Halfway into 2024, commercial real estate (CRE) headwinds aren’t blowing with particular strength in any specific sector. Inflation remains above the Fed’s 2% target, and there’s speculation that interest rates will indefinitely remain at current levels. Modest changes in the bond market have resulted in a slight flattening of the yield curve but are not necessarily signaling a definitive change of direction.
Here are trends in CRE that are emerging — and could gain momentum — over the second half of 2024:
Busier Offices
Roughly 75% of the American workforce remains committed to being in the office — at least part of the time. Return-to-office (RTO) migration continues to grow at a steady pace, making it one of the most followed trends in CRE. A strong labor market, coupled with employers weighing new-hire salaries in favor of in-office employees, are also helping to spur bustling in-office environments.
While much of the conversation around high vacancy rates has been attributed to workers’ continued reluctance to return to the office, that’s only part of the story. The pandemic also forced the rapid integration of technologies that enabled global workforces to seamlessly interact — forever changing how teams work outside — and inside — the office. The result: A pronounced desire for higher-quality office space — just a lot less of it.
Trophy properties (Class A office space) and newer construction are actively meeting demand, while also enjoying stable vacancy rates and, in some cases, record lease rents. According to Marc DeLuca, CEO and Eastern regional president at KBS, this leasing activity reinforces the consistent performance of high-quality office properties in strong locations.
“Companies are drawn to these highly amenitized buildings as a way to attract top talent and help them remain competitive,” says DeLuca.
While this “flight to quality” trend could result in initial revenue losses for some portfolios as legacy leases expire and tenants seek fresh locations with more appealing amenities, investors willing to take the risk of renovating or repurposing older assets located in higher-demand suburban areas or conveniently located downtown areas could see long-term gains.
Retail Resilience
Consumer confidence is keeping the economy humming, which is great news for most retailers. And, while consumers continue to favor online purchases, their buying habits have not replaced in-store shopping and, in response, retailers are knitting together online and in-store experiences. Additionally, many retail property owners are investing in modifications that create a more inviting in-store shopping experience, integrating dining and entertainment to drive traffic, while continuing to supporting online shoppers with functional services such as in-store pick-up or return drop-offs.
Due to a lack of new construction over the past several years, retailers on the move will find existing market space somewhat tight. Suburban shopping staples such as strip malls and neighborhood shopping centers anchored with grocery store tenants also should remain stable throughout 2024. Mall-based retailers are the one outlier, with many closing lower-performing locations to migrate to the smaller, open-air centers that their desired demographics prefer.
Renovations and Conversions
There are currently more than double the amount of unoccupied office square footage compared to this time a year ago, and forecasts suggest that this will continue. Again, this is partly due to a quality vs. quantity conversation, as today’s tenants require less space, but desire higher quality work environments.
Suburban assets — as well as downtown assets with ample access to public transportation — are finding renewed popularity, as employers seek to draw employees back to the office with easy commutes and higher-quality office spaces.
A stalemate persists between sellers, who remain optimistic on asset price values, and buyers, who are willing to wait to buy the right property at the right time. Investors who had moved to the sidelines as interest rates rose may find themselves in an advantageous position as traditional financing resources continue to pull back in response to higher vacancy rates and falling property values. There’s also concern for continued CRE loan defaults, as well as the $1.5 trillion of U.S. CRE debt coming due before the end of 2025. How that plays out for CRE and the broader markets, remains to be seen.
More Single-Family Rentals
Continued higher mortgage interest rates are keeping many middle-class individuals and families out of the homebuying market. According to a recent report from CoreLogic, single-family rents were up 3.4% in March year-over-year. This increase will likely contract as more supply comes onto the market — over the last four quarters, 80,000 built-for-rent homes began construction, a jump of nearly 16% from the prior four quarters. However, even with the added volume, unless mortgage rates begin to drop substantially — or housing prices drop — the demand for single-family rentals will likely sustain.
The future is somewhat mixed for single-family attached properties and multi-family apartments. Single-family attached properties saw their first year-over-year rent declines in 14 years, attributed to supply gains in multi-family apartments in some markets. Multi-family apartments saw modest rent growth in Q1 2024, lower than what is usually seen at this time of year — but that’s likely in part due to the volume of new units that have recently entered the market, with even more under construction. In fact, 2023 saw the most new apartments hit the market in more than 35 years.
For portfolios evaluating converting defunct office space into affordable housing, some jurisdictions are offering financial incentives to offset conversion costs. That process, however, is easier envisioned than done. Factors such as building age, size, configuration, location, and more, indicate that only 3 to 5% of buildings have conversion potential.
Data Centers
Connectivity is key — further increasing the need for data centers, and cell phone towers to manage growing workloads. One of the areas with the fastest-growing demand for energy is generative AI data centers, which require a lot of energy for training and producing answers to queries. CRE portfolios weighted heavily in industrial arenas are likely evaluating long-term gains in renovating older office space to accommodate new facility construction. While the likelihood of increased workforce demand for more and faster technologies remains high, so are construction and energy costs — which may offset initial profits.
More Reshoring and Nearshoring Hubs
E-commerce has accelerated consumers’ delivery expectations, with same- or near-same day deliveries becoming a common baseline. Additionally, adjustments in supply chain logistics are reshaping the flow of goods and bringing expanded fulfillment center operations to the East Coast and Golden Triangle-area cities such as Memphis, Tennessee, Wichita, Kansas, and Huntsville, Alabama.
Construction activity skyrocketed post-pandemic, peaking at 283 million square feet in 2022, with 2023 close behind. With demand stabilizing, new construction has slowed, with completions dropping from nearly 58 million square feet in Q4 2023 to just 20.3 million square feet in Q1 2024. Opportunities similar to those for data centers may continue to avail with key decision factors being affordability and access to logistics infrastructure.
Green Integrations
Sustainability measures are a foundational component of new construction and conversions. The U.S. Securities and Exchange Commission’s (SEC) recent ruling requiring CRE investors to account for the carbon footprint of real estate portfolios, together with tenant preferences for eco-friendly buildings, is likely adding ESG considerations into the decision-making process.
How green to go requires a strong cost-benefit analysis, which should include the financial incentives offered through tax breaks and long-term reductions in utility bills as well as the competitive advantages a LEED or GRESB certification could provide in current or future markets.
KBS was recognized for sustainability and received a Green Star designation in the 2023 GRESB Real Estate Assessment. This is KBS’ first year participating in the GRESB assessment. With plans to participate annually, the company is demonstrating its continuing commitment to ESG transparency and improved performance. Tenant perceptions also play a factor, as greener buildings are often able to command higher lease rents.
KBS, for one, is committed to furthering its industry leadership through ESG and is being proactive about office well-being efforts. Last year, KBS set the goal of achieving a 5% greenhouse gas emissions reduction by 2025. This includes both the emissions that are under direct control and the on-site emissions generated by tenants in the properties we manage.
CRE Outlook 2024: The Trend “Blend”
The continued evolution of work dynamics, consumer shopping behaviors, mortgage interest rates, and technological advancements — including the expansion of AI into CRE — are creating a uniquely interconnected dynamic. Skillful assessment of these trends, when paired with customary risk assessments, may result in transformative strategies that send CRE in exciting new directions.
Learn more by visiting KBS.com/Insights.
