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Office Sector

Leasing and demand trends in Cleveland’s office market suggest that long-term utilization patterns are still normalizing heading into the second half of 2023. While annual leasing volume is elevated relative to the last two years, it is still about 20% below the average annual total in the three years leading up to the pandemic. Positive leasing volume has not translated into positive net absorption, however, and around 1 million SF of space was vacated over the last 12 months.

Many of the largest lease deals in recent months are firms relocating their space rather than new business moving into the market, which is weighing on overall demand. One of the most recent examples of tenants adjusting their space needs comes from marketing firm BrandMuscle, which leased just under 13,000 SF at the Post Office Plaza building in the CBD Submarket. The move marks a 77% reduction in footprint from its current location at Oswald Centre.

Weakness in the market is visible in both urban and suburban areas. Leasing as a share of inventory sits above the market average of 1.4% in the CBD, as well as suburban office clusters such as Chagrin Corridor, Lyndhurst/Landerhaven, and the Southeast Submarket which includes areas such as Solon and Warrensville Heights. But despite above-average leasing volume, net absorption in these submarkets is among the weakest in the market overall.

Unlike the national office market, sublease space in Cleveland represents a small share of total available space. Late last year, American Greetings put 250,000 SF of space at its headquarters in Westlake back on the market. This pushed total sublet space in Cleveland to its highest point since 2011 at nearly 800,000 SF. While this represents a 30% increase year over year, it accounts for just 7% of available space in Cleveland relative to the national benchmark of 15%. In addition to modest sublease availability, limited speculative development activity could also help curb the rise in vacancy over the near term. Overall construction is near record level with 1.4 million SF of space is underway, representing 1.3% of inventory, which is slightly below the national benchmark. But just 5% of space underway in Cleveland is being built on a speculative basis. The largest project under construction is a 1 million-SF headquarters for Sherwin-Williams in the CBD Submarket, which is slated to deliver in 2024.

Conversion activity has also helped to keep the office vacancy rate in Cleveland well below the national benchmark. Cleveland has been converting buildings, especially downtown, at a rapid pace over the past decade, and more than two-thirds of residential units delivered in the CBD since 2010 are the result of conversions. The latest office property to come off the market is 700 Prospect Avenue, a 121,000-SF property originally built in 1899. Local firm K&D Real Estate purchased the property last year after longtime tenant, The United Church of Christ, relocated to the AECOM Building. Conversion plans include 130 residential units and ground floor retail space.

In line with the national office market, investment activity fell significantly in the first half of 2023 and around $30 million traded hands, just 13% of the average mid-year total in the three years prior to the pandemic. Medical office properties represent about a quarter of mid-year sales volume, well ahead of the average of 13% over the same period in the last three years. Softening market fundamentals and elevated interest rates will likely keep office sales muted through the remainder of the year.

Industrial Sector

Similar to trends in the national market, deliveries in Cleveland is sending industrial vacancy higher heading into mid-2023. The rise in vacancy will likely be minimal, however, as supply underway in Cleveland is limited compared to the national market. Although deliveries in Cleveland are slated to total a record-breaking 3.3 million SF in 2023, this represents just under 1% of total market inventory while deliveries at the national level represent 3.1%.

The redevelopment of the former Ford Cleveland Engine Plant is driving construction activity in Cleveland. The site is being re-branded as the Forward Innovation Center and will add nearly 3 million SF of industrial space to the market and will be one of the largest developments in Cleveland when it delivers later this year. This influx of supply could push vacancy up 80 basis points by the end of the year, but overall vacancy in the Cleveland market remains tight and hovers in the 4% range.

Limited availability of modern industrial space is keeping demand modest in Cleveland when compared with the national market. Net absorption over the past 12 months in Cleveland totals 2.3 million SF, which is in line with the annual average in the three years leading up to the pandemic. At the national level, annual demand sits nearly 60% above the pre-pandemic average. Cleveland’s industrial market expanded less than 2% over the past decade and availability among properties delivered since 2013 is just 4%.

Leasing volume contracted for the third consecutive quarter in 23Q1, and on an annual basis, space leased totals just over 5 million SF, which is the lowest level since 2020. Despite this slowdown, leasing volume is healthy relative to recent years and sits 16% above the pre-pandemic average. One of the largest leases signed in recent months comes from Victory Packaging, which signed for 221,000 SF at the Forward Innovation Center. The company plans to occupy the space upon delivery in 23Q3.

In line with the national trend, industrial rent growth in Cleveland is slowing from its peak in mid-2022. Year-over-year gains average 6.2% as of the third quarter of 2023 and slightly outperforms the national market. Gains are modest relative to regional markets, particularly those with a heavy concentration of logistics demand such as Columbus, Louisville, and Indianapolis, where rent growth is in double-digit territory. As market fundamentals soften in the quarters ahead, rent growth continues to moderate and could fall back in lien with the national rate by late 2023.

Investment activity fell notably in the first quarter of 2023 and totaled just under $50 million, which is the lowest quarterly volume since the onset of the pandemic. The rising cost of debt and a widening bid-ask spread will likely keep sales volume muted in the months ahead.

Despite slowing leasing activity, tight vacancy and limited supply risk should keep Cleveland’s industrial market balanced over the near term.

Retail Sector

Cleveland’s retail market continues to tighten heading into the second half of 2023. Retail availability fell 50 basis points year over year to the lowest level on record at just 4.5%, 250 basis points below the historical average.

Limited availability is a key factor in below average leasing trends, as tenants looking for space are unable to find quality storefronts in prime locations. Annual leasing volume totals around 1.5 million SF, 23% below the annual average in the three years leading up to the pandemic. In line with recent trends, discount, grocers, and home improvement retailers are behind some of the largest leased signed in Cleveland in recent months.

With softening leasing activity, demand in Cleveland slowed in the first half of 2023 with less than 10,000 SF of positive net absorption, just 3% of the total over the same period last year, and well below the pre-pandemic average. Despite a below average pace of store closures, limited availability is constraining new openings from offsetting recent closures and is weighing on overall demand in the market.

Another factor keeping Cleveland’s retail market balanced are limited deliveries. Less than 800,000 SF of space delivered since 2022, and speculative development represented about a quarter of recent deliveries. Of the space added to the market in the last 18 months, just 6.5% remains available. Higher construction financing rates are weighing on development activity. Space underway fell for the fifth consecutive quarter and represents just 0.1% of inventory compared to the national benchmark of 0.5%. And with construction starts at the lowest level in CoStar’s data history, supply will remain limited over the near term.

While national rent growth is beginning to decelerate, gains in Cleveland hover near record level. Rents rose at the fastest clip in Cleveland over the past two years, and annual gains sit around 6.5%, far above the 10-year average of just 2.3%. Rent growth is highest among smaller box sizes where availability is at a historic low of 3%. In spaces smaller than 10,000 SF, annual rent growth sits in the 8% range.

Although down from the prior year, sales volume held up in 2022 and quarterly volume maintained a steady pace throughout the year. Activity is beginning to show signs of slowing and volume in the first half of the year totals around $102 million, less than half of the mid-year total in 2022, and 45% below the mid-year average in the three years prior to the pandemic. Net lease deals account for a quarter of sales volume over the past 12 months, and higher cap rates relative to the national average are a likely draw for yield-motivated investors.

Despite a potential pullback in demand in the months ahead, tight market conditions and healthy retail sales should keep the Cleveland market balanced over the near term.