This article is part of MACo’s Deep Dive series, where expert analysts explore and explain the top county issues of the day. A new article is added each week – read all of MACo’s Deep Dives.
For decades, commercial real estate has served as a safe investment for the public and private sectors. Policymakers and investors alike viewed commercial corridors as engines of growth. Leases were traditionally longer than residential real estate, translating into more predictable revenues and profits. For counties, this meant a steady stream of income – both from property taxes and the creation of jobs
But like many things in the modern world, COVID-19 significantly disrupted this model. Headlines (almost daily) point to weaknesses in the commercial real estate market, with working from home proving to be a lasting legacy of the pandemic. As many news outlets point to surplus office space as the harbinger of the next economic recession, it’s important to understand the current state of commercial real estate and where that market may be going next.
The Current State of Commercial Real Estate
Before the pandemic, private industry was gradually transitioning to remote work – most of this was concentrated in the tech sector. Advents in technology meant that for at least a generation, employees could theoretically work from home, but deeply ingrained office culture meant managers were wary of offering such flexibility. COVID-19 forced this dynamic to change as employers were faced with either pivoting to remote work or shuttering operations.
As communities reopened following broad vaccine availability, many areas of the economy experienced a rebound. One of the few areas still lagging has been commercial real estate. Almost overnight, many companies that had long fought against working from home embraced the idea. Workers, who, for the first time in decades, had the upper hand in the labor market, were deeply committed to holding onto this new flexibility. Environmentalists joined the chorus of supporters citing less pollution from commuting. Those companies that still opposed some form of work-from-home were at a strategic disadvantage. Today, most organizations use a hybrid model where workers spend some time in the office and some time at home.
This transition to remote or hybrid work gutted much of the demand for commercial office space. With some level of remote work as a common practice, employers largely began shrinking their office footprints. This shrinkage translated into less revenue from rent, less economic activity from workers using the goods and services in commercial corridors, less revenue from workers taking public transit, and, ultimately, greater liabilities for property owners and counties.
“A vicious circle is emerging: Lower office building use leads to less spending at surrounding businesses and, as leases turn over, less rent revenue. This leaves less money available for building improvements, which further decreases property values and resources for maintenance and upgrades. As vacancies persist, businesses that cater to office workers close or relocate, creating more vacancies and often causing public-safety problems that cities struggle to address with diminished tax revenues.”
Maryland’s counties have been feeling the impact of this shift. Downtown Baltimore has a 20% vacancy rate. Bethesda, in Montgomery County, has a 22.5% vacancy rate (and Montgomery more broadly stood at 20.5%). Neighboring Washington, D.C., is experiencing a similarly high 19.2% vacancy rate. The national average vacancy rate is 16.4%. Only a handful of urban areas, such as Columbia in Howard County (which has a 12.5% vacancy rate), are at or below the national average.
Where the Commercial Real Estate May Going Next
Two words spell out the most likely future for commercial real estate: mixed-use. The Federal Reserve Bank of Minneapolis notes that mixed-use developments “provide more than one use or purpose within a shared building or development area. Mixed-use projects may include any combination of housing, office, retail, medical, recreational, commercial or industrial components.” With current work-from-home trends, the best way to revitalize Maryland’s sluggish downtowns is to turn them into more livable communities. This ultimately means more amenities and services, access to public transportation, increased walkability, and an emphasis on safety.
Conversion and future development are the two paths to making mixed-use a reality. While not feasible on every current office building, those that can be converted to mixed-use or full residential facilities offer a starting point to getting more people engaged in historic urban cores. Areas with pre-war office buildings should have an easier time with conversion, but conversion alone will not yield the net changes necessary for a full revitalization. In all likelihood, future development – whether through new construction or demolition and reconstruction – will yield the greatest amount of change.
Counties recognize that if mixed-use is to be a success, they must act. Many jurisdictions are working to incentivize public-private partnerships, streamline permitting, rework land use regulations, and develop strategies that plan for more mixed-use communities. But counties cannot undertake this transformation alone…private and state stakeholders must also do their part. Private actors must plan and be prepared to develop mixed-use where appropriate, and the State must continue providing incentives, such as tax credits, to keep projects affordable.
As a result of the pandemic, the commercial real estate market is fundamentally changing. Once thriving commercial corridors are now experiencing record-high vacancies and a lack of purpose. When used where appropriate and/or feasible, a shift to mixed-use development offers a way for public and private leaders to revitalize struggling urban cores. While counties do play an outsized role in this transformation to mixed-use, they cannot do it alone. Counties stand ready to work with private and state stakeholders to ensure our commercial corridors remain destinations to work, live, and play.