The last few years have been turbulent for the commercial real estate business. Some sectors have struggled, while others have proven to be surprisingly resilient. New pandemic-altered priorities and perspectives are shaping how office, industrial and mixed-use projects are developed, designed, leased and used.
The big question, as usual, is what comes next? What dynamics are shaping the market today, what trends will have the most impact in the future, and what is likely to drive the next commercial real estate boom?
Durable industrial demand
It’s not exactly breaking news to point out that industrial demand has skyrocketed. What is unusual is the degree to which this trend is likely to be more durable than most. Driven by big shifts in demand for home deliveries across a broader range of retail and food segments, quality industrial space—especially for last-mile facilities and hybrid retail-industrial uses—is in high demand. Consequently, a significant percentage of spaces that may have previously been considered fringe locations and slated for multifamily are now likely to find their highest and best use as an industrial redevelopment project. With new shopping routines and consumer preferences unlikely to go away anytime soon (if ever), the result isn’t just a seismic shift in the commercial real estate landscape but one that is almost certainly built to last.
While big shifts come with big opportunities, the commercial real estate industry will need to grapple with a host of new and emerging structural, logistical, and economic challenges in the months and years ahead. Some of those are already present, like the steep rise in construction costs and the supply chain disruptions that have profoundly impacted development pipelines and construction timelines. Others, such as rising interest rates, are likely to become more of an issue in the not-too-distant future. These new costs and complexities could make redevelopment and adaptive reuse opportunities more attractive than ground-up development in the future. However, both categories will likely have to contend with zoning and local policy considerations that come whenever the industry experiences a great deal of change in a relatively short period of time.
Developing human capital
One of the fascinating factors shaping the future of commercial real estate isn’t bricks and mortar; it’s about new perspectives and priorities for the people who live and work in those spaces. The pandemic has dramatically impacted individual ideas about a work-life balance and has demonstrated the possibilities of virtual and hybrid-office models. People are living and working in different places and in different ways while flexibility and lifestyle are increasingly important considerations for employers to attract and retain human capital.
In short: office space isn’t going away, but it might look very different five or 10 years from now. Companies may determine they no longer need a large office footprint and instead opt for a space that focuses on design priorities that enhance and enable their workforce with greater flexibility and lifestyle options. Another area for potential exploration is underutilized offices in certain markets that are driving the potential for adaptive reuse and repositioning to something like multifamily—especially in urban areas with a supply-constrained housing market. In addition to the economic benefits realized by finding an alternative highest-and-best use, creatively adapting obsolete product to increase supply can have a meaningful impact on a city’s affordability. The demand for multifamily product may be further driven by shifting perspectives about the value/benefit of increasingly expensive homeownership, lack of conviction in the growth of home equity, and the likelihood that more people will prioritize access and mobility, all of which increase the appeal of renting.
New tenants creating new spaces
The emergence of new companies and concepts in life sciences, technology, and data science is also likely to influence the future of the office. Many of those tenants are likely to require larger spaces for laboratories and call centers, and we are likely to see more overlap and interchangeability between different types of office and industrial spaces. Expanding or perhaps even redefining what office space looks like will also present abundant opportunities to create value for developers who can position themselves at the forefront of that trend. One wildcard in the industrial sector is the impact of emerging industries like cannabis, where opportunities that may be missed by cautious institutional investors waiting for full federal legalization and normalization could be seized by those with a higher risk tolerance.
If there is an overriding theme to the direction of commercial real estate development in a post-pandemic world, it is one of blurred lines. We are already seeing some lines blurring between commercial real estate segments as new ideas and creative concepts emerge to fill gaps and replace old assumptions. That blurring extends to usage and operational considerations, as landlords, tenants, and developers prioritize more flexibility in their workspaces, office hours and commutes. Whenever there are so many significant changes in such a short time, historically rapid evolution in the design and use of space is inevitable. While plenty of question marks remain, any big shakeup also comes with many redevelopment opportunities, where distressed properties get repositioned into something more viable.
The pre-pandemic focus on amenities and communities offering diverse live/work/play environments isn’t going away. With so many spaces and communities designed and populated based on pre-pandemic realities, a shuffling of assets is already underway. Traditional malls filled with big-box retailers will continue to decline, many dated office spaces are likely to be redesigned or become candidates for adaptive reuse, and we will likely see creative new spaces and uses that aren’t even necessarily on the radar—such as vertical urban farms, data mining centers for the gig economy, and other innovations. Priorities of location and experience are likely to be joined by a third: flexibility. The commercial real estate jigsaw puzzle pieces are still on the table, and in time they will be reconfigured to fit together in creative ways, revealing an entirely new image of the future of commercial real estate.
Scott Russell and Maxwell Rittner both serve as vice president of Investments for Cottonwood Group. Headquartered in Los Angeles with offices in Boston and New York, Cottonwood is a private equity real estate investment firm. To reach Scott or Maxwell directly, email [email protected] or [email protected].