Stable. Resilient. And steady. That is how commercial real estate professionals describe Cleveland’s CRE market today, even when faced with the challenges of higher interest rates, the work-from-home movement and a slowdown in investment sales activity.
And that resiliency? It’s not a new feature for Cleveland. The CRE pros Midwest Real Estate News spoke with agreed that Cleveland’s commercial real estate market has long benefitted from developers who don’t overbuild and lenders who don’t make unwise loans.
Kevin Malinowski, executive managing director with the Cleveland office of Colliers, said that higher interest rates have impacted Cleveland much like they have all markets: They’ve slowed investment sales and mostly halted new development in the city and its nearby suburbs.
This is slowly changing, though, Malinowski said. Developers and investors are slowly getting used to today’s rate environment. They are gradually accepting the new normal of doing business.
“Everyone was hoping that the Fed would lower interest rates,” Malinowski said. “The thing that we are seeing in 2024 that we didn’t see last year is that in 2023 everyone felt that the Feds were going to make a change. This year has brought the new reality that interest rates will most likely stay where they are at.”
And where rates are at? Malinowski said that it isn’t necessarily a bad place. The low interest rates that the country saw during the COVID years were the exception. Today’s interest rates aren’t too far off from where they were before 2020.
“People are hopeful that the Fed will drop its interest rate. But when they do that, it creates an artificial environment,” Malinowski said. “To say that rates are high today isn’t quite right in my opinion. It’s about getting back to a more normal environment.”
Grant Fitzgerald, vice president and regional manager with the Cleveland office of Marcus & Millichap, agreed that Cleveland’s commercial real estate market has been resilient even with the challenges of high interest rates.
“As is always the case, Cleveland is a market that rarely booms and rarely busts,” Fitzgerald said. “We have faced the same economic challenges that every other market in the country has faced, though, during the last couple of years. But Cleveland is consistently doing OK. There are still sales and leases happening.”
Of course, those sales and leases are happening at a slower pace than what Cleveland saw in its recent peaks, especially when you compare today’s commercial real estate activity to the amount of sales and leases here in 2021 and 2022.
That said, Fitzgerald says that Cleveland’s CRE market remains stable.
“There is a steady amount of business being done,” he said. “And hopefully, there is a light at the end of the tunnel coming soon.”
That light? It might come in the form of the Federal Reserve Board cutting its benchmark interest rate. But Fitzgerald warns not to expect too much of a surge in sales activity from a single rate cut.
“An upcoming rate cut is somewhat priced in and expected already,” Fitzgerald said. “Certain lenders are tightening their risk spreads a bit in anticipation of a September rate cut. The first cut won’t make a gigantic difference. But it might bring a sigh of relief, maybe a boost to people’s psyches. And if further rate cuts come? That could bring the local and national market back to life a bit. People are waiting to do something. They are looking for a reason.”
The Cleveland commercial real estate market has handled the jump in interest rates well, Malinowski said. That’s largely because Cleveland isn’t a boom or bust real estate market. Developers don’t overbuild here, something that protects the market when the economy slows.
Malinowski said that he describes Cleveland as a bond market, not an equity market. Cleveland is steady. It doesn’t offer real estate investors the soaring high-water returns they might get in more volatile markets. But it doesn’t come with the risk of big drops in value, either.
“What did happen in Northeast Ohio, though, was that as cap rates were shooting down and the larger markets got so aggressive, all of a sudden Cleveland became attractive to investors,” Malinowski said. “You can chase a 6% cap rate in Northeast Ohio as opposed to a sub-5% cap rate in other markets. That has brought new investors to Cleveland.”
Real estate owners in Cleveland, though, face the same challenge as they face in other markets. Owners might have a loan with an interest rate of 4% or 4.5% that is now coming up for refinancing. Because interest rates are so high today, the market value of many of these properties isn’t supporting that refinance if the owners don’t put up cash.
Not all sectors are performing equally well, of course. Fitzgerald said that multifamily, retail and industrial are seeing the most activity today. Office, as it is across the country, is facing challenges, he said.
There is variance, too, in how different submarkets are performing in each commercial asset class. Fitzgerald pointed to the multifamily sector. Vacancy rates tend to be lower in the suburban areas than they are in Cleveland’s CBD, he said. It’s not that the multifamily sector in Cleveland’s CBD is in dire straits, Fitzgerald said. But suburban markets are simply even more attractive to renters today.
“The downtown apartment market is not in peril,” he said. “But the suburban markets are outperforming it today.”
As Fitzgerald says, there remains a shortage in the number of single-family homes for sale in the suburbs. That has persuaded many suburbanites who might have otherwise bought a home to rent for a year or two longer than they normally would have.
At the same time, housing prices remain high. Higher mortgage interest rates also make it more challenging for renters to make the move to owning, so many are continuing to rent apartment units.
“If you are looking to become a homeowner, and you are looking at the interest rates and cost of houses? That is an equation for staying a renter longer,” Fitzgerald said.
As with other markets, the office sector in Cleveland is seeing the most distress today, thanks to both high interest rates and the lingering work-from-home movement.
In good news, though, for Cleveland? Cleveland is one of the top markets for office-to-multifamily conversions. That is taking some of the older, obsolete office spaces off the market, raising the demand for the office space that remains.
CBRE reported in April that 11% of Cleveland’s office inventory is either being converted or is being planned for conversion to multifamily. CBRE also reported that 119 office conversions as of April were either underway or already completed in 2024.
Malinowski said that the office-to-apartment conversions have helped lessen the challenges faced by Cleveland’s office sector.
“If that activity had not occurred, we would not have an office market here that is as stable as it is,” he said. “I won’t tell you that it’s all roses in our office sector. It has challenges. But it could have been even worse without the conversions.”
Malinowski said that there are several factors fueling the boom in office-to-apartment conversions. First, with interest rates high, many families that might have purchased a single-family home are now renting instead. That increased demand means that Cleveland, like many markets, needs more multifamily space.
Secondly, Cleveland has invested heavily in its downtown, making it more attractive to potential residents. The office-to-apartment conversion activity here means that Cleveland’s downtown apartment supply has grown from 10,000 to 12,000 units to now more than 20,000. And city officials expect that downtown Cleveland will have somewhere around 30,000 apartment units by 2030.
“Cleveland has a well-designed downtown that is very walkable,” Malinowski said. “It is safe and has good amenities. And when you have more residential units, it helps the restaurants and shops that are nearby. Retail is all driven by demographics. It is a very mathematical model.”
The flow of new residents into downtown Cleveland is a steady one, too, Malinowski said. Young professionals move downtown when starting their careers. Many eventually migrate to the suburbs when they start a family.
But many choose to return to downtown Cleveland once they become empty nesters, Malinowski said. They no longer need a three- to five-bedroom home. Instead, they downsize and move to downtown Cleveland to enjoy the experience of walkable, urban living.
This steady stream of residents coming into the market has also helped fuel the office-to-multifamily conversion trend, Malinowski said.
The challenge with conversions, though, is that they require the perfect property in an ideal location. In most cases, it’s simply too expensive to convert an office building to an apartment development, Fitzgerald said.
“People do talk about conversions,” Fitzgerald said. “Conceptually, it is a nice idea. But it can be extremely expensive. In most cases, it is cheaper to demolish a building and rebuild it as an apartment.”
Where conversions do work well? When developers save and renovate an historic office building, one that has the character that renters will like. A good example is the Standard, a former union headquarters in Cleveland that was turned into 287 apartments that began leasing to residents in 2019.
“That conversion made sense,” Fitzgerald said. “But that was a very specific project. It wasn’t a 1980s-era square office building. The Standard had more character and flavor to it. In situations like that, conversions can work. But for most office buildings, the juice isn’t worth the squeeze.”
The industrial sector is solid in the Cleveland market, too, Malinowski said. Northeast Ohio has long benefited from the Amazon effect, he said. COVID required companies to boost their distribution networks and opening new warehouses and distribution centers in Northeast Ohio made sense.
The reshoring trend has helped Northeast Ohio’s industrial market, too. Cleveland has long been a manufacturing-based economy. Reshoring has only brought even more demand for industrial space in Northeast Ohio.
Fitzgerald said that Cleveland’s retail sector is performing well, too. Multi-tenant strip centers are especially strong, he said.
“That has become a popular product type in the last two or three years,” Fitzgerald said. “They are performing well and are favored by investors. I have no sensational stats to give you, but from an investor standpoint, those multi-tenant strip centers are a popular segment of the retail industry.”