With office vacancy rates sticking at about 50% – thanks to hybrid and remote work arrangements – specialty manufacturing and multi-family residential are on track to grow in the region this year.
From office buildings and compounds to manufacturing, distribution, rentals, retail and institutions like schools and hospitals just about any buildings that are not single family residential falls to the commercial real estate side.
A recent Forbes.com report said commercial real estate products including industrial, apartment, hotel, office and retail (with office) space declined in the third quarter of 2023. Office space had the biggest demand decrease, the website said.
Manufacturing gaining ground
Specialty manufacturing continues to be a bright commercial spot in the Lehigh Valley, according to Donald “Don” Cunningham Jr., president and CEO of the Lehigh Valley Economic Development Corporation in Allentown.
“There’s a movement to smaller specialized manufacturing and tech projects, and a slowdown in the larger industrial sector. The office market continues to be pretty flat, though there is leasing in new and Class A office space,” Cunningham said.
Continued appetite and demand for manufacturing includes most food and beverage makers and produce manufacturing while life sciences, tech and semi conductor manufacturing are growth areas, Cunningham said.
“I think we’re coming off of a peak period during and post pandemic in 2021 and 2022, where there was a tremendous amount of activity on the industrial side,” he said.
Office space defined
Office space and assets continue to struggle, according to Cunningham.
He predicts Class B and C professional office growth will continue to be slow going this year.
Class A – the highest grade office space available – should continue to be attractive to investors and tenants, he said.
Area Development.com defines Class A office space as “the newest and highest quality” space available in a market. These buildings are the best looking, have well positioned locations, are well maintained and managed offering the best of amenities.
Class B office space is older, but still remains well maintained and managed. Often in prime locations, with upgrades Class B can return to Class A specs, the website said.
Class C office space is the lowest graded commercial office space; typically in need of significant renovation. It may be located in less desirable areas and suffer from outdated technology access and infrastructure.
Conversion opportunities
CBRE.com (Coldwell Banker Richard Ellis), a global commercial real estate firm reported hybrid working arrangements will continue to stymie the demand for office space growth while a demand for more data centers will drive construction expansion.
CBRE.com predicts better interest rates and a “mild recession” could soften markets and create opportunities for commercial real estate investors in 2024.
Conditions could be ripe for office conversion projects – especially for older Class B and C buildings, the website said.
While conversations about redeveloping suburban office parks and repurposing buildings to residential uses continues, Cunningham said few viable proposals are coming to the table.
One promising commercial to residential conversion project is gaining traction in the Lehigh Valley: The former Dixie Cup Factory compound in Wilson Borough, Northampton County.
LVB.com reported about the roughly $150 million luxury apartment redevelopment plan for the factory property is pending approval of hazardous waste cleanup from the Department of Environmental Protection and the Environmental Protection Agency before construction begins.
“I think residential conversions will remain hot, particularly in the cities, [when] Interest rates come down as there is a huge demand on the residential side,” Cunningham said.
He said the markets are poised on the “…cusp of a transition period. People have been running hard down existing lanes of operation. With market dynamics changing you’re seeing policy makers and planners,” think of more creative approaches to projects, he said.
Office space in central Pennsylvania’s downtown Harrisburg and its suburbs isn’t faring much better.
“I think it’s fair to say we’ve never seen more large floor plate office buildings on the market that are either vacant or have a very small percentage of occupancy,” said Mike Rohm, director of valuation and advisory for Landmark Commercial Realty in Camp Hill.
Seller financed deals on the rise
In the Harrisburg region seller financed deals for commercial real estate are an emerging trend, Rohm said.
Among his current seller deals include an apartment complex, a restaurant, a self storage compound and an HVAC company.
“They all are trying to do seller financing as a part of a sale, and I find that to be a fairly noticeable trend in commercial real estate” right now, he said.
Rohm said the benefits of such deals include spreading out the tax burden from the sale of the business and creating years of passive income for the previous owner.
“In all these conversations it’s all about taxes,” Rohm said.
There is a significant education process for sellers interested in financing a buyout. Those unfamiliar with the mechanics of financing the sale of their business to a buyer may not have thought about the process involved.
“On the surface it’s a super attractive structure, but there’s a difference between returns – and risk adjusted returns,” he said.
Sellers might not realize they are underwriting – or guaranteeing – the borrower’s loan the same way a conventional lender would.
Personal credit reports, collateral, underwriting and all other financial lending steps are still part of the buy out process.
Rohm said for some sellers, shouldering the financial risk to become a commercial lender may be more than they are willing to assume – even when the savings of such financing can be significant.
“This is a great return on paper, but let’s look at the risks you are taking – and if it’s worth the risk,” he said.
“It’s the same analysis you’d go through to decide if you invest in real estate, the stock or bond market. Personal risk tolerance and your personal investment tolerance will become factors” to decide if a seller financed deal is right for you, Rohm said.