A struggling office market, continuing housing affordability and access challenges, and financing opportunities were explored by panelists in banking, law, accounting, and real estate during IB’s June 13 Real Estate and Construction Symposium.
The symposium, which has become an annual event, was held at the Marriott Madison West and keynoted by Chris Caulum, vice president–commercial brokerage for Oakbrook Corp. In his keynote address, Caulum noted the Madison real estate market has largely recovered from the COVID-19 pandemic shutdown, but the office market continues to struggle, especially Class B and C buildings that lack the amenities of more coveted high-end, Class A office space.
Not only is there little new office construction, but some notable employers — Spectrum Brands, TDS, and Exact Sciences Corp. — are subleasing large segments of existing space in their facilities. Meanwhile, office property managers continue to upgrade Class B and Class C space to Class A — the so-called “flight-to-quality” trend that followed the pandemic — in order to attract tenants.
While Madison’s office situation isn’t as dire as other metropolitan markets, the office vacancy rate of 13% is still more than three points higher than it was during the last pre-COVID year of 2019. In addition, absorption — defined as the rate at which commercial space is leased or sold over a given period of time — has not returned to its stronger pre-pandemic levels, and some argue that tenants are in a stronger position to renegotiate leases.
“COVID did what two recessions could do,” Caulum stated.
One factor contributing to the office malaise is the desire of the workforce to maintain at least a hybrid schedule of working from home and the office. There are some employers who are in a position to require a full return to the office — Epic Systems, which is once again adding to its Verona campus, has a “work-from-work” policy, Caulum noted — but most employers would be wise to maintain flexibility, especially those whose work is easier to do remotely. “If you can objectively measure their job performance,” Caulum advised, “then it’s easier to let them work from home.”
Other panelists, notably Chris Richards, managing director for Colliers, worry that the next economic recession, even with Madison’s traditional insulating effects, could return the local office market to much higher, Great Recession-level vacancy rates. At that lowest point of that recession in 2008–09, Madison’s overall office vacancy rate approached 18%. However, the 2024 economy, has managed to stay afloat.
The bright sides
The news is much brighter in the industrial, multifamily, and retail markets. Industrial inventory has grown nearly 10% in the past five years, with vacancy now just above 2%. The most notable industrial project is a planned Amazon warehouse north of I–94 in Cottage Grove, which will consist of five stories of 360,000 square feet of space on each floor. According to Caulum, Cottage Grove village officials still hope the project will be completed in the next 10–15 months, but there is some question about whether Amazon will find enough Madison-area workers to fully staff the facility, and therefore some automation is expected.
The demand for multifamily construction is largely driven by Greater Madison’s population growth, which shows no signs of abating. The new Dane County Regional Housing Strategy, a five-year action plan involving 17 municipalities, says the county needs to produce roughly 7,000 housing units per year to meet existing needs and keep up with projected growth. That’s about 2,000 more units than what is currently produced on an annual basis.
The plan addresses the regional housing crisis with priorities that include reducing racial disparities in housing and homeownership. In all, the plan prescribes that Dane County produce 139,000 new housing units from 2020–2040 to keep up with demand. Also according to the plan, the county needs 13,000 more new rental units that are affordable to households making under 30% of the county’s median income, as well as housing units that meet a range of resident needs — some for rental and for sale, some single-family homes, and some larger apartment buildings.
The action plan is aimed at supporting families locked out of homeownership, including the following groups: lower- and middle-wage workers with increased transportation costs and job turnover due to commutes from affordable housing outside the county; older adults in need of alternative housing options; lower-income households unable to balance the costs of rent, medical care, food, and other necessities; and young adults on the verge of homelessness.
However, developing affordable housing units continues to be a challenge because the existing economic conditions — including rising construction expenses and lands costs — point toward more upscale multifamily projects as the most financially prudent, according to panelist Gretchen Richards, first vice president of investment properties–multifamily for the Madison office of CBRE. Higher-end apartments with finer finishes are getting built, but not as many of the middle-market, mid-sized projects are being pursued. “A lot of people are pencils down at the moment,” stated Richards.
James West, vice president of the Madison office of CBRE, cited studies that show Madison is not keeping pace with its housing needs, and he cited a telling statistic about younger homeowners and the daunting affordability picture they face. “First-time homebuyers are looking at a $4,000 monthly mortgage cost,” West noted. “If that continues to get worse, I don’t see how we’ll be able to keep pace.”
Chris Ehlers, president of Veridian Homes, the area’s most active home builder, noted that the median home sale price has gone up $100,000 since 2021, and higher interest rates for home financing is one of the incentives that is causing older homeowners to stay in their homes and age in place. About 70% of Dane County homeowners have a moderate mortgage rate of 3.5% or less “locked in,” he notes, and that means fewer homes are on the market.
Financial factors
A second panel focused additional attention on commercial construction financing challenges, including the fact that more banks are keeping their powder dry for existing clients, according to Brian Hagen, senior VP-director, commercial real estate banking, with First Business Bank. Good deals are still getting done, Hagen added, but one effect of the 2023 Silicon Valley Bank collapse is that while it did not cause a systemic failure, bank liquidity is declining.
The limitations of tax increment financing (TIF), with its “but-for” funding test, also was a topic of discussion. Thanks to more than $6 million in TIF money, city of Madison officials recently confirmed that they’re on track to build 553 more affordable apartments on the old Hartmeyer site on Madison’s North Side, but this form of financing has limited applications. The but-for test stipulates that the development would not happen without some assistance — endorsing the use of tax dollars but only in certain circumstances.
Another topic was existing state levy limits on county and municipal governments. Municipal property tax levy limits, imposed by the Wisconsin Legislature, have been the target of criticism from municipal leaders such as Madison Mayor Satya Rhodes-Conway and the League of Wisconsin Municipalities, which advocates on behalf of cities, towns, and villages.
They argue that levy limits restrict a community’s ability to make local decisions, and Rhodes-Conway has called for the state Legislature to help municipalities by reversing cuts in state aid to cities, easing property tax levy limits, and allowing municipalities to create new revenue streams such as a local sales tax — if approved by local voters in a referendum.
Asked whether eliminating or relaxing the limits, which would require state legislative action, would enable municipalities to put more skin in the commercial real estate development game, attorney Kevin Ramakrishna of the Reinhart Boerner Van Duren law firm indicated the issue is more fundamental than incentivizing commercial construction. Ramakrishna says the limits don’t allow the city to keep up with population growth, which puts more pressure on the property tax to maintain the city’s basic service levels. “It really becomes kind of a human issue,” he stated.
Energized financing
Laura Cataldo, a director with Baker Tilly’s development advisory practice, touted the tax credit provisions of the Inflation Reduction Act (IRA), which is one of the newer financing opportunities for energy upgrades, especially a direct-pay provision that developers and government can take advantage of.
While recipients of the credits must be in compliance with prevailing wage and other legal requirements, the $270 billion allocated for the credits, which can be paired with other energy incentives, do not have to be used for solar farms and other large-scale projects. They also can be used for EV charging stations and other small-scale energy improvements. “It’s a very powerful tool that can be stacked on top of state programs,” Cataldo noted. “It has created a strong demand for energy projects and developments.”
