By Laura Calugar
The Midwest area is one of the best-performing regions in the country. Secondary markets have begun to shine lately, especially because their development scene is particularly active in the large industrial distribution area. The commercial real estate market, however, is a very different matter.
Retailers continue to announce layoffs in the traditional sector, but some of these jobs are shifting towards e-commerce. This has pushed demand for distribution space and warehouses. According to a Newmark Grubb Zimmer fall report from last year, e-commerce jobs have increased a stunning 334 percent during the last 15 years. Amazon has recently signed long-term industrial leases and announced large distribution center projects in Midwestern markets such as Kansas City and St. Louis, Mo.
Valbridge Property Advisors President Laird Goldsborough, a state-certified general appraiser in Kansas and Missouri, thinks that big-box outlets and enclosed malls will continue to struggle as point-to-point and almost-immediate delivery become the norm. Goldsborough expects a slowdown in new development over the next two years, as pricing is historically rich and other forms of investment are becoming more attractive. He discussed with Commercial Property Executive how e-commerce continues to influence commercial real estate investments and the likeliness of a new bubble in the next few years.
Which areas of the Midwest are most active when talking about the commercial real estate sector?
Goldsborough: Capital has historically been drawn to the larger Midwestern cities such as Chicago and Minneapolis. Primary markets have greater economic diversity when compared to smaller, secondary and tertiary markets. Diversified markets are less susceptible to new development and economic downturns and have greater space demand, which results in reduced risk to real estate investors. Cities that have a more varied workforce are less impacted by the highs and lows of real estate cycles. Larger markets also tend to attract higher quality employees making them an ideal place for businesses to locate.
As yields have become compressed in most gateway markets capital has started to flow to secondary markets such as Kansas City, Mo.; Detroit and Columbus, Ohio. As we continue through the current cycle, investments will continue to be attracted to deals that offer the most attractive risk-adjusted return, which is currently occurring in the multifamily and industrial spaces. Minneapolis-St. Paul is widely considered the leading Midwest metro in terms of commercial real estate demand. According to the Urban Land Institute’s Emerging Trends in Real Estate 2018 report, other Midwest cities with an above average outlook include: Indianapolis, Des Moines, Iowa, and Madison, Wis.
The expenses associated with operating large enclosed malls and the shift in consumer tastes toward online shopping and open-air shopping centers have led to hardships. What’s the situation in secondary markets such as Kansas City?
Goldsborough: In Kansas City there are only two large enclosed malls remaining and each of them are facing challenges. The Independence Mall on the east side of the metropolitan area was originally developed in 1974 and it was reportedly headed toward foreclosure in February 2018. Oak Park Mall, located in Overland Park, recently suffered a setback with the announcement of Nordstrom’s departure for the Plaza shopping area. This move will not happen for a couple of years, so some repositioning of this area of the mall may happen and there is a little time to figure that out.
Other large indoor malls have been demolished—the Great Mall of the Plains in Olathe and Bannister Mall in Kansas City—and these areas are being redeveloped. Bannister has become the location of the Cerner Innovation Campus that will eventually house 16,000 employees, while the Great Mall site is currently seeking STAR bonds for redevelopment into a tourist entertainment and shopping area.
What is going to happen with former big-box and junior-box buildings?
Goldsborough: Big-box and junior-box buildings will be among the commercial building types that have slightly higher vacancy, but they will get absorbed by users that may put them to another type of retail use. In some cases, they will be repurposed for uses such as office, warehouse with showrooms, churches, or schools. Several former grocery stores have been converted to self-storage, while others have been repurposed into furniture showrooms. I do not expect vacancies for these buildings to be significantly higher than other classes of retail, as long as they are in attractive locations and their highest and best uses have not changed as the result of external factors.
Laird Goldsborough: The logistics of Kansas City make it an ideal hub for distribution. The intersection of two major interstates—70 and 35—allow for easy access to most major cities in the U.S. The central location and lower cost of doing business help Kansas City standout as an attractive location for a distribution facility.
As online retail sales continue to grow and the demand for same day and two-day shipping increase, Kansas City is positioned favorably among other competing Midwestern cities. The Kansas City area has seven connected interstate highways and has the highest number of highway lanes per capita of any major city in the country. Overall, Kansas City is within a one day truck drive of virtually every major Midwestern market and a two day truck drive of 78 percent of the population of the U.S. Additionally, Kansas City is the second largest rail hub in the country, trailing only Chicago in terms of total freight cars per year. There are five Class 1 railroads headquartered in the U.S. and four of these railroads pass through the Kansas City area and so does the Canadian Pacific Railroad, the second largest railroad company in Canada.
Development of large distribution facilities remains active, primarily due to the ongoing shift in consumer spending habits, coupled with the region’s centralized location, robust distribution infrastructure and multiple large intermodal railroad operations. Kansas City’s centralized location and infrastructure allows companies to operate outside of the more densely populated and congested coastal cities.
Goldsborough: There has been a shift in housing construction away from multifamily and toward single-family residential. Single family permits have steadily increased at 10 to 15 percent per year since 2011. Multifamily permits showed significant increase from 2010 to 2014, steady construction in 2015 and 2016 and a significant drop in 2017. The greatest demand continues to be for anything that is leased and the stronger the tenant, the better, but this is no different than any time.
In terms of market sector, apartments still are in the greatest demand and I expect that to be the case in the short term—a year or two—at least. That bubble will eventually burst, but three years ago I would have told you that by now the bubble would have burst. I was wrong about the strength of that segment, as it continues to be strong.
How close are we to a new bubble? Is development poised to slow down in the next couple of years?
Goldsborough: Coastal markets tend to be leading indicators for the Midwest and the coastal Valbridge offices are not reporting dramatic changes in the commercial real estate sector at this time. I do not see an imminent downturn. We have enjoyed a robust cycle of recovery followed by expansion and new development and redevelopment continue to be in full swing. The slow interest rate increases that are occurring and expected may eventually cool things down, but I am bullish in the near term.
Image courtesy of Valbridge Property Advisors