Des Moines isn’t unlike other major cities across the United States: Higher interest rates have slowed commercial real estate sales here. And commercial real estate professionals say that this slowdown won’t end until the Federal Reserve Board provides the country with more certainty regarding its benchmark rate.
But Des Moines does have certain advantages that are helping the city’s commercial real estate market remain resilient, even with the uncertain U.S. economy. That includes the city’s prime location in the center of the city, its strong labor force and its low cost-of-living.
We spoke with three CRE professionals from the region, Adam Kaduce, president of R&R Realty Advisors; Justin Lossner, senior managing director of the Des Moines office of JLL; and Jason Lozano, senior vice president with the same office of JLL, to learn more about how resilient commercial real estate activity has been in the Des Moines market and how higher interest rates have impacted it despite this resiliency.
Let’s start with the topic that is on everyone’s mind: interest rates. How have higher interest rates affected real estate sales in the Des Moines market?
Justin Lossner: Right now, there haven’t been many sales. Industrial continues to be the strongest asset class from a leasing standpoint. But there are not many assets coming to the market for sale. That has been the effect that we have seen from higher interest rates.
There is still a lot of dry powder out there. People are waiting for opportunities to invest in commercial real estate. Transactions will happen again. But it will take some time. When you were able to borrow money at 3.5% and 4% just 12 months ago and you are now looking at something that starts with a 7 or a high-6, you might not be too eager to finance an investment today.
Adam Kaduce: The higher interest rates have driven some of the activity out of the market. We seem to be in a price discovery mode today. Sellers still have the same price in mind they would have gotten a year ago. Buyers are coming to the table and saying that this price doesn’t work for them. That has caused the flow of deals to slow. On the institutional side, there are players who have capital that they need to deploy. In those deals, we are seeing less debt. The institutional players are putting more cash in and reducing their overall leverage on a project. Most of the sales we are seeing are on the industrial and multifamily side, not in the office sector.
Is this disconnect between sellers and buyers easing yet?
Kaduce: Things are starting to settle out. There is more predictability with the interest rate forecast then there was six or eight months ago. It seems like the Fed’s rate hikes are mostly behind us. We will probably see more 25-basis-point hikes instead of 50-basis-point hikes. We have more stability on where interest rates are at and where they will remain for the foreseeable future. Now it’s about buyers and sellers figuring out what makes sense for their projects.
Have the higher rates hit different assets in different ways?
Jason Lozano: The office investment product has been especially slow to move. There is so much uncertainty with occupancy that is playing a role with that, too. It’s not just the interest rates when it comes to office. Interest rates haven’t helped, but office is also facing other challenges that are slowing sales activity.
Companies need to settle upon their long-term occupancy strategies. How often will they require their employees to work from the office? Once more companies make these decisions, the office market will stabilize.
How close are companies to finalizing their office occupancy plans?
Lossner: Much of that is based on the size of the company. Smaller, more nimble companies are getting there faster. Many have flocked to higher quality office space in the Des Moines metro area. The larger users, those taking 70,000 to 80,000 square feet, are getting more serious about making long-term decisions. But it is taking time.
The bad news is that the downtown office market isn’t quite as robust as what we’ve seen in suburban areas. Downtown Des Moines has a heavy concentration of large publicly traded companies that have been slower to wrap their arms around their occupancy strategies. We get the feeling that flex is here to stay. But so is office space. Does that mean companies will need less square footage? Maybe. If you have 2,000 employees instead of 20, it takes longer to figure out that balance. The core of downtown, then, has seen slower office sales and leasing velocity. But we think that in the next 12 to 18 months, this will change.
Kaduce: As you drive around Des Moines, you are starting to see parking lots filling up. On Tuesdays through Thursdays, there are more people in the office, in the suburbs and downtown. The larger employers are setting on three-days-a-week back-to-the-office plans with remote days on Mondays and Fridays.
Interest rates haven’t slowed leasing in many sectors, right?
Kaduce: Leasing has been more of a bright spot in this market. There has been some good leasing activity in the first quarter. In this market, though, more of the leasing tends to be in the suburbs. More of the office leasing activity, for instance, is taking place in the west side of town in the suburbs. In downtown, there is still some uncertainty.
Wells Fargo vacated almost 1 million square feet of office property and put it on the market. Other companies are talking about downsizing. The suburbs do see some of that, but it’s not quite as bad as what is happening downtown. That’s partly because there are more small and mid-size office users in the suburbs. That kind of smaller space is easier to backfill. The bigger office spaces have been on the market for a while and will remain there until we have more certainty in the economy.
How about other sectors? Are you still seeing strong demand for industrial leases?
Lozano: Our office is tracking a strong pipeline of industrial activity in the market. We have had pretty good growth of industrial construction in our market during the last three years. There is less development coming through the pipeline now, though. We have had spec buildings constructed, so the industrial vacancy rate in the Des Moines area has ticked up a bit. But there has more to do with the delivery schedule of new space than it does to a lack of activity in the market.
Tenants are looking for larger spaces and struggling at times to find it. If you are looking for a 200,000-square-foot industrial space, you do have some opportunities in the Des Moines market. But you have just a handful of options as opposed to several.
What makes Des Moines such a strong market for industrial users?
Lozano: Our location is a big positive. Amazon has built a large facility here. That has helped to spur additional growth in our industrial market. Labor is a factor, too. Companies have access to a strong labor force in Des Moines. We are spoiled here: It takes no more than 25 minutes to get anywhere in the metro. For Amazon, that means it has a pretty wide area in which to find workers. That labor situation has helped industrial growth area.
Lossner: I grew up in Des Moines. I have watched the city evolve. What I have noticed is that the city has provided more robust entertainment offerings while offering a lower cost-of-living than a lot of cities around us. That makes Des Moines more attractive for the workforces of companies looking to move. It makes the city a better destination for companies. When I was growing up, people sought out cities like Kansas City that had more to do than what we had in Des Moines. That has changed. At the same time, we have a strong school system and a low cost-of-living. It’s one thing to have plenty of land at a low cost and a safe environment. But you also need to entertain the population. It’s been fun to watch that entertainment factor improve over the years.
Are there any other commercial sectors that are seeing strong leasing or sales activity today?
Lossner: There has been an uptick in healthcare demand. There has been a strong growth in the number of clinics that are opening across the Des Moines market. The major hospital systems are reinvesting in their footprints. That goes hand-in-hand with the demographics of our population. It’s also why we are seeing so many beautiful senior housing complexes popping up around the metro. We expect the healthcare sector to continue to grow.
Lozano: There’s been an exciting subset of the office market that had been doing well, too, the tech sector. Before the pandemic, Des Moines was starting to become an exciting tech hub. Several Texas-based companies were looking at our metro area and were adding satellite offices in Des Moines. Hopefully, that market comes back.
How about multifamily? How strong is that sector today when it comes to leasing activity?
Kaduce: The multifamily space has been especially stable in the Des Moines market. Our region has been steady in terms of population growth. But it’s not a boom or bust type of growth. It’s steady growth. That has helped the multifamily market. At the same time, we are adding new multifamily supply that is of a high quality. We also have capital sources from the east and west coasts that are chasing cap rates. You can get a higher cap rate here than you can on the east and west coasts. That has helped on the multifamily side.
We have seen a slight pause in the development of new multifamily product since the pandemic. But we are still seeing new apartment product coming online. There is good demand out there for new apartments. As mortgage interest rates have gone up, that has slowed some renters from making the move to owning. They have stayed as renters longer. People are graduating from Iowa universities and moving to Des Moines and absorbing our multifamily product. We need to add more multifamily development to keep up with this demand. You are seeing young people who have been living downtown. They might want to move to the suburbs but they aren’t ready to buy. Instead, they are renting in the suburbs. That’s largely because many of our suburbs now offer entertainment, restaurants and shopping that renters can walk to.
Back to office, how important are higher-end amenities today? Are those helping to bring workers back to the office?
Lozano: When companies are downsizing their footprints, we do often see that they are moving into spaces with better amenities. They are focusing on the amenities, looking for buildings that have fitness centers and shared conference facilities. They want a space that offers an area with a fresh-food options or a Starbucks kiosk. It has been a flight to quality. You see that, too, from landlords who are considering adding more amenities in their buildings to encourage companies to lease space.
Kaduce: There has been a flight to quality in the office sector. It really is the higher-end class-A office buildings that are getting the most attention. Companies have figured out that there is a close relationship between talent and the quality of their office spaces. Having nice office space is a way to win talent. Then there is the cost. Companies can spend the same money to get into nicer office buildings with newer amenities because they need less square footage today. We see that flight to quality happening across all parts of town.
Overall, then, how optimistic are you that any slowdown in real estate sales caused by interest rates is only temporary?
Lossner: The Des Moines metro area remains healthy. Our leasing activity is solid in all categories, especially in our suburban markets. I am optimistic that the infrastructure that city leaders have invested in the core of downtown Des Moines will help reignite a spark there as companies work through their office-occupancy strategies.
As far as the future goes, is there any new development in the Des Moines market that you are particularly excited about?
Kaduce: One of the exciting things is that there is consideration for a new professional soccer stadium in Des Moines. This would be a 6,300-seat stadium at the Dico Superfund site on the south side of downtown. The process of cleaning up that site is largely complete. The real estate arm of Krause Group is planning this stadium.
I think that professional soccer would be a new amenity that the community would embrace. It’s also a project that would bring new development to this part of downtown. We’ve already seen some housing and retail go up in that area. If and when the soccer stadium is built there, you’ll see a lot of new development targeted for that corner of our downtown. For a long time, that area has been a hole in terms of new development. A new soccer stadium and new development there would expand our downtown and bring in new amenities. A lot of people are waiting to see how that turns out.