Real estate and construction companies pivot, adapt to changing markets

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A sluggish commercial real estate sector has amplified the market for Class A office space. 

Volatile interest rates, uncertainty over the need for traditional office space since the coronarvirus pandemic, hybrid work arrangements, construction industry labor shortages and higher costs for raw materials are ingredients folded into the slower market’s simmering brew. 

“Most of what’s been happening in the market isn’t a surprise,” said Heather Kreiger, brokerage advisor at High Associates, Ltd. in East Lampeter, Lancaster County. 

Kreiger said unknowns and uncertainties moving into 2024, along with higher interest and cap rates, will likely mean the sector’s slower growth will persist. 

“The year has been quiet. There has been a lot of pricing exercises [estimates] but not a lot of construction starts,” said William J. Sutton II, chief strategy officer at Mowery Construction in Silver Spring Township, Cumberland County. 

Even with interest rate and market volatility, central Pennsylvania has an advantage over big metro areas like Pittsburgh and Philadelphia, Kreiger said. 

“We are doing OK in terms of vacancy rates,” she explained. 

According to Kreiger and a recent report produced by CoStar, a national database of commercial properties: The overall national average vacancy rate for commercial office space was 13%. Across Central Pennsylvania, the average vacancy rate was about 5%, Harrisburg was 8.3%, Lancaster was 2.9% and York was 3.1%. 

“CoStar tracks commercial real estate research trends and properties that it collect and releases data on a quarterly basis,” she said. 

Higher construction costs and loan interest rates caused developers to “push pause on their projects,” Sutton said. 

Mike Rohm is a senior associate and director of valuation advisory at Landmark Commercial Realty in East Pennsboro Township, Cumberland County. 

“A lot of [business] projections are based on their exit strategy, and that’s become a lot cloudier,” Rohm said. 

Sutton expects more market and economic stability in 2024; factors which could prompt a decline in interest rates and construction costs. 

Making the grade: Renovations on the rise 

While new starts are slim, Sutton said renovation projects are entering more commercial construction conversations– and resulting projects.  

He said commercial clients are looking to upgrade the assets they already have. 

The most attractive and appealing office space fits into the Class A level, he said. 

“There is a lot of inventory that is not at that highest level, so it’s being upgraded to make it more attractive,” Sutton explained. 

Commercial building spaces are transforming to become more home-like environments, aimed at enticing employees to come back to the office.  

“Gyms on site, walking trails and entertainment amenities will very important moving forward,” Kreiger explained. 

She said quality office compounds will be “a big thing” and landlords able to offer high end amenities will be positioned better than those who do – or can – not. 

Indoor amenity upgrades include more comfortable lounge areas, improved community spaces for collaboration, high-end kitchen and break rooms, quality countertops and cabinetry, improved coffee service and coffee makers, higher quality furniture, furnishings, lighting, and sound and audio visual systems, Sutton said. 

Retrofits and building upgrades have been an important business funnel for Mowery during 2023. 

“It’s really been keeping us going during a slower year,” he said. 

Smaller office spaces 

Kreiger said smaller, more flexible office spaces are part of Central Pennsylvania’s commercial real estate hallmarks. 

Factors that determine if a building can be repurposed or subdivided include its layout, “floor plate,” overall size and the placement of mechanical systems. A floor plate is the overall measurement of a building’s story or floor measured from the exterior walls. 

“A single floor, 100,000-square-foot building will be harder to break up than a building that is 10,000-square-foot. As we move forward in the new workforce and environment, I think the trend of smaller offices spaces will continue,” she said. 

Rohm believes building innovation is “the next big thing.” 

“I think people will be more conscious about how they are building office space,” he said. 

That includes a stewardship mindset of the present need and what the future may hold. 

“What structures will make a building more feasible for a conversion when the intended use becomes obsolete,” Rohm said. 

Office to multi-family living conversions 

Sutton said repurposing vacant commercial buildings into multi-family housing are becoming a stronger trend. 

“The number one growth market is affordable, multi-family housing,” he said. 

Recent commercial to multi-family conversions include the former Lemoyne Middle School to 701 Schoolhouse Flats apartments, BenMar Apartments and Menaker Apartments in downtown Harrisburg. 

“People want to move into more flexible spaces and apartments are booming in York, Harrisburg and Lancaster” downtowns, Sutton said. 

Manufacturing and mixed-use  

Manufacturing is picking up as more businesses look to bring production back from overseas suppliers. 

Aluminum extrusion in Millersburg and battery manufacturing plants are two recent examples of growth in the industrial space, according to Sutton. 

“We can’t build battery manufacturing facilities fast enough,” he said. 

But the nature of most manufacturing plants makes them difficult to repurpose to other uses in a cost effective way, according to Sutton. 

Mixed use: Retail, professional and apartments on the rise 

Mixed-use projects are increasing with smaller office space, restaurants, retail or medical on the street level and apartments on upper floors, Sutton said. 

This type of conversion may be the sweet spot appropriate older buildings. 

“As soon as these things are built, they’re getting leased up. I see more creativity in retail spaces, and in health care moving into what used to be retail, because they want to be more customer facing space,” he said. 

Labor squeeze continues 

Having enough skilled labor to build out a job is critical for any project’s success. Sutton said labor continues to be a stubbornly scarce resource with which construction firm’s grapple. 

“If you look at demographics we’re dealing with an older retiring generation. For many years we did not replenish the ranks,” he said.  

Sutton said Mowery recently held a construction bid event and invited 70 contractors; only 50% attended. 

“The rest were too busy to even come and hear the details,” he said.