New Construction off to a Shaky Start in 2023

According to a recent GlobeSt article, the US construction industry should prepare for a 3% drop-off in construction starts (i.e. new construction projects) in 2023. This follows on from a complicated couple of years for the industry in 2021-2022, as soaring materials prices and supply chain disruptions kept developers guessing about their next steps. 

GlobeSt was reporting on data from the Dodge Construction Outlook Conference which took place in November 2022. The Dodge Construction Network provides data analytics and insights to construction executives and industry leaders across the US, and the annual conference is cited as: “the leading economic forecast event for commercial construction.”

Multifamily set to slow

As is often the case, the expected decline will affect specific real estate sectors in different ways. GlobeSt notes, for example, that the value of multifamily construction may see a large decline (around 7% when adjusted for inflation).

In their own report on the data, industry news site Engineering News Record (ENR) adds: “In the multi-family sector, starts are expected to finish the year [2022] up 16%, but will drop 9% next year.”

Mixed bag for Retail, Office and Industrial

ENR also notes that the increases in retail and manufacturing starts seen in 2022 are likely to taper off, though it’s worth pointing out that the manufacturing industry saw gains of 196% over the year.

Quoted in the article, Dodge Chief Economist, Richard Branch, noted that despite an anticipated 43% drop for manufacturing construction, “that is still historically a very strong record level of activity.”

Meanwhile the dollar value of office construction is in for a “slight decline” of 1% in 2023, as remote work trends and the tight labor market continue to put pressure on the sector.

Niche sectors still offer respite

Despite these generally downhill trends, other predictions made during the conference include ongoing strong performance from some of the niche CRE sectors we’ve seen rise to prominence in recent years. As Archinect reports:

“While traditional school construction is set to fall, life science buildings and healthcare projects, including outpatient clinics and hospitals, continue to rise.”

These are assets we’ve seen big things from over the past year, and it seems they’re set to continue attracting investors in the year to come.

Recession effects

As the above predictions show, there are still many factors in play that will influence how things shake out for the construction sector in 2023. Arguably the biggest determinant is the likelihood and severity of a potential recession.

In Branch’s words: “We’re walking the razor’s edge here. In our estimation, there is a very, very, very narrow path to avoiding a technical recession in 2023.”

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Conflicting Signals: What do Layoffs Mean for the Labor Shortage?

In recent news from the Washington post, tech giant Meta is cutting around 11 000 jobs, representing 13% of the company’s workforce. Twitter is also continuing with layoffs, after already slashing jobs drastically earlier in November.

Meanwhile Forbes reports large-scale layoffs at Amazon, adding that multiple other major companies – from Disney to Barclays, Salesforce, and Lyft have all already cut jobs or have announced cutbacks and hiring freezes.

With all of these changes incoming, the question that’s top of mind is: How will this affect the labor shortage we’ve seen since 2021?

In larger context

The names above are some of the biggest players (and employers) in the market, so it’s natural to assume that these cuts mean the labor shortage is inevitably reversing. Before making that deliberation, however, it’s worth taking a look at some of the figures from the U.S. Chamber of Commerce (USCC) to get a sense of the bigger picture.

In October, Stephanie Ferguson, the USCC Director of Global Employment Policy & Special Initiatives outlined the magnitude of the shortage, stating: “We have a lot of jobs, but not enough workers to fill them. If every unemployed person in the country found a job, we would still have 4 million open jobs.”

State and sector

The shortage stems, Ferguson says, from the unprecedented number of jobs added in 2021 – approximately 3.8 million. At the same time, the labor force has shrunk, with many workers retiring early, and workers quitting their jobs in unprecedented numbers as part of the Great Resignation.

USCC data shows that these shortfalls are  largest in Northern and Eastern States, and that certain industries, like hospitality and healthcare, have disproportionately high levels of job openings.

All of which is to say, that while the big moves happening in the tech sector right now are certainly concerning, they still form part of a much larger, and more nuanced, picture.

CRE concerns?

For the commercial real estate (CRE) industry, the effects are likely to be similarly varied, depending on where and what type of business we look at. We have already seen some sharp downturns for specific Proptech companies. Redfin, for example, has cut a further 13% of its staff, following on from an earlier round of layoffs in June.

Other Proptech outfits are facing similar difficulties, as 2022 shapes up to be a tough year for CRE startups.

Labor market outlook

What these cuts ultimately mean for the labor market, and CRE operations in the Bay Area where many tech companies are concentrated, is still unclear.

For now, it seems that worker availability, even in tech, is still falling short of demand from employers. Amid the current economic uncertainty, however, that situation might well change as we head into 2023. As always, we’ll be keeping a sharp on the trends, and potential impacts in CRE markets.

Thought Leader Cybersecurity

Risky Business: Why Cybersecurity Should be Top of Mind for CRE Professionals

Over the past year, it’s sometimes felt like the number of factors that we, as commercial real estate (CRE) professionals, need to keep track of have grown exponentially. Especially in the face of challenging market conditions

At the same time, there’s an ever-increasing need to be conversant with new technology and tech tools that help boost productivity and add value for clients. The tools available  span the spectrum from social media to drone technology, climate-savvy building tech, and even augmented or virtual reality software.

For brokers, building managers, and developers incorporating these game-changing technologies, the possibilities are nearly endless.

There is, however, a flip side to this coin. And, like many things tech-related, it’s an area where CRE professionals have often been slow on the uptake: Implementing the right cybersecurity protocols.

A growing threat

Part of the problem is the idea that cybersecurity is something that’s handled exclusively by a dedicated team, or automatically built into the software being used. While that’s true to some extent, the fact remains that the tactics cyber criminals use, and the number of incidents each year, are continually growing.

Sophisticated “phishing” attacks, which aim to get staff to unwittingly compromise system security, and ransomware are the order of the day, and, as a recent incident in Australia shows, the real estate sector is far from exempt from these threats.

Given the amounts of sensitive data passing through or stored by the CRE industry, the question we need to ask is: Are we truly prepared in the event of a breach?

New risk vectors

The first thing all CRE businesses should consider is whether all possible systems, and avenues of access to those systems, have been identified and are properly protected. 

In an excellent recent interview on cyber threats in CRE, security consultant Coleman Wolf points out that many possible avenues of attack go unnoticed. These may be linked to building control systems (think temperature or lighting management) and other smart tech, or even to the specialized Internet-of-Things (IoT) systems being used in industrial operations.

If these systems are connected to the internet, but not adequately protected, they may act as a springboard for access to other systems or data. Hackers may then be able to tap into sensitive information, including financial and personal data stored elsewhere. Alternately, simply taking control of building systems can be used as a tactic in ransomware attacks.

As the CRE industry begins to adopt new smart building technologies, and we increasingly repurpose buildings for niche markets, like the booming medical office sector, the potential for sensitive information to form part of breaches also grows exponentially.

Other trends, like the Bring-Your-Own-Device (BYOD) movement where employees use personal devices in the office, create additional avenues of attack if those devices aren’t properly secured.

Best principles

While all the above may make it sound like it’s impossible to keep track of potential threats to a building or CRE enterprise, the good news is that there are certain essential principles that can be followed to mitigate the risk.

In a recent article on cybersecurity best practices in CRE, J.P. Morgan advises that:

  • CRE companies should ensure all employees, beyond just the IT team, are aware of potential risks from phishing or ransomware and have been trained in how to minimize those risks.
  • Companies ensure there’s appropriate access control. For example, implementing multifactor authorization (MFA) and other safeguards.
  • Employees are aware of the risks of oversharing on social media (e.g., detailed information on job responsibilities and the type of data they have access to, which could make them phishing targets).

Of course, these recommendations are only starting points, and the exact requirements and level of detail needed will vary based on each firm’s unique context. There’s certainly no “one-size-fits-all” solution for CRE cybersecurity.

That said, an excellent resource to familiarize yourself with upcoming benchmarks and strategies for cyber-security can be found in PwC’s “C-suite united on cyber-ready futures” guide (you can register for free to download the report).

Securing the future

As we head into 2023 and beyond, some of the most exciting aspects of the CRE industry come in the form of new technology. There’s an ever-expanding array of Proptech tools on hand to help us close deals. Smarter building technologies ensure we meet environmental and climate imperatives while also offering something new and different for tenants and investors alike.

As CRE professionals, we’re right to be excited by the possibilities on offer. But we also need to make sure we keep security top of mind as we begin to integrate these tools.

As PwC summarizes: “Digitization makes security everyone’s business. The future promises more connected systems and exponentially more data — and more organized adversaries. With ever expanding cyber risks, business leaders have much more work to do.”

DEAD IN THE WATER

Joseph Hauman

Do you know where the saying dead in the water comes from? It was originally used to refer to a boat that was stuck out at sea with no wind. No wind means no movement and as you could imagine, no movement is not good for a boat in a large body of water. Over the last 2 years, people have been telling me that the office market in Cleveland is “dead in the water” as everyone from your nephew’s Lemonade stand to Google decide if they need more space or if they even want any space. To be honest with you I believed it for a little bit too. I thought there is no wind in the sails of the office market in Cleveland, but then I allowed myself to take a real look at the industry.

Sailboats are great but they need something to push them. A tide, current, or wind is needed to make a boat with no motor move. I believe that office rents in the Cleveland Market have stayed stagnant because they have been the tide, current, or wind in the sails of our largely vacant office market.  What do I mean by that? Owners in Cleveland often think that they are in competition with each other. They attract tenants to their buildings by offering a low price, free rent, and higher tenant improvement allowances than what they view are their competitor’s. That, in turn, makes other owners lower their prices and it becomes a price war at its most basic level. For years, that has been the reason why the office market continued to truck along with very few new buildings and stagnated rent growth. Lower prices and increasing free rent packages were the slow wind that was pushing the sails of a fundamentally broken office market.

Why are low prices so bad in an office market? The answer is they aren’t when they can be controlled and used to attract quality businesses that will help the area grow. That, however, is not the situation that the Cleveland office market is in. We are in a vicious cycle of rent reduction to attract businesses that don’t choose Cleveland because of the lack of amenities, in both buildings and the city, and because they don’t choose Cleveland both the owner and city miss out on valuable tax and rental income that could be used to pay for new amenities to attract new businesses. This is the reason why the Cleveland office market is “Dead in the water”.

Nobody cared about this issue until the past two years when work from home skyrocketed and tenants didn’t care how much you reduced their rent; they just wanted out. It was no longer a price war because price mattered very little anymore. It became an agent’s job to keep tenants from bull rushing out of a building. Any wind that was ever present, was lost. No hope, right? Wrong.    

Going back to what I had said earlier when technology advanced we learned that we could put an engine on a boat and we had no more need for the wind to propel us. The wind and the sail didn’t matter anymore because the fundamental idea of a boat changed. It was no longer difficult to maneuver, slow, or relied on something totally out of one’s control. Instead, a boat became fun, attractive, and a sign of success for most. Office buildings need a motor. The entire idea of an office building needs to be changed. Low rent and new paint aren’t enough anymore. You need a space that makes people want to come to work. If your building doesn’t do that, then you need to take a hard look at the future success and viability of that building. If you are a landlord you must know your effective vacancy on any building you own. I don’t mean how many people you are getting checks from every month or the number of available square feet you tell your broker to put on the flyer. I mean how many people are coming in and using your space on a DAILY basis? If you have amazing tenants that don’t want that stuff then, congratulations, you have won the jackpot. If you have large amounts of vacant space and are wondering how to change it, then hold on because I’m going to tell you.

ASK AND YOU SHALL RECEIVE

I know most office buildings or parks are purchased as a semi-passive investment which is great and I fully support it, but if you have a high vacancy you need to get a broker, or property manager or go yourself to each tenant and ask what they are looking for. Ask what your building lacks and where it could be improved. If you have current amenities in the building ask if they use them and how often. If you have someone that works in an amenity like a dry cleaner, food service, or gym, ask them how often people come through and what sort of mood they are in when they come in. If you have services in the building you need to find out if people are using them because the service is good or if it’s convenient. If tenants are using it out of convenience then that’s great, but it’s not enough to keep them there at your building. The true testament to the amenities that you provide should be if a tenant leaves and still comes back to your building to use your amenities. Obviously, not all amenities are offered to people that are not tenants, but ones that are, such as an open cafeteria or dry-cleaning service should be good tests. If you ask tenants for their opinion make sure they are valued and listened to. Asking them questions only to do nothing in hopes that they will stay is going to do you no good. If you want to have a low vacancy you need to get things in the building that people want. Let the ideas flow. Everything from a VR gaming setup, driving simulator, or golf simulator might be options that are relatively inexpensive in comparison to renovating a cafeteria or building out a new gym. Take the answers to the questions that you get from your tenants and mix them with your ideas and see if it’s possible. Maybe call me and let me come take a look and allow me to give you my opinion.

If your building represents a sailboat that is quickly or slowly losing wind then pull it out of the water and put an engine on that sucker because if you don’t make a change soon your boat will be dead in the office market water. 

Have something to say? Great, I would love to hear it. Shoot me an email at Joe.Hauman@NAIPVC.com or give me a call 440-591-3723.

SIOR report shows sentiment waning in Office, Industrial

Despite a red-hot streak that’s outperformed other commercial real estate (CRE) asset classes, it seems that bullish sentiment on the industrial sector is finally cooling off. A recent report from the Society of Industrial and Office Realtors (SIOR) indicates that realtor confidence in the market dropped to 5.5 (out of 10), compared to 7.7 in Q1. Office sentiment fared poorly as well, with a 32% drop in confidence from 6.5 in Q1 to 4.4 in Q2.

Declining activity  

While general factors, such as prevailing economic conditions, played a role in the flagging sentiment, SIOR reported specific indicators of a downturn between Q1 and Q2 as well.

For industrial, these included:

  • Only 31% of members reporting an active leasing market (down from 61%)
  • An increase in “on-hold” transactions (from 10 to 14%) and canceled transactions (from 7 to 11%)
  • 69% of members reporting “booming” or “average” development conditions (down from 81%)

Meanwhile, office realtors reported a similar shakeup, with SIOR noting that:

  • 37% reported “little” or higher leasing activity in Q2 (down from 58%)
  • Canceled transactions jumped from 7% to 11%, and
  • There was a 61% reduction in the number of members reporting a “booming” or “average” development environment in their area.

SIOR adds that uncertainty around inflation and potential “economic turmoil” were the main drivers of the downturn. Or, as one of the survey respondents put it:

“Consistent commentary among clients is that the future is very uncertain and a recession likely coming.”

Concerns in context

Sentiment analysis across the broader US market indicates that the general consumer outlook continues to drop as we progress into Q3. This makes July the third consecutive month that consumer confidence has taken a knock.

Economic sentiment indicators in Europe show similar retractions, with confidence in the industrial sector declining by 3.5% in the region. Challenges such as the high cost of energy and gas shortages are hitting Europe particularly hard. In July this year, Reuters reported that Germany, the region’s industrial powerhouse, could be on the verge of recession.

For sectors like office and industrial, these reports indicate that there may be strong headwinds incoming.

SOCIAL: How have the industrial and office sectors performed in your region in recent months?