Strategic advice | October 2024 3 steps for a more resilient commercial real estate strategy for business owners

As you begin mapping out a CRE optimization strategy for your business, it’s important to keep in mind that the commercial real estate market is not uniform.

“What national market outlooks overlook is that CRE is local and driven by use,” says Pella. “Right now, there are certain submarkets where job growth and supply constraints produce some level of pricing power for commercial real estate owners. Segment your market analysis, and you’ll have a lot more clarity when mapping out a commercial property strategy.”

Breaking the market into its three primary divisions—industrial, retail, and office—clarifies how drivers affect the portions of the market you own or lease in.

To illustrate this point, Pella analyzes current commercial real estate trends in each sector and suggests approaches to help mitigate the elevated interest rates and rising inflation shaping the market.

• Industrial: Reshoring initiatives and an ongoing focus on improving logistics have helped propel an all-time high for new supply, but rents and development expenses remain elevated. “Industrial buildings are typically farther from a city center, and that can help drive down both of those costs, but you have to balance that approach with labor availability,” says Pella. “Reduced cost and lower rents aren’t going to help that much if the commute is so long that it produces labor scarcity in your warehouse or manufacturing plant.”
  
  
• Retail: Healthy demand for retail space has landlords in good spirits about filling vacancies. Despite being challenged by various market headwinds—including the pandemic—the sector has adapted. “Tenants continue to evolve the way they do business, but most have concluded there’s a need for brick and mortar as key space for engaging with customers,” says Pella. “Retail has also been an important component of mixed-use developments, which draw in customers by creating vibrant, community-oriented spaces.”
  
  
• Office: Due to increases in remote work arrangements and shortened lease periods in the wake of COVID-19, since 2020 this sector has lost 200 million square feet of occupancy and experienced devaluation.⁴ “The overall office environment has been challenging, but we’re beginning to see certain trends play out. Well-amenitized buildings, for example, are experiencing leasing velocity,” says Pella. “Established owners with capital are remagnetizing top-end buildings with amenities that pull people back in. And for categories below A+ that are facing stronger headwinds, cities like Washington, D.C., are passing meaningful tax abatements that will provide a minimum of $41 million to help convert office space to residential in cases where conversion can work.”⁵

Location plays a crucial role in determining how to shape your CRE strategy. With each market having its nuances, choosing the right areas for your office, retail, or industrial locations can have a significant impact on your business’s financial outlook.

A regional and local perspective of the CRE space can help spot opportunities and obstacles missed by whole-market outlooks. With a quick overview of present submarkets, Pella demonstrates the advantages of taking a more granular view.

• The Sun Belt—particularly Southeastern states like Florida, Georgia, Tennessee, and the Carolinas—has experienced a decade-long trend of new construction activity in office, industrial, and retail that’s spurred by population and job growth. Regardless of sector, this makes it an ideal region for owners looking to expand their business with increased odds of improving their real estate strategy. 
  
  
• Northeastern and Midwestern markets provide potential advantages—like proximity to ports and large employment centers—for industrial property owners looking to increase the chances of securing long-term leases. These features are also positive for industrial tenants. A move to the Northeast could reduce transportation costs through easier port access, while Midwestern relocations could accomplish the same reduction through the establishment of a centralized hub for companies operating nationally.
  
  
• Metropolitan statistical areas (MSAs) may conform to overall trends, but in cities like Phoenix and Columbus, Ohio, the respective establishment of semiconductor and chip plants has created a cascade effect of other industrial builds and an increase in retail construction. For tenants and lessees with the ability to relocate, these sorts of hyperlocalized ripple effects that exist for individual MSA markets provide a variety of potential advantages, from elevated demand to decreased rents, tax incentives, labor surpluses, and increased scalability.

While specifics of sector and region rule out applying one-size-fits-all approaches and optimization strategies for the CRE space, trends emerge in every market that indicate useful starting points for building tailored solutions.

For example, across regions and sectors, Pella points out three popular strategies that are currently helping owners and lessees break out of the cycle of elevated costs created by spiking interest rates and inflation.

• A sale leaseback is the sale of a property that is then leased back from the buyer, enabling the original owner to unlock capital while also strengthening their ability to define lease terms as they transition into tenancy. “If you own a 100,000-square-foot building but can smoothly operate with half of that space, an offer to sell can be enticing to a third party that gets a built-in, reliable tenant for half the building and leaves them another 50,000 square feet that can likely be leased out under a long-term lease,” says Pella. “Depending on the debt and the value of the building, you may also return capital to your company.”
  
  
• Consolidation strategically reduces the amount of property your company occupies. Owners can sell off underutilized or redundant spaces, and companies that are tenants in one building and owners of others can shed unfavorable lease agreements by concentrating operations in their owned spaces. “It can be great for navigating the current market,” says Pella. “But before making that move, you need to understand how consolidation will affect you from a cost perspective and gauge how disruptive it will be for your operations.”
  
  
• Subleasing is one of the best ways for tenants to reduce high rents and for owners to maintain income while increasing occupancy stability. “Terminations don’t benefit you as an owner, and they can come with steep exit costs if you’re a lessee,” says Pella. “If you’re paying for 100,000 square feet but don’t need all of it, a sublease reduces costs if you’re a tenant, and permitting it decreases the likelihood of terminations if you’re an owner.”

In addition to these three steps, a key part of mapping out a course through the CRE market is keeping lines of communication open with your banking team.

“Check in with your relationship manager at least 12 months ahead of any real estate decision and keep that line of communication open—because a lot can change between the start of that conversation and the date by which you need to make a choice,” says Pella. “And keep in mind that the importance of these ongoing conversations goes well beyond your loan or lease. The decisions will have a ripple effect on how you adjust and shape your overall business strategy.”

Whatever your business lifecycle stage, region, and sector, working closely with your relationship manager ahead of a real estate transaction enables them to provide support against elevated rates and rising inflation. By helping explore potential solutions like commercial mortgage-backed securities, long-term financing with fixed rates through life company (LifeCo) loans, debt fund investments, and non-balance sheet solutions, relationship managers can help optimize your CRE strategy in a way that strengthens every aspect of your business planning.

“While a head start isn’t a magic fix, waiting until the last minute can hurt even the best strategy,” says Pella. “The CRE market is in a transition, but if you do your research, approach your financial team early, and take the time to work through your options with them, you can put together a commercial real estate strategy that adapts to whatever shape it takes.”