Commercial real estate market slowdown

Pandemic disruptions and financial headwinds have left the commercial real estate market creeping along

Todd Greer, director of Mobile’s Innovation Portal, which offers co-working and incubator space. Photo by Dan Anderson.

While home might be where the heart is, the office these days is wherever the Internet service is. Including at home, or almost anywhere else.

The increasing ability to work outside of a traditional office space was already nudging at the commercial real estate market even before the COVID-19 pandemic sent much of the workforce home. And while employees have been gradually returning to the office over the past year or so, the CRE market itself remains in a state of transition, according to several real estate representatives throughout Alabama.

The issue is two-fold. First is the ongoing societal shift — especially among younger generations — toward work-from-home or some sort of home-and-office mix rather than spending 40 hours each week in a conventional office setting. Combine that with several recent disruptive economic factors — inflation, rising interest rates, soaring construction costs — and suddenly the CRE market is facing a period of major uncertainty.

“It has been a perfect storm of things,” says Jason Scott, senior advisor for Louisiana-based Stirling Properties, which has an office in Mobile. “This mentality and desire for more of a work-life balance was already there. Then when the pandemic hit, it just exacerbated that.

“And now we have all these issues on the economic front. People are still trying to figure things out. We haven’t seen a lot of reductions yet (in office space leasing), but we haven’t seen many long-term renewals of existing space, either.”

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In mathematical terms, the situation is simple. If employees are spending less time working in an actual office, then businesses should be able to handle things with less office space. This is an issue particularly in the major downtown markets, which can accommodate larger companies with more employees but usually at much higher leasing rates.

John Tally, of Harbert Realty Services in Birmingham, predits that companies are beginning to look for smaller office footprints.

“I think the big trend coming up is a lot of these companies that are taking up larger footprints in the larger buildings are going to start trying to decrease their footprint,” says John Tally, leasing and brokerage associate for Harbert Realty Services in Birmingham. “They’ll do that through subleasing, or they’ll just wait until their lease comes up for renewal and then try to reduce their square footage.”

One recent study by the New York University Stern School of Business predicts a nearly 40% decrease in office value, a decline that the report calls “an office real estate apocalypse.” While Tally does not use terms quite so stark, he also doesn’t offer a rosy vision for the near future of the CRE market.

“A lot of the larger landlords are still in a wait-and-see mode,” Tally says. “But if these offices were going to get reactivated to returning to the level of pre-pandemic employees, I think that would have happened by now. And I don’t think the next year or two is going to change much.

“There’s been a little bit more activity toward the suburbs. But for the most part, overall leasing activity has been extremely slow across the board for the Birmingham metro. So, these landlords are going to have some tough decisions to make. People are going to have to get creative for how to utilize all these big blocks of space.”

Of course, there are some business sectors where work-from-home is not a practical option. Government agencies, the defense industry and many high-tech companies require a regular in-person presence.

Nadia Niakossary, of RCP Companies in Huntsville, says the market is stronger there, in part because it’s harder for people in jobs that require security clearances to transition to working from home.

Those happen to be sectors that have been growing steadily in Huntsville through such entities as Redstone Arsenal and Cummings Research Park. As a result, the CRE market in Huntsville is on somewhat steadier ground, according to Nadia Niakossary, senior director of development at RCP Companies.

“The defense and tech industries are not slowing down, and a lot of those jobs require top security clearances that make it more difficult for people to work from home,” Niakossary says. “Beyond that, I hear of more and more employers who are requiring their employees to return to work. I do see the office returning to normal a bit.”

Still, Niakossary admits that even Huntsville cannot escape the financial factors that have bogged down the CRE market in most places.

“Construction costs are just through the roof, and that affects tenants who might want to expand their spaces or build new space,” Niakossary says. “It’s also a challenging time to recruit new, smaller businesses, since they have a hard time getting the financing because of how expensive it can be to rent those spaces.”

While the financial squeeze has forced many building owners to increase their rental rates, Scott says the lack of strong demand for commercial properties has kept those hikes in check.

“Rates really have not risen dramatically, even though the costs to the owner have,” Scott says. “They know they can’t just keep pushing rents up to the point that they’re no longer competitive. It’s a strange dynamic, because the economics from financing and construction costs are going up, but the rates are not.”

In this environment, co-working spaces are emerging as a potential alternative to the traditional office, as building owners look for different ways to utilize some of their square footage. Niakossary says when RCP Companies helped develop the MidCity District in Huntsville, a co-working space was included as part of the plans in response to this trend.

“It’s a popular model,” Niakossary says. “Many businesses enjoy having smaller spaces where they don’t have to fully furnish and supply their office space, but they also still want their employees to work collaboratively.”

Todd Greer, executive director of the 30,000-square-foot Innovation Portal business incubator in Mobile, says the current rise in co-working spaces mirrors the interest in the concept that occurred following the major recession of 2008-2009.

“In times of downturn, businesses question whether they need the same footprint that they had before. And that feeling is increased this time by the fact we’re coming out of COVID,” Greer says. “So, what if we don’t bring everybody back to the office every day? How will that influence our need and use of space? A lot of companies are asking those questions.

“I don’t think we’re ever going to see the office completely gone. But what we are seeing is many organizations are looking at office overhead and trying to maximize their value. A lot of factors are coming together and leading to an environment where we’re going to see a major reallocation of human capital across the country. And because of that, you’re going to see these changes stay around as part of a much longer plan.”

Cary Estes and Dan Anderson are freelance contributors to Business Alabama. Estes is based in Birmingham and Anderson in Mobile.

This article appears in the November 2022 issue of Business Alabama.

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