Welcome to 2024. If we thought 2021, 2022, and 2023 were wild real estate years, we had no idea what was still ahead. I have already put my wagers down on the fact that there will be no “return to normal” as defined by how things worked before COVID. But I am increasingly thinking that a longer-term correction is in process.
A portion of this is tied to a conversation with a friend this week where he told me about the correlations between unemployment rates and office vacancy. His thoughts are worth a separate read. But it boils down to the fact that the commercial real estate markets today share a striking similarity to the post-S&L crisis markets.
Follow along with my logic:
- Employees are working less often from the office – regardless of whether there is a mandate in place or not.
- Companies need less space because there are fewer people in the office.
- Three conditions prevent companies from immediately acting upon this reduced demand:
- Managers hold a false belief that they can still eventually force employees back to the office and kick the decision down the road.
- Lease critical dates prevent the company from implementing a move until later.
- Project financials do not generate the necessary ROI to downsize at the first opportunity.
- The above conditions mean that companies are spreading out their actions to downsize their space (potentially by as much as a decade depending on their lease) while also pushing landlords for significant concessions to make the project meet internal finance targets.
- Landlords are facing an increasing demand for tenant improvement dollars while also seeing increasing vacancy rates and stagnant to declining net effective rent rates.
- Not all landlords experience this change in demand at the same time as they may encounter earlier or later movements by their tenants.
- Banks with significant exposure to commercial real estate loans will face a steady, but increasing, demand for new loans in the face of less favorable market conditions (the above plus higher rates).
- As the above effects flow through the system, there will be a cascading effect in some markets or with some institutions magnifying the impacts.
Together, I could see it taking until 2030 or longer before the commercial real estate world finds stability again. What this means to occupiers is a bit up in the air still as they are a significant portion of the equation. But it likely means that we will see interesting opportunities quickly spring up and then disappear as well as markets and timings where everyone can act like all is normal and going up for a time. Consistency and certainty will not be the cornerstones of our strategy until stability returns.
For me, this means that there has been no better time in the last 30 years to strongly consider an aggressive approach to a new real estate strategy. If you do not have a strategy prepared, you will not be able to take advantage of the opportunities that suddenly arise. If you have not gotten the business on board with a new direction, time will not be on your side to get new projects approved.
Maybe I am wrong and normalcy returns next year. I do not see how that is likely given all the turmoil we can see around us, but it is possible. The worst case then is that you have built a new strategy and have fewer really outstanding opportunities to take advantage of. There will still be plenty and having a clear strategy is never a disadvantage.