Like in most major cities across the Midwest, Cleveland’s commercial real estate market is thriving. Demand is soaring for industrial space and multifamily units. Retailers are opening new locations here. Healthcare providers continue to open new locations across the Cleveland area. And even the office market is showing some positive signs.
Not to say there aren’t any challenges. No one knows exactly how rising interest rates might slow deal velocity in Cleveland and its suburban areas. Developers and contractors continue to struggle with supply shortages and the rising costs of materials. And many major employers in the area still haven’t finalized their back-to-work plans, keeping the office sector in its COVID limbo.
But three CRE pros from the Cleveland office of Colliers said that leasing activity is strong in most commercial sectors today in their market. And in even better news, these pros are predicting that the rest of 2022 and the beginning of next year will be strong in Cleveland, too.
What’s behind the commercial real estate momentum in this key Midwest city? You can credit Cleveland’s ideal location in the center of the country, its strong workforce, pro-business environment and investors’ insatiable demand for commercial real estate assets.
Industrial keeps booming
Tim Breckner, senior vice president with Colliers in Cleveland, specializes in the industrial sector. That’s a big plus: Industrial real estate remains the darling of investors today. And demand for industrial space is slowing no signs of falling, either across the country or in the Cleveland market.
As of the second quarter of this year, the industrial vacancy rate in the Cleveland market had fallen to 4.2%, according to Colliers’ research. Breckner said that this is the lowest this vacancy rate has been since Colliers first started tracking it.
The second quarter again saw positive net absorption in the Cleveland industrial market. Breckner said that Cleveland hasn’t seen negative absorption in the industrial sector since the second quarter of 2019.
“It seems like COVID was a big factor for increasing industrial demand even further,” Breckner said. “Things were already trending in this direction. People were already ordering everything online. But after COVID, people started ordering even more frequently online. They grew comfortable ordering clothes, foods, consumables, whatever they needed. That is a big part of why demand has only grown for industrial space since the pandemic started.”
Another positive for Cleveland’s industrial market? The city and its surrounding areas did not have much spec industrial construction until recent years. This mean there hasn’t been an overabundance of supply in the area. Once developers started building new modern industrial space, then, the demand for it remained high.
And this new spec space has filled quickly, often while the facilities are still under construction.
Breckner said that end users are looking for specific amenities when it comes to new industrial space today. This includes higher clear heights, with some of the new product entering the market boasting clear heights of 40 feet. At the minimum, new facilities must have clear heights of at least 30 feet, Breckner said.
Users also expect wider column spacing inside facilities, more docks and more room to park trailers, Breckner said.
“We have what I consider to be a lot of spec space under construction today,” Breckner said. “But for the most part, this space is filling quickly. We are not seeing any high vacancy rates. Demand is so high that landlords are becoming more strategic when it comes to who they lease to. They are seeking full-building users. If they can’t get that, they only want to split their buildings up among two users instead of chopping it up for several users. Landlords can be more selective in this market, too.”
While the Cleveland-area industrial market continues to thrive, it does face challenges, Breckner said. Not surprisingly, these challenges come down to rising interest rates and supply chain disruptions.
Breckner said that developers are still struggling to get the materials they need to build industrial space. He said that today dock equipment and the panels for overhead doors have become especially difficult to get. These materials have also become more expensive.
The rising cost of materials means that industrial space itself might continue to get more expensive for end users. As Breckner says, asking rates for industrial spaces in the Cleveland area were up again this quarter. They’re also up on a year-over-year basis, he said.
Despite these potential headwinds, Breckner said he doesn’t expect demand for industrial space in the Cleveland market to slow any time soon.
“It comes down to the way people shop now,” he said. “They go online to buy anything they need. People also don’t consider all the returns they make. Those returns also go back through a chain of warehouses. It’s almost a two-fold increase, then, because of the way people’s shopping habits have changed. You buy something. You send it back. In each direction, it goes through a warehouse or series of warehouses.”
An uncertain office sector
As it is in most cities, the office sector in Cleveland remains in a state of uncertainty. Many of the area’s bigger employers are still finalizing back-to-work plans. And many of the area’s office workers continue to work from home, at least two to three days a week.
This has left Cleveland – and especially the city’s downtown office market – with a higher vacancy rate. Again, this is hardly unusual; Most major cities across the United States face the same challenges with their office space.
Brian Hurtuk, managing director with the Cleveland office of Colliers, said that most companies with office space in downtown Cleveland are operating on a new normal: They are encouraging their office workers to come into the office at least three days a week.
This means that on any given weekday, about 60% of the normal workforce is traveling into downtown Cleveland, Hurtuk said.
“We have a long way to go, then, before we get to a more normal office environment,” he said.
In the suburbs, the equation is a bit different. Hurtuk said that on any given weekday in Cleveland’s suburban communities, about 75% of the normal workforce heads into offices.
Why the difference here? The suburban office market is dominated by smaller, more flexible companies that began asking their workers to return to the office sooner than have the larger, national companies that dot the downtown office market.
The suburban office market is also filled with buildings that are typically smaller. If workers are worried, say, about crowding into an elevator, they can take the stairs. Suburban office buildings don’t tend to be as vertical as those in downtown Cleveland.
“The interesting thing is the businesses downtown — professional firms, law firms, accounting firms, banks and insurance companies — are doing well financially,” Hurtuk said. “Companies are paying rent on time. Very few companies of any significance have said that they are going to give space back to the market. No one of significance has put a big block of space back on the market for sublease.”
Before the pandemic hit, the Cleveland office market was seeing high vacancy rates in all classes of buildings. Some of the market’s higher-end office buildings were even generating more than $30 a square foot in asking rates.
Today? Asking rents have taken a hit of about 10% overall. And tenants in the market are asking for economic relief from landlords and building owners, Hurtuk said.
Hurtuk said that tenants are also asking for a greater amount of tenant improvement dollars when moving to a new office space or renewing their leases in an existing building. Overall, building owners are giving tenants almost 20% more for tenant improvements than they were before the pandemic.
“There are some positives in the market,” Hurtuk said. “The higher-end buildings are seeing more activity. And there are other buildings in the market that are building momentum, too. We are not jumping up and down with joy about the office market, but we are also not standing on window ledges. We are cautiously encouraged. The more we have office workers back downtown every day, the better it is for everybody.”
Many companies that are looking for new office space are targeting buildings with robust amenity packages, Hurtuk said. That’s one way for them to attract workers back to the office, at least on a part-time basis.
Amenities that matter today include on-site restaurants that serve healthy food, fitness centers that offer the latest exercise equipment, ample and easy-to-access parking and conference rooms fitted with the latest technology.
Hurtuk points to 200 Public Square in Cleveland as an example. That iconic Cleveland office building is in the middle of a $6 million capital campaign spent on conference rooms, a cafeteria, fitness center and refreshed lobby area.
Getting people back into the office has become a priority for many employers in Cleveland, Hurtuk said. They realize that younger workers need to be around those with more experience. Mentoring doesn’t work remotely. They also realize that brainstorming new ideas and crafting creative business strategies is more likely when workers are in the office.
“I’m hoping that more organizations will encourage and entice their workers back to the office on a daily basis,” Hurtuk said.
More people are returning to downtown Cleveland, Hurtuk said. But this activity tends to be clustered on Tuesdays, Wednesdays and Thursdays, he said. Mondays and Fridays remain far quieter than they were before the pandemic.
“It has been a big change,” Hurtuk said. “Just two short years ago, everyone was coming into the office every day. Now everyone is trying to figure out what they need for office space. What is the secret sauce? Right now, we have not seen any announcements or grumblings of significant downsizings or give-backs of space. So that’s a positive.”
Demand still rising for multifamily space
Along with the industrial sector, the multifamily space has been thriving in Cleveland, with demand for apartment units high before, during and after the pandemic.
Just ask Gary Cooper, senior vice president with the Cleveland office of Colliers. He specializes in the multifamily sector and says that the apartment market has remained resilient throughout the Cleveland market.
“It’s been another good year,” Cooper said. “Occupancies and rent growth have both remained strong. Everyone thought we’d hit a wall or show some cracks in the multifamily market. But we aren’t seeing those cracks. People are bullish moving forward.”
The only slight concern? Cooper said that the Cleveland market is showing a bit of rent fatigue in workforce and lower-income apartment buildings. These buildings are also seeing a small amount of collection issues, he said.
“The economy can be challenging for many people today,” Cooper said. “When you look at some people, we go to the gas pump and complain. But we are still able to buy food. For a lot of folks, to spend $200 more a month on fuel alone forces them to make some difficult choices. Then there are the rising food costs and utility bill costs. That is where we are starting to see a bit of rent fatigue. People are getting pounded from every level, every time they go to the pump or the grocery store or the home-improvement store. They are facing sticker shock today.”
Not as many renters in the workforce housing or low-income end of the market fell behind on their payments during the height of COVID, Cooper said. Stimulus checks and enhanced unemployment checks helped them pay their bills. Now those financial safety nets have disappeared while inflation is boosting prices, making it more difficult for some to pay their rent each month.
Still, Cooper said that the situation is far rosier than what some predicted at the start of the pandemic. Back then, people worried that as many as 40% of renters would stop paying their rents. That, obviously, never happened.
What has led to the long hot streak in demand for multifamily, both in Cleveland and across the country? Cooper points in part to the soaring prices of single-family homes. The National Association of REALTORS® reported that the median sales price of an existing home hit $403,800 in July, up 10.8% from a year earlier. Last month, the median sales price hit an all-time high of $413,800.
At the same time, new apartment product comes with higher-quality finishes and amenities, Cooper said. It featured high-end kitchens and bathrooms.
“When you combine the economic fundamentals and the rental product what has been out there, you have a perfect recipe for continuing demand,” Cooper said.
Cooper said that demand is so high in certain Cleveland submarkets that it’s difficult for renters to find space. This is especially true in many of Cleveland’s nearby suburban communities.
“You go to properties and they say they have nothing to show you,” Cooper said. “They say they are full and they’ve even rented out the model. If there are occupancy challenges, it is usually property specific. A certain property might have maintenance issues, a bad roof or structural issues. But demand for most multifamily properties is very high today.”
The strength of the multifamily market in downtown Cleveland is a surprise to many, Cooper said. People still want to rent in downtown, even if workers aren’t yet coming back to their downtown offices in strong numbers, he said.
“You would think that the slowdown in office workers would lead to a slowdown in demand for downtown multifamily. But we haven’t seen that,” Cooper said. “We are seeing nothing but continued demand. How many people can pay $1,800 a month for a one-bedroom apartment in downtown Cleveland? When will this market hit a wall? I don’t know. We haven’t seen it yet.”