With the news that China has lifted travel bans, travelers from across the globe are gearing up to visit the country and provide a welcome cash injection for the Chinese tourism industry. At the same time, the greater Asia-Pacific (APAC) area is getting ready to receive an influx of Chinese nationals as they flock to neighboring countries for business and leisure.
While that’s good news on a number of economic levels, it’s also a tailwind for the APAC commercial real estate (CRE) industry. And, according to recent reports across the region, the two sectors that are anticipating the biggest benefits are multifamily and hospitality.
Apartment sales are on the up
Multifamily sales in Singapore, for example, are expected to improve, with some analysts anticipating a “more than 10% increase in the number of homes purchased by Chinese this year” in the city-state.
A recent article in the Australian Financial Review (AFR) adds that another possible effect of China’s reopening is an uptick in Australian apartment sales. AFR says: “At a time of little new apartment supply, Australia’s residential developers will benefit from returning demand from returning foreign migrants.”
AFR notes that luxury apartments in particular are likely to see elevated sales but states that overall Australia is “lower down the list of countries to directly benefit from China’s reopening.”
Tourism and hospitality boost
Countries like South Korea and Japan are expecting a bigger boost, especially from the tourism and hospitality sectors. Likewise in Thailand, hospitality is gearing up for a major influx of Chinese tourists, with Thai Deputy Prime Minister, Anutin Charnvirakul, stating:
“The arrival of tourists from China, as well as from countries around the world to Thailand is expected to increase continually. This is a good sign for Thailand’s tourism sector,” adding “…it will accelerate the economic recovery after our suffering from the Covid-19 pandemic for three years.”
Worth noting, however, is that some APAC countries have introduced restrictive new travel policies regarding Chinese nationals, including Covid testing requirements, which could act as a headwind to recovery.
Economic ‘silver lining’
At the start of a year where murmurings of recession have kept economic prospects largely subdued, China’s reopening is a strong positive signal for the global economy.
“China’s sudden reopening is set to offer a boost to a flagging world economy. The growth impulse will be felt through services sectors such as aviation, tourism, and education as Chinese people pack their bags for international travel for the first time since the pandemic.”
FinCEN Alert Could Mean Greater Scrutiny for CRE Markets
A new alert issued by the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) is warning banks and other financiers to be on the lookout for potentially suspicious investments into US commercial real estate (CRE). FinCEN says some of these investments may be an attempt by Russian oligarchs to use CRE to move or hide funds and avoid international sanctions.
What this means for CRE firms is that there may be greater regulatory pressure, and greater scrutiny, in the cards.
Shoring up ‘vulnerabilities’
FinCEN points out that there are “several vulnerabilities in the CRE market” that could be exploited to avoid sanctions, including the fact that CRE markets and transactions: “involve highly complex financing methods and opaque ownership structures that can make it relatively easy for bad actors to hide illicit funds in CRE investments.”
Part of the challenge lies in the fact that CRE transactions often involve trusts, private companies, and other legal entities as buyers and sellers, making it tricky to pin down ownership.
Risks and regulations
While it’s not yet clear what specific requirements may be incoming, in a recent CoStar article on the matter, bank regulatory attorney, Dan Stipano noted that: “FinCEN has started a rulemaking process that would impose requirements to prevent money laundering on the commercial real estate industry.”
He added that the process is still in the early stages, however, and that we don’t know which aspects of the industry new regulations will target.
The move to take a closer look at US CRE investments is part of a bigger trend of scrutinizing property markets across the globe. Back in December 2022, a FinCEN Financial Trend Analysis noted that CRE markets in Turkey and the United Arab Emirates had “become a safe haven” for this kind of illicit activity, and the UK National Crime Agency issued a broader “Red Alert” on sanction evasions in July.
Taken together, these moves add up to a global environment where CRE investments (and investors) may have a tougher time finding financing and completing the required diligence processes needed by increasingly cautious lenders.
That said, the good news is that the Commercial Real Estate Finance Council (CREFC) is also keeping a close eye on the situation and have noted that they are: “working with policymakers to educate them on the CRE finance markets, including how the industry works to prevent, detect, and report illicit activity.”
Last month, we had the first part of our “double period” and discussed various types of loan structures that can be utilized by a real estate investor. This month, we are going to roll into the second part of this discussion and highlight various key terms associated with loans.
There are two specific documents. The first is the mortgage, which pledges the real estate as collateral for the loan. Equally important is the promissory note (usually called the note), which is the document that contains the terms and conditions between the borrower and the lender. It memorializes the deal that both sides need to live with, so it’s important to understand some key components.
This is the amount of money the lender has provided. If funds are going to be held back from the full amount, the note will specify when and how the borrower will receive these additional funds.
Method of repayment
As discussed last month, there are all types of loans, including fully amortizing, partially amortizing, interest-only, participating, etc. This section of the note will detail exactly how, when and under what conditions the loan will be repaid.
The contract interest rate will be clearly stated in the note, along with a description of any future adjustments to this rate. For example, if the loan is tied to an index, this section will clearly state the index, the specific timing associated with future adjustments and any margin or spread that will be applied over the specified index.
The note will include the initial date of the loan and the maturity date, or when the outstanding loan balance must be repaid to the lender. Some loans have a term that matches the amortization period. For example, loans originated by a pension fund will often have a 15-year term that matches up with a 15-year amortization period. However, most loans will have a term that is shorter than the amortization period. It may be amortized over 20 years but have a term, when the loan balance must be repaid, of five years.
This clause is always included in a note, as it gives the lender a strong position to force repayment. Under an acceleration clause, the lender has the right to declare the entire loan balance due in the event of default, which can be defined to include missing one or more mortgage payments, failing to keep the property maintained to building codes, failing to pay insurance premiums or property taxes, having a key loan metric such as debt service coverage ratio fall below a specified threshold, etc.
Because lenders have a direct interest in a property’s ability to generate income, they may use various mortgage covenants to specifically outline various controls. For example, a lender may have to approve leases that exceed a certain size threshold or consent to various repairs that exceed a certain dollar amount.
Most loans will have a grace period that allows the borrower the opportunity to cure some of these defaults.
A lender may want to protect the yield received on a specific loan by specifying a time period which the loan cannot be prepaid, often called a lockout period. Or the loan may be allowed to be repaid with an associated pre-payment penalty. Certain loan products, most notably CMBS loans, will include a variation such as defeasance and yield maintenance, which allows the borrower to repay the loan according to a fairly sophisticated formula that again results in the yield being protected.
Due on sale
This clause will require full repayment of the loan upon the sale of the underlying real estate collateral.
A lender may establish various accounts that are used to withhold funds that are earmarked for specific events. The most common examples are escrow accounts for real estate taxes and property insurance premiums, as the lender will want to ensure that sufficient funds are available to pay these obligations when they become due. Reserve accounts go one step further and will withhold funds associated with a significant future expenditure. For example, if the roof on a large warehouse is anticipated to need replacement in a few years, the lender may require that the owner establish a reserve specifically to hold funds associated with this future replacement.
Property management & operation
Because lenders have a direct interest in a property’s ability to generate income, they may use various mortgage covenants to specifically outline various controls. For example, a lender may have to approve leases that exceed a certain size threshold or consent to various repairs that exceed a certain dollar amount.
Lenders may require additional security for the loan, beyond the value of the property, and a personal guarantee from the borrower is a common way to accomplish this. In the event a loan is personally guaranteed, the lender can require the borrower to pay any shortfall in the event of default or foreclosure. As a result, the security of the loan is beyond just the immediate real estate collateral and is extended to include other assets controlled by the borrower. A related concept is joint and several liability. If two or more borrowers are a party to a recourse loan, a joint and sev- eral loan guarantees the lender a right to recover the full amount of the deficiency from any of the borrowers, regardless of their ownership interest in the property.
Although not all loans contain guarantees/recourse, even non-resource loans will have some personal liability. These are commonly called carveouts and include full personal liability in certain events or circumstances. These circumstances include acts of fraud, misrepresentation, omission of facts or causing environmental damage to the property. Now that we have discussed the various forms a loan can take as well as the common terms and conditions they will contain, it’s time to get to some numbers. But that will have to wait until next month, when we head to the eighth and final period of the school day.
In our first installment of “By the Numbers”, we looked at a common metric for return on investment: a property’s capitalization rate or “cap rate.” As we saw there, many factors can influence a property’s cap rate and determining what makes for a “good” rate is often a lot more complicated than just looking for the higher number.
In addition to cap rates, however, there are several other metrics investors and commercial real estate (CRE) professionals can use to determine returns. Another common return metric that can tell you a lot about a property’s investment potential is the Internal Rate of Return or IRR.
Investopedia defines IRR as: A financial metric, used to measure the profitability of an investment, that takes into account the time value of money.
In other words, the IRR metric accounts for the fact that money received earlier is more valuable (given inflation and the potential to generate interest). This also means that, to calculate IRR, you need to have some idea of the cash flows a property will produce each year over the period of investment.
For example, an IRR calculation would include what you initially paid for the property, the amount you expect it to generate in rent each year (which would vary), and the amount you expect to be able to sell the property for later.
The actual equation to calculate IRR is fairly complicated (the Corporate Finance Institute gives an excellent breakdown here) and you’d typically use software or an online calculator to determine it. For the purposes of understanding the importance of this metric to CRE investing, however, it’s more useful to break things down in terms of what IRR tells us about an investment.
Because IRR considers cash flows on a yearly basis over multiple years, it allows investors to see when they could expect a full return on investment, and how much profit they would make each year thereafter.
Comparing the IRR of two properties can therefore give investors a more nuanced understanding of how each will perform over time, and which is likely to be the better investment. All else being equal, a property investment that generates the same earnings sooner will have a higher IRR.
A “good” IRR?
Importantly, like cap rate, IRR is another metric where simply having a “higher value” doesn’t tell you whether a specific property is a better investment. For example, two properties might have the exact same IRR, but one generates a lot more profit over time than the other. The catch is that those profits are paid out later.
As the above scenarios show, with the same initial investment, but different cashflow horizons, the IRR is the same. The difference between the scenarios lies entirely in when returns are provided, and how much those returns are.
The value of the investment therefore really depends on what the investor’s expectations are. Would they rather wait longer for a bigger payoff, or could short-term gains be put to use in a way that generates more money elsewhere?
As with all things CRE, the exact value that constitutes a good IRR also depends on the sector, and the risk, involved in the investment.
IRR and other metrics
Like many return metrics, IRR can help investors understand specific information about a potential deal. IRR is useful in that it takes into account cash flows generated over multiple years and gives a view of returns on an annualized basis. Worth keeping in mind, however, is that IRR relies on forecasting cash flows (and a potential exit sale price), and many risk factors can affect those valuations in the long run.
By comparison, cap rates provide a “snapshot” of the income a property generates in a year in relation to its current value. It’s a less nuanced metric, but one that can also tell investors something about immediate risk versus reward.
In addition to these two, there are several other metrics the savvy investor should consider. We’ll be examining those in detail in future installments, so be sure to check back for more insight into CRE “By the Numbers.”
With lunchbreak now behind us, the school day moves on as we head to fifth period. We lingered a little too long at the lunchroom table and our next class is a double period so there is no time to waste!
It’s very popular for a real estate investment to include capital from sources in addition to the investor’s equity. The most common form is a mortgage, sometimes called a permanent loan, and many think that a loan is a loan is a loan. But that is not always the case. While a traditional mortgage is a very common tool used by investors, it’s not the only way to use other people’s money (OPM). To learn more about some alternatives, read on.
A construction loan is specifically used to finance a construction project. These are typically negotiated between a developer and a lender, with the loan being used to fund construction costs. But it is very different in its structure and characteristics. Construction loans have relatively short terms, usually one to three years, while permanent loans are much longer. A construction loan is disbursed from the lender to the borrower/developer gradually as the project progresses. These usually take the form of “draws,” with the borrower making a request to fund a specific amount. During the time, the only repayment obligation is the interest associated with the outstanding loan balance for a given time period and the interest is based on a short-term variable or floating rate. Once the project is completed, the entire outstanding balance is due in full. This is usually accomplished by using a permanent mortgage.
A loan is sometimes used to cover the time period between the construction loan ending and the permanent loan commencing. A common scenario is the development of a speculative project, where the building is completed without sufficient tenant commitments in place that would be necessary to qualify for a permanent loan. The construction lender will want to have their loan retired when the project is physically completed but the permanent lender may not be willing to disburse funds until the building is substantially occupied. A short-term loan, sometimes called a “mini-perm,” is a common way to fill this gap.
Mortgages are ranked in terms of priority and any type of mortgage that is subordinated to the first mortgage is called a second mortgage. Second mortgages carry greater risk than first mortgages because of the potential to be eliminated should there be a foreclosure of the first mortgage. This is particularly true if the value of the property has decreased since the loan(s) were originated. Therefore, second mort- gages usually carry a higher interest rate and have a shorter outstanding term. The second mortgage holder typically gives notice of this encumbrance to the first mortgage holder and the first mortgage holder usually must consent to allow the creation of a second.
It’s very popular for a real estate investment to include capital from sources in addition to the investor’s equity. The most common form is a mortgage, sometimes called a permanent loan, and many think that a loan is a loan is a loan. But that is not always the case.
An alternative to using a second mortgage to obtain additional financing is to use a mezzanine or “mezz” loan. It is different than a second mortgage because it is secured by the investor’s equity in the property instead of being collateralized against the real estate. As a result, if there is a default on repayment of the mezz loan, the lender would engage in legal proceedings that would give them an equity interest in the property. The mezz lender usually will enter into an agreement with the first mortgage holder to have a right to take over the mortgage should there be a default by the borrower. Mezz debt typically has an associated interest rate that is several percentage points higher as compared to the first mortgage and the repayment of the mezz loan ranks ahead of any cash distributions made to the equity investor but obviously behind any loans that have priority.
This type of loan is similar to a mezz loan in that it is provided to the borrower and collateralized against the borrower’s equity interest. But in this instance, the loan holder has the right to convert the debt into a share of the equity rather than have the obligation repaid or retired. The timing, terms and result of a conversation will vary and be clearly spelled out in the loan document.
This is a mortgage secured against the real estate that typically has an associated interest rate lower than that of a traditional loan. In exchange for achieving a favorable rate, the borrower agrees to allow the lender to share in the upside of the investment. This sharing can come from various sources. The lender could receive a percentage of gross income, net operating income or cash flow after debt service and/or can share in the gain achieved because of the property being sold or refinanced. The agreement related to a participation loan is highly negotiable and there is no standard structure.
While not a loan in a traditional sense, a joint venture has several characteristics of an encumbrance in exchange for a stake in the real estate. In a joint venture, or JV, two or more parties share in the ownership of a real estate venture. This can be an effective way to pool equity from more than one source, as well as include parties with different expertise, capacity or access to capital. As with a participating loan, there are all sorts of arrangements and structures for a JV.As you can see, a loan is not always a loan, at least not in the way we traditionally think. Next month, we will roll into the second part of this class as we will dig a little deeper into some ways to analyze a few of these alternative approaches, as using OPM sometimes is a result of thinking outside of the box.
Alec Pacella, CCIM, president at NAIPleasant Valley, can be reached by phone at 216-455-925 or by email at email@example.com.
GlobeSt was reporting on data from the Dodge Construction Outlook Conference which took place in November 2022. The Dodge Construction Network provides data analytics and insights to construction executives and industry leaders across the US, and the annual conference is cited as: “the leading economic forecast event for commercial construction.”
Multifamily set to slow
As is often the case, the expected decline will affect specific real estate sectors in different ways. GlobeSt notes, for example, that the value of multifamily construction may see a large decline (around 7% when adjusted for inflation).
In their own report on the data, industry news site Engineering News Record (ENR) adds: “In the multi-family sector, starts are expected to finish the year  up 16%, but will drop 9% next year.”
Mixed bag for Retail, Office and Industrial
ENR also notes that the increases in retail and manufacturing starts seen in 2022 are likely to taper off, though it’s worth pointing out that the manufacturing industry saw gains of 196% over the year.
Quoted in the article, Dodge Chief Economist, Richard Branch, noted that despite an anticipated 43% drop for manufacturing construction, “that is still historically a very strong record level of activity.”
Meanwhile the dollar value of office construction is in for a “slight decline” of 1% in 2023, as remote work trends and the tight labor market continue to put pressure on the sector.
Niche sectors still offer respite
Despite these generally downhill trends, other predictions made during the conference include ongoing strong performance from some of the niche CRE sectors we’ve seen rise to prominence in recent years. As Archinect reports:
“While traditional school construction is set to fall, life science buildings and healthcare projects, including outpatient clinics and hospitals, continue to rise.”
During my school days, lunchtime was always an interesting experience. In addition to providing a nice break and opportunity to socialize, there was the actual main event – food. And with this came great variety, sometimes in a good way and other times in a bad way. I have similar thoughts when looking back at the commercial real estate investment market in 2022.
To see how our real estate market relates to school lunches, read on.
Nothing made me happier heading down the lunch line than seeing a huge sheet of pizza, cut into squares, of course. And nothing made investors happier last year than seeing a new, net leased industrial warehouse offering. This sector continued to be red hot, both on the leasing and the sale side. Occupancy was at an all-time high and increasing rental rates coupled with falling cap rates led to record activity and pricing. Facilities leased to Amazon led the pack and routinely traded at cap rates in the upper 4% range with pricing eclipsing the $300 per square foot (psf) mark. But even more routine deals were greeted with cap rates around 6% and pricing of $75 to $85 per square foot. These include the JB Hudco facility in Bedford ($83 psf at a 6.25% cap rate), the ID Images facility in Brunswick ($77 per square foot at a 5.8% cap rate) and the True Value facility in Westlake ($75 per square foot at a 6.75% cap rate).
CHICKEN NUGGETS WITH CRINKLE FRIES
Nuggets and fries along with some packets of BBQ sauce was a close second in my book, similar to investor interest in apartment properties being right on the heels of industrial warehouses. And while glitzy complexes such as the 401 Lofts in Akron made headlines with equally glitzy per unit pricing that exceeded the six-figure mark, it was the solid activity amongst the Class B product that carried this sector last year. Examples include Clifton Plaza Apartments in Cleveland (108 units sold for $57,000 per unit), Oak Hill Village in Willoughby (182 units sold for $77,000 per unit), State Hill Manor in Parma (110 units sold for $75,000 per unit) and 200 West in Fairview Park (173 units sold for $65,000 per unit).
SPAGETTI AND MEATBALLS
This lunch choice was always polarizing, with some loving a heaping platter of pasta while others hating it. It reminds me of the appetite for retail properties last year. A favorite type was well-located, smaller footprint centers occupied by credit tenants. Examples include Great Lakes Plaza, a 7,200-square-foot center occupied by Condoda Taco and Sleep Number, which traded for $5 million, and Parma Outlet Center, an 8,000-square- foot center anchored by Bank of America and Verizon, which sold for $1.8 million. Meanwhile, a clear unfavorite was tradi- tional, larger centers in mature locations. Examples include Stow Falls Center, a 95,000-square-foot center occupied by Planet Fitness and Litehouse Pools, which traded for $6.1 million, and Pheasants Run, a 30,000-square-foot center in North Olmsted, which sold for $1.7 million.
SLICED HAM WITH GREEN BEANS
When this showed up on the menu, most students opted to pack their lunch, which is similar to the activity in the office sector last year. When an office building showed up for sale, most investors headed in the opposite direction. The sector continues to struggle with weak fundamentals, including static occupancy, flat rent but rising expenses, all against a backdrop of uncertainty of the future of office space. As a result, pricing has languished. Examples of this softness include Westgate Plaza, a 92,500-square-foot building in Fairview Park that sold for $25 per square foot. Springside Place, a 97,000 square-foot property in Montrose that sold for $37 per square foot; the PDC Building, a 70,000 square-foot property in Beachwood that sold for $50 per square foot; and One Independence Place, a 100,000 square-foot building in Independence that sold for $50 per square foot.
ICE CREAM SANDWICHES
No matter how good or bad the lunch choices were, there was always a line when the ice cream freezer opened. This is very similar to investment activity in the single-tenant, net leased sector. Regardless of what may be going on in the broader real estate market, investors always seem to be able to make room for a good net leased offering. There were plenty of examples last year. A newly constructed Jiffy Lube in Avon traded for just over $700 per square foot, at a 7.2% cap rate. A Citizens Bank in Bainbridge sold for $1,400 per square foot, at a 5% cap rate. A Starbucks in Aurora sold for $1,100 per square foot, at a 5.75% cap rate. And a Wendy’s in Cleveland sold for $1,450 per square foot, at a 4.5% cap rate.
While the full effect [of the Fed rate hike]on the commercial real estate market isn’t readily apparent, the activity level clearly slowed over the last part of the year. More importantly, this sluggishness is anticipated to continue into the first part of 2023.
NEW MENU COMING
One of the most interesting days in the cafeteria was when the new menu for the upcoming month was posted on the bulletin board. Everyone would gather around to figure out what days they would packing their lunches and what days they would be buying them. Last year, the bulletin board was replaced by our phones or computers. But we weren’t looking for a menu but rather a news release on the results of the most recent Federal Reserve Board meeting. The Fed met eight times last year and raised the fund rate at seven of these meetings. As a result, the rate went from 0.75% to 4.5% and has obviously had a dramatic impact on the cost of borrowing. While the full effect on the commercial real estate market isn’t readily apparent, the activity level clearly slowed over the last part of the year. More importantly, this sluggishness is anticipated to continue into the first part of 2023.
But I’m starting to get into 5th period so for now, let’s just kick back and enjoy the rest of our lunch!
What I C @PVC
PAINTING A PRETTY PICTURE Last year ended with a bang when it was announced that Sherwin- Williams was entering into a sale/leaseback for the new 1 million-square-foot corporate headquarters. Benderson Realty Development is paying $210 million for a 90% interest in the property, which is currently under construction and scheduled to be completed in early 2025. –AP
Meanwhile Forbes reports large-scale layoffs at Amazon, adding that multiple other major companies – from Disney to Barclays, Salesforce, and Lyft have all already cut jobs or have announced cutbacks and hiring freezes.
With all of these changes incoming, the question that’s top of mind is: How will this affect the labor shortage we’ve seen since 2021?
In larger context
The names above are some of the biggest players (and employers) in the market, so it’s natural to assume that these cuts mean the labor shortage is inevitably reversing. Before making that deliberation, however, it’s worth taking a look at some of the figures from the U.S. Chamber of Commerce (USCC) to get a sense of the bigger picture.
In October, Stephanie Ferguson, the USCC Director of Global Employment Policy & Special Initiatives outlined the magnitude of the shortage, stating: “We have a lot of jobs, but not enough workers to fill them. If every unemployed person in the country found a job, we would still have 4 million open jobs.”
State and sector
The shortage stems, Ferguson says, from the unprecedented number of jobs added in 2021 – approximately 3.8 million. At the same time, the labor force has shrunk, with many workers retiring early, and workers quitting their jobs in unprecedented numbers as part of the Great Resignation.
All of which is to say, that while the big moves happening in the tech sector right now are certainly concerning, they still form part of a much larger, and more nuanced, picture.
For the commercial real estate (CRE) industry, the effects are likely to be similarly varied, depending on where and what type of business we look at. We have already seen some sharp downturns for specific Proptech companies. Redfin, for example, has cut a further 13% of its staff, following on from an earlier round of layoffs in June.
What these cuts ultimately mean for the labor market, and CRE operations in the Bay Area where many tech companies are concentrated, is still unclear.
For now, it seems that worker availability, even in tech, is still falling short of demand from employers. Amid the current economic uncertainty, however, that situation might well change as we head into 2023. As always, we’ll be keeping a sharp on the trends, and potential impacts in CRE markets.
Risky Business: Why Cybersecurity Should be Top of Mind for CRE Professionals
Over the past year, it’s sometimes felt like the number of factors that we, as commercial real estate (CRE) professionals, need to keep track of have grown exponentially. Especially in the face of challenging market conditions.
At the same time, there’s an ever-increasing need to be conversant with new technology and tech tools that help boost productivity and add value for clients. The tools available span the spectrum from social media to drone technology, climate-savvy building tech, and even augmented or virtual reality software.
For brokers, building managers, and developers incorporating these game-changing technologies, the possibilities are nearly endless.
There is, however, a flip side to this coin. And, like many things tech-related, it’s an area where CRE professionals have often been slow on the uptake: Implementing the right cybersecurity protocols.
A growing threat
Part of the problem is the idea that cybersecurity is something that’s handled exclusively by a dedicated team, or automatically built into the software being used. While that’s true to some extent, the fact remains that the tactics cyber criminals use, and the number of incidents each year, are continually growing.
Sophisticated “phishing” attacks, which aim to get staff to unwittingly compromise system security, and ransomware are the order of the day, and, as a recent incident in Australia shows, the real estate sector is far from exempt from these threats.
Given the amounts of sensitive data passing through or stored by the CRE industry, the question we need to ask is: Are we truly prepared in the event of a breach?
New risk vectors
The first thing all CRE businesses should consider is whether all possible systems, and avenues of access to those systems, have been identified and are properly protected.
In an excellent recent interview on cyber threats in CRE, security consultant Coleman Wolf points out that many possible avenues of attack go unnoticed. These may be linked to building control systems (think temperature or lighting management) and other smart tech, or even to the specialized Internet-of-Things (IoT) systems being used in industrial operations.
If these systems are connected to the internet, but not adequately protected, they may act as a springboard for access to other systems or data. Hackers may then be able to tap into sensitive information, including financial and personal data stored elsewhere. Alternately, simply taking control of building systems can be used as a tactic in ransomware attacks.
As the CRE industry begins to adopt new smart building technologies, and we increasingly repurpose buildings for niche markets, like the booming medical office sector, the potential for sensitive information to form part of breaches also grows exponentially.
Other trends, like the Bring-Your-Own-Device (BYOD) movement where employees use personal devices in the office, create additional avenues of attack if those devices aren’t properly secured.
While all the above may make it sound like it’s impossible to keep track of potential threats to a building or CRE enterprise, the good news is that there are certain essential principles that can be followed to mitigate the risk.
CRE companies should ensure all employees, beyond just the IT team, are aware of potential risks from phishing or ransomware and have been trained in how to minimize those risks.
Companies ensure there’s appropriate access control. For example, implementing multifactor authorization (MFA) and other safeguards.
Employees are aware of the risks of oversharing on social media (e.g., detailed information on job responsibilities and the type of data they have access to, which could make them phishing targets).
Of course, these recommendations are only starting points, and the exact requirements and level of detail needed will vary based on each firm’s unique context. There’s certainly no “one-size-fits-all” solution for CRE cybersecurity.
That said, an excellent resource to familiarize yourself with upcoming benchmarks and strategies for cyber-security can be found in PwC’s “C-suite united on cyber-ready futures” guide (you can register for free to download the report).
Securing the future
As we head into 2023 and beyond, some of the most exciting aspects of the CRE industry come in the form of new technology. There’s an ever-expanding array of Proptech tools on hand to help us close deals. Smarter building technologies ensure we meet environmental and climate imperatives while also offering something new and different for tenants and investors alike.
As CRE professionals, we’re right to be excited by the possibilities on offer. But we also need to make sure we keep security top of mind as we begin to integrate these tools.
As PwC summarizes: “Digitization makes security everyone’s business. The future promises more connected systems and exponentially more data — and more organized adversaries. With ever expanding cyber risks, business leaders have much more work to do.”
Last month, we continued our “back to school” theme and started a discussion regarding capital accumulation. And equally important, we took a walk down memory lane, discussing slot car racing sets that were a part of my childhood in the 1960s and ’70s.
If you read last month’s column, you may recall that although Internal Rate of Return (IRR) is a well-established measure of an investment, it has some deficiencies. This is particularly true related to what I called the investor’s total pile of cash. IRR only cares about money in the deal and gives no consideration to money that comes out of the deal – even though an investor can reinvest these cash flows. Interwoven in that discussion was the story of AFX, a leader in the slot car racing scene of the ‘60s and ‘70s, and upstart Tyco, which proved to be a worthy alternative. This month, we are going to continue this discussion as AFX vs. Tyco isn’t the only battleline being drawn. This is the last period before our lunch break so let’s go! Modified Internal Rate of Return (MIRR) was initially developed in the 1960s and primarily used by businesses to make a more accurate comparison between investment alternatives. It addressed one of IRR’s main limitations of ignoring cash flows produced from a primary investment by introducing a couple concepts. If you recall, last month I used the analogy of putting money produced by an investment in a mason jar and burying it in the back yard. This would equate to a reinvest- ment rate of zero, as the money in that jar would be earning nothing. But we can do something more productive with those cash flows – like redeploy them at a realistic reinvestment rate, usually a rate comparable to the firm’s cost of capital. Also, any additional outlays that would be needed to cover anticipated shortfalls (i.e., negative cash flows) over the holding period are assumed to be funded upfront at the firm’s cost of debt. Figure 1 illustrates the MIRR process, using an 8% cost of capital and 4% financing cost. As you can see, the $10,000 negative cash flow anticipated to occur in year three is acknowledged at the beginning of the investment by dis- counting the shortfall back to time period 0 at 4% and adding this to the initial investment. Meanwhile, all of the positive cash flows are reinvested at 8% to end of the fifth year. As a result, the $108,890 initially invested is anticipated to produce $201,501, which equates to a MIRR of 13.10%.
Capital accumulation is newer, developed in the 1980s. While the basic premise is the same as MIRR, the concept is more specific to a real estate investor and introduces a few twists. A primary difference is the treatment of negative cash flows. MIRR eliminates future anticipated deficits by setting aside the additional capital necessary upfront, at time period 0. Capital accumulation discounts negative cash flows back one year at a time, offsetting it against any positive cash flows produced in the preceding year(s) until the deficit is eliminated. This is done at a “safe rate,” which represents the rate of a secondary investment that can confidently be achieved. After eliminating any negative cash flows, the remaining positive cash flows produced by the primary investment are assumed to be reinvested at rate representative of an investment alter- native readily available to the investor. But rather than compounding the positive cash flows produced each year to a corresponding future value at the end of the time horizon, capital accumulation only compounds each annual cash flow forward to the following year. This is added to any cash flow expected to be released in that following year and then the entire sum is again compounded forward one year. A second, related nuance is that capital accumulation can have multiple, or tiered, reinvestment rates. A higher reinvestment rate may be available as specific dollar thresholds are met. This acknowledges a premium in return as a result of the aggregate amount being reinvested. This kicker is a concept similar to “jumbo CDs” of years past. By compounding cash flows one year at a time, the opportunity to exceed any established thresholds can be realized. This acknowledges a premium in return as a result of the aggregate amount being reinvested. This kicker is a concept similar to “jumbo CDs” of years past. By compounding cash flows one year at a time, the opportunity to exceed any established thresholds can be realized.
Figure 2 illustrates an investment with the same series of cash flows but utilizing the capital accumulation approach, with a tiered reinvestment assumption of 8% for positive cash flows up to $50,000 and 9% thereafter as well as 4% safe rate for negative cash flows. Note the differences in handling of both positive and negative cash flows as compared to Figure 1. Capital accumulation uses periodic positive cash flow in year two to offset the discounted shortfall from year three. It then compounds the remaining positive cash flows one year at a time, which allows it to take advantage of the higher 9% return as a result of exceeding the $50,000 threshold in year four.
These subtle nuances have a significant cumulative impact on the results; the $100,000 initially invested is anticipated to produce $190,077 by the end of year five, resulting in a capital growth rate (CGR) of 13.71%.
AFX slot car racing has several similarities to MIRR. Both are more established and set a standard in their respective worlds. Both have a wide following. And both take a more conservative approach. Tyco and capital accumulation also have several similarities. Both are upstarts and offer some twists to their more established counterparts. Both have a niche following. And both take a more unconventional approach. By understanding these nuances and choosing the path that best fits your needs, you will be in a better position to end up in the winner’s circle.
STILL HOT Investment sales, particularly industrial warehouse product, continues to achieve record pricing. Last month, a 125,000-square- foot facility in Middleburg Heights sold for $13.7 million or $109 per square foot. This is the 12th industrial investment sale to break the $100 per square foot mark this year. –AP
Investing in Gender Equity is an Investment in CRE’s Future
When it comes to parity, commercial real estate (CRE) still has some ways to go in leveling the playing field for women in our industry. That’s the central message of the latest report from the Commercial Real Estate Women Network (CREW), a national organization with a focus on diversity, equity and inclusion in CRE.
One of the biggest pain points for women in the industry according to the report is the culture of secrecy around salaries. Of the 1228 CRE professionals interviewed, 68% indicated they’d change jobs to work at a company with greater salary transparency (even with a similar salary offer on the table as what they currently earn). Around 82% said they wanted job listings to include wage and benefits information, with many adding this would give them more confidence in salary negotiations.
In an industry with a proven record of pay disparity, those numbers are especially telling and highlight an important point. Part of creating equity is building transparency into the recruiting and salary negotiation process.
Another concern raised was the disparity faced by women of color specifically, who, according to PayScale’s 2022 Gender Pay Gap data, typically earn far less (across a variety of industries) than white men or even their white women counterparts. CREW also noted in a previous report, that women of color were less likely to have a sponsor or mentor in CRE, blocking their opportunities for advancement in the industry.
Building better businesses
Besides the obvious social imperative to address these issues, investing in gender and racial equity is an increasingly important part of building business resilience.
As, Lily Trager, Head of Investing with Impact for Morgan Stanley Wealth Management, recently pointed out: “When our quantitative team analyzed global companies based on their percentage of female employees and other metrics of gender diversity, companies that have taken a holistic approach toward equal representation have outperformed their less diverse peers by 3.1% per year.”
Trager added that a growing requirement from Morgan Stanley’s “high-net-worth investors” is that Diversity, Equity, and Inclusion (DEI) be a priority for the companies they invest in.
For us in CRE, the challenge is to address the historically low numbers of women both in our industry, and especially in C-suite positions. And while that process should be driven by everyone, it’s especially important that the policy decisions and changes we make to promote equity are guided by the experience and expertise of women in the space.
The CREW Network’s recommendations in this regard include:
Committing to pay transparent practices – In other words ensuring that both salaries and the processes for earning pay increases are clear and accessible.
Supporting professional development – Encouraging women in your organization to pursue professional development opportunities (and join women’s forums) and financing those opportunities.
Formal mentorship and sponsorship programs for women – We all know that in the real estate industry, mentorships are invaluable in shaping the trajectory of an individual’s career. For women, and especially women of color, we should incorporate and encourage mentorship as a central part of our business.
A commitment to gender equity
The legacy of gender, and other, inequities won’t be undone overnight. What’s vital to accelerate the process is that, as business leaders, we commit to creating workplaces that make Diversity, Equity, and Inclusion a reality. In doing so, we can build a CRE future that enables the best in our people and our business.
For more information about NAI’s own commitment to Diversity, Equity, and Inclusion, please visit our page here, or find more information about the NAI Global Women’s Alliance here. Or join us in becoming signatories to the CREW Network’s Pledge for Action![SR2]
Do you know where the saying dead in the water comes from? It was originally used to refer to a boat that was stuck out at sea with no wind. No wind means no movement and as you could imagine, no movement is not good for a boat in a large body of water. Over the last 2 years, people have been telling me that the office market in Cleveland is “dead in the water” as everyone from your nephew’s Lemonade stand to Google decide if they need more space or if they even want any space. To be honest with you I believed it for a little bit too. I thought there is no wind in the sails of the office market in Cleveland, but then I allowed myself to take a real look at the industry.
Sailboats are great but they need something to push them. A tide, current, or wind is needed to make a boat with no motor move. I believe that office rents in the Cleveland Market have stayed stagnant because they have been the tide, current, or wind in the sails of our largely vacant office market. What do I mean by that? Owners in Cleveland often think that they are in competition with each other. They attract tenants to their buildings by offering a low price, free rent, and higher tenant improvement allowances than what they view are their competitor’s. That, in turn, makes other owners lower their prices and it becomes a price war at its most basic level. For years, that has been the reason why the office market continued to truck along with very few new buildings and stagnated rent growth. Lower prices and increasing free rent packages were the slow wind that was pushing the sails of a fundamentally broken office market.
Why are low prices so bad in an office market? The answer is they aren’t when they can be controlled and used to attract quality businesses that will help the area grow. That, however, is not the situation that the Cleveland office market is in. We are in a vicious cycle of rent reduction to attract businesses that don’t choose Cleveland because of the lack of amenities, in both buildings and the city, and because they don’t choose Cleveland both the owner and city miss out on valuable tax and rental income that could be used to pay for new amenities to attract new businesses. This is the reason why the Cleveland office market is “Dead in the water”.
Nobody cared about this issue until the past two years when work from home skyrocketed and tenants didn’t care how much you reduced their rent; they just wanted out. It was no longer a price war because price mattered very little anymore. It became an agent’s job to keep tenants from bull rushing out of a building. Any wind that was ever present, was lost. No hope, right? Wrong.
Going back to what I had said earlier when technology advanced we learned that we could put an engine on a boat and we had no more need for the wind to propel us. The wind and the sail didn’t matter anymore because the fundamental idea of a boat changed. It was no longer difficult to maneuver, slow, or relied on something totally out of one’s control. Instead, a boat became fun, attractive, and a sign of success for most. Office buildings need a motor. The entire idea of an office building needs to be changed. Low rent and new paint aren’t enough anymore. You need a space that makes people want to come to work. If your building doesn’t do that, then you need to take a hard look at the future success and viability of that building. If you are a landlord you must know your effective vacancy on any building you own. I don’t mean how many people you are getting checks from every month or the number of available square feet you tell your broker to put on the flyer. I mean how many people are coming in and using your space on a DAILY basis? If you have amazing tenants that don’t want that stuff then, congratulations, you have won the jackpot. If you have large amounts of vacant space and are wondering how to change it, then hold on because I’m going to tell you.
ASK AND YOU SHALL RECEIVE
I know most office buildings or parks are purchased as a semi-passive investment which is great and I fully support it, but if you have a high vacancy you need to get a broker, or property manager or go yourself to each tenant and ask what they are looking for. Ask what your building lacks and where it could be improved. If you have current amenities in the building ask if they use them and how often. If you have someone that works in an amenity like a dry cleaner, food service, or gym, ask them how often people come through and what sort of mood they are in when they come in. If you have services in the building you need to find out if people are using them because the service is good or if it’s convenient. If tenants are using it out of convenience then that’s great, but it’s not enough to keep them there at your building. The true testament to the amenities that you provide should be if a tenant leaves and still comes back to your building to use your amenities. Obviously, not all amenities are offered to people that are not tenants, but ones that are, such as an open cafeteria or dry-cleaning service should be good tests. If you ask tenants for their opinion make sure they are valued and listened to. Asking them questions only to do nothing in hopes that they will stay is going to do you no good. If you want to have a low vacancy you need to get things in the building that people want. Let the ideas flow. Everything from a VR gaming setup, driving simulator, or golf simulator might be options that are relatively inexpensive in comparison to renovating a cafeteria or building out a new gym. Take the answers to the questions that you get from your tenants and mix them with your ideas and see if it’s possible. Maybe call me and let me come take a look and allow me to give you my opinion.
If your building represents a sailboat that is quickly or slowly losing wind then pull it out of the water and put an engine on that sucker because if you don’t make a change soon your boat will be dead in the office market water.
Have something to say? Great, I would love to hear it. Shoot me an email at Joe.Hauman@NAIPVC.com or give me a call 440-591-3723.
Despite a red-hot streak that’s outperformed other commercial real estate (CRE) asset classes, it seems that bullish sentiment on the industrial sector is finally cooling off. A recent report from the Society of Industrial and Office Realtors (SIOR) indicates that realtor confidence in the market dropped to 5.5 (out of 10), compared to 7.7 in Q1. Office sentiment fared poorly as well, with a 32% drop in confidence from 6.5 in Q1 to 4.4 in Q2.
While general factors, such as prevailing economic conditions, played a role in the flagging sentiment, SIOR reported specific indicators of a downturn between Q1 and Q2 as well.
For industrial, these included:
Only 31% of members reporting an active leasing market (down from 61%)
An increase in “on-hold” transactions (from 10 to 14%) and canceled transactions (from 7 to 11%)
69% of members reporting “booming” or “average” development conditions (down from 81%)
Meanwhile, office realtors reported a similar shakeup, with SIOR noting that:
37% reported “little” or higher leasing activity in Q2 (down from 58%)
Canceled transactions jumped from 7% to 11%, and
There was a 61% reduction in the number of members reporting a “booming” or “average” development environment in their area.
SIOR adds that uncertainty around inflation and potential “economic turmoil” were the main drivers of the downturn. Or, as one of the survey respondents put it:
“Consistent commentary among clients is that the future is very uncertain and a recession likely coming.”
Concerns in context
Sentiment analysis across the broader US market indicates that the general consumer outlook continues to drop as we progress into Q3. This makes July the third consecutive month that consumer confidence has taken a knock.
Economic sentiment indicators in Europe show similar retractions, with confidence in the industrial sector declining by 3.5% in the region. Challenges such as the high cost of energy and gas shortages are hitting Europe particularly hard. In July this year, Reuters reported that Germany, the region’s industrial powerhouse, could be on the verge of recession.
For sectors like office and industrial, these reports indicate that there may be strong headwinds incoming.
SOCIAL: How have the industrial and office sectors performed in your region in recent months?
Last month, we went back to school and discussed some useful financial calculations incorporated within Microsoft Excel formulas. This month, we are going to continue the school day and, along the way, weave in the theme of renovation being covered throughout this issue of Properties. Both fit perfectly for me; I teach a course at the University of Denver and just finished writing a question for the midterm exam, as follows:
An investor is contemplating installing an automated ticketing system in their parking garage. If continued to be operated with a manned attendant, the garage is expected to produce $100,000 next year and anticipated to grow $2,500 annually in subsequent years as a result of planned increases in the parking rate. The reversion value at the end of five years is expected to be $1,200,000.
The automated system is anticipated to cost $250,000 but income will increase to $125,000 in the first year, as a result of no longer needing an attendant and thus realizing lower expenses. Annual increases are projected to remain the same, $2,500 per year, and the reversion value at the end of five years is expected to be $1,500,000, based on the higher income level.
Using a discount rate of 10%, which alternative should the investor choose?
This is a classic renovation analysis – should the investor keep on keeping on, as-is, and not incur the upfront expense which will result in lower annual cash flows and lower reversion. Or should the renovation be completed, which will result in a significant upfront expense but higher annual cash flow and higher reversion. Who’s ready to go back to school?
We are going to use a three-step approach to solve this problem, dragging in our old friend the CCIM T-bar to help. The first step is to model the cash flows associated with doing nothing. The present value (PV) component would be zero, as no initial money is being spent. The payment (PMT) component would start at $100,000 in the first year and increase $2,500 each subsequent year of the holding period. And the future value (FV) would be $1,200,000. Figure 1 represents the T-bar for these cash flows. The second step is to model the cash flows associated with making the renovation. The PV component would be ($250,000), reflecting the cost of installing the automation system. The PMT component would start at $125,000 in the first year and increase $2,500 each subsequent year of the holding period.
And the FV would be $1,500,000, which is the anticipated value of the garage at the end of the holding period. Figure 2 represents the T-bar for these cash flows.
The third step is to calculate the net present value (NPV) of each T-bar, using the 10% target rate. You’ll need a financial calculator to perform this function (unless you were paying attention to last month’s column). Once completed, you will discover the “as-is” scenario has a NPV of $1,141,339 while the “renovate” scenario has a NPV of $1,172,385. At this point, the decision is simple; based on the assumptions provided, it is worth it to pursue the renovation.
We are not done yet – the university students also have a related bonus question, so why shouldn’t you? We can take this analysis one step further by using a concept known as “IRR of the differential.” Calculating it is straightforward and is the IRR of the difference between the renovated series of cash flows less the as-is series of cash flows. As you can see in Figure 3, the PV of ($250,000) is found by subtracting the PV of the renovated T-bar (Figure 2) minus the as-is T-bar (Figure 1). The PMT in year one in Figure 3 is found by subtracting the year one PMT of the renovated T-bar minus the as-is T-bar. Lather, rinse, repeat for the cash flows in years two through five and the reversions. Plug these into a financial calculator (unless, again, you were paying attention to last month’s column) and we come up with an IRR of the differential of 13.08%.
But the bonus question on this insidious mid-term exam doesn’t ask for the IRR of the differential. C’mon, these are graduate students! It asks what this concept means – because to me, this is the most important number on the board. And I’ll save you the grief. From a purely mathematical perspective, 13.08% is the exact rate at which the NPV of the as-is scenario and the NPV of the renovate $1,500,000, which is the anticipated value of the garage at the end of the holding period. Figure 2 represents the T-bar for these cash flows.
scenario are equal. You are welcome to try it but, trust me, you will come up with an NPV of $1,015,465-ish for either scenario if you use a discount rate of 13.08%. But mathematics doesn’t pay the bills, understanding the practical application is what’s important. The 13.08% discount rate is considered the point of indifference or cross-over point. At that exact rate, there is no difference between the as-is and the renovate scenario. They are equivalent decisions. But at any rate less than 13.08%, the decision swings to the renovate scenario and the lower the rate, the more pronounced the renovate decision becomes. Conversely, at any discount rate greater than 13.08%, the decision swings to the as-is scenario and the higher the rate, the more pronounced the as-is decision becomes.
Gang, our business is all about under- standing and quantifying risk, and the concept of IRR of the differential is a hallmark example. The break-even risk versus return for this proposed renovation is 13.08%. If you believe the risk associated with this proposed renovation demands a return greater than this point of indifference, you are better off to not spend the money and keep on keeping on. But if you perceive a low degree of risk associated with the renovation, and are good earning a return at some rate less than this break-even rate, you are better off to spend the money. And if you liked second period, just wait to see what we have in store for third period!
by Alec Pacella for Properties Magazine, November 2022
Staying on top of new developments and technologies is a necessary, but demanding, part of being a savvy commercial real estate (CRE) professional. With the Top Tech series of blogs, we aim to highlight some of the ones that have caught our attention while also showcasing the work of NAI partners that we feel are changing the CRE game.
Worth keeping in mind is that these blogs aren’t “partner content” or sponsored; rather they’re an opportunity for us to share tools that we think really add value for real estate professionals, from across our diverse partner-base.
That said, we are proud to add that the company featured today is the brainchild of NAI’s own Ethan Kanning. Ethan is a co-founder of valuation software company Harken, which through their “Bankable Real Estate Data” approach, has found a home with some top brokers and brokerages in the NAI Global network.
What do Harken do?
Harken’s software combines automated analytics with a built-in comps (comparables) database to simplify the process of estimating a specific property’s value. This approach allows brokers to complete a Broker Opinion of Value (BOV) in record time, which of course translates into quicker turnaround for clients and more business for brokerages and firms.
The platform’s reports are also white labeled to the broker’s company, allowing them to build their brand and establish expertise in the market. Meanwhile, for those that need to be Dodd Frank compliant, the process is simplified by having all relevant fields already included in the BOV form. With these functionalities built-in, you can see why Harken is one of our top picks as a tool that streamlines real estate workflow.
A company with a conscience
Another thing worth noting about these up-and-coming entrepreneurs, is that Harken doesn’t draw the line at “just business.” In addition to making top-notch software, they are also committed to keeping DEI (Diversity, Equity, and Inclusion) top of mind. As one of the sponsors for the Women’s Alliance initiative at the NAI 2022 Global Convention, they had this to say:
“We believe the healthiest, most vibrant, and sustainable company is one that focuses on DEI initiatives… A diverse team with a focus on self and other’s awareness, helps us recognize both our personal and company biases. Once these biases are understood, we can begin working together to create a more inclusive and sustainable business environment for everyone.”
With their genuine desire to make the workplace both easier to navigate and more inclusive, it’s not hard to see why we consider Harken a Top Tech partner!
Throughout 2021, the cost of building materials was a constant pain point for the construction industry. In an analysis by the Associated General Contractors of America (AGC) earlier this year, prices were found to have jumped over 20% between January 2021 and January 2022. The cost of specific materials like steel and plastic sky-rocketed, leaving construction firms caught between shrinking profit margins and a sharp decrease in available labor.
As we head into the second half of 2022, the question that’s top of mind for building contractors and many Commercial Real Estate (CRE) professionals is: Has the situation improved?
Well, the cost reports from the first and second quarter this year are in. Here’s how it’s looking.
Prices climbed in Q1
Overall, the first quarter was still rough for price increases, with the National Association of Homebuilders (NAHB) indicating that the cost of residential construction materials jumped 8%. One of the biggest price hikes was softwood lumber, which increased 36.7% over the period.
Meanwhile, a Q1 report from construction consultancy Linesight showed increasingly high costs for resources like copper (3.3% estimated increase from Q4) and steel (4.7 and 8.9% for rebar and flat steel respectively), accompanied by moderate hikes in cement, asphalt and limestone. Bear in mind that these increases are on top of the price surges many of these materials already saw last year.
Materials costs still (mostly) soaring in Q2
Any hopes of price relief in Q2 were also met with resistance, as costs for many materials continued a steady climb. In an analysis of recent Producer Price Index (PPI) data, AGC showed that the overall cost of inputs for new non-residential construction had jumped 1.1% between May and June alone.
The report also noted that the cost of supplies like concrete products, insulation material and some plastics had increased over the same period. In terms of other materials, however, there were bright spots, with lumber and plywood costs dropping 14.7%, while steel saw a more moderate 1.8 % retraction.
Lumber prices continue to tumble
Lumber has proved an interesting case overall, hitting record highs in 2021 that carried through into 2022. And while in March 2022 the lumber market was still showing a massive price spike, by July it had experienced a 50% decrease. At the time of writing, prices have dropped even further, adding an extra layer of complexity to forecasting and planning for new construction.
Overall, the market remains in flux, with some prices still increasing rapidly. In a recent article covering AGC’s July Price Index analysis, Ken Simonson, Chief Economist for AGC stated:
“Since these prices were collected, producers of gypsum, concrete and other products have announced or implemented new increases. In addition, the supply chain remains fragile and persistent difficulties filling job openings mean construction costs are likely to remain elevated despite declines in some prices.”
In a separate post, Simonson pointed out that the Construction Industry Confidence Index (CICI) also dropped 17 points to a value of 44 in Q2 2022. The index, which measures sentiment amongst industry executives, only indicates a “growing market” if the value is over 50.
Heading into the rest of 2022 the situation remains uncertain, but some experts have predicted a drop-off in materials prices. Whether this translates into gains for the construction industry amid other pressures, only time will tell.
SOCIAL: How have fluctuating materials prices affected new development in your area?
Employment numbers are up according to a recent news release from the Bureau of Labor Statistics (BLS). In their analysis, BLS announced that the unemployment rate had dropped to 3.5%, with 528,000 new jobs added over the course of the month.
These figures mean that, for the first time, unemployment measures have returned to their February 2020, pre-pandemic levels. BLS also noted that the gains were led by the leisure and hospitality industry.
Strong recovery in hospitality
Reporting on the figures, Real Deal pointed out that hiring at hotels, restaurants and bars was responsible for a large percentage of the 528 000 jobs created in July. Together with construction and healthcare, these sectors accounted for 43% of the overall job gains posted. Quoted in the article, Mortgage Bankers Association Chief Economist, Mike Fratantoni added: “This is not a picture of an economy in recession.”
Mixed results for other sectors
Though the construction industry was a strong performer, with an additional 32,000 employees hired, it’s worth noting that this figure would likely have been much higher if there were more workers available. The sector is still deep in the grips of a labor shortage that has put pressure on projects across the US, and led to a slow-down in new developments.
Meanwhile, the office sector also faced constraints, with the percentage of workers staying remote due to the pandemic remaining at 7.1%, exactly the same as in June. As one of our NAI Offices recently reported, the future of offices has generated some strong dissenting opinions among those in the know, and exactly how the situation is going to pan out remains unclear.
For other experts, the picture is more nuanced. Lawrence Yun, Chief Economist at the National Association of Realtors (NAR) puts it like this:
“It would be one of the most unusual recessions — if it [the economy] does technically reach it — in that there are worker shortages. Some industries will lay off workers, but there could still be more job openings than the number unemployed throughout the recession.”
How the current job situation plays out, and how this affects Commercial Real Estate professionals, remains to be seen. We do know that the employment numbers we are seeing now exceed predictions that were made just a few months ago. If the positive trend in hospitality and construction continues, there could be a lot of new projects, and prospects, on the cards.
SOCIAL: How have hiring trends impacted commercial rentals and development projects in your area?
A recent report from the Federal Deposit Insurance Corporation (FDIC) states that Commercial Real Estate (CRE) lenders are about to come under greater scrutiny. In the report, titled “Supervisory Insights Summer 2022”, the agency adds that there will be an increased focus on new lending activity, along with CRE sectors and geographic areas that are “under stress.”
This comes on the back of a record year, with “the volume of CRE loans held by banks recently peaking at more than USD2.7 trillion.” And while FDIC doesn’t oversee all these institutes, banks supervised by the FDIC account for around USD1.1 trillion of that amount.
The agency adds that there will be increased emphasis on transaction testing (i.e. sampling individual lending transactions), saying:
“Given the uncertain long-term impacts of changes in work and commerce in the wake of the pandemic, the effects of rising interest rates, inflationary pressures, and supply chain issues, examiners will be increasing their focus on CRE transaction testing in the upcoming examination cycle.”
Areas of concern
During 2021, FDIC examiners noted some specific CRE loan concerns, including poor risk analyses and improper assessments of whether loans could be successfully repaid. For example, some assessments failed to check whether a borrower’s business would be able to repay the loan when stimulus or other relief funds were no longer in the balance sheet.
Another area where some banks seemed to fall flat was in conducting a thorough and up-to-date analysis of prevailing market conditions. The agency added that examiners also saw cases where banks have “applied segmentation techniques ineffectively” or “have not drawn conclusions from the analyses performed.”
CRE lending outlook
Specific sectors identified as challenging for valuation in 2021 included some hospitality properties, offices, and malls, along with “some geographies, such as the Manhattan borough of New York City, [which] lagged.” In a Bloomberg article on the report, Brandywine Global portfolio manager, Tracy Chen added that “there are some challenges in pockets of CRE debt, such as offices and retails.”
In an environment where some banks have already announced cutbacks on CRE lending, the additional scrutiny may mean those lenders adopt an even more cautious disposition, especially for sectors they consider “high risk.”
Have there been any effects from changing lending policies on deal-making in your area?
Few innovations have had more of an impact on investment analysis than spreadsheet software. Dominated by Microsoft Excel for the last 25 years, this sector is currently used by an estimated 78% of U.S. businesses. While most know how to quickly copy, sum, drag and format, fewer may know about the real power of this software – a whole host of integrated functions and formulas.
I ran into a long-time reader a few weeks ago, who remarked on covering some ‘soft content’ during recent columns. As a result, this month we are going back to school to discuss some useful but perhaps little-known functions to help get your Excel game in gear.
Present value is a foundational concept and represents a value today for a series of cash flows to be received in the future at a specific discount rate. This concept has tremendous value to a real estate investor, as it allows us to determine what this series of cash flows is worth today. The formula is =PV(discount rate, time periods, periodic payments, future value).
Future value is also useful and is the exact opposite of present value. It rep- resents that value at some point in the future of a present lump sum value and/or a series of periodic payments, collectively compounded at a given compounding rate to a specific point in the future. The formula is =FV(compounding rate, time periods, periodic payment, present value).
We have discussed the concept of net present value several times over the years in these very pages. A kissing cousin to IRR, this concept adds a slight twist by discounting all future cash flows back at a target discount rate and nets the sum against the initial investment. The initial investment can be entered as zero, which makes this formula a very common way to determine the current value of an investment at a given discount rate. The formula is =NPV(target discount rate, series of periodic cash flows).
The addition of the ‘x’ allows for more specific control over the timing of cash flows. While NPV considers annual periodic cash flows, XNPV can distinguish between monthly, quarterly, semi-annual or annual periods, all within the same range of cash flows. The formula is =XNPV(target discount rate, series of periodic cash flows, range of associated dates).
Enter NPV’s kissing cousin. Most of us think of IRR as the rate of return that each dollar earns in an investment while it’s invested. But there is an alternative definition – IRR determines the exact rate at which all future cash flows dis- counted back to the present and netted against the initial investment equals zero. As a result, the IRR of an investment will be the same as NPV’s target discount rate when NPV equals zero. IRR is a very important metric to many investors but thankfully, the formula is simple: =IRR(series of periodic cash flows).
Similar to NPV, the addition of the ‘x’ allows for more control over timing. While IRR is an annual measure, XIRR can accurately calculate a mixture of time periods, including monthly, quarterly, semi-annually or annually. The formula is =XIRR(series of periodic cash flows, range of associated dates)
Back in the day, any real estate professional worth their salt would have a little red covered book called the “Ellwood Tables for Real Estate Appraising and Financing” right by their side. Filled with page after page of tables, it allowed the reader to quickly figure out the annual loan payment at a variety of nominal interest rates and amortization periods. This function in Excel makes the process a snap: =PMT(nominal interest rate, amortization period, initial loan amount). One word of caution – most loans are amortized and paid on a monthly basis so be sure that the nominal interest rate and amortization period both reflect this.
FV to find loan balance
Once you determine the loan payment, you can easily find the loan balance at any point during the life of that loan. The only time the future value (FV) will be zero is once the final payment is made and the loan is fully amortized. The formula is =FV(nominal interest rate, specific period for loan balance, periodic loan payment, original loan amount). Two input items of note. First, be sure that the interest rate, specific period and periodic loan payment all reflect months if using monthly compounding. And second, be sure to enter the periodic payment as a negative if the original loan amount is entered in as a positive.
Sticking with the loan theme, we know that the concept of classic loan amortization results in a portion of each periodic payment representing interest and a portion representing principal, which in turn reduces the outstanding loan balance. While both portions are important, we can use the IPMT function to determine exactly how much interest is associated with a particular periodic payment. The formula is =IPMT(nominal interest rate, specific payment period for interest component, total amortization period, original loan amount). Once again, be sure that all of the components represent months if using monthly compounding.
While IRR is a very useful tool, it has limitations related to its treatment of both negative and positive cash flows that the primary investment produce. Diving into the nuances associated with the treatment of negative cash flows can be the subject of an entire column (spoiler alert) so for now, just set that one aside. As for positive cash flows, IRR makes no assumption for cash flows that come out of an investment. The only thing that IRR cares about money coming out of a deal is that it is no longer in that deal. That’s an issue because, as an investor, I can re-invest that money into another investment. A concept known as Modified Internal Rate of Return (or MIRR) addresses this limitation by introducing consideration of a secondary investment, and associated reinvestment rate, for any positive cash flows that are generated by the primary investment. The formula is =MIRR(series of cash flows, safe rate applied to negative cash flows, reinvestment rate applied to positive cash flows).
While Excel has certainly changed the landscape of accounting and financial analysis, it wasn’t the pioneer. If you have a long enough memory, you may be thinking about Lotus 1-2-3, which was introduced in 1983. But four years prior to that was the OG – VisiCalc was the first spreadsheet software developed for personal computers in 1979. It is rumored that when co-founder Dan Bricklin, then a student at Harvard, showed his creation to a group of accountants, they sat in stunned belief at the ease by which simply changing a number would automatically update the sum total. And then, one of them started to cry. We certainly have come a long way, baby.
Financial Strategies by Alec J. Pacella, for October 2022 Properties Magazine.
Over the last few years, the hospitality industry has taken some hard hits. And for Commercial Real Estate (CRE) professionals focusing on the sector, 2020 may well have felt like a trial by fire. When we looked at the industry last year, however, things were starting to look up, with at least some evidence of a mounting recovery.
The good news in 2022 is that, as business travel and tourism resume, the hospitality sector seems set to hit highs we haven’t seen since before the pandemic.
RevPAR revving up
According to a recent article by hospitality analysts STR, the RevPAR (Revenue Per Available Room) for U.S. hotels is set to surpass levels seen in 2019. RevPAR is an important metric for the industry and is used by owners to calculate hotel performance. The new predictions suggest a $6 increase in RevPAR compared to 2019.
It’s worth noting though that the gains fall short when adjusted for inflation, and it’s likely the industry will only achieve full recovery in 2024. That said, the sentiment in the hospitality sector still seems to be bullish, especially on the back of average daily occupancy rates of nearly 60% in May this year.
Back in Business
One factor that seems to be fueling the gains is an uptick in business travel. STR president Amanda Hite states: “…right now, we are forecasting demand to reach historic levels in 2023 as business travel recovery has ramped up and joined the incredible demand from the leisure sector.”
The New York Times adds that domestic business travel in particular is on the increase, with cities like Las Vegas leading the pack in terms of the number of trade shows and events scheduled in 2022.
While the recovery for international travel seems to be slower, they note that business trips to Europe are leading recuperation on that front.
The European connection
The hospitality situation in Europe is certainly heating up, with many top destinations reporting strong gains in the last few months.
Taken together, these latest reports suggest that there may be some welcome relief for the hospitality sector as travel, both for business and pleasure, resumes. Going into 2023 and 2024, we may see a level of robust recovery that means the industry can finally put the hard times of the last few years behind it.
SOCIAL: For those working in hospitality real estate, how are the numbers stacking up in your area?And how do you anticipate the trend developing through the rest of 2022?
CRED iQ regularly monitors distressed rates and market performance for nearly 400 Metropolitan Statistical Areas (MSAs) across the US, an enormous data set that includes some $900 billion in outstanding CRE debt.
Month-by-month improvements In the report, they’ve laid out distressed rates and month-over-month changes for the month of June 2022, for the 50 largest MSAs, as well as a breakdown by property type (see below). “Distressed rates (DQ + SS%),” they write, “include loans that are specially serviced, delinquent, or a combination of both.”
Standout areas Of the top 50 MSAs, some 43 showed month-over-month improvements “in the percentage of distressed CRE loans within the CMBS universe”. New Orleans (-9.57%) and Louisville (-3.41%) were two of the MSAs with the acutest declines [in distress rate] this month.
On the other end of the scale, Charlotte (+1.15%) and Virginia Beach (+1.12%) were among the seven MSAs showing increases in distress rates last month.
By property type “For a granular view of distress by market-sector”, the report also delves into distress by property type, which potentially holds strategic insight for regional commercial real estate professionals.
“Hotel and retail were the property types that contributed the most to the many improvements in distressed rates across the Top 50 MSAs,” they detail. “Loans secured by lodging and retail properties accounted for the 10 largest declines in distress by market-sector. This included the lodging sectors for New Orleans and Detroit as well as the retail sectors for Tampa and Cincinnati.”
SOCIAL: What data metrics do you find most useful for understanding the health of CRE in your region?
Credit for commercial real estate (CRE) looks to be entering a crunch state in the second half of 2022 as a number of the big lenders announced in July that they were pulling back in that sphere.
The latest to make such an announcement are Signature Bank and M&T Bank. The former said it “expected to cut back on lending for multifamily and other commercial real estate assets”, and the latter laid the blame squarely at the feet of higher interest rates in its decision to make “fewer CRE loans this year”.
M&T’s CRE loan balances decline by 2%, or $830m in Q2 2022, as reported by the Real Deal, who extracted key takeaways from an earnings call hosted by M&T chief financial officer Darren King. King reportedly specified that construction loans declined, alongside a decline in completed projects and new developments coming online.
Interest rates and inflation
King said the rates moves were “affecting cap rates and asset values” and that they were “not seeing the turnover in properties like you might have under normal circumstances. And that will affect the pace of decline and our growth in permanent CRE.”
According to BisNow reporting, “Interest rates, raised in an attempt to beat back record-high inflation, have contributed to a drop in investment volume from the highs of 2021 and early 2022, slowing CRE deal volume”.
In broad term, these economic conditions are seen at varying rates around the world right now. As S&P’s recent update explains: “Economic growth is slowing. Interest rates remain stubbornly high. Estimates of the risk of recession or even stagflation creep upward and questions persist on whether central banks are under- or over-reacting in pursuit of monetary normalization.”
Additionally, on the residential side, their PMI research indicates “a steep contraction in demand for real estate amid tightening financial cost of living”.
Social: How is the rising cost of living playing out in your market?
A new report out from JP Morgan Chase provides an interesting mid-year review for commercial real estate (CRE), showing positivity in the first half of 2022, despite the various headwinds the industry faces.
“Despite rising interest rates—with the potential for more hikes in the coming months—commercial real estate has seen success in 2022,” writes Al Brooks, Head of Commercial Real Estate, Commercial Banking at JPMorgan Chase.
Giving retail a boost Even the beleaguered retail space has some standouts, according to JPMorgan. The report highlights a handful of factors that have bolstered strip malls in highly populated residential areas, underpinned by the likes of “grocery stores, fast-casual restaurants, and other retailers offering in-person services”, reads MPAMag’s coverage of the findings.
“JPMorgan observed that walk-in MRIs, testing clinics, and other non-traditional tenants may fill more shopping centers as retail evolves and adapts,” they add.
Class B and C malls, however, “continue to struggle” and the report authors call them “prime candidates for adaptive reuse” – into affordable housing and even industrial use, like fulfillment centers.
Industrial still booming Given the huge demand for industrial space – a trend that continues unabated – the report posits that we may start to see this category of property maturing in interesting ways. This could include adding the kinds of facilities and amenities which we associate with offices, such as gyms, complimentary snacks, nursing rooms, and so on.
This would fit with the evolution towards “multiple business purposes” within industrial sites, “such as a shipment center with offices or a showroom”, according to the report authors.
Casting forward As for the next six months, the report has a tone of tentative positivity, writing: “Multifamily and industrial properties have thrived in 2022. With healthy balance sheets, consumer demand could bolster retail, multifamily and industrial asset classes.”
But, they say, they’re keeping an eye on how “the country navigates hybrid work” and “on interest rate hikes, supply chain issues and geopolitical events, as well as ongoing relationships between public and private entities in affordable housing”.
For more information, and a link to the webinar replay, click here.
Social: What was the state of CRE in the first six months of 2022 in your region?
According to a recent report by Moody’s Analytics, the rest of 2022 might be the start of an economic rough patch as increasing risk factors boost market volatility. Moody’s states that economic risks and tightening monetary policy could translate into higher cap rates all the way into 2023.
Cap rate forecasts
The report also points out, however, that all is not equal in commercial real estate (CRE) markets, with sectors like hospitality, office and retail already showing signs of an increase in cap rates in response to rising interest rates. Multifamily and industrial cap rates have meanwhile remained steady in the face of uncertainty.
Worth noting is that the existing low cap rates seen in multifamily mean that an overall rise in cap rates will likely cause an increase for the sector. Put another way: “…sectors that have been transacting at very low cap rates have little place to go but up.”
Is a bump up inevitable?
Earlier this year, the National Association of Realtors (NAR) predicted only a modest rise in cap rates in 2022, counterbalanced by upward pressure in CRE prices. NAR notes that sales price growth has been on the up, especially for the industrial and multifamily sectors.
Moody’s Head of CRE Economic Analysis, Kevin Fagan, adds:
“There are strong opinions in the market both ways, that cap rates will go up significantly with rising rates, and others saying that cap rates will go down, and demand and expectations of rent growth will compress risk premiums.”
In a May 2022 interview with Wealth Management, Fagan added that the biggest headwinds currently facing US CRE are a combination of inflation, lower consumer expenditure and the risk of a recession.
Moody’s adds that, given the current economic climate, the chances of 2022 being a recession year have risen to 33%, while 2023 faces an “uncomfortable 50% probability” of a recession setting in.
Taking the long view
Though these predictions certainly add some uncertainty in the coming year, worth bearing in mind is that the outcome of the current volatility is far from set in stone. The way these factors play out in the CRE market remains to be seen.
For now, Moody’s takeaway prediction is that we should “expect to see more volatility in transaction and capital markets before we record pronounced effects on rents and vacancies.”
SOCIAL: Have you seen any movement in cap rates in your area? And what sectors do you think will be most affected?
Growing up in a small town in western Pennsylvania meant that I wasn’t necessarily on the cutting edge of technology. Any new electronics took months if not years to trickle down and even then would usually mean a trip to bigger cities such as Youngstown or Pittsburgh to track down. A great example is the LED watch. It was initially developed in 1971 and became widely available by the mid-1970s. But it wasn’t until Darrell Knight showed up sporting one on his wrist right after Christmas break of 1978 that I actually saw one, live and in person.
The use of technology in real estate seems to follow a similar path, with innovations taking months, if not years, to be integrated into the industry. This month, we are going to discuss some ways, specifically in the area of smart buildings, that technology has finally begun to make a big impact.
While certain sectors, such as medical and clean manufacturing, have been driving advances in clean air filtration and monitoring, the advent of COVID- 19 has placed a spotlight on this topic. The result is a whole ecosystem of products and strategies known as IAQ, or indoor air quality. The most common IAQ technologies revolve around higher-efficiency filters. Humidification and dehumidification systems have also become much more advanced, helping to control dust and mold while maintaining comfort. More advanced systems assist with heat and energy recovery ventilators to offset the increasingly “air- tight” nature of modern construction, as well as UV purifiers to neutralize airborne bacteria and viruses.
Voice-and touch-activated tech
Again, this type of technology received a huge boost in the wake of COVID-19. If you have ever used systems such as Alexa, Siri or Google, you are already well aware of the power and convenience voice-activation can offer. And while touch-activated technologies have been around for decades, the overwhelming popularity of smartphones and apps are leading to more advanced applications. In the commercial real estate sector, it’s no surprise that the hotel sector has taken the lead implementing this type of technology, ranging from speaking to control lights, temperature and entertainment to accessing the room and ordering room service from your smartphone. And don’t look now but many larger commercial property owners are beginning to integrate these same technologies, offering them to their tenants as a standard building amenity.
This may seem like something reserved for only big cities such as New York, Chicago and Los Angeles.
In the commercial real estate sector, it’s no surprise that the hotel sector has taken the lead implementing [voice activation] technology, ranging from speaking to control lights, temperature and entertainment to accessing the room and ordering room service from your smartphone.
And these cities certainly began adopting technologies years ago, with the advent of apps such as SpotHero and ParkWhiz, which allow parking operators to maxi- mize their occupancy through digital notification, reservation and even sub- leasing processes. But if you’ve ever parked in the decks at Hopkins airport, you’ve probably seen another, even sim- pler example that uses a small green or red light above each space, allowing potential parkers to quickly differentiate vacant spots from occupied spots
Energy efficient systems
This can fall into two categories:
1) systems that optimize energy via continual monitoring and 2) clean or renewable energy features. The former is the real heavyweight when it comes to smart building design and is mainly based on the autonomic cycle of data analysis tasks (ACODAT) concept. Basically, the HVAC systems have a central processor that continually monitors usage, time of day, outside air temperature, building occupancy and a host of other factors to not only be reactive in running the HVAC system at peak efficiency but also be predictive by learning patterns over days, weeks and months. The latter includes a host of advances in technologies such as heat pumps and geothermal systems as well as solar- and wind-enabled sources.
The most common acknowledgement of building technology is a certification known as Leadership in Energy and Environmental Design (LEED), through the U.S. Green Building Council. A similar certification is known as the Building Research Establishment Environmental Assessment Methodology (BREEAM) rating. Both of these involve achieving points related to set standards that address carbon, energy, water, waste, transportation, materials, health and indoor environmental quality. There are many examples of LEED-certified buildings in Northeast Ohio, including the Maltz Performing Arts Center at Case Western Reserve University, UH Avon Health Center and the Children’s Museum of Cleveland, among hundreds of others.
And there have been many noteworthy projects worldwide, including the following high-achieving facilities.
Developed by Siemens, the build- ing contains a variety of dynamic and artificial intelligence to power its operation. A noteworthy feature is an advanced air volume system that can put the entire building into “green mode,” which is a setting that uses aggregated historical data to optimize humidity, air pressure and temperature. It also has a decontamination mode that raises the temperature to acceler- ate the decay of airborne virus particles.
This was the first building in Toronto to be rated as a LEED Core and Shell Platinum building. It links up Cisco’s business operations and helps to power Cisco’s Internet of Everything (IoE) while also streamlining all building data into a single network.
Arguably the most striking example of the IoE in smart buildings, the Mitie building uses automated alarms, remote systems management, machine learn- ing and data analytics to achieve a 95% accuracy rate for predictive main- tenance calls and a 3% improvement of energy usage by clients.
By the time we hit high school, Darrell Knight’s simple, push-button, red-hued LED watch had been eclipsed by a series of LCD watches that integrated features like alarms (with music, no less), stop watches and the ability to track multiple time zones. And while today’s smart buildings have shown great advances over the last two decades, the pace of technology promises to have an even greater impact on this sector.
Those keeping track of our ongoing Top Tech series will know that this regular blog is aimed at highlighting some of NAI’s key tech partners and the game-changing solutions they bring to the commercial real estate (CRE) space. These are not sponsored blogs, but rather a way for us to share tools, technology, and ideas that are changing CRE for the better and streamlining and improving the services we offer.
This month’s partner is Apollo Energies. Below we discuss their approach to creating carbon-free properties and helping clients hit ambitious Environmental, Social, and Governance (ESG) goals.
What does Apollo Energies do?
The starting point for Apollo’s commercial services is typically an energy audit that helps clients determine the best way to streamline their building’s operations and bump up energy efficiency. Apollo also advises clients on how to meet safety, health, and wellbeing requirements in line with today’s ESG standards.
In recent years, there’s been an increasing push for corporate entities to meet sustainability commitments and to be able to show their progress. ESG criteria, which detail the goals these companies must meet, are also being used by investors and the public to evaluate the impact that company has on society and the environment.
With a focus on the ‘E’ of ESG, Apollo aims to help its partners meet the right goals, and lower their own energy spend in a clearly documented and reportable way. Their approach includes evaluating carbon emissions from a company’s operations, reducing carbon tied to power use, and assessing the carbon impact of the enterprise’s supply chains.
They also work with clients to meet benchmarks for Energy Star® certification, identifying their buildings as top performers in energy efficiency and ESG accountability.
The results of this focus and dedication are certainly impressive, and one of the reasons Apollo are a top choice among NAI brokerages across the country. At time of writing, the company has improved some 52 million square feet of building space and saved nearly 7.5 million kilowatt-hours (kWh) of energy across their client base.
There’s no getting around it – the last couple of years have not been kind to the office sector. The way we work and use office space is also changing, leading to what many consider a fundamental shift in how business, and office real estate, operates. While some consider these developments a chance to reevaluate what adds value in office, for others 23the signal is far more bearish.
Recently, Bisnow reported on a study that falls into the second camp, stating that office values are set to drop by $500 billion by 2029. Reasons given for this dramatic downturn included work-from-home and the resulting change in office risk premiums.
Breaking down the office downturn
The study in question, titled: “Work From Home and the Office Real Estate Apocalypse” suggests that 2020’s losses are just the beginning and that the sector should buckle up for a rough few years ahead.
The authors, focusing on data from the New York market, say that office should prepare for a 28% decline in value in the long run. Drivers of the decline include changes in lease revenues, office occupancy, lease renewal rates, and rents. They add that the impacts are much heavier for ‘low quality’ office buildings, and we can expect the ongoing ‘flight to quality’ to buffer the effects for high-end properties.
Another angle on office
It’s a pretty dire set of predictions for the sector, but, as is often the case, there’s some strong disagreement from other analysts. In a recent report, Moody’s Analytics painted a somewhat different picture, stating: “A two-year onslaught of gloomy, sometimes hyperbolic headlines about the future of office and cities could give casual observers the impression that urban areas are on a course to become post-apocalyptic ghost towns… However, doomsday headlines are at odds with empirical office performance.”
Moody’s went on to highlight that many office markets rebounded strongly in 2021, and that office loan delinquencies are still low, despite economic uncertainty.
Interestingly, the Moody’s analysis also points out that the New York market was one of the hardest hit in terms of rent growth, but that rent and occupancy decline is still less than what’s been seen in past cycles. They add that, overall, the evidence for a sustained decline in office occupancy or value is lacking, and that tenants are still signing and honoring lease agreements.
Moody’s takeaway from all of this? In the words of the report: “The office apocalypse is clearly on hold.”
A balanced view
As the above viewpoints show, the future of the office sector is a topic that currently generates a lot of strong opinions. How things play out in the long-term, however, remains to be seen. For our part, we’ll keep a practiced eye on the sector as prospects, and opportunities, continue to unfold.
SOCIAL: What have your own observations been of market trends in the office space this year? And what’s your go-to source when dealing with conflicting market information?
We have experienced, either directly or indirectly, all sorts of changes over the last few years. We are paying more at the pump each time we fill up, we are waiting longer for certain products that may or may not show up and we probably know companies that are desperate to hire workers that simply cannot turn up.
As we continue through a summer of uncertainty, the questions are not just increasing but also getting tougher. Everyone wants answers but few know where to look. This month, I’m going to review some of the most common economic indicators. When viewed collectively, these can provide significant insight.
Gross domestic product (GDP)
This is a basic measure of overall production for the U.S. economy, including the value of all finished goods and services that were produced in a given time period. During times of expansion, the GDP will increase. Real GDP will include the impact of inflation while nominal GDP considers the current market prices. This measure is produced by the Bureau of Economic Analysis, which is a division of the Department of Commerce. It is reported each quarter, generally released within four weeks of the end of the quarter. Most will use the associated change, on a percentage basis, from one quarter to the next. For the most recent quarter as of press time, first quarter 2022, GDP decreased 1.6%.
Consumer price index (CPI)
This tracks the changes in prices for what is considered a market basket of consumer goods and services. These include items such as energy, food, apparel, education, new vehicles and medical services, among others. As such, it is also the most common measure of inflation. CPI is tracked and produced by the Bureau of Labor Statistics and can be sorted by various base indexes and geography, but the most common is the All Urban Consumers (CPI-U). This index increased 1.0% in May 2022 and 8.6% over the trailing 12 months. The report is produced monthly and is generally available within two weeks after the end of the month.
U.S. unemployment rate This measures the total number of workers currently unemployed as a percentage of the total workforce. It is also tracked and produced by the Bureau of Labor Statistics and, similar to CPI, it can be broken down by job sector, such as Transportation & Warehouse, Construction and Manufacturing, as well as by geography. The unemployment rate for May 2022 was 3.6%. This index is produced monthly and generally available the Friday following the last day of the month.
Consumer spending This tracks consumer spending on goods and services by U.S. residences. It is similar to GDP in a few ways. First, it will increase during times of expansion. Second, it illustrates the change, on a percentage basis, from a previous time period. And finally, it is produced by the Bureau of Economic Analysis, who also produce GDP. This index was up 0.9% in April and 6.3% over the trailing 12 months. It is produced monthly, generally released by the end of the last weekday of the following month.
As we head into a summer of uncertainty, the questions are not just increasing but also getting tougher. Everyone wants answers but few know where to look.
Home sales This measures sales volume and prices of existing single-family homes in the U.S., including condos. It also breaks down the country by geographic regions. As with many of the indicators, a common metric is the percentage change from the prior period. This measure is tracked and produced by the National Association of Realtors (NAR), who publish it monthly. It is typically released on or about the 20th of the following month. For April 2022, home sales decreased 3.4% but the median sale price exceeded $400,000 for the first time ever, coming in at $407,600.
Housing starts This report tracks housing starts, as well as building permits and housing completions, associated with privately owned, single-family homes. Like many of these indexes, the information can be separated on a regional basis and is produced each month. It is produced on a joint basis by the U.S. Census Bureau and the U.S. Department of Housing. For May 2022, there were 1,549,000 housing starts, which was a 14.4% decrease over the starts in April. It is typically released on or about the 15th of the following month. Federal Reserve beige book If anyone has their finger on the pulse of the U.S. economy, it’s the Federal Reserve – or, as discussed next, perhaps they are the pulse. Eight times a year, they publish a compilation of reports collected from each of the 12 regional banks that make up the system. The result is a sampling of information; some is anecdotal, and some is statistical but all of it is insightful. The most recent edition came out June 1, with future editions scheduled for July 13, September 7, October 19 and November 30. Federal Reserve meeting Few events have more impact on the U.S. economy than the regularly scheduled meeting of the Federal Reserve Board. At these meetings, all sorts of decisions are made directly related to monetary policy, including the (in)famous discount or federal funds rate. The most recent meeting in June 2022 sent shockwaves worldwide when the Fed raised interest rates by 0.75%. This is the largest increase since 1994. The Fed meets a total of eight times a year, with the remaining meetings scheduled for July 26 & 27, September 20 & 21, November 1 & 2 and December 13 & 14. The list above is by no means all inclusive, as there are all sorts of other meaningful and insightful indexes, reports and surveys available. The key is to focus in on a group and consistently track it every month. As the old saying goes – the past is history, and the future is a mystery. But indexes and reports can definitely help to make today a present.
Few events have more impact on the U.S. economy than the regularly scheduled meeting of the Federal Reserve Board. At these meetings, all sorts of decisions are made directly related to monetary policy, including the (in)famous discount or federal funds rate.
New Zealand’s city of Hamilton – or Kirikiriroa in Maori – sits on the banks of the famous Waikato River which features heavily in its sights and site. In this city known for its beautiful greenery and walks, the most popular tourist attraction is the 54-hectare Hamilton Gardens.
With a population of just under 200,000 people, Hamilton is the fourth most populous city in the country. In 2020, it was named ‘most beautiful large city in New Zealand’. The wider Hamilton Urban Area includes Ngāruawāhia, Te Awamutu, and Cambridge, which collectively cover some 110 square kilometers of land. It is also the third fastest-growing urban area.
Leading industries and outputs
Hamilton’s economic heritage is as an agricultural services hub, particularly dairy cattle, and vegetable farming, but it also has thriving business services, construction, and health and community services. Additionally, R&D is an emerging sphere, given the city’s high tertiary educated population.
Residential market factors
New Zealand has typically seen high demand and low supply for residential housing in recent years which has kept prices elevated. There are, however, some movements in the markets, and new regulations around lending coming into play that could mean fewer residential buyers would qualify and those that do could be in for “bargains” in 2022 – according to a January 2022 report from Stuff.co.nz citing Mortgage Lab chief executive Rupert Gough.
Additionally, Realestate.co.nz recently reported new house listings in November 2021 were hitting their highest level in seven years, and Stuff.co.nz added that data from Infometric showing consent and permissions for new build projects were also much increased, compared year on year.
Our Hamilton reports that the city’s “total property Capital Value (the total value of the land and any buildings on it) increased 53%, and Land Value 67% since 2018”. “On average,” the article continues, ‘Capital Values for commercial and industrial property have increased by 40% across the city”.
Insight from NAI Harcourts in the country suggests that industrial will remain “the darling of the three commercial property sectors”, but also that there is momentum in the Hamilton office market, which they characterized as coming from a “flight to quality” that was pushing local business in the central business districts to up their game.For more regional insight, contact NAI Global’s partners in Hamilton and surrounds.
I’m always pleased to see comments from loyal readers. Most of the time, these are complimentary. But as a wise Yoda once told me, “Compliments grow flowers, but criticisms grow roots.” And while one of the comments I received in response to last month’s column wasn’t a criticism, it was insightful.
The gist was a historically limited viewpoint from the lender’s perspective. The comment wasn’t wrong; prior to the concept of 365/360 loan amortization covered last month, it had been a few years since anything related to the lender’s perspective was considered. And make no mistake – lenders are a dominant part of the commercial real estate landscape. Last year, nearly $4 trillion of capital invested in commercial real estate came from lenders, as compared to $2.7 trillion of equity. Given the significant role that lenders play, this month will be a bit of a ‘two-fer’ and follow up on some basic metrics that a lender uses to determine the appropriate level of participation in an investment.
One of the most common (and easy to understand) metrics used by a lender is the loan-to-value (or LTV) ratio. This approach considers the underlying value of the real estate as compared to a ratio established by the lender. For example, the lender determines a property to have a value of $1 million and has established a 75% LTV ratio.
In this instance, the lender would be willing to provide a maximum loan of $750,000 ($1,000,000 x .75). Another metric related to LTV but less common is the leveraged ratio. It measures the amount of equity as compared to the total investment. In the example above, the leveraged ratio would be 4:1, which means that every dollar of equity equates to four dollars of total value ($1,000,000 divided by $250,000). LTV and leveraged ratio are both focused on the underlying value of the real estate, but a lender will also look at the income characteristics of the asset. A primary measure with this focus is known as the debt service coverage ratio (or DSCR), which helps to ensure the property has sufficient cash flow to make the loan payments. LTV and leveraged ratio are simple and only require one step. DSCR is a bit more involved and requires two steps. The first step is to determine the maximum annual debt service given the property’s income, as represented by net operating income (NOI) and the DCSR established by the lender.
This ensures there is not just enough but more than enough income to service the debt. Assume a property has a NOI of $80,000 and the lender establishes a DCSR of 1.25. In this instance, the maximum annual debt service would be $64,000 ($80,000 divided by 1.25). This ensures a measure of safety for the lender, as the NOI could fall by up to
Another metric that has risen in popularity over the last decade is known as debt yield, which represents the percent of NOI as compared to the original loan amount. This is a helpful measure of risk for a lender as it illustrates the yield that a lender would realize if they were to come into a direct ownership position due to a default by the borrower. It is also a valuable metric as it helps to ensure the loan amount is not inflated by low cap rates, low interest rates or a long amortization period. Calculating this is straight-for- ward: dividing NOI by the loan amount. Again, using our example and assuming a $750,000 loan, the debt yield would be $80,000 divided by $750,000 = 9.375%.
The last metric I would like to discuss is also one that has been around the longest the venerable loan constant. It measures the annual debt service, including principal and interest, as compared to the original loan amount. Using our example and again assuming a $750,000 loan, the loan constant would be $61,910 divided by $750,000 = 8.255%. At the risk of sounding like the kid that had to walk to school and back uphill and in two feet of snow, a loan constant was used to calculate loan payments in the days before financial calculators. The cutting-edge real estate tool back then was a little book with a red cover entitled “The Ellwood Tables.” It was filled with pages upon pages of tables with eight-digit numbers.
At the risk of sounding like the kid that had to walk to school and backup hill and in two feet of snow, a loan constant was used to calculate loan payments in the days before financial calculators. The cutting- edge real estate tool back then was a little book with a red cover entitled “The Ellwood Tables.”
To use it, you would match up the columns for the lender’s nominal interest rate and loan amortization period. Once the corresponding eight-digit number was found, you multiplied it by the initial loan amount and, shazam, the annual debt service would be known. In the example above, matching up the column for a 20-year loan amortization with the row for 5.5% interest would result in a factor of .08254667.
Upon reviewing a sampling of past articles, the topics associated with mortgages and the debt market are indeed far and few between. And if it wasn’t for some- one taking the time to point this out, this month’s article would likely have been centered around internal rate of return, net present value or cap rates.
In May, law firm DLA Piper released the 2022 edition of their Annual State of the Market Survey report, highlighting that “optimism about the future of commercial real estate (CRE)” remains strong despite the headwinds the industry faces.
The survey on which the report is built was conducted in February and March of 2022, by collating and analyzing input from CRE leaders and professionals in the US – specifically their take on matters including “pandemic recovery, economic outlook, attractiveness of investment markets and overall expectations over the next 12 months”. This input is further contextualized with additional research, presented the report.
Overall, the report [PDF] shows “increased bullishness”, with “more respondents in 2022 [having] a higher level of confidence for the real estate industry’s next 12 months”.
Findings from the report also include that 73 percent of respondents are “expecting a bullish market”. This is consistent with 2021 expectations. “However,” they added, “this year, respondents reported feeling a higher level of confidence in a bull market over the next 12 months; 33 percent described their bullishness as an 8 or higher in 2022, compared to just 16 percent in 2021.”
Top contributing reasons include the apparent availability of capital in the market, with over half of the respondents citing this as the main source of their confidence.
Viewed per sector, Commercial Property Executive says in their analysis of the report, “Industrial (66 percent) and multifamily (57 percent) remain the property types that investors believe offer the best risk-adjusted returns over the next 12 months.”
Inflation and interest rate changes were ranked most likely to have an impact specifically in the CRE market in the coming year, but ecommerce, migration of workers out of city centers, and the “redesign/reimagining use of office and other commercial spaces” were also common responses.
Top concerns included interest rate increases (cited by 26 percent of respondents), inflation (18 percent), as well as the Russian invasion of Ukraine.
US gains and advice
Finally, respondents to the survey said they felt the US would be seen as a safe and stable option, attracting non-US investment. “During times of uncertainty – like the pandemic or the conflict in Ukraine — investors often flock to safe havens,” the report reads, adding “a well-defined legal system, transparency and proven economic resiliency” are among the US’s assets.
In the face of global uncertainty though, the report authors caution that CRE professionals and firms must “remain agile and prioritize adaption, with an eye towards staying ahead of the curve”.
SOCIAL: Do you see the US CRE market as a safe haven in times of global uncertainty? How do you expect inflation to make itself known in your CRE specialty?
The Q2 2022 has been a scary ride for markets and investors around the world. Increased geopolitical tensions, widespread inflation, and rising interest rates in many territories have been a cause for concern, and the capital markets bore the brunt of that low sentiment.
A recent look at the numbers shows that real estate investment trusts (REITs) didn’t escape the sell-off.
Crunching the numbers
The FTSE Nareit All Equity REITs index shows a decline of 3.66 percent in April. This is, as Wealth Management succinctly argues, “a major reversal from 2021, when REITs posted a 40 percent rise in total returns”.
Benchmarking against peers
Despite this, REIT total returns are trending stronger than many other indices in 2022, including some “darlings of the market” like S&P 500 (contracted 12.92 percent) and the Dow Jones Industrial Average (declined by 8.73 percent).
A history of performance
Bezinga data says: “The FTSE Nareit All Equity REITs index has outperformed the S&P 500 in total returns during 13 out of the last 20 years with an average total annual return of 13.1% versus 11.1% for the S&P 500 over the same time period”.
REITs use case
As an investment vehicle type, REITs are considered one of the most accessible ways for individuals to buy into commercial real estate (CRE), which has long been the terrain of institutional investors.
Although regulation changes have opened up this category in recent years, REITs still enjoy popularity with retail investors for the above reasons, and the relatively high dividend yields.
Although we do not offer this as financial advice and individual investment products must be reviewed on their own fundamentals, REITs are still largely considered an inflation hedge when rents are rising – making them one fascinating asset type to watch in 2022.
A recent report – released in late May 2022 – shows the industrial commercial real estate (CRE) boom is far from over, even when the “headwinds” are accounted for.
The May 2022 Matrix Industrial Report, from Yardi Matrix, says that although the “economy hit a rough patch in the first quarter due to inflationary pressures and rising energy prices, […] demand for industrial space continues to be robust”.
The continued presence of market fundamentals like increased consumer spending and job growth are adding to the sense of resilience seen from the sector, which has made huge strides since the dawn of Covid-19 kicked online shopping and fulfilment into particularly high gear.
CRE in general and the industrial CRE sector in particular do face a range of economic pressures as we look to the second half of the year. Slower economic growth in the first quarter, supply chain issues, and “persistent inflationary pressures” are not insignificant depressive factors, but the drivers of demand are not going anywhere either.
The boost factors, on the other hand, include “healthy consumer spending”, and “the need to bring the nation’s stock up to snuff to support modern logistics”.
Additionally, occupancy across most US metros remains high and “rents are growing well above historical levels around the country,” according to the report. Rental averages across the US have increased by 440 basis points year-on-year.
Industrial building supply chain
The report calls the new supply chain for industrial building “extraordinarily robust”, but, as Commercial Property Executive reporting on the report highlights, “[a]lthough the under-construction pipeline is ballooning, experts see the industrial market as severely undersupplied”.
This assessment, from Prologis, draws from several different data sources including the Purchasing Managers Index, retail sales data, and job growth statistics, to posit that the US has “16 months of available industrial inventory”.
Reportedly, over 640 million square feet of industrial space was under construction nationwide at the end of April. Including planned projects takes the pipeline to 650 million square feet.
Far from being a US-only trend, demand for industrial is high among most developed economies – or almost anywhere with a strong consumer base demanding more and quicker online shopping and delivery.
As this Financial Times article shows, that’s the case even where Amazon space acquisition is slowing: “There has been record demand for UK warehouses in the past two years,” they write, “with take-up north of 50 [million] square feet compared with a pre-pandemic average of 32 [million square feet]”.
Social: Are you operating in a well-supplied industrial CRE market, or are people scrambling to find space? Tell us where in the world you are, and what the “pulse of industrial” is in your region?
Foreclosures in the US were up in the first quarter of 2022 – setting what the data provider calls a “post pandemic high”. The data provider in this case is Attom, who specialize in real estate and property data – including tax, mortgage, deed, risk and other information for “over 155 million properties” country-wide.
It must be noted however that this level of foreclosure activity is still considerably better than the highs seen in 2020, before government intervention (more below).
A tale of two months
Attom’s Q1 2022 U.S. Foreclosure Market Report – released in April 2022 – shows a total of 78 271 properties filed for foreclosure in the first quarter of 2022. This is, they write, “up 39% from the previous quarter and up 132% from a year ago”.
Additionally, in March 2022 alone, the data indicates over 33 000 US property foreclosure filings – an increase of 29% from the prior month, and 181% compared to March 2021.
A mere month later, however, in the month-to-month reporting from the same provider (April 2022, released in mid-May), showed “a total of 30,674 properties with foreclosure filings — default notices, scheduled auctions or bank repossessions”. This was down 8% from March, but up 160% from April 2021.
Questioning the headline
As covered before on this blog, it is important to assess data and market reports like this one as pieces of a larger picture – viewed in context of time and other indexes. It is also worth noting that there is typically a delay between economic “crunch”, consumers feeling the pressure, and market movements showing the effects of said pressure.
The above caveats notwithstanding, the trend line this report highlights is concerning for investors who watch the residential market, and commercial brokers whose specialty/sectors are affected by residential, such as multi-family.
Specifically, the data point that March 2022 was “the 11th consecutive month with a year-over-year increase in U.S. foreclosure activity”, is not a positive direction for this metric.
Post-moratorium balancingWriting about the Q1 2022 “record”, a spokesperson for Attom explained that this foreclosure activity is “gradually return[ing] to normal levels since the expiration of the government’s moratorium” and the CFPB’s enhanced mortgage servicing guidelines”.
What economic and commercial property data do you keep a close eye on?
According to a recent article by the Massachusetts Institute of Technology (MIT), things are moving fast in the Asian real estate market. More specifically, MIT outlines that: “Every 40 days, a city the equivalent size of Boston is built in Asia.”
And while this means exciting development prospects for anyone involved in Asian commercial real estate (CRE), it also means that sustainability, and an innovative approach to growth, are becoming ever more important.
With those issues in mind, MIT’s Center for Real Estate (MIT CRE) recently launched the Asia Real Estate Initiative (AREI), with the goal of “connecting sustainability and technology in real estate.”
Addressing climate issues through innovation
During 2021’s United Nations Climate Change Conference, the real estate sector was identified as a key target for reducing global emissions, and one of the sectors Asian governments are aiming to transform to meet environmental targets.
Zhengzhen Tan, director of AREI, puts it like this: “One of the most pressing calls is to get to net-zero emissions for real estate development and operation.”
As a part of that goal, AREI is focusing on research across three main themes:
The future of real estate and live-work-play dynamics;
Connecting sustainability and technology in real estate; and
Innovations in real estate finance and business
Tan points out that the choices investors and developers make in the region now will “lock in environmental footprints” for the next decade and adds: “We hope to inspire developers and investors to think differently and get out of their comfort zone.”
Sustainability in mind in 2022
The initiative comes in the midst of a strong recovery trend for Asian CRE markets, with PwC’s Emerging Trends in Real Estate® Asia Pacific 2022 report noting that: “Transactions are rebounding after nearly two years of lockdowns and travel embargoes.” The report also adds, however, that the investment landscape in Asia has changed, particularly in terms of how different real estate assets are used.
One of the key trends highlighted in the report is a move towards renovating buildings to change usage or upgrade their environmental performance to a higher standard.
Speaking to the impact AREI is expected to have on this developing landscape, faculty director of MIT CRE and AREI faculty chair, Professor Siqi Zheng, had this to say: “The research on real estate sustainability and technology could transform this industry and help invent global real estate of the future.”
He adds that merging tech and real estate can help developers build out strategies that are “green, smart, and healthy.”
Global climate concerns
In the coming years, it’s likely CRE will see a larger global shift towards these types of sustainability initiatives as developers and investors become more environmentally conscious, and aim to address climate change challenges. For the savvy CRE professional, it’s a space worth keeping a sharp eye on as we move to make green initiatives part of the broader real estate picture.
Seoul is the capital of South Korea – officially the Republic of Korea. It is a massive, bustling city known for its amazing street food, pop culture influence, and cutting-edge technology, but it’s also an ancient city with many sites of historic significance.
This clash of the new and old – temples and skyscrapers, street markets, and teched-out headquarters – is one of the many reasons that Seoul remains a popular destination for global and regional tourists, while its robust and advanced infrastructure keeps it a business hub too.
Geared for industry and export
South Korea’s economic success is one for the textbooks – countless case studies have been done on the rapid transformation that took this economy from a “developing nation” to a global leader in record time. These days, South Korea is one of the top five largest economies in Asia, and within the top ten in the world – or 14th by some estimates.
Today, the gross domestic product (GDP) hovers around the $2 trillion mark – driven by an emphasis on research and development, value chain dominance, exports, and a highly-skilled workforce. Seoul is the epicenter of the economic activity in the country, especially in terms of electronics and finance.
Leading industries in Korea include electronics (especially semiconductors and mobile phones), telecommunications, vehicle production, shipbuilding, steel, and chemicals. Additionally, the economy of South Korea is largely export-oriented.
According to NAI Global’s partner in Seoul, NAI Korea, the country’s economy showed “clear signs of rapid recovery in 2021 with the economy expanding 4% year-on-year and is expected to be about the same in 2022”.
Residential market factors
In terms of population, Seoul has been designated a mega-city for having more than ten million residents. Residents typically enjoy high levels of education and employment, but housing does come with a certain premium – as in any large city.
To address this, the city government recently agreed to lift the 35-story restriction on residential buildings. Property prices tracking in the city is a mixed bag, but largely steady — with some parties recording a 0,03 percent decline recently and others a 0,01 percent increase.
Commercial property outlook
Office space, logistics, and warehousing remain “top of the pops” for Seoul commercial real estate, with major companies like Samsung, chip maker TES, Hyundai, and LG, as well as offices of Amazon, Deloitte, and IBM, all maintaining a considerable presence in the city.
Significant portions of Seoul have been earmarked for rejuvenation, while other regions – such as Gangnam – have enjoyed lengthy periods of consistent interest and investment. Where public spending on rejuvenation has been undertaken, significant public and commercial benefits have been realized.
For example, greening and restoration of the Cheonggyecheon district had a dramatic impact on land prices therein. As the World Bank notes: “Before the restoration, land prices within a 100-meter radius of the Cheonggyecheon were only 15 percent higher compared to those within a 600-meter radius. However, after the transformation to a green space, the gap in value doubled by 30 percent.”
Recent data from the Mortgage Bankers Association’s (MBA) latest Commercial/Multifamily Mortgage Debt Outstanding report shows that the level of outstanding debt on commercial/multifamily mortgages – during the final three months of 2021 – was $287 billion (7.4 percent) higher than the level seen at the end of 2020.
The MBA releases this data on a quarterly basis and this provides a snapshot of debt and market health at the time. Released at the end of March 2022, this report focuses on the last quarter of 2021 – and compares figures to the preceding quarter and the corresponding quarter of the previous year.
For the purposes of this research, the four major investor groups considered include: “bank and thrift; commercial mortgage-backed securities (CMBS), collateralized debt obligation (CDO) and other asset-backed securities (ABS) issues; federal agency and government-sponsored enterprise (GSE) portfolios and mortgage-backed securities (MBS); and life insurance companies”.
Their data shows that “total mortgage debt outstanding rose by 2.9 percent ($116.0 billion) in fourth-quarter 2021” and specifically that “multifamily mortgage debt grew by $42.1 billion (2.4 percent) to $1.81 trillion during the fourth quarter, and by $121.9 billion (7.2 percent) for the entire year”.
Understanding the data
MBA’s Vice President of Commercial Real Estate Research Jamie Woodwell commented: “Strong borrowing and lending backed by commercial and multifamily properties drove the level of mortgage debt outstanding to a new high at the end of 2021.”
This was evident in every major capital source, he said, adding: “The 7.4 percent annual increase in outstanding debt compares to a 19.5 percent increase in underlying property values.”
As Yield Pro points out in their analysis, government-sponsored enterprises (GSE) “continued to have the largest share of multifamily mortgages outstanding”.
In related material, MBA confirmed that commercial and multifamily mortgage delinquencies in the US also declined in Q4 2021, characterizing the rates as “down or flat for every major investor group”.
The general feeling seemed to be that 2022 will build on the overall strong figures from 2021, carrying forward the market momentum despite concerns from some about headwinds from the current rates environment. As with last year, specific asset classes are again expected to steal the show in terms of growth metrics.
Multifamily and industrial: Still real estate darlings
One of the strongest performers is multifamily, with a large part of the one trillion USD forecast attributable to properties in this class. Lending for multifamily is expected to make up 493 billion USD of the overall total, a 5% increase on 2021’s 470 billion USD.
The ongoing demand for these asset classes is unsurprising, given their recent performance. In 2021, both classes recorded record-breaking metrics for rent growth according to Moody’s Multifamily and CRE in 2021 analysis.
For multifamily, Moody’s reported that: “asking and effective rents grew by 7.5% and 7.9%, respectively.” These figures present the highest growth rates on record since the start of quarterly data recording in 1999. Multifamily vacancy rates also dropped to pre-pandemic levels by Q3, making these properties an increasingly sure-footed investment.
The third quarter also posted some strong gains for industrial, with vacancies falling to 8% and effective rents reaching 1.9%, the strongest quarterly growth for the class in five years. In particular, warehouses turned out to be one of 2021’s savviest investments.
Moody’s reports that vacancies for warehouse properties dropped to 7.5% by Q3 and effective rents rose a staggering 3%, the highest upwards shift in over 10 years.
Looking ahead to 2023, MBA predicts similarly high numbers, with commercial borrowing and lending expected to exceed 1 trillion USD for the year. Multifamily remains their top contender and with around 474 billion USD in lending anticipated.
Worth bearing in mind, however, is that there’s always the potential for a market shift, so we’ll be keeping a close eye on incoming predictions as we move ahead in 2022.
SOCIAL: How are multifamily vacancy rates and rentals adjusting in your area? And do you anticipate that the trend will continue?
In a recent NAI article, we looked at the advent of the metaverse[SR1] and what this new tech might mean for commercial real estate (CRE). Though we concluded that the answer to how the metaverse might impact the real world remains uncertain, since then, there have been some interesting virtual developments.
To be clear, the “mortgages” in this case are funded entirely by TerraZero itself, rather than an external financial institution, but employ a system of down payment and instalments, much like the real thing. The first one was issued for a piece of land on a platform called Decentraland, where users can own, and sell, virtual assets. And as strange as this all sounds from a real estate perspective, there have recently been several big players setting up shop in the virtual world.
Perhaps the biggest, from a credibility point of view, is global financial leaders JPMorgan who recently launched a “virtual bank”, though at the moment it’s only being used for marketing purposes. In tandem with the purchase, JPMorgan issued a report, where they discuss their expectations for the metaverse’s development, saying:
“The success of building and scaling in the metaverse is dependent on having a robust and flexible financial ecosystem that will allow users to seamlessly connect between the physical and virtual worlds.”
They added that, in just the last six months of 2021, the average price for a virtual plot of land jumped from $6,000 to $12,000.
Despite this apparent endorsement from one of the world’s leading financiers, there are still plenty of metaverse critics urging caution. One of the main points raised is that, unlike physical real estate, metaverse purchases can’t satisfy both property value fundamentals: namely scarcity and location.
Or as Louis Rosenberg, CEO of Unanimous AI and a veteran Augmented Reality (AR) developer, puts it:
“We don’t even know which platforms are [going to] be popular, let alone which locations… so it’s like somebody buying a piece of land anywhere in America and hoping that it becomes San Francisco or New York.”
For many companies though, hedging bets is taking the form of securing their own piece of the virtual pie. The Wall Street Journal reports that accounting firms PricewaterhouseCoopers and Prager Metis have also recently snapped up virtual sites, with the latter spending $35,000 on its purchase of a virtual HQ.
Is the metaverse here to stay?
Though it’s still early days, and impossible to say how the virtual property trend might play out, the recent developments in the space suggest it’s certainly worth keeping an eye on. At the very least, the metaverse poses an interesting proposition, and one a lot of people seem to be willing to speculate on.
SOCIAL: Do you think there’s a future for metaverse property? And if so, how do you see it unfolding?
Over the past few years, the use of drone technology in the commercial sector has seen massive growth, with drones being used for everything from agriculture to law enforcement.
In the commercial real estate (CRE) context, the value of drone technology is also rapidly becoming apparent. Drones deployed for site inspections can save time and money, in addition to keeping personnel out of harm’s way. In the event of disasters and damage to premises, drone photography provides accurate images for insurance purposes and a detailed catalog of damage.
In this latest blog in our ongoing tech series, we explore these applications in more detail, along with other smart technologies that are changing how we approach real estate development and management.
One of the main areas where drones add value is by enabling fast and accurate building inspections. Processes that would normally take a long time for a human team, such as surveying rooftops, can be completed in a single programmed flyover. There is also potential for the technology to be deployed for façade inspections and other critical, but time-intensive, maintenance operations.
The advantage of using drones for these tasks is that they can access areas that are difficult, or even dangerous for human crews. And they do it in a fraction of the time.
When equipped with the appropriate hardware, like thermal imaging cameras, drones can also check on a building’s heat loss profile, potential gas leaks, and even expedite operations during construction, all while making the overall project more sustainable.
Easing insurance and investment
Drone surveys can also add value during dealmaking, with detailed drone imagery that lowers investment risk when properties are changing hands. With a flyover, it becomes a matter of a few minutes to figure out whether a property shows signs of external structural issues. The task of valuation also becomes easier, allowing property sales to proceed smoothly.
As a recent Wall Street Journal article points out, there’s also been wide-scale adoption of drone technology in the insurance industry. The use case here is rapid assessment of claims and the ability to respond to critical situations, such as assessing property damage after a natural disaster.
Quoted in the article, Travelers Insurance VP, Jim Wucherpfennig, puts it like this:
“The technology allows us to write damage estimates more quickly for our customers, pay them more quickly, so that they can begin the repairs to their property and get back on their feet.”
As with maintenance inspections, he adds that deploying drones to these sites ensures that claims professionals are kept out of harm’s way in potentially dangerous areas.
Smart glasses and CRE
A second technology that is gaining traction for site inspections is Augmented Reality (AR) “smart glasses”. In essence, smart glasses allow the user to combine what they are seeing in the real world with superimposed virtual tools, making it easier to measure and quantify key parameters during construction and development.
As an example, on a building site, an inspector equipped with smart glasses could take measurements just by looking at a doorframe or window and then compare their findings to virtual plans. They would also be able to photograph, record and stream what they’re seeing, ensuring no details are missed during an inspection.
Like drones, smart glasses also enhance on-site safety. In this case by ensuring personnel can focus on what’s in front of them, rather than the tablet or smartphone in their hand.
What’s important to bear in mind is that these technologies don’t negate the need for human intervention. Rather, they shift the human element to the controller’s seat.
The photographic surveys undertaken by drones, for example, still need to be interpreted by human experts. Similarly, the video feed from a pair of smart glasses still streams back to the team at the office, who are then enabled to support decision-making processes at the site. So instead of replacing human expertise, these technologies supplement it, providing the means to optimize routine operations.
For CRE professionals, these technologies offer another tool to add to the toolbox. And some extra options for making deal negotiations as smooth and seamless as possible.
Social: Are smart tech and drones already part of your CRE environment? And how do you see this space developing?
One of my favorite types of cuisine is Thai food. I love the variety, flavors and especially the spiciness. Like many, I have my favorite go-to location but was recently in Scottsdale, came across a Thai restaurant and had to give it a try.
While the curry dish that I ordered was fantastic, I made a classic blunder that rendered it almost inedible. With Thai food, it’s common to be able to select a specific spice level, typically expressed as a range from one to 10. At my Lakewood go-to, I always chose a four, which hits me just right. And of course, I did the same thing at this Scottsdale establishment – after all, a four is a four is a four, right? After almost having my eyeballs melt, I was quickly reminded of the danger of assumptions and how a four in Lakewood, Ohio can mean something very different as compared to a four in Scottsdale, Arizona. I know what you are thinking right about now; how is Pacella ever going to tie red curry to real estate? And by now, you likely know the response – read on! The next day on that Scottsdale trip, I met with a developer that was building a flex-warehouse project. The discussion soon settled on economics and this developer quoted a figure that was preceded with the phrase “modified gross.” I immediately hit the brakes on the conversation, as the memory of my scorched tonsils was still very fresh. I needed to understand exactly what the developer’s definition of modified gross was, as this is one of those terms that can mean dramatically different things to different people. This month, we are going to discuss the terminology used to describe the most common lease structures. Along the way, I will point out specific items to be aware of and components that can vary. Leases generally fall into two camps: net and gross. The term “net” is an indication that, in addition to rent, the tenant is also responsible for a portion of the related occupancy expenses such as real estate taxes, insurance, common area maintenance, repairs, etc. The term “gross” is an indication that the rent includes landlord contributions to at least some portion of occupancy expenses.
The following is a hierarchy of lease types, ranging from the types with the greatest tenant responsibilities to the types with the greatest landlord responsibilities.
Absolute net lease This lease structure requires the tenant to pay for any costs related to the premises, including real estate taxes, property insurance, repairs, maintenance, utilities, etc. It also requires tenant to pay for large-scale items such as a roof replacement or new HVAC unit or even rebuilding the structure should it be damaged or destroyed. The best example of this type of lease is a ground lease, where a tenant pays rent associated with the underlying ground and is also responsible for all other types of occupancy cost, including constructing, maintaining, repairing and replacement of any improvements. This type of lease can also be referred to as a bond lease and is most often seen in single-tenant retail properties, especially restaurants.
The term “net” is an indication that, in addition to rent, the tenant is also responsible for a portion of the related occupancy expenses…. The term “gross” is an indication that the rent includes landlord contributions to at least some portion of occupancy expenses.
Triple net lease This is by far the most widely used lease term and, like the term “cap rate,” it is often thrown around with reckless abandon. While some may assume this type of lease to result in the tenant paying for everything, that’s not usually the case. Let’s talk about what the tenant does pay for – in addition to rent, the three “nets” are real estate taxes, insurance and common area maintenance. These can be paid either directly (the tenant contracts for and pays the snow plowing expense) or indirectly (the landlord contracts for and pays the snow plowing expense and then sends a bill to the tenant for reimbursement). Now let’s talk about what the tenant does not pay for. Top of the list is replacement of major items, such as roof, mechanicals, structure or parking lot. And some gray can creep into this, as the lines between maintenance and replacement can be blurry. For example, an HVAC unit may need the belts replaced and a control unit swapped out. Would that be considered a repair (and thus an expense borne by the tenant) or a replacement (and thus an expense borne by the landlord). Another item is rebuilding expense. Suppose part of the property’s façade is damaged due to high winds – is this the tenant’s responsibility to repair or the landlords? While a well- constructed lease document will make situations like these clearer, one cannot simply rely on the term “triple net” as a catch-all. This type of lease is most often seen among multi-tenant retail properties, as well as single-tenant retail, industrial and office properties.
Modified gross lease If ever there was a catch-all term, this would be it. Also known as a double net or a hybrid lease, this structure connotes that some of the expense responsibility falls on the tenant and some falls on the landlord. Unfortunately, that’s as clear as things get. Sometimes, it means that the landlord pays for insurance and common area maintenance and the tenant pays for real estate taxes. Other times, it can mean that the landlord pays for real estate taxes and the tenant pays for insurance and common area maintenance. And still other times, it may mean that the landlord pays for maintenance and real estate.
Full service gross lease typically implies that the tenant pays for all operating expenses, such as real estate taxes, insurance, repairs and maintenance of the grounds and building, etc. up to a set threshold. Future increases in these collective expenses that exceed the threshold are the responsibility of the tenant.
Full-service gross lease
This is a very common structure in multi-tenant office properties in our market. It typically implies that the tenant pays for all operating expenses, such as real estate taxes, insurance, repairs and maintenance of the grounds and building, etc. up to a set threshold. Future increases in these collective expenses that exceed the threshold are the responsibility of the tenant. The tenant is also responsible for electricity usage within their premises, sometimes referred to as “lights and plugs.” But even this common structure has some pitfalls. One is janitorial – sometimes the landlord contracts and pays for cleaning of the tenant’s premises and other times the tenant will be required to contract for cleaning directly. Another is electricity. As electrical usage can be directly metered to the tenant’s premises, it can be sub-metered to the tenant’s premises, or it can be fed via a master meter and then charged on a pro rata basis.
Absolute gross lease This structure is rarely seen, save for one type of tenant. And if any of you have ever been involved with a lease for the U.S. Government, you know exactly what I’m talking about. In an absolute gross lease, the landlord pays for everything for the entire term of the lease. There are no pass-throughs, escalations or separately metered utilities. The day the lease is signed, the tenant will know exactly what they will be paying each month for the entire duration of the lease. There is not a “one size fits all” lease structure and even when we hear a common term, there can still be nuances. As I was painfully reminded in Scottsdale, assuming you know something based on a commonly used term can be a sure way to get burned!
Vancouver, in British Columbia, is one of Canada’s most well-known and densely populated cities. It is positioned on the west coast, just 45km north of the border with the United States. Some 650 000 people live in the “city proper”, while the larger metropole (bearing the name “Greater Vancouver”) is home to almost 2.5 million people. Vancouver is reportedly Canada’s most cosmopolitan city, with an ethnically and linguistically diverse population.
The city is a popular destination for the film industry (nicknamed “Hollywood North”), and for tourists, as well as enjoying a reputation as a cultural hub with many galleries, museums, and theatres. With a busy port, rail network, and as a nexus for the transcontinental highway, Vancouver’s economy was built on trade, and has expanded to include film and TV, tourism, raw materials, construction, and technology. Recently digital entertainment and the green economy are also driving GDP growth.
Like most of the world, Vancouver was rocked by Covid-19, with business shutdowns and job losses. However, it was relatively more resilient than other Canadian metros. The region’s gross domestic product (GDP) is expected to bounce back by 6.8% in 2021, and forecast to grow by 4.1% in 2022.
By September 2021, however, the Vancouver region’s employment figures had recovered in absolute terms. The Vancouver Economic Commission says: “Some jobs have migrated sectors; retail & hospitality are still recovering, while other sectors – such as tech and construction – have gained jobs.” Employment in the Metro Vancouver area hit 101.3 in September 2021, the highest figure in the country and “finally surpassing pre-pandemic levels”.
Vancouver is the country’s most expensive residential market and the most expensive place to live, which means that while it enjoys high scores in quality of life metrics, it has priced a lot of younger buyers out of the market. It enjoys high demand, and is considered a strong commercial real estate (CRE) market – especially for the multifamily and office sectors.
Software and data provider Altus Group says CRE investment in the Vancouver market area “saw a significant surge in the second quarter of 2021”, adding that the robust multifamily and apartment market is “fueled by the highest apartment rental rate in Canada, a shortage of rental product in the construction stage, and the anticipation of border openings to international students and immigration in the near future”.
Commercial vacancies naturally increased during the pandemic (increasing from 4.4% in late 2019 to 7.5% in late 2020) and the “return to office” expectations of 2021 was tempered by news of variants and secondary outbreak waves.
Companies seeking space in the city are increasingly looking to develop former industrial space in the east, according to Business in Vancouver, with particular interest from firms in high tech and the medical and life sciences. They are however competing for space with a powerhouse industrial segment. In Q1 and Q2 2021, investment in the industrial market in Vancouver surpassed $1.1 billion, and lease pricing reached a new record high of $15.50 per square foot.
According to The Washington Post – drawing from the studies presented at the world’s largest climate science conference in December 2021 – extreme weather events as a result of climate change are here to stay, and will get worse. The word from researchers is brace yourselves for a “new era of climate disasters”.
Extreme weather has already had huge ramifications for residential property – planning, building, and critically insuring – and the global commercial property sector must grapple with the same set of issues.
Residential and commercial
In the US, a new report from nonprofit, First Street Foundation and engineering firm, Arup suggests that an estimated “730 000 retail, office and multi-unit residential properties face an annualized risk of flood damage”. The risk assessment they used did incorporate fundamentals like sea-level rise, but – the researchers told CNBC – “focused more on flash floods, also known as pluvial flooding”.
First Street Foundation previously worked with Realtor.com to enable flood scoring for all US-based residential properties, and tools like this and other research models are increasingly going to be a part of the real estate developer’s toolbox.
Harvard finance lecturer John Macomber – writing in the Harvard Business Review – says that “climate risk has become financial risk”, and he argues that owners and developers have five options open to them for risk mitigation or “in investing in resilience” as he calls it. These are “reinforce, rebuild, rebound, restrict, and retreat”.
The challenge, he concludes, is “to look ahead, not behind, and to make these choices with intent”.
New York City (NYC) is virtually synonymous with commercial real estate. It’s a mega sector there, with legendary dealmakers and eye-watering costs. With an incredibly dense population and as a home to a huge number of global headquarters, the city was not only hit hard by the Covid-19 pandemic, but also responded with some of the strongest mitigation tactics seen stateside and in the world. A report from the New York State Comptroller Thomas DiNapoli (published late 2021) now shows the true costs of Covid on NYC’s iconic commercial real estate (CRE).
Setting the scene
In 2019, reads the report, the office sector in NYC employed 1.6 million people, or a third of all city jobs. In the preceding decade, office market property values and billable values (on which property taxes are levied) had “more than doubled”. Off this incredibly strong base, employment in the office sector shrunk by 5.7% in 2020 – certainly a blow, but less than the 11.1% drop in total employment.
The gap here lies in remote work as a mitigation strategy, but that resulted in reduced office space demand. “Asking rents are down 4.2% in the second quarter of 2021, while vacancy rates are at 18.3%, a level not seen in over 30 years in New York City,” according to the report.
Market values down
The result is a steep drop in the full market value of office buildings (463 million square feet of inventory), which fell $28.6 billion citywide – based on the 2022 financial year (FY) final assessment roll. This is the first decline in total office property market values since FY 2000.
In turn, Market Watch’s analysis says, the declines “cost more than $850 million in property taxes in the city’s fiscal 2022 budget.
Charting the return
What the ledger numbers don’t indicate, though, is “what next?”. Partnership for New York says that while the labor market recovery “remains sluggish”, NYC saw “strong income and sales tax revenues and pandemic-era highs in hotel occupancy and transit ridership” during Q3 2021.
The New York City Recovery Index – a joint project of Investopedia and NY1 – puts the state of the city’s recovery at a score of 85 out of 100, or “over four-fifths of the way back to early March 2020 levels”.
The CRE shakeup has also led to some much needed strategic thought and speculation about the future for NYC, including suggestions that empty office space be converted to residential to address the city’s need for affordable housing.
Despite the ongoing uncertainty of the new virulent Omicron variant of Covid-19, there are a lot of positive signs that we can expect in 2022 for commercial real estate (CRE), according to a round-up of sources.
The case for optimism
First, however, an important caveat: Of course, all of these predictions are opinion. No matter how great the historical data used to inform those opinions, they are still not to be considered “financial advice”. Having said that, after a difficult two years (for global business, not just real estate), a little optimism is a welcome break.
“Eighty percent of respondents [to their survey] expect their institution’s revenues in 2022 to be slightly or significantly better than 2021 levels,” writes the report’s authors.
…And so does the data
Meanwhile, Forbes real estate contributor and economic analyst Calvin Schnure has done a list of predictions for the year ahead, starting with this one: “Property transactions will rise further in 2022 as the economic recovery gains momentum, and CRE prices will maintain growth in the mid-single digits. REIT mergers and acquisitions could top 2021 as well,” writes Schnure.
How does he come to this conclusion? It’s a matter of looking at the bigger (data) picture trends, he says – plotting this graph from RCA, Bloomberg and NAREIT data.
Finally, in December 2021, investment and commercial analysis publication The Motley Fool issued a “rare ‘all in’ buy alert” for CRE, offering three key points of their bullish positioning:
“Industrial and multifamily sectors look the most promising in the new year.”
“Retail and office CRE should have its good performers but see more headwinds.”
“REITs remain a promising avenue for overall returns.”
For the nitty-gritty in how they came to this conclusion, read the full analysis by author Marc Rappaport here.
As we said above, a prediction isn’t a guarantee, a forecast isn’t fact, but we think these bold analysts make a great case for optimism and a solid-looking year ahead for commercial property and investing.
From us to you, happy new year to our CRE network and peers!
Extended uncertainty about the anticipated return to the workplace will have ramifications in the securities markets, but commercial mortgage-backed securities (CMBS) are holding strong… for now.
Commercial mortgage-backed securities (CMBS) are a financial product, a type of bond issued in securities markets, and built on the cash flow from pooled mortgages on commercial properties. They are often grouped by region or type of property, such as office CMBS or multifamily CMBS.
Vacancy rate effect
Naturally, the health of the underlying category influences the CMBS itself, although, unlike direct investment, these have a degree of diversification built into the asset which represents a bundle of loans.
In the US, the office sector currently accounts for almost a third of the underlying value within CMBS, and this has institutional investors wary, despite the 38.6% improvement in office occupancy in late 2021, investment specialist Jen Ripper told Commercial Observer.
This means “upcoming lease rolls and loans” would be “under heavy investor scrutiny”, she added.
Trends over time
CMBSes have, however, been resilient throughout the Covid-19 pandemic. CRED iQ – a data company – told the publication that CMBS office debt has remained relatively unscathed, with only 2.89% in “either delinquency or special servicing”. In December, the delinquency rate declined made for a 17-month streak of improvement.
“By property type”, they added, “individual delinquency rates for lodging and retail exhibited modest month-over-month improvements but still remain the two most distressed sectors.
This is largely in line with the results from data provider Trepp, who found the delinquency rate across categories dropped 20 basis points from October to 4.41% in November 2021. Within Trepp’s report, though, lodging and retail “saw the biggest improvements”.
Beyond its relevance for investors, keeping an eye on the strength of CMBS loans can help commercial real estate (CRE) professionals in spotting opportunities and even leads – as it forms part of property debt research.
by Alec Pacella for Properties Magazine January 2022
The dust has finally settled on 2021 and, for better or worse, it looked a lot like 2020. It’s that “better or worse” part that will be the focus of my annual wrap-up column.
I’ve used this theme a few times in past columns, sometimes I termed it “best of times, worst of times’ while other times I called it “glass half full, glass half empty.’ As has been said several times in the recent past, COVID has accelerated trends that were already present and the concept of ‘better or worse’ is no exception. To see what fared better and what fared worse, read on.
So far in this blog series, we’ve looked at some of the most cutting-edge emerging technologies: The Internet of Things (IoT), robotics, and virtual reality. We’ve discussed the potential these developments have to revolutionize the way we do business and work in the real estate space.
While each of those has its applications, none hold quite the same promise for changing the fundamental aspects of how we make, and document, commercial real estate (CRE) deals as blockchain. In this fourth entry in the emerging tech series, we have a look at the implications of this pivotal technology.
Nowadays, blockchain is a term everyone’s hearing with increasing regularity. To start, it’s worth having a brief recap of exactly what the tech is. At its simplest, a blockchain is a ledger – a record of information. Not all that different from the databases you’re already using to record details of properties, clients, or transactions.
The feature that makes blockchain unique is the way that information is recorded. Each “block” can hold a certain amount of data. Once a block is full, a new block is started and the previous block forms part of an immutable chain – essentially a timeline extending outwards from the first block to the current one.
Information on the blockchain is public and distributed across a network of computer systems – meaning that it’s very, very difficult for one person to hack or alter the information stored in the chain.
The opportunity blockchain presents for the CRE space, is the ability to streamline a lot of time-consuming tasks. Imagine having all of the paperwork for a given property digitized, accessible to everyone involved in the deal, and confirmed as accurate by multiple parties.
“There are two areas where I think the blockchain is. There’s going to be the intersection with legal tech, so that’s land registry and recording and ownership, and all of that paperwork that exists in the system… the other is the intersection with fintech.”
Of course, an issue that comes up here is how this system can be used with potentially sensitive information – client details that shouldn’t be a matter of public record. For business networks, private blockchains can be set up to only allow access to specified parties. In this case, the identity of participants is verified in the network as well, unlike public blockchain where users can remain anonymous. Private blockchains function more like a traditional database in this sense, trading off some of the immutability of their data for privileged access.
Sealing the smart deal
Maybe the most promising application of blockchain for CRE deals is being able to deploy “Smart Contracts” for things like tenancy agreements. Smart contracts hard code the details of an agreement on the blockchain, and are uniquely suited to real estate deals, because they can handle conditional clauses.
As an example, startups like UK-based Midasium are already providing a prototype platform that replaces traditional landlord-tenant agreements. Using smart tenancy contracts, clauses of the agreement are automatically enforced when certain conditions are met. This can include paying rent, returning a security deposit, and directly deducting maintenance costs from the rental amount paid across to the landlord.
It’s a system designed for transparency and rapid settlement, and the concept is gaining traction in other parts of the world. An added bonus of using smart contracts for tenancy is the possibility of building up a database of real-time data for rental prices and trends in the rental market.
A growing sector
Overall, enterprise reliance on blockchain is set for rapid acceleration. Forbes, quoting an International Data Corporation (IDC) report notes that:
“Investment in blockchain technology by businesses is forecast to reach almost $16 billion by 2023. By comparison, spending was said to be around $2.7 billion in 2019, and we will see this acceleration ramping up over the coming year.”
Blockchain adoption in CRE, however, is still in the early stages. The tech still needs to overcome a few growing pains – in terms of privacy concerns, operational complexity, and a lack of standardized processes – before we’ll necessarily see it forming the backbone of CRE transactions.
That said, it’s a space well worth keeping an eye on. There’s been growing interest, for example, in CRE tokenization – splitting the value of a given asset into separately buyable blockchain-based tokens. What this means in practice is that instead of looking for one buyer for an expensive asset the value gets subdivided and opened to a much broader market. Which in turn may actually boost the value of the underlying asset.
There’s a lot of potential and little doubt that blockchain will make its way into CRE one way or another. But, like many things in the cryptocurrency and blockchain space, the real challenge will be separating the wheat from the chaff, the fact from the hype, and identifying functional applications of the tech rather than purely fanciful ones.
We’ve all seen how the Covid-19 pandemic gave the industrial sector the shove it needed to go from well-poised to interstellar. Now research from the Commercial Real Estate Development Association (NAOIP) suggests there is no slowing down for commercial real estate’s (CRE) newest darling sector.
The NAIOP’s Industrial Space Demand Forecast for Q3 2021 shows that “sustained growth in e-commerce [and] demand for industrial real estate continues to outpace supply”. This, they say, puts the sector in a state of net absorption that will continue throughout the year and into 2022.
Digging into the numbers
The authors of the report are Hany Guirguis, PhD, Manhattan College and Michael J. Seiler, DBA, College of William & Mary. They write that “the demand for industrial real estate still outpaces supply” even with “nearly 100 million new square feet delivered nationally since the beginning of the year, 450 million square feet currently under construction and another 450 million planned”.
Their data then boils down to net absorption of some 162.6 million SF in the second half of the year, and they state that they’ve “returned to their pre-pandemic confidence levels”.
Triangulating more data The demand has of course been driven primarily by the boom in e-commerce. GlobeSt.com reports that e-commerce sales hit “a quarterly record of $222 billion in the second quarter of this year”, accounting for 13.3% of all retail sales. But there are contributing factors, such as growth in cold storage, materials and construction, manufacturing and medical industries.
With the combination of factors, CRE data analysts such as YardiMatrix are predicting the growth to stay buoyant through 2026. Yardi’s predictions include delivery of 348 million SF next year, 360 million SF in 2023, and up to 370 million SF in 2026.
New growth There are other blooming products and industry categories that will only increase this demand. The cannabis processing industry is hungry for space in deregulated regions and in countries with widespread legalization like Canada and Latin America. Finally, there are superlative predictions for the industrial square-footage needs of the commercial space industry too.
No wonder, NAIOP CEO Thomas J. Bisacquino calls industrial “a bright spot in the CRE industry”.
Reporting in the Evening Standard, based on data from Remit Consulting, indicates improvements in the UK’s commercial property sector. The firm’s data shows that rent collection in the last quarter reached its highest level in the pandemic period, which is partially due to the easing of lockdown regulations in the country.
Data from their REMark Report shows that “…an average of 72.1% of rents due in the UK had been collected with seven days of the September quarter rent day, which covers payments for the three months ahead”. This includes rent for retail and dining establishments, bars, and warehouses. Comparatively, in the previous quarter, 66.5% of rentals due were collected by the same point. Retail rents were sitting at 68.8% (up from 62.3%) and leisure at 57.2% (up from 40.1%).
This is in keeping with a general upward trend, the firm told the newspaper, “which is good news for investors and landlords such as pension funds and other institutions, particularly as the upward trajectory of payments from tenants is similar to the previous quarters of the pandemic.”
…but not all good
Despite the strength of this news, it’s not a unilaterally positive picture, as the data also indicates that this ‘record high’ is still considerably lower than pre-Covid levels. Altogether, since the start of the pandemic, there is a shortfall in rent from commercial occupiers amounting to nearly £7 billion – a considerable chunk for property owners and investors, including institutional investors such as pension funds.
Managing the fallout
The matter of the “missing rents” is something the industry and public service are keeping a close eye on. This report from the International law firm Morrison & Foerster LLP gives an excellent rundown of the public consultation that the UK government has done around trying to establish a way forward for both struggling commercial tenants and landlords.
The policy paper published in August 2021 can be found here, and outlines the government intentions to “legislate to ringfence rent debt accrued during the pandemic by businesses affected by enforced closures” and their intent to formalize a “process of binding arbitration to be undertaken between landlords and tenants”.
Meanwhile, a number of the large and influential property industry associations have called on the government to end the moratorium on evictions that came into effect during the height of the pandemic and lockdown measures.