by Neil A. Dolgin
After a strong economic rebound for commercial real estate in 2021, data from the National Association of Realtors (NAR) indicates a slowdown in the growth of commercial real estate in 2022 resulting from the effects of the Covid-19 pandemic, rising inflation, higher interest rates, and geopolitical events that have caused a spike in energy prices. The slowdown has affected demand for apartments and office spaces.
The good news is that we continue to see robust activity in the industrial building, retail and the medical office sectors where Kalmon Dolgin Associates has specialized for decades.
The demand for retail spaces has remained positive for seven straight quarters, according to NAR, and we’re seeing strong demand locally. Net absorption increased to 23.3 million sq. ft. in the third quarter of 2022, a 22% increase from the second quarter. And neighborhood retail that offers in-person services continues to advance even faster. Net absorption for neighborhood centers rose by 35 percentage points compared to the year’s second quarter.
The commercial office sector is facing challenges. While companies are trying to encourage employees to return to the office, employees are resistant. According to a report by the Building Owners and Managers Association International, a consistent majority of decision makers continue to support more work from home. Almost 30% of workforces are expected to remain mostly or fully remote for the next 12 to 18 months.
NYU Stern Professor Arpit Gupta and co-authors Vrinda Mittal and Stijn Van Nieuwerburgh (Columbia Business School) recently reported on the NYC commercial office marketplace and found dramatic shifts in corporate office lease revenues, office occupancy, lease renewal rates, lease durations, and market rents as companies shifted to remote work in the wake of the Covid-19 pandemic. They revalued the stock of commercial office buildings taking into account pandemic-induced cash flow and discount rate effects and found a 45% decline in office values in 2020 and 39% in the longer-run, the latter representing a $453 billion loss in value. The NYC commercial office marketplace faces serious challenges ahead.
Things are far better for the industrial building sector. We continue to see a strong local demand for industrial buildings. Nationwide, there was a net absorption of nearly 425 million sq. ft. in the last 12 months ending in Q3 2022, according to NAR. The volume of industrial space absorbed is still around double that of pre-pandemic times. The Industrial sector has also had the lowest vacancy rate (4%) compared with other sectors in the commercial real estate market.
Challenges still remain for buyers and sellers of industrial buildings due to a trifecta of challenges: high inflation, rising interest rates and the increasing costs of doing business in New York City. I’m reminded of the 1970s and early 1980s when interest rates were very high, and you could put your money in the bank and earn 3% to 3.5% interest without needing to invest in bonds or stocks.
Now it’s becoming increasingly difficult to sell a building; buyers are asking for higher cap rates while owners insist on an asking price that may have made sense at the peak of the pandemic but makes little sense now. As brokers we try to step carefully with both buyers and sellers in ways that bring them closer to the deal they both want. Our advantage is our experience. We know all sides of the deal – as brokers, owners, and building managers having worked with hundreds of tenants. We also know New York City’s neighborhoods, families of owners, and building values both historically and contextually. We rely on this vast experience in serving our clients.
When it comes to making a deal, the failure to account for economic conditions might mean walking away from a good deal that might take a long while to come around again. In the meantime, winter is fast approaching and owners of vacant buildings will be facing rising costs for building maintenance, repairs and energy.
The industrial rental marketplace remains strong. We’re excited to see that some unsold industrial buildings are coming back onto the rental market. We recently took over an exclusive on a building down in the Red Hook section of Brooklyn. Red Hook is a great location for industrial, manufacturing, construction and maritime businesses that need to deliver fast turn-around times to local clients, and companies needing transportation like barging and shipping. Instead of leasing a 20,000 SF unit to one tenant, the owners want to have four units of 5,000 SF each because they don’t want to put all their eggs in one basket with one tenant. We help owners transition their buildings from sale to rent, including reinventing their buildings so they deliver what they need to deliver to make a building really attractive. We also work with owners and tenants on innovative leasing terms that advantage both parties. In some cases, we have convinced owners to take a new tenant for two years versus five or ten years, to establish the relationship. We encourage owners and renters to be flexible with prices and lease terms, especially in these challenging economic times, so we can attract tenants to a particular building.
If you have a question on today’s commercial real estate marketplace, email me any time.
Neil A. Dolgin is co-president of Kalmon Dolgin Affiliates. Founded in 1904, Kalmon Dolgin Affiliates (KDA) has grown into one of the New York metropolitan region’s leading commercial and industrial real estate firms. Kalmon Dolgin Affiliates specialize in all aspects of real estate services for developing, managing, selling, leasing and marketing commercial and industrial property. KDA’s highly-trained professional brokers offer clients a practical, street-wise approach to commercial and industrial real estate brokerage, leasing and sales, supported by the latest in real estate marketing, management and research technology.