As we look to close the page on calendar year 2021 and head into 2022, we continue to see uncertainty affecting the outlook for the commercial real estate market as it recovers from and tries to survive the COVID-19 pandemic. Real estate users' needs are shifting in reaction to the pandemic. Landlords, developers, and owners must remain creative, adaptive, flexible, and receptive to changing space needs to be well-positioned to succeed in the future.
Uncertain Path Forward
A CEO I recently spoke with described the current state of the commercial real estate market as being "in limbo." The recent emergence of the Omicron variant is a gloomy reminder that the pandemic continues to impact the global economy and presents opportunities and obstacles for different geographic markets and asset classes.
Demand for office space is impacted by the recent spikes in infection rates and continued trepidation about returning to work in the office. Many top U.S. cities continue to see reduced foot traffic compared to pre-pandemic levels as fewer people commute to work and travel, which has the effect of softening demand for office space and prevailing rents. Eventually, these cities will rebound, but the question is when.
The widespread return to the office this past fall that many hoped for hasn't yet materialized as the whole nature of work continues to undergo fundamental shifts. Property owners are in flux as they develop future occupancy strategies and projects. According to national statistics, demand for new office space has generally softened through the fall and into early winter, and landlords are increasing concession packages and amenities to attract and retain tenants more competitively.
A tight labor market also affects the outlook for office space, as employers must continue to offer employees flexible work-from-home options to remain competitive in the market. Notably, demand for office space has a ripple effect on the travel, retail, and hospitality industries
While demand for office space has softened, industrial and warehouse space demand continues to thrive and exhibit strong performance. Companies continue to acquire and lease warehouse and stocking spaces to accommodate continued e-commerce activity and address "last mile" delivery and logistics issues as consumers continue to shop remotely.
Many owners and developers are repurposing real estate to accommodate new ways of living and working to future-proof their assets and remain competitive in an ever-changing environment. I expect to see increased conversion of existing spaces to new uses (i.e., redesigning existing office space to eliminate individual offices or work stations to accommodate flexible working and co-working arrangements).
"Time May Not Be On Your Side"
Supply chain backlog and disruptions, material and labor shortages, and rising costs of labor and materials continue to significantly impact the commercial real estate market. Current delays are expected to continue well through 2022, with some research analysts conservatively expecting the backlogs to continue into 2023. With that outlook, it remains critically important to carefully review and negotiate contractual provisions tied to completion milestones or otherwise impacted by an inability to timely procure materials and commence, perform, or complete construction.
Additionally, we see clients experience delays in obtaining permits, approvals, and sign-offs from municipal and government agencies. It is important to consider protective permitting contingencies on new development and construction projects, whether it be a ground-up development or the build-out of a retail showroom.
Due diligence inspections and reviews are taking longer to complete as third-party vendors, such as surveyors, architects, engineers, analysts, environmental consultants, and title examiners, simply have more deals than they can handle. Many clients are experiencing extended lead times when procuring third-party diligence.
Companies and government agencies continue to work remotely and/or with reduced staff; continuing government restrictions and social distancing measures further contribute to the delay issues.
Low-interest rates and the continued availability of credit and financing have led to a sharp increase in transaction volume.
Concerns about potential increases to capital gains taxes in 2022 under President Biden's proposed plan are creating unprecedented deal volume, particularly in the M&A space where many deals involve owned or leased real estate.
With such a saturated and frenzied market, it's important to ensure transaction documents provide sufficient time to complete diligence review with current delays.