6 Commercial Real Estate Trends to Watch
Experts say 2024 may be an opportunity for the commercial housing market to get back on solid footing by embracing shifting preferences and emerging trends.
WASHINGTON – As we enter a new year, the commercial real estate industry finds itself at yet another crossroads.
The market is continuing to take shape and redefine itself after several years of new challenges. In 2023, the industry remained on unsteady grounds as economic uncertainty persisted, return-to-work plans shifted at large companies, and rising interest rates continued to limit access to affordable capital. As a result, many real estate firms are still experiencing revenue declines thanks to higher vacancy rates and slow rent growth.
However, despite the challenging conditions of the past several years, there's still plenty of reasons to be optimistic about the commercial real estate industry. In fact, many see 2024 as an opportunity for the market to get back on solid footing. Whether you are a property owner, investor, property manager or tenant, these changing winds can impact both your short- and long-term strategies.
As experts representing clients in a range of real estate transactions involving everything from small office leases to large, mixed-use properties, our real estate team at Buchanan is closely following the trends that have the potential to significantly impact the future of commercial real estate.
Here are the top trends we're keeping an eye on in 2024 and beyond:
1. The evolution of return to office
The single most important trend impacting commercial real estate will be the future of return-to-office plans for companies across the U.S. After several fits and starts since the peak of the COVID-19 pandemic, we're starting to see more momentum behind large companies encouraging their workforce to return to office spaces. Many of these companies are pointing to declining corporate culture, less effective training, and a lack of camaraderie as reasons to call employees back in.
In order to make the transition back to the office more attractive, proactive landlords and tenants are addressing concerns that employees may have. As physical safety has become a concern for many employees in metro areas across the country, one of the steps that forward-thinking property owners and employers are taking is to increase workplace security measures. They're doing so by engaging security companies and even working with local municipalities to elevate police presence in their area. As dense metro areas continue to make the most sense for workspaces due to their proximity to mass transit, office owners and managers will need to ensure their facilities are safe to provide peace of mind to their tenants.
2. The outperformance of high-quality offices
Employers are also seeking out higher quality, “Class A” spaces to draw employees back into the office. As employers adopt hybrid plans that only require partial attendance throughout the week, many tenants are seeking smaller, higher-quality spaces with more amenities, like on-site fitness centers, cafeterias, and outdoor workspaces, that enable tenants to upgrade their office without meaningfully increasing their overall rent. Many property owners are also making plans to upgrade their facilities to increase their draw to tenants seeking newer, higher quality offices that are more appealing to their employees.
3. The future of interest rates on CRE activity
Over the last 18 months, rising interest rates have created challenging conditions in the commercial real estate industry. As rates climbed, the number of real estate construction projects and transactions declined due to the higher borrowing costs. The projects that did get underway faced significant deficits due to the higher rates, with owners of existing properties also running into issues refinancing existing loans.
In 2024, the majority of observers expect interest rates to flatten out or even decline slightly. If this comes to fruition, the lower rates could also lead to more new construction projects as financing becomes less costly and more readily available.
4. The shifting mix of new construction projects
Considering the oversupply of traditional office spaces, new office construction is expected to remain limited in 2024. However, new construction projects are also beginning to pick up in certain parts of the market. We're beginning to see new construction and large renovation projects kick off for properties outside of office spaces, like the life sciences industry, universities and public institutions. However, the declining number of union contractors, electricians and other tradespeople may contribute to delays on projects where highly skilled labor is preferred.
5. Ongoing property conversions
The availability of excess office space post-pandemic has led to an increased interest and emphasis on converting some properties to affordable housing. While some buildings may be easier to convert than others (e.g., office buildings without an open central core for light and air and no associated parking), there is an interest in finding ways to make this work, including financial incentives being offered by some jurisdictions to help offset costs. However, given the difficulty of these conversions, property owners are seeking further government support in the form of streamlined approval processes and, depending on the area, zoning code changes.
Retail properties are also interested in undertaking a different type of transformation. Property owners with empty traditional retail spaces are seeking ways to convert areas into entertainment centers that draw people into their facilities. Tenants that provide entertainment services are being courted aggressively and offered favorable leasing terms. By securing more entertainment offerings in their shopping centers, property owners can increase foot traffic to the surrounding retail locations, thus increasing the attractiveness of their property to additional retail tenants.
6. Additional affordable housing legislation
There is a large, ongoing need for affordable housing in many areas of the U.S. As noted by the National Low Income Housing Coalition (NLIHC) in its Out of Reach 2023 report, “The U.S. currently has a shortage of 7.3 million rental homes affordable and available to extremely low-income renters.” NLIHC also cites data from the U.S. Department of Housing & Urban Development (HUD), “Between 2011 and 2022, the number of HUD-assisted renters did not significantly change, while the supply of low-cost rental units in the private market declined.” In December of 2023, HUD released Part 1 of The 2023 Annual Homelessness Assessment Report (AHAR) to Congress, which revealed a 12% increase in the number of individuals experiencing homelessness on a single night compared to 2022.
The largest production vehicle for affordable housing continues to be the federal low-income housing tax credit (LIHTC), a program that has long received bipartisan support and generally benefits households at or below 60% of area median income. Post-pandemic, these transactions are receiving the further benefit of funds provided by the 2021 American Rescue Plan Act (ARPA), and the deadline to obligate them of December 31, 2024, is now approaching. Depending on the recipient, ARPA may no longer be available, or it may be prime time to receive a commitment of unobligated ARPA funds before the obligation deadline, provided the development can meet the December 31, 2026, expenditure deadline.
On the heels of Florida's Live Local Act that contained a variety of measures to spur development of housing for the so called “missing middle,” a new Workforce Housing Tax Credit (WHTC) has been introduced by bipartisan legislators in both the House and Senate to assist a broader income range of households that cannot afford market rate rents, between 60% and 100% of area median income. As proposed, WHTC would be fairly similar to the LIHTC and focus on the segment of the workforce, such as teachers and first responders, who cannot currently afford to live in the communities in which they serve.
The Inflation Reduction Act (IRA), enacted in August 2022, offers several additional opportunities. The IRA extended and increased the new Energy Efficient Home Credit available under Internal Revenue Code §45L and added specific provisions designed to benefit developers of LIHTC developments. Updates to Internal Revenue Code §48 contained in the IRA targeted to spurring investment in underserved communities may be sufficient reason for affordable housing developers, sponsors and investors to consider investing in solar and wind facilities in connection with upcoming developments to potentially lower operating and utility costs. HUD developed the Green and Resilient Retrofit Program to implement Section 30002 of the IRA to reduce energy and water use in HUD-assisted multifamily properties, to make HUD-assisted multifamily properties more resilient to extreme weather events and natural disasters, and to reduce greenhouse gas emissions from HUD-assisted multifamily properties.
Finding solid ground
The commercial real estate industry is extremely resilient. After several years of challenging conditions, we expect 2024 to bring some semblance of balance as the market begins to normalize and become more predictable. In the meantime, property owners, investors, property managers and tenants will need to continue adjusting to this new operating reality and stay ahead of the latest trends and developments. At Buchanan, our attorneys are keeping our finger on the pulse of these changes and are here to help your business navigate this evolving landscape.
Source: Jason D'Amico and Michelle Yarbrough Korb, Florida Realtors.