Post-COVID commercial real estate trend not yet clear

Facilities management was the biggest challenge of 2020 to A&L Properties, owner of the Technology Village at the corner of Lake Ave. and Superior St. in Duluth.

 

While the real estate mantra, “location, location, location,” probably still holds true, experts in the commercial real estate field, from practitioners to academics, have been adding to it the COVID motto: challenges and opportunities.

Monica Haynes, director of the Bureau of Business and Economic Research at the Labovitz School of Business and Economics, said the commercial real estate market is one industry that didn’t see major negative impacts from COVID-19, at least in the Twin Ports, and points out that in 2020, the city of Duluth issued permits for construction projects collectively valued at more than $399 million – a record-setting year.

“However,” she said, “the nature of the commercial real estate market is that these projects take many years to come to fruition, so the projects that were happening in 2020 were ones that had been planned well in advance,” said Haynes. “It’s hard to know now whether the economic downturn will have a negative impact on commercial real estate in the coming years, but according to news reports, 2021 is also expected to be a busy year for construction.” 

She pointed out that the city of Duluth hasn’t yet issued the biggest building permit that Essentia will need for its three-year project. “That project has created a lot of additional interest in vacancies between Lake Avenue and the Fitger’s complex.”

Haynes cited the recent passage of the American Rescue Plan and the possible passing of a major infrastructure plan in playing a significant role in the sustainability and expansion of small businesses that can benefit from them. She advises commercial real estate investors and owners to keep a close eye on small businesses and be prepared to seize opportunities. This should lead to better economic conditions, she added .

“Downtown Duluth currently has several office buildings on the market, including the Duluth News Tribune building and the U.S. Bank office building,” said Haynes. “Many business owners may not realize that the entire city of Duluth, including the downtown area, is designated as a federal opportunity zone. Opportunity zones are an economic development tool that are designed to spur economic growth and job creation in low-income communities while providing tax benefits to investors.”

There are some unique characteristics of the Twin Ports to consider, she said. 

“Despite a number of new apartment buildings that have gone up in recent years, the Twin Ports still has a severe housing shortage, so investments in new housing combined with commercial or retail space are likely to continue.” For example, she continued, plans for construction of the 15-story mixed-use housing/retail complex at the corner of Superior Street and Fourth Avenue East in Duluth are finally advancing after several postponements. 

Haynes speculates that the Twin Ports has the potential to benefit from the trend toward remote work. She noted Duluth was recently named one of the top 10 “remote-ready cities in the U.S.” by Livability.com for its “unparalleled access to nature and outdoor recreation opportunities.” It has also recently gained attention as a supposed “climate refuge.” 

“If businesses continue to allow their employees to permanently work remotely post-pandemic, Duluth could see an increase in residents in the coming years, increasing the demand for housing and commercial real estate investments,” said Haynes.

Holappa Commercial Real Estates, Inc. (HCRE) has been in business serving commercial real estate sellers, buyers, landlords and tenants in the Twin Ports area since 1990. Dave Holappa joined the firm in 1999 as a sales agent, and in 2002 became the primary broker and president. 

While 2020 wasn’t a complete disaster for HCRE, it certainly was not as active as the previous few years had been, Holappa said. This year has started out relatively flat, with some smaller deals that helped pay the rent. 

“The firm has been able to assist some local companies in their desire to grow even in the middle of the pandemic, resulting in relocation to newer larger spaces, some as tenants and some purchasing new properties,” Holappa said. 

 He agreed that due to ongoing pandemic threats, predictions for the future of the CRE market are still unclear, and that there will still be a “wait and see,” attitude. But with the rollout of vaccinations, lifting of restrictions and more federal stimulus and infrastructure initiatives on the way, there are positive signs that the recovery of the market as a whole is well under way. 

“I do see opportunities coming this year as restrictions are lifted, people begin to move around again and companies open up,” says Holappa. “However, the office market is a real question mark. Many people have grown comfortable working remotely, and as office spaces welcome staff back to the office, the question of whether people will want to return remains. Some companies have discovered they have not suffered any loss in productivity as a result of staff working remotely. The office market has seen negative pressure in rental rates already with some long-term vacancies remaining in the central business district. There may be opportunities in the commercial brokerage business as companies determine whether or not they want to retain the current level of office space or potentially shrink.”

 Regarding federal initiatives under the Biden Administration and how they might affect CRE investments, Holappa explained that commercial real estate investors of all levels use a number of tools afforded them in the tax code, such as IRS Section 1031, which allows for deferral of taxes on capital gains and recapture of depreciation when proceeds of a sale are reinvested in like-kind investments. The way he sees it, Holappa said, this section in the code is potentially going to be restricted or limited under current federal proposals. 

“The ability to transfer assets upon death at a stepped-up basis, you know, the value at the time of death to heirs, is also potentially going to be restricted under current proposals,” said Holappa. “The loss of these tools would have a negative impact on investors and could cause them to simply sit on investments rather that sell and trade up. If that occurs, it will negatively affect the CRE market all over the country, including the Twin Ports, and therefore brokerage services provided by HCRE.”

Holappa said that the Twin Ports market has long been in need of additional industrial/warehouse spaces. He would not be surprised to see speculation occur with new construction. However, he added, the cost of construction is so high currently, it likely will be delayed and not occur in 2021. 

Like Holappa, Tiffany Hughes has experienced the highs and lows of commercial real estate for decades. Currently, she is president of A&L Properties, leasing and overseeing all areas of the firm’s properties, from tenant relations to facilities management. She admitted that 2020 was no doubt challenging, but, other than most of A&L’s buildings sitting empty as many tenants worked from home, the firm was affected minimally regarding leasing. She said they lost fewer than a half dozen tenants, the majority of which were one or two-person operations. On the flip side, A&L brought in new tenants who leased a combined 16,000 square feet of space, and they were able to retain and renew leases with existing tenants filling more than 55,000 square feet of space.

“The biggest challenges our company faced in 2020 related to facilities management,” said Hughes. “We needed to secure supplies that were hard to find and revamp what was needed within our buildings to keep tenants who weren’t working from home comfortable. We also continued to prep our buildings to be ready when those who had worked from home returned to their offices.”

 Regarding Twin Ports as a whole, Hughes said she knows there were companies that struggled to retain tenants, but believes the larger companies were not impacted too terribly. The loans and assistance provided to companies at the federal, state and local levels were a lifesaver to many businesses and landlords since companies were able to utilize the funds to pay rent, she added. 

“Things are going well for A&L Properties so far this year,” said Hughes. “To date in 2021, A&L Properties has brought on two new tenants and we’ve renewed seven other large tenants.”

 She noted that during the past year, tenants voiced two sets of concerns. First, everyone wanted to be sure offices and common areas of the building were thoroughly and frequently cleaned to provide their employees a safe environment. Second, some feared that pandemic challenges would make it hard or impossible for them to pay rent.

“Our staff at A&L worked tirelessly to keep their spaces and common areas clean, implementing additional special requests tenants may have had as well,” said Hughes. “For tenants whose budgets were suddenly strained, we worked out individual plans until things turned around. “

For Titanium Partners, the hardest hit assets were hospitality and retail, said President and CEO Brian Forcier. 

“Multi-family and industrial holdings have done well through the pandemic. I’d say 2021 has started off slow in leasing, but the development side of our business is very busy.”

Titanium Partners currently oversees the redevelopment effort at Duluth’s largest office building, the United HealthCare facility on Rice Lake Road. Forcier said he has seen robust interest in the property from prospective tenants and anticipates success in the next two years at the current pace of leasing activity.