Stubborn Inflation, Banking Crisis, and Uncertain Interest Rate Environment Causing Strain on Real Estate Leasing and Sales Activity Locally
On a positive note, non-residential construction surged 17 percent between May 2022 and February 2023 and currently sits at the highest level on record.
The combination of rising interest rates and the uncertainty of future occupancy needs of companies has negatively impacted leasing activity throughout the greater Baltimore Metropolitan region in Q1 2023, resulting in the lowest quarterly total since 2011. Baltimore City’s Class A buildings have an availability of 24.8 percent, compared to five years ago when the rate stood at 15.8 percent. Stubborn inflation, the failure of two banks which produced tightening credit nationwide and talk of a looming recession have further exacerbated already negative conditions which are not expected to improve in the near-term. The lone bright spot is the 17 percent surge in non-residential construction between May 2022 and February 2023, which elevated activity to its highest level on record. Retail leasing activity softened, with 130 retail transaction occurring last quarter, compared to 188 during the same period last year. The data and analysis is according to the Market Report 1st Quarter 2023 Local Outlook, recently published by MacKenzie Commercial Real Estate Services, with report conclusions that include an economic summary from Anirban Basu, CEO of Sage Policy Group.
Key takeaways according to Basu and MacKenzie include:
– Inflation is still running too hot and the demand side of the economy has yet to show any meaningful sign of weakening
– Despite high profile layoffs, the demand for labor remains significantly greater than supply
– Consumer spending remains elevated due to low unemployment and excess savings from the pandemic – retail sales rose during the first two months of 2023
– Non-residential construction spending sits at the highest level on record
“Despite all this negative news each market, be it up or down, presents an opportunity,” stated Scott Wimbrow, President and Principal, MacKenzie Commercial Real Estate Services. “For example, with demand down and vacancies rising, there is no better time to be an office tenant in the market for better space. If you are an investor that was priced out of the market over the last few years, those same buildings are now ‘on sale.’ Interest rates should not scare investors away as they will drop again and project can always be refinanced in the future. It is important to remember that it is always darkest before the dawn and, long term, commercial real estate has proven its resilience.”
Negative net absorption of more than 265,000 square feet of space in commercial office sector
At the end of Q1, Baltimore City’s Class A buildings had an availability of 24.8 percent compared to five years ago when the availability rate was 15.8 percent. Sublease transactions during Q1 were high, totaling nearly 100,000 square feet of space, compared to only 25,000 square feet during the same period last year. Office sales in the Baltimore market for buildings more than 10,000 square feet of space has waned in recent years, with only 13 occurring in Q1. Baltimore City achieved nearly 60,000 square feet of positive net absorption, while the I-83 Corridor submarket suffered a negative absorption of more than 210,000 square feet of space. Rental rates have remained steady over the past year with the highest rates in Annapolis and Columbia at $30.14 and $29.14 per square foot respectively. Across the entire market, negative net absorption reached more than 265,000 square feet of space.
According to recent analysis from Owen Rouse, Senior Vice President with MacKenzie Commercial Real Estate Services, 2023 is expected to be “the year of increases,” led by rising interest rates, prices of everyday goods and construction materials, tenant improvement costs, wait times for materials and higher vacancy rates among commodity office buildings in suburban areas. “Combined with the enduring work-from-home dynamic and other emerging trends impacting businesses, now might be the ideal time for owners and investors of commercial office assets to strongly consider new disposition or reposition strategies,” Rouse explained. He adds that “holding an asset too long in an illiquid or declining market can force owners to become extended checkwriters due to rising expenses and vacancies.
Retail leasing activity softened to start the year with overall vacancy rate ticking up to 6.4 percent
The overall retail vacancy rate in the greater Baltimore metropolitan region ticked up 1 percent from the previous quarter to finish at 6.4 percent. More than 130 retail transactions were completed comprising 465,000 square feet of space, but this total was below those from last year’s Q1 which saw 188 transactions totaling 927,000 square feet of space. Activity is coming from multiple car wash operators, Wawa, Royal Farms, Sheetz, Raising Canes, Chase Bank, Planet Fitness, Five Below, Dollar Tree, Lidl and ALDI. Children’s learning centers and national self-storage brands are also in a major expansion mode. Vacancy rates could see a steep increase based on the recent bankruptcies filed by Party City and Tuesday Morning, with other retailers going through “portfolio optimization,” which translates to the relocation of stores to other markets with a higher upside. Optimism remains high in Baltimore City for a possible retail renaissance, centered around MCB Real Estate’s plan to assume control of the iconic Harborplace on the city’s waterfront and proceed with a redevelopment strategy.
Industrial sector flashing some signs of weakness with vacancy rate rising to 5.9 percent
The Baltimore industrial market, though still active, is flashing early signs of weakness with activity for larger blocks exceeding 150,000 square feet considerably slowing. The Q1 vacancy rate rose slightly to 5.9 percent – from the previous 5.2 percent and overall leasing activity fell below two million square feet of space, which has not occurred since 2008. Investment sales activity has retreated as well. The rise in interest rates has created an even greater pricing gap between buyers and sellers, and not one industrial building over 100,000 square feet of space in size changed hands. Over the past 20 years, that has happened only one other time. Overall rental rates rose from $8.27 PSF to $8.97 PSF and, in some instances, tenants are facing a 100-200 percent increase in market rents. As a result, many companies are examining options to acquire buildings to control their long-term occupancy expenses.
Nonresidential construction spending surged 17 percent between May 2022 and February 2023
Nonresidential construction spending surged 17 percent between May 2020 and February 2023 and currently sits at the highest level on record. MacKenzie Contracting Company, which is celebrating its 35-year anniversary this year, has generated the largest backlog in the history of the company, with overall construction volume expected to increase approximately 45 percent this year.
“With many companies and their employees embracing remote or hybrid work arrangements, there has been a dramatic decrease in the volume of commercial office construction but, in the Baltimore-Washington, D.C. region, this has been offset by robust activity in the medical/healthcare, education, retail and senior living categories,” explained MacKenzie Contracting Company President/COO Marty Copsey.
As hospital operators continue to push services closer to the communities they serve, Copsey expects to see the need for more outpatient facilities, especially in the suburban areas. Certain neighborhood shopping center projects, struggling to fill vacancies caused by failed operators, are targeting medical uses due with the promise of free parking, locations near major highways and access to consumers. “Diagnostic and behavioral health facilities, together with urgent care practices, can relieve the strain on emergency room traffic, and patients are looking for healthcare options near their homes to bypass visits to the main hospital campus,” he added.
Earlier in the year, Basu made these observations about the year ahead. “We expect 2023 to be quite challenging for the economy as a whole and the commercial real estate sector in particular,” Basu added. “Recessions, of course, cause hardships but it is important to search for the silver linings. It is often said that one should never waste a good recession. Downturns force businesses to rethink their corporate strategies, to escape unproductive segments, and to place a greater share of resources in areas of promise.”
MacKenzie Commercial Real Estate Services is the real estate brokerage arm of The MacKenzie Companies, which operates six full-service divisions addressing all real estate asset classes including MacKenzie Management Company, LLC, MacKenzie Contracting Company, LLC, MacKenzie Capital, LLC, MacKenzie Investment Group, LLC and MacKenzie Multifamily Management, LLC. The company provides customized real estate solutions for institutional owners, investors, private companies and individuals. For additional information, visit www.mackenziecommercial.com.
