Reichle Klein Group's 2024 Mid-Year Office Overview

CONTACT:
Joe Mehling – Director of Marketing
419.794.1137
jmehling@rkgcommercial.com

The Reichle Klein Group mid-year 2024 survey of the Toledo, Ohio office market found a meaningful, technical improvement in core market metrics. However, the underlying facts merit an asterisk. The number that really jumps out is 175,034 square feet of positive net absorption in the first half of the year, 147,885 of which occurred in the Central Business District. Secondarily, overall market vacancy dropped from its recent high of 20.4% at year end 2023 to 19.1% at mid-year representing a 5.3% decrease in vacancy in six months. Considering all the bad news around the office market the last several years, this seems like great news. But here is where the asterisk and footnotes come in.

The big downtown absorption is due to Lucas County moving Children’s Services agency from 705 Adams Street – a County owned building – to Summit Center. Summit Center is a privately controlled and previously vacant Class A building that competes with other privately owned buildings and is tracked in our survey as part of the competitive inventory. Further, Children’s Services was relocated from 705 Adams because of the physical and functional obsolescence of the building and the costs of renovation. While the County intends to sell the building, it will most likely be redeveloped for a use other than office space. Even if it is redeveloped as office space for private sector use, the building would not be included in our survey of competitive space until the redevelopment is complete. In reality, the deal is nothing more than a tenant moving from one building to another which in other circumstances would result in zero net absorption. But, because of all the technical factors outlined above the transaction had an outsized statistical impact.

The reduction in vacancy among downtown, Class A buildings that results from the Children’s Services deal is real and needed. It led to the sizable decline in the overall market vacancy rate which was further aided by leasing activity in the suburban submarkets, all of which recorded at least minor improvements.

Deal activity is up from the last couple of years. There are several factors at work. First, tenants are using the opportunity created by approaching lease rollovers to shop the market seeking upgraded space or better terms. We are also seeing at least a small uptick in companies instituting back-to-office strategies. Some we have been engaged with are companies that had offices in the Toledo market pre-COVID that were shut down and given up during the pandemic. An encouraging signal to be sure.

There remain very strong headwinds to successful transactions. The cost of tenant improvements and the availability of funds to pay for them is the single greatest hurdle. Higher interest rates and lenders leery of the risks in the office market make financing tenant improvements nearly impossible. Not every building owner is in a position to or wants to use precious cash on tenant improvements. It is creating real dilemmas with hard choices for landlords.

As a result, those buildings or spaces that are leasable with little or no changes have the advantage. Central Business District towers are generating leasing activity by getting very aggressive on their rents for recently vacated spaces that can be re-used in as-is condition. The deals that the owners of these buildings are offering are successfully generating serious consideration from tenants who would otherwise only consider suburban locations where there is a relative shortage of similarly advantaged spaces.

Landlords are truly in a very difficult place. The market continues to be over supplied relative to demand and tenants have lots of leverage. Yet, landlords are pressured to raise rents to cover rapidly increasing operating costs, particularly for insurance, utilities, janitorial services, and real estate taxes. Further, some are facing interest rate increases through looming rate adjustments or loan expirations.

Owners of buildings in Maumee, one of the largest suburban office submarkets, are facing additional challenges resulting from recent City ordinances and administrative enforcement of zoning and building codes. These initiatives by the city of Maumee are adding to operating costs as well as requiring burdensome capital expenditures. Meanwhile, owners in Maumee are in fierce competition for scarce tenants who can choose to locate wherever they like.