A Whole New World

Ingram’s 2021 Historical Perspectives Series: Commercial Real Estate

Everything you thought you knew about the history of commercial real estate in Kansas City? Put it on a shelf: That history is being rewritten right now.

Various megatrends for years had been rocking development of retail, industrial and multifamily sectors. Thanks to the global pandemic of 2020, the office market entered its own era of wrenching change. And where it’s all going to take us is just about anybody’s guess. Even when you cast for opinions among seasoned CRE executives.

With commercial real estate anywhere, it’s a bit of a challenge to produce a health scorecard for any single community. The market for each must be viewed through the lens of those four constituent elements, each of which can influence growth in the others. But in general, regional real estate executives offer this snapshot of their world at the dawn of 2021:

Industrial. The Kansas City area, long considered on the national level as being a low-secondary to high-tertiary market, is moving up—fast. Too many millions of square feet continue to separate us from the biggest markets in the nation, such as Chicago, Los Angeles, New Jersey or Dallas. But the past five years have witnessed unprecedented growth and put this region into logistics conversations taking place at national and global companies.

Retail. What more can be said about the well-documented changes retail has seen since the first Amazon trucks started rolling? In the final quarter of 2015, on-line purchases accounted for 7.5 percent of U.S. retail sales. The good news for retailers stung by lower foot traffic is that, as sales soared to nearly $5 trillion in early 2020, the on-line share more than doubled since, hitting 16.1 percent by the second quarter of last year. The surge in on-line buying during the pandemic will only drive that number up. Slammed with business operating restrictions as well as changing consumer habits, tens of thousands of retail establishments have gone under, leaving gaping holes in shopping centers, but creating intriguing opportunities for repurposing.

Office. This sector is the billion-dollar question. Within days of the pandemic’s arrival in the United States, employers emptied out their offices and switched staffs—hundreds, even thousands at a time—to remote workplaces. As many as 40 percent of those remain out of the office nearly a year later, and many aren’t expected to return to those settings. Ever. Demand for new offices is being reshaped to focus on spacing, ease of sanitation and horizontal construction: Buildings that require high-density elevator cars have rapidly lost their appeal; many may be destined for new life as residential facilities if they remain standing at all.

Multifamily. Amid a luxury-apartment building boom, the question started gathering currency as far back as 2012: “When will the luxury-unit construction wave crest?” That peak would come the following year, as post-recession construction in the area topped out just shy of 7,000 units. But even as permitting has tailed off consistently for most of the years since, real estate executives still classify the market here as “strong.” Market-rate units continue to dominate construction here, and while COVID put a dent in the numbers in 2020, those executives expect a solid rebound when the pandemic eases. Those are the broad brushstrokes of commercial real estate in this region today. Things get more complex, but nonetheless interesting, as you dive deeper into each sector.

Industrial

“Without a doubt the bright spot, even without the COVID impact factored in, has been the industrial sector,” says Kevin Wilkerson, managing director for JLL Kansas City. This region, he says, “continues to emerge as a big-box market, especially for the secondary market. The trend we’re experiencing has been phenomenal.”

There are good reasons for that, but Michael Mayer of Cushman & Wakefield brings them to life with numbers. “From 2001 through 2013, just five warehouses 450,000 square feet or larger were delivered in Kansas City,” says the managing partner at Cushman & Wakefield. From 2014 through 2020, he says, that increased seven-fold, to 35 warehouses of at least that size, and in most cases, far larger.

Why?

“Kansas City’s location for logistics and distribution is fantastic, and we have great infrastructure (as one of our lead industrial researchers likes to say: ‘It really hard and really expensive to move a railroad.’)” Mayer says. “The demand was there, and we believe more demand exists. As additional product comes online, more tenants will locate here due to the location and the infrastructure. The only thing that prevented all this from happening even sooner was the existence of modern warehouse space.”

There’s another major factor in that scope of development: The emergence of NorthPoint Development under the leadership of Nathaniel Hagedorn. Within just a few years of taking the reins of its predecessor firm and remaking the business model, NorthPoint became the nation’s biggest developer of industrial space. A good deal of that was right here, thanks to Logistics Park Kansas City, where the firm has raised the roof on two dozen buildings and more than 18 million square feet of logistics facilities.

Part of that was man, moment, vision and team. Part of it was grounded in calling Kansas City its home.

“Real-estate development is still very much a local business, as every city and region have different supply and demand drivers, barriers to entry, and geopoli-
tical forces at work which define how and where buildings are built,” says Mark Pomerenke, NorthPoint’s chief investment officer. “Supply chains and logistics, which is what our customers really care about, requires a much broader lens.  To understand a business’s industrial and warehousing need you need to look at their entire supply chain, which often means looking outside of the market you are operating in.”

The firm has applied deep understanding of various market attributes to become a powerhouse. Closer to home, Pomerenke says, “Kansas City is unique in that new-to-market users are often considering other midwestern markets, and so the ability to promote unique Kansas City attributes like the work force and transportation infrastructure, such as the BNSF intermodal in Edgerton, have been key in securing new industrial development.”

Kansas City is unique, Pomerenke says, “in that new-to-market users are often considering other midwestern markets, and so the ability to promote unique Kansas City attributes like the work force and transportation infrastructure, such as the BNSF intermodal in Edgerton, have been key in securing new industrial development.”

Office

If three words could assess the future of office real estate, they might be “We don’t know.” That’s the position most brokers are taking as the nation—the world, really—waits to see which changes wrought by the 2020 COVID-19 pandemic will be temporary, and which will be permanent.

What we do know is that in the immediate response to the outbreak, a staggering 59 percent of employees in America had abandoned their office cubicles to work from remote locations. By October, according to Gallup, that had dropped to 33 percent, but industry executives believe it will hold there throughout 2021 and possibly into 2022.

When—if—it comes back, it will be into a new office-working paradigm. Your guess on what that will look like.

“I don’t really know what to say about office, other than basically, if your business has been declared non-essential, your offices have been shut at least some of the past year, and if you’re essential, you were open,” says Ken Block, managing principal at Block Real Estate Services. “But even with a lot of essential businesses, employees were still working—at home or off-site, but not in the office.”

Some of the biggest companies in the nation, he said, are sitting on office caverns that were still 80 percent empty at year’s end. And once the crisis is over, Block said, it will become a question of “what space do we really need in the future? How are we going to operate? Will work from home work for our business from now on? Every decision that has to be made in terms of space needs is being re-examined.”

In many cases, says Kessinger/Hunter & Co. managing partner Pat McGannon, companies need that office dynamic. “It’s hard to train guys on a Zoom call,” he said. “Corporate America, in some cases they’re going to say that if you want to live in Dallas and work for us in Chicago, that’s fine—you can come to four or five meetings a year in Chicago, so I don’t know what the future of business travel is. But a lot of transactions in our industry, and others, simply need to be face to face.”

The downsizing that was already happening in office environments—tenants and corporate owners pressing for more efficient use of space—will adjust somewhat, but there’s no getting around the notion that a distanced work force will require more square footage. Use of that space, then, will be key, with moves to “hoteling” work spaces, with one employee moving into a cleaned work sta-tion after another rotates out.”

“There won’t be a desk with a picture of your family on it—you’ll have that on your computer screen,” McGannon said. “I don’t think the office world is going away, but I will tell you, we do a lot of leasing around here, and right now, we’re doing a lot of 1-year renewals because companies don’t know what’s going to be on the other side after that.”

There’s no question, though, that the regional office market took a statistical thumping in 2020. Leasing activity, for example, fell by nearly a third, from 2.5 million square feet through to 1.7 million in the first three quarters of the year, and total net absorption was a negative 935,00 square feet.

On the bright side, as tough as it was for the nation’s employers, the demand for space held up well in Kansas City, all things considered. At 8.8 percent, this market posted the third-lowest vacancy rate in the U.S., behind only the 8.5 rate posted in Seattle and Raleigh-Durham, N.C., for the third quarter of 2020. That was helped, in part, by entering 2020 with a 20-year-low in office vacancies.

Flexibility with use of space, says Wilkerson, remains key. “There is no substitute for in-person interaction, and office is the only way to achieve that,” he says. “More highly concentrated work environments allow for more collaboration, connection and innovation.” Chief operating officers at companies realize now that there will be a difference in the post-COVID environment, he said, but those differences will be specific to the unique needs and missions of their organizations.

Retail

What 2020 hath wrought in retail was not a sea of change—it was simply a bigger, faster wave in that sea of commerce. Consumer trends for the better part of a decade had shown where things were going, moving away from brick and mortar/big box stores to on-line purchases backed to-your-doorstep delivery.

But a global pandemic, realty professionals say, dramatically altered the shape of that arc.

“I put retail and restaurants together,” says Block. “Retail was already losing ground because of ecommerce, but with retail and restaurants both being hit as non-essential-type businesses, good, bad and indifferent, retailers really got hurt. But people are not shopping the same ways, other than at grocery, Walmart and Target stores. But even there, foot traffic is way down, people are wearing masks and they’re not as comfortable with the shopping experience.”

The pandemic, he said, “pushed online shopping trends four to five years ahead of they pace they were on.” Over the course of 2020, iconic retail brands like J.C. Penney, Brook Brothers, J. Crew and Neiman Marcus all resorted to bankruptcy protection, but the pain going forward won’t be confined to retailers who survive.

“Entertainment venues, sporting and concert venues, hotels, airlines—they are all just devastated,” Block said. “Travel was just destroyed. And a lot of people are still afraid, even though they say travel by commercial airline is one of the safest ways to get around now because of the work the airlines have done.”

Multifamily

“Multifamily,” Pat McGannon says, “is still a big deal. I don’t know how it just keeps going, but it does.” Perhaps some of the reason he’s mystified by that trend is what’s happening demographically. For years, development officials and real estate executives watched a boom with market-rate apartments in the urban core, then the inner-ring suburbs—all driven, they believed, by Millennials too financially gun-shy to buy a home after seeing their parents’ biggest investments throttled during the Great Recession.

But young renters, it turns out, aren’t the only ones interested in that lifestyle. “You’d be surprised at the numbers of people 65 and older, as well as the 30 and under—with the the older ones, it’s not just all Boomers sel-ling houses to downsize,” McGannon says.

Interestingly enough, says Block, occupancies have remained “pretty darn high” even in a year where tens of millions saw their incomes disrupted by layoffs. Much of that stability can be attached to unemployment relief approved by Congress, but for many, that was running out as 2020 was winding down.

Moving Ahead

Despite the wrenching changes on almost all fronts, you’d have a hard time finding a pessimist in commercial realty today. Mayer echoes most veteran executives when he assesses Kansas City’s position in the CRE market place.

“I truly believe Kansas City has two major advantages over probably any market our size: a diversified economy and a real sense of entrepreneurship and innovation,” he says. Cost of living statistics and labor availability are very appealing, he notes, but there are other markets that rank about the same. Not so with innovation. What we do have here, he said, is a creative mindset. “Are there challenges ahead as we expand? Sure,” Mayer said. “But I think our greatest strength is commitment and creativity. I’m not worried about any of that becoming a negative.”

Upcoming Historical Perspectives

Topics we’ll explore throughout 2021:

• FEBRUARY Higher Ed and the Workforce

• MARCH Regional Banking

• APRIL Agribusiness at Our Core

• MAY Engineering and Design

• JUNE Logistics and Warehousing

• JULY The Law Firm Landscape

• AUGUST Sports in KC

• SEPTEMBER C-Suite Changes

• OCTOBER Reinventing Health Care

• NOVEMBER A Kansas City Makeover

• DECEMBER Philanthropic Realignment