Will rising interest rates slow commercial real estate sales, leases and developments in the Kansas City market? That’s difficult to say. But what can’t be disputed is that Kansas City and its suburbs have benefitted from a steady commercial real estate market for years, one that has survived the challenges of the COVID-19 pandemic and is poised to make it through whatever economic uncertainty hits next.
Kansas City benefits from its location in the middle of the country, something that makes it attractive to companies that need to deliver their products to as many consumers as quickly as possible. This explains why the industrial market here is thriving.
But other commercial sectors are performing well, too. Demand remains high for multifamily units in both the city and suburbs. Retailers are bouncing back from the toughest days of the pandemic and are fighting through a labor shortage as they adapt to the changing shopping habits of consumers. And while the office market remains mired in uncertainty, the brokers working in the Kansas City market say they see signs of hope in this sector, too.
We spoke with Aaron Mesmer, principal of acquisitions and investment sales with Block Real Estate Services, about the reasons behind the steady pace of Kansas City’s commercial real estate market. Here is what he had to say.
Have rising interest rates slowed deal activity at all in the Kansas City market?
Aaron Mesmer: Deal activity in the first part of the year was strong. A lot of people were still in a place where they could sell their real estate and still garner solid profits. As we get into the later part of 2022, though, there have been fewer trades in the market. The sellers are less motivated because the amount of profit they can make by selling has come down a bit.
Look at it this way: If you had a deal worth $50 million and then four months later, you are now receiving offers for $45 million, are you as motivated to sell? Or would you rather hang onto that property? There is not a lot of distress in property fundamentals today. Owners are not motivated from that standpoint to sell. If the properties are doing well, and you have in mind a valuation that you are no longer able to get today because of rising rates, you are more likely to hang onto that property instead of selling it.
Deals with permanent financing might have prepayment penalties, too. If you can sell your property for a higher number, you might be willing to pay that penalty. But if you are not getting that super premium, you might instead wait until the loan matures before selling and having to make a prepayment penalty.
Despite the uncertainty that comes with rising interest rates, are you still seeing a strong demand for multifamily properties in the Kansas City market?
Mesmer: From a user standpoint, we are seeing very strong demand in our multifamily properties. With interest rates going up, home buying has cooled off a bit. Typically, we work in the Class-A multifamily space, with people who are renters by choice. We would typically lose more residents to homeownership than for any other reason. But that has slowed down because of rising interest rates. Our occupancies in our multifamily buildings are in the upper 90% range. That is pretty strong.
How is demand for some of the other commercial property types?
Mesmer: We delivered two office buildings in 2020, brand-new multi-tenant office buildings. We saw a year without a lot of office activity in 2021. But during the past year, both of those buildings have gone from being 40% pre-leased to occupancies in the upper to mid-80% range. Even in office space, we are seeing good activity in Class-A, highly amenitized and well-located properties. I don’t know if it is the same for Class-B office space, but as people get more clarity about work plans in the post-COVID world, we are seeing office space start to fill up again.
Are you seeing a flight to quality in the office sector?
Mesmer: That is happening. We have a company that had 20,000 square feet in a building. That company reduced its footprint to about half of that, but it wanted to move to more compelling space for the workers they have who are coming back to the office. They wanted a class-A location and amenities. And that’s not uncommon. Companies are saying that they want to reduce their office footprints and put the savings into a higher-quality office space. This is a real thing. It’s not just a buzzword or talking point. We are seeing this happening in our office properties.
What kind of amenities do tenants want in their office spaces?
Mesmer: A lot of tenants want break areas with full kitchen setups. They want flexibility so that they can accommodate a hybrid-work model. They want onsite fitness centers. Our office properties are also walkable to retail and restaurants. Tenants want to be able to offer their workers easy access to dining options, dry cleaning services and other services that they’d need.
Are you seeing a return of people and companies to downtown Kansas City today?
Mesmer: We have two multifamily properties in downtown Kansas City. Both of those are now full, 98% occupied and 100% leased. People are interested in living downtown. There was a slowdown during the pandemic. Property occupancies fell into the low 90% range. We were doing more concessions than we had previously done. But now our occupancy rates for downtown multifamily are back to full.
The commercial real estate market in the Kansas City area has proven to be resilient. What is behind that?
Mesmer: Kansas City is a great place to live and work. It has a terrific quality of life. You still have access to all the big city amenities, professional sports teams, theater, great dining options. But it’s also a very livable community. You can get to downtown from the suburbs in 20 to 30 minutes. We also benefit from business-friendly practices. A lot of companies recognize that we have a well-educated workforce. We also have lower taxes than in some of the coastal markets. From a logistics standpoint, we are right in the middle of the country. We go head-to-head with Chicago in terms of rail service, too. We have great rail service and available land for industrial development. That puts us on the radar when it comes to logistics.
I feel that we are also very entrepreneurial as a city. When something happens, when Sprint, say, is acquired by T-Mobile, people spring out of that and start their own telecommunications companies. They are willing to take that risk and be in this market. That adds to the vibrancy of this market.