding, relocating), landlords are willing to listen and offer competitive terms to win their business. For tenants comfortable committing to longer-term leases, it is a great time to capitalize on this current environment. Tenants also need to understand the landlord’s debt situation. 

Landlords: Win every deal and keep investing in the building. With higher availability rates and numerous options for tenants to choose from, landlords need to offer competitive packages to win each deal. Landlords should continue to look at expenses that help the leasing efforts including common area renovations and space prep to allow their property/space to elevate their asset amongst the competition. 

Sellers: In this environment, sellers need to be more strategic about when to bring a property to the market. With a significant jump in interest rates and the abundance or distressed property for sale, assets must be well positioned before starting the selling process. I think the office market will continue to improve and many economic forecasts anticipate some mild decline in interest rates going into Q2-Q3 2024 that will help with better pricing on the office assets. 

Investors: We are already experiencing an abundance of REO and bank forced sales, often with stabilized assets going through maturity default. I anticipate this to continue to be the case through 2024. Many of these property sales are transacting at a fraction of what they were valued several years ago. 2024-2025 will be a great year to acquire great value-add opportunities.

On the long-term prospects for office. Sultenfuss: I believe long-term that office users will backfill the downsizing trend eventually although there will be continued downsizing as current leases approach expiration. The Flight to Quality trend will continue as staff, and especially young professionals, will want to come into an office with cool features that they might not have at home. As more office landlords create a “live, work, play” environment, it will drive a return to the office.

Lockwood: I am actually bullish on the long-term outlook for office with a new wave of construction in the years ahead but only if we see a decline in the current high interest rate environment.

Moen: Chicago/Chicagoland is a major economic hub and it will find ways to reinvent itself. I anticipate for the longer term the amount of office building square footage in the market to stay flat or mildly decline. Older office buildings will find new uses including multifamily/hospitality development in the urban zones, and in the suburban market you will see more razing of corporate parks for industrial or alternative uses.

On the long-term prospects for industrial. Thornburgh: The industrial landscape has experienced an unprecedented run over the last few years, breaking records on a global scale. For a long time now, we have enjoyed the benefits of cheap money and extraordinary demand. Supply imbalances have been the most significant we have ever seen for industrial space.
 
We are now seeing that sector shift. While each market has its own unique story, they all are experiencing the direct impact of rising interest rates, inflation, uncertainty, and the resulting significant drag on pricing.
 
How large of an impact these changing influences will have on industrial long-term is anyone’s guess. What is clear in any transformative environment – this will push building design, pricing, businesses, and real estate professionals in ways that we have not seen before. Those who maintain a quick and nimble mindset will be best equipped to capitalize on whatever tomorrow brings.
 
Despite economic uncertainty clouding forecasting, the future of industrial real estate remains far more stable than many of its other commercial counterparts. However, if we have learned anything in recent years, it is to expect the unexpected.

Sultenfuss: The long-term industrial users will have to adapt to the changing market and strategize to maximize the cube with better and more efficient racking and layout as well as adding automation to become more cost feasible. Like Tampa, other big cities are seeing low vacancy rates in the industrial market. For this reason, warehouse users seeking space in big cities may have to consider both optimization strategies and options outside of their current geographic range.

Herzog: I think as you see online shopping continue to grow in percentage of sales and crime deter brick-and-mortar shopping, the need for warehousing will remain strong. Job growth in our area, the Seattle Metro, is still diversified and growing in size, which will keep the demand for CRE stable.