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?

US foreclosures: records and rebalancing

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? 

Netting Things Out

Alec J. Pacella

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!

Alec Pacella, CCIM, president at NAI Pleasant Valley, can be reached by phone at 216-455-0925 or by email at apacella@naipvc.com. You can connect with him at http://www.linkedin.com/in/alecpacellaccim or subscribe to his youtube channel; What I C at PVC.

See Properties Magazine for March 2022

Three “glass-half-full” forecasts for the new year

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.

Survey says…

First up, Deloitte’s annual forecast report for the CRE sector is out, and generally reflects a high degree of buoyancy.

“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.

Source: https://www.forbes.com/sites/calvinschnure/2021/12/01/top-10-things-to-watch-in-commercial-real-estate-in-2022/?sh=352375d63002

“All in alert”

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!

CMBS market still resilient despite office headwinds

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.

CMBS 101:

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”.

Uncovering opportunities

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.