Top Commercial Real Estate Trends in Q4 2021

Here are the top takeaways from this year’s CRE brain trust:

1.  Yields Driving CRE Investments Over the Next Year. The U.S. economy is heating up at a fast rate. Due to a doubling of the Federal Reserve balance sheet over the last 18 months and an injection of stimulus capital into the economy equal to 25% of the annual GDP, there is a massive amount of money in play. Banks and investors are having trouble finding places to invest this capital. At the same time, low-interest rates push investors to search for yield and are pushing down cap rates—the longer we have low rates, the lower cap rates will go. This bullishness bodes well for commercial real estate, as this “need for yield” should drive investments over the next year.
2. A Strong Economic Recovery from COVID-19 Points to a Big Recovery for CRE Markets (At Different Rates). WITH STRENGTH, the U.S. and world economies are coming out of the COVID-19 pandemic. Strong economic growth coupled with low-interest rates creates an excellent environment for real estate investment evaluation. As a result, most CRE sectors are trading competitively above pre-pandemic levels, with the office being the one exception (except for highly leased first-class office projects in urban areas) for the sole reason that most employees have not yet returned to the office, which should change in the next year. Many office tenants are still trying to figure out what their office footprint will look like. For the next 24 months, many tenants will be trying to figure out what that balance will look like for them.
3. Demand for Office Space that Incorporates Collaborative Outdoor Areas Will Skyrocket. With businesses in a post-COVID-19 world eager to bring back employees to the office, there is a massive new demand for office layouts to emphasize outdoor space—decks, rooftops, terraces, and plazas will be incorporated into workspaces like never before. The workplace environments are moving towards a greater engagement with the outdoors: “with COVID and other things that will come up in the future, more and more meetings will take place outside, whether they’re small group collaborations or several hundred-person events.”
4. Employees Will Return to the Office in Greater Numbers Than We Think. Despite the current hesitancy of workers to return to the office, a return to office life is inevitable, and a year from now, offices will be filling up faster than we anticipate. It will look different, with offices filled to 65- 80% of pre-pandemic levels on any given day. There will be more separation between employees and more collaborative workspaces. Still, the bottom line is that companies have realized the importance and value of having employees collaborate in an office. Employees themselves will follow suit due to a fear of missing out. Though a hybrid work-from-home model will likely be the future for many companies, research conducted by CBRE indicates that “most companies want their employees to come into the office at least 2.5 days a week, if not more. The smaller the company, the higher the expectation that people will come to the office all the time.
5. State-of-the-Art, Reimagined Office Space is Needed to Bring Employees Back to the Office, Causing a “Flight to Quality.” In a post-COVID-19 world, it’s clear from insights that companies will need to re-think their office space in fundamental ways to attract talent and bring their employees back to the office. Aside from an increased emphasis on outdoor space, “a common theme for office tenants today is a flight to quality, safer new spaces, and buildings as their top choice.” Whether it’s larger lobbies and conference areas, blurring the lines between outdoor and indoor space, or offering a variety of different spaces within the office where employees can work, it will help the employer compete for and attract talent, which is vital right now. “What we’re moving into is a world where employers will have to make their workspace so much more appealing and productive than being at home that there’s no doubt for employees that they will get more done at the office,” The product that can’t do that will have to be re-imagined to make it unique enough to bring workers back to the office and give them a reason for being back at work.
6. Leasing Transactions are Mixed, Depending on Location and Industry. The consensus among all the leasing markets observers is an optimistic outlook across most sectors and regions. However, it may take a year or two to get office leasing (other than first-class office space in urban areas) back to pre-pandemic levels.
7. Sublease Space is Still Prevalent, but it is Decreasing. During the pandemic, vacant subleased space skyrocketed as large tech companies found their massive offices empty and questioned how much they would be using their space moving forward. This uncertainty has led to more clarity for companies who have determined that office culture will still be a vital part of their work environment moving forward, though the time frame is still unclear. As a result, this sublease space is beginning to be taken off the market due to increased demand. When you look at some of these rental rates, pricing and asset values are up—even in some multi-tenant assets—in an environment where everyone is still questioning how much we’ll be using the office moving forward. It’s safe to say that this trend will continue as the office picture becomes more apparent in the coming months.
8. The Trend of Office-to-Life Science Conversions Will Slow. Currently, the lack of demand for office space in many regions has spurred the conversion of office space to life science space, which is red hot right now. As employees begin to return to the office and office space becomes more in-demand, this life science conversion trend will slow, and we will see people gravitate towards traditional office buildings. As we begin to get closer to a pre-pandemic world with a return to the office, people that are going to life science as a haven will start to reassess the need to make this conversion.”
9. COVID-19’s Effects on Construction Site Protocol, Material Costs, and Availability Have Impacted Developers, but Not Stopped Them. Developers reported a significant learning curve to adjust to construction site COVID-19 protocols, which led to some inefficiencies. Still, residential projects continued to be built and delivered, albeit a bit behind schedule and over budget (commercial projects were deemed non-essential and could not move forward for a period). Supply chain disruption during the pandemic caused delays and price spikes for construction materials, which has increased overhead costs considerably for many projects. Lumber costs saw a considerable end at one point and have since come down to 2018 prices, while overseas steel delivery has seen a significant delay. We’re still in a transitory inflation period that’s affecting commodity prices, and there’s a backlog of orders that are still getting filled due to factories being shut down last year. It will probably take six to nine months for that backlog to get churned through before prices start to settle.”
10. There is Still Much Uncertainty as to how COVID-19 Applies to Force Majeure Clauses in Construction Contracts. Owners and contractors will be reconsidering the specific force majeure language, and allocation of force majeure risks, in construction contracts from now on. The contract language we’re going to get now will contemplate these things, and there will be a new negotiation around delays that come from these kinds of events. These negotiations could cause issues with lenders, who may have problems with the increased costs resulting from these negotiations.