The Reconfigured Market for Commercial Facilities

The Reconfigured Market for Commercial Facilities

Monday, June 5, 2023 from Floor Covering Weekly

The Reconfigured Market for Commercial Facilities
Commercial construction and real estate have undergone significant transformation over the past three years. While construction levels in this sector are very healthy at present and demand for commercial space overall is strong, the composition of activity in this sector has changed dramatically. Spending on the construction of commercial and industrial buildings totaled over $325 billion last year, an increase of almost 18 percent over 2021 spending levels. Yet not all the sectors benefitted equally from this surge in construction.

Spending on manufacturing facilities grew by almost 35 percent last year. Many companies that had experienced supply chain disruptions during the pandemic decided to bring back — or reshore — at least a portion of their manufacturing capacity to limit this exposure in the future. Hi-tech companies in particular have incentives to increase domestic production of their products. Most notably, the 2022 CHIPs and Science Act allocated roughly $280 billion in new funding to boost domestic research and manufacturing of semiconductors in the United States.

Construction in the retail and other commercial facilities category increased over 20 percent last year. However, over half of spending in this category was for high demand warehousing facilities, not traditional brick and mortar retailing where activity continues to be quite weak. Other commercial categories also haven’t fared well recently. Spending on the construction of lodging facilities increased by less than 2 percent last year, not nearly enough to offset inflation in construction costs, while spending on offices increased by less than 1 percent.

The dramatic increase in remote work during the pandemic has been a major reason why some types of commercial construction have fared well while others have not. However, even with the recent termination of the COVID-19 public health emergency, we won’t see commercial construction patterns rebalance to pre-pandemic levels. For example, recent government surveys report that fully a quarter of paid workdays nationally are worked remotely, a share that seems to have held relatively steady recently. Still, there is a lot of variation in this figure across different industries.

In the information industries (including telecommunications, publishing and data processing) over two-thirds of companies allow employees to work remotely all of some of the time. For professional and business services (including law and accounting) this share is just under 50 percent according to the U.S. Department of Labor. With this level of remote work among industries that have heavily relied on traditional offices, the demand for space is likely to remain weak for the foreseeable future as the already high office vacancy rates are likely to stay high. As leases come up for renewal, many companies will look to downsize their space. What will happen to this excess office space?

A lot of it is being reconfigured. U.S. architecture firms report that at present about half of their project work is reconstruction projects — retrofits, renovations, rehabilitations, and additions to existing facilities — rather than designing new buildings. For over a quarter of these reconstruction projects, the principal goal is adaptive reuse or building conversion, meaning finding another use for the building. There have been numerous media accounts of underutilized office buildings being converted to affordable housing, distribution facilities, or neighborhood health care centers, types of facilities that are still in high demand.

Architects also report that the principal goal of another quarter of their reconstruction projects is basic interior modernization. When demand is weak for office space for example, tenants often look to trade-up to nicer space to take advantage of the favorable rents. This leads to upgrades of basic interior components to capture more interest from these prospective tenants. So, while the overall commercial market is healthy at present, even some of the weaker sectors offer opportunities.