Another lender announces slow down for CRE credit

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”.

Construction slump

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”.

Global pressures

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?

Report says CRE leaders expect post covid resurgence

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.

Highlights

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.”

Shaping CRE

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.

Concerns remain

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?

Industrial CRE’s “strong fundamentals” mean resilience

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.  

Drag factors

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.

Boost factors

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.

Global trend

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?

Record rents point to UK CRE recovery

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%).

Good news…

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.

CRE outlook stronger despite supply chain challenges

Since April 2020, the National Association of Industrial and Office Properties (NAIOP) has been keeping track of the pandemic’s impact on CRE with their regular COVID Impact surveys. NAIOP’s June 2021 survey collected data from 239 US-based members, including brokers, building managers and owners, and real estate developers. A recurring theme in this latest survey was the increasing challenges commercial real estate (CRE) is navigating associated with supply chain disruptions and materials costs.

Supply and delay
With more than 86% of developers reporting delays or materials shortages, it seems the impact of COVID on supply chains is set to become one of the longest-lasting effects of the pandemic. Adding to difficulties, 66% of those surveyed reported delays in permitting and entitlements, a figure that hasn’t changed since June 2020.

Fixtures and equipment for stores are also in short supply, with order backlogs stretching into months for some retail sectors. While this isn’t necessarily surprising, given setbacks in manufacturing in key suppliers such as China, the CRE market shows promising signs of being on-track for continued recovery nonetheless.

Development despite setbacks
Despite the issues highlighted in the report, the survey still showed an increase in retail prospects. New acquisition of existing retail buildings was indicated by 39.1% of respondents, while 31.3% mentioned new development going ahead. Both of these figures represent a strong improvement from a previous survey in January. Deal activity was also noted to be on the up, with figures doubling for office and retail properties over the course of a year, and industrial deal activity increasing over 20% since June 2020.

“Bricks and clicks”
International industry players have also noted that, though larger spaces are still facing delayed rental uptake, 20,000-30,000 square-foot sites are garnering increasing interest. The potential for these spaces is as part of a multichannel retail/warehouse approach – the “bricks and clicks” strategy. As the demand for online retail increases, logistic assets, and storage spaces become more valuable, contributing to an overall uptick in both virtual and brick-and-mortar marketplaces. 

A promising prognosis
Even with the supply chain challenges facing the industry, the Federal Reserve agrees with the trend data gathered from NAIOP participants. In their June 2021 Beige Book, the Fed noted upward movement in industrial output and consumer demand. Though economic gains were noted to be slow, the outlook remains steady and positive.

President and CEO of NAIOP, Thomas J. Bisacquino, puts it like this: “The materials and supply chain issues are lagging effects of the pandemic, and they are affecting every industry. While the pandemic’s impact was deep, there’s a sense of optimism among NAIOP members, with deal activity rising and an increase in people returning to offices, restaurants and retailers.”