History Repeats Itself

We have all heard the saying “history repeats itself”, but does it really? The world works in cycles. We see it most in the financial world, but it’s everywhere. Life has a funny way of coming back around, but never in the same exact way as before. The astute are able to recognize trends before they happen, even when the cycles come in different forms. This post is all about the recognition of a new cycle within the industrial sector of real estate and how the past can help us make better decisions in the coming years.

Our industrial inventory in Cleveland, OH, is dated and aging due to the manufacturing backbone that Cleveland was built on. Two and three story industrial facilities make little sense for the needs of modern users. Likewise, not many of those users even exist in the U.S. any more. The large-scale exportation of manufacturing jobs to places like China and India made many of our facilities obsolete. This is where the cycle began. The loss of jobs in the US during this time was a big fear for the country. Our businesses began to shift to service-based needs instead of manufacturing-based needs. Accelerated by the recession in 2008, our country lost jobs and lost them in thousands as companies moved to countries with less expensive labor. The decade between the recession in the late 2000s and current times was a transition period. For industrial real estate, this period was marked by developers purchasing property for cheap and attempting to redevelop it or offer low rental rates to get occupants in the space. This was not a bad strategy, but due to the economic downturn, the users of the space were significantly reduced, so many spaces sat vacant and falling apart.

The 2010s ushered in a new era of technology, and online shopping boomed. Manufacturing jobs were beginning to be replaced by distribution jobs. Large manufacturing facilities were not required, but warehouses were. Developers began building to satisfy the needs of their clients, this mostly entailed building 36-foot-clear multi-dock facilities to help companies transport goods more effectively. It is often said that the last mile of the distribution process is the most challenging and expensive portion. Many companies combated this by placing smaller facilities closer to their customer bases. This meant they could also fill many jobs that were lost as manufacturing left these communities. I identify this time as the beginning of the new cycle. Business began to recover; the country’s economy was strong, and consumer desires shifted as the online shopping brands grew.

Much like the great recession fueled job loss and a move away from manufacturing, the global pandemic fueled job creation and a move toward distribution space. COVID-19 accelerated the cycle. Thousands of local jobs were created as people stayed home and ordered from companies like Amazon. Third-party resellers stressed the resources of FedEx, UPS, and USPS as internet shopping increased significantly more than the country anticipated. This strain was felt on the industrial real estate market as vacancy rates reached a historic low in the Cleveland area. Companies were willing to fully lease buildings before developers had even put up walls. As demand grew and supply diminished, asking rates hit all-time highs.

It would be easy to look back now and see the lack of bulk distribution as an issue for Cleveland, but the truth is that before COVID-19, the lack of this space was not felt by the market. Now, however, we have multiple major spec distribution centers being built in all areas of northeast Ohio, most of which will be leased before these buildings are completed. This is good for the market because more space will be available for those companies that require it; however, as more bulk space becomes available, market velocity may begin to slow. Tenants who require the advantages of these large facilities will pay market rates for brand new high-end space. Smaller users who were pinched during COVID-19 may have an easier time finding flex and B-C space that meets their needs. The labor market grew as the economy grew. Jobs lost in 2008 were now being replaced in abundance in new distribution centers.

My question now is, when is it enough? What does the next cycle look like? We lost jobs in 2008 due to cheaper labor in other areas of the world. Is the rise of technology going to be the next thing that takes jobs away? According to a leaked Amazon memo, the company expects to run out of labor in many of its major metropolitan areas by 2024. I believe many distribution jobs within these facilities will slowly be replaced by machines that make the jobs of the employees in the physical building easier, but is that really going to take jobs away if large companies are already expecting labor issues in the coming years?

With the collapse and bailout of SVB and many other banks seemingly on the ropes, is this another 2008? It seems as if the cycle has come back around and rested where we began almost 15 years ago. We may have clues as to how the market might be impacted, but as I said earlier, every cycle is just a bit different. How and when the pieces will fall is still a question that is unknown. I take comfort in the fact that our world works in cycles because it allows us to be confident that perseverance through bad times will pay off.


China Reopening Set to Boost Asia-Pacific Multifamily; Hospitality Sectors

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.”

The reopening is also a positive signal for the hospitality sector in many other South-East Asian countries, which have battled low hotel occupancy and slow revenue recovery over the last 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.

As a recent Bloomberg article quoted in the Japan Times puts it:

“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.”

Capital Markets FinCEN scrutiny CRE transactions

FinCEN Alert Could Mean Greater Scrutiny for CRE Markets 

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. 

Ongoing developments

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.”

OPM – Part II

Alec J. Pacella, CCIM

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.

Loan amount

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.

Interest rate

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.

Acceleration clause

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.

Prepayment provisions

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.

Escrow/reserve accounts

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.

Loan guarantees

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.

Properties Magazine March 2023

CRE “By the Numbers”: Internal Rate of Return (IRR)

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.

IRR defined

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.

IRR essentials

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.

Real estate investment platform ArborCrowd gives a useful example:

(Source: ArborCrowd)

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.”