How CRE Investors Can Still Create Value In A Rising Rate Environment

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A building that makes “no sense” to most investors could be a diamond in the rough to another — and knowledge and information is key in the current rising rate environment, according to one industry watcher.

“You can’t add value to bonds — and unless you own a VC firm or you’re Warren Buffett or Elon Musk, you really can’t create value by owning stocks,” says Marcus & Millichap’s John Chang. “Other than owning a company or a franchise, only real estate allows investors to roll up their sleeves, either physically or metaphorically, and create value in an investment.”

And Chang says this happens in one of three ways: repositioning, management, or knowledge.  Repositioning can be as simple as upgrading common areas and as complex as transforming high-rise office towers into apartments (a trend that’s happening at a rapid rate in some major metros).  It can also fall somewhere in between those extremes: think moving a Class C property to Class B or repurposing an outdated shopping mall into a mixed-use asset.

“Creating value in management can also run the gamut,” Chang says. “At the simplest level, an investor may see some high value but basic operational things that can be done — perhaps just cleaning up a property, adding professional management and moving the rents to market. Something more complex may be re-tenanting a building. An office investor I know bought a very large property with an enormous vacant space. He already had a major tenant lined up so he bought the building, restructured the space a bit and then plugged the new tenant in. Boom: the building went from 25% occupancy to 90% occupancy and the property value changed dramatically.”

Chang also draws on another anecdote, this time in the multifamily space, to illustrate this point further. He says an investor he knows with a great apartment management team bought several small- to mid-sized near the ones he already owns and leveraged that team across multiple units.

And finally, there’s knowledge, which Chang says is “all about finding market inefficiencies and exploiting them.” This could include acquiring assets based on emerging demographics or population migration, or could come on the heels of a major employer changing its HQ location or in advance of a tax or policy change. Chang says there are ample opportunities to “capitalize on information where the pending changes are not baked into an asset’s price.”

Several recent examples bear that out: the global supply chain dilemmas plaguing virtually every sector of the economy have prompted many companies to consider re-shoring or near-shoring to mitigate those types of risks in the future.

“These and more opportunities are out there, and a lot of them will make sense regardless of rising interest rates or other factors affecting the market,” Chang says.

 

Source: GlobeSt

Insurers Increase Scrutiny Of Older Commercial Building Roofs

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Insurers are increasing their scrutiny of the age and condition of commercial building roofs and imposing more restrictive terms under property policies, experts say.

Commercial buildings with older roofs that haven’t been updated and those located in regions exposed to windstorms, severe convective storms and wildfires are seeing insurance coverage for roof damage limited by policy provisions, they say. And coverage restrictions have accelerated in the wake of numerous named windstorms, tornados and hail events in recent years, according to several brokers.

Properties located in the south Florida tri-county region, comprising Broward, Miami-Dade and Palm Beach counties, are seeing the most restrictive roof coverage in policies, said Jeff Buyze, Fort Lauderdale, Florida-based national property practice leader at USI Insurance Services LLC.

Changes include covering older roofs on a depreciated, actual cash value basis rather than on a replacement cost basis, Mr. Buyze said. Initially, this applied to roofs that were more than 15 years old, but insurers are now limiting payouts to actual cash value on buildings with roofs that are just five years old, he said.

The definition of roof covering has also broadened to include roof decking, so that any damage to decking falls under the quote on roof covering, he said.

“Picture a 10,000-square-foot commercial real estate building. … The delta between replacement cost and actual cash value is quite often massive. You could be talking about hundreds of thousands of dollars,” Mr. Buyze said.

Occupancy classes seeing more restrictive roof terms include habitational accounts and public entity business, especially municipalities and school districts, said Peter Fallon, national property practice leader at brokerage Risk Strategies Co. Inc. in Boston.

“It’s those accounts where … they just haven’t put the money into the maintenance to make sure their roofs can withstand hail and wind damage, so underwriters are saying, ‘We are going to have to do something,’” Mr. Fallon said. “Tighter roof terms are impacting admitted as well as non-admitted risks. We’re seeing it in the standard market, too.”

Changes tend to be dependent on roof age, especially those that are more than 15 years old, Mr. Fallon said. Where coverage applies on an actual cash value basis, insurers may also impose a surcharge and a higher deductible, he said. Insurers may also add component deductibles to reflect an additional exposure such as water damage, he said.

Underwriting scrutiny based on roof materials is a focus in areas exposed to windstorm, hail and wildfire, said Michael Korn, global property and marine leader at EPIC Insurance Brokers in San Francisco.

“In the case of wildfire, underwriters are concerned that embers can travel miles from a wildfire and land on a combustible roof and start a fire in a different area,” Mr. Korn said. “Many roofs on buildings in California are constructed of wood or with shingles.”

Valuations are increasing to help cover the rising costs of roofs and to ensure buildings are insured to value adequately, said Randy Doss, Houston-based senior broker at CRC Insurance Services Inc.

“Let’s say the norm five years ago was $65 a square foot for frame buildings. Nowadays they’re up to $100 or $110 per square foot for frame buildings to kind of offset some of those roof costs,” Mr. Doss said. “Variations in building codes in different states and problems with roofing contractors in certain states might also affect the terms that are available.”

Values overall have become a focal point for the market, specifically on roofs in high-hazard zones that are subject to the vagaries of wind, rain and water damage, said Henry Daar, Chicago-based executive vice president and head of property claims at Willis Towers Watson PLC.

“Carriers don’t want to pay for the same thing twice or three times,” Mr. Daar said. “In the case of a roof that has been previously subject to loss but hasn’t been repaired, insurers will either exclude from coverage pre-existing unrepaired damage or limit what they cover to a percentage of the damage. Other clauses limit the amount insurers will pay out for so-called cosmetic damage to a roof — for example if a hailstorm results in pock marks but is not determined to have caused loss of structural integrity. Roof claims can be costly and based on the roof composition and building structure run the gamut anywhere from a $25,000 loss to a $5 million loss.”

 

Source: Business Insurance

 

Pompano Amends Its Code To Encourage Mixed-Use, Mixed-Income Development On Commercial Corridors

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The Pompano Beach City Commission recently approved a change to the city’s zoning code to incentivize well-designed mixed-use and mixed-income developments along the Dixie Highway corridor and along other specific commercial corridors within Pompano Beach.

The initiative began at the Pompano Beach Planning and Zoning Board meeting in February 2021, when Chair Fred Stacer started a discussion related to the city’s interest in beautifying the Dixie Highway corridor following the city’s investments in the roadway itself through the G.O. Bond program.

Stacer said the expectation of quality design for new development should increase. This discussion evolved into the creation of a Dixie Highway Task Force by the chair of the city’s economic development council, Tom DiGiorgio. Stacer was appointed as chair of the task force. The task force adopted the goal of creating mixed-income and mixed-use regulations for Dixie Highway, and ultimately, for all applicable commercial corridors of the city, with additional requirements and incentives in those areas where combatting poverty has been identified as a priority.

According to a study conducted on behalf of the city by the Lambert Advisory Group, Pompano Beach has the highest number of income-restricted housing units in the county (2,140 units), followed by Fort Lauderdale (1,941 units).

Additionally, Pompano Beach has the third-highest proportionate share of income-restricted units to non-income-restricted units in the County — for every 25 residential units in Pompano Beach, one unit is income-restricted. A large proportion of income-restricted units are being developed in census tracts where there is already a high concentration of existing rent-restricted or subsidized units.

The new change to the city’s code uses criteria set forth in the affordable housing incentive policy that Broward County adopted in March 2021. It also integrates the mixed-income housing policy the city adopted in December 2021 to encourage affordable housing and provide relief from the adverse impacts of the concentration of income-restricted housing within Pompano Beach.

The County’s policy allows additional density (more dwelling units per acre) in residential land use categories and unlimited density in “Commerce” and “Activity Center” land use categories for projects on eligible roadways that include affordable housing.

The city’s new mixed-income housing policy intends to be more restrictive than the County’s policy: A minimum of 50% non-income-restricted residential units will be required in residential developments that are within a half-mile radius of an income-restricted residential development project.

Density for properties with a B-3 Commercial zoning, which is predominant along the commercial corridors, will be regulated by the city’s zoning code. Along Dixie Highway (between city limits) and North Powerline Road (between Atlantic Boulevard and NW 15th Street), a minimum of 80% non-income-restricted residential units will be required. The city would provide a minimum 50% density bonus as an additional incentive to redevelop those properties inclusive of the non-income-restricted units.

The new regulations also set design standards that must be maintained by all development along these commercial corridors, including light industrial uses such as warehouses, which are permitted along corridors like Dixie Highway. In addition, a screening requirement was added for visible parking garage façades, as recommended by Stacer.

In addition to Dixie Highway and Powerline Road, the eligible commercial corridors within the ­­­­­­city where the new regulations can be applied include Federal Highway, Sample Road, Copans Road, NW 31st Avenue, Atlantic Boulevard and McNab Road west of Dixie Highway, a portion of Andrews Avenue, and the western portion of MLK Boulevard.

Only properties that have a Commercial land use designation and are abutting those corridors will be eligible to receive residential entitlements through the County’s policy.

Speaking to the City Commission at its March 22 meeting, Stacer said he talked extensively with the redevelopment team of John Knox Village to make sure the three blocks that abut Dixie Highway from SW 3rd Street to SW 6th Street were properly integrated into the city’s new policy for the commercial corridors, as well as the desires of John Knox Village.

 “The new policy is probably going to be cutting edge for the county,” Stacer told the Commission.

Deerfield Beach city officials have taken interest in it, and in the future, there may be opportunities for Pompano to coordinate with them regarding what happens on the Dixie Highway corridor, said Stacer.

Stacer noted that the new guidelines will bring the city’s corridors into the 21st century design criteria, and will help protect single-family residences from the “massive amount of pressure” the city is going to experience due to an increase in population.

“This sets the stage for years to come,” said Mayor Rex Hardin. “It’s not going to transform any roadway today, but this will help guide development in the future for many, many years.”

 

Source: Point!Publishing

 

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Ten Issues That Will Impact CRE For The Rest Of 2022

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LaSalle is expecting a high-impact second half of 2022, according to its Mid-Year Update.

The firm provided the top 10 issues it believes could steer commercial real estate’s direction, including those related to bonds, returns, capital flows, expenses, energy, construction and central banks.

GlobeSt.com highlighted LaSalle’s No. 1 top issue: Cost Of Debt.

Following are the others that made its list and LaSalle’s assessment, as well as commentary from others in the industry.

2. Rising Corporate Bond Yields – Upward pressure on discount rates and exit cap rates.

Jon Spelke, managing director of LFB Ventures in El Segundo, tells GlobeSt.com, “Cap rates will continue to follow interest rates upward trends to avoid negative leverage situations. It will be difficult to underwrite a deal with negative leverage and relying on rent growth to bail out the deal. Especially while expense growth continues to trend and at an equal rate as rents.”

3. Higher Required Returns – As a corollary of No. 2, investors will seek slightly higher returns from real estate, given that alternative credit market products will now be priced at higher yields.

Spelke added, “Unlevered yields will continue to follow interest rates and as asset pricing adjusts to the new financing norms (i.e. sellers come to grips with the current asset pricing versus what they thought they could get 90 days ago) deal flow will resume. This economic situation was/is not caused by the real estate industry, (i.e., over building, etc.) so real estate remains a healthy asset class in most regions and submarkets. Once values adjust, the deal flow will resume with strong fundamentals following.”

4. Capital Flows To Real Estate – Despite the mixed impacts listed above, real estate’s reputation as a better inflation hedge than fixed income will likely maintain its status as a favored asset class while the securities markets experience volatility.

Eli Randel, chief operating officer, CREXi, tells GlobeSt.com that increasing costs of capital will likely result in expanded yields and softened values, however, large supplies of capital seeking deployment may help sustain current asset values.

“Commercial real estate, even at compressed yields, remains a more attractive investment vehicle to many relative to cash, bonds, and equities and as a result quality assets in quality markets will find abundant capital demand even at still high-prices,” Randel said. “Look for low-leverage, negative-leverage, and all-cash deals to become more prominent with pricing on those deals reflecting sub-optimal levels. An institutional flight to quality will create a bifurcation in the market where core deals will trade at aggressive pricing with suboptimal deals seeing a decline in value.”

5. Capital Market Shifts – Investor demand moves away from fixed long-term leases and toward shorter indexed leases.

Jeff Needs, director, Moss Adams Real Estate Advisory, tells GlobeSt.com, “As markets continue to search for price stabilization, expect to see shorter-term leases, reduced capital improvements and negotiating leverage continuing to tip to tenants. Vacancies that are best suited to be used in ‘as-is’ condition will lease first, and some landlords will do minor tenant improvements upfront to be more competitive. Though individual markets perform at their own pace, we haven’t reached the bottom yet so expect this to continue until there’s a turning point.”

 6. Rising Cost Of Construction – Chilling effect on construction, wherever rents can’t keep pace.

“As the market slows, the upward pressure on cost (labor and materials) should ease for a bit,” Spelke said. “Subcontractors looking to keep crews engaged will look to be more competitive as projects are put on hold and shelved.”

7. Higher Energy Prices – Higher occupancy costs will erode tenants’ ability to pay higher rents.

Marilee Utter, CRE, global chair of The Counselors of Real Estate, tells GlobeSt.com “The consequences building and that business owners are facing – and need to consider in business continuity and resiliency planning – include rising insurance costs and increased investment in on-site energy resilience.”

8. Slowing Demand – While central banks attempt to cool off overheated sectors, broad-based tenant demand will likely step down a notch because monetary policies are blunt instruments that don’t distinguish well between sectors. In some parts of the world, ‘recession’ danger signals are flashing.

9. Currency Movements – Differentials in interest rates/inflation will favor currencies with rising interest rates and could raise hedging costs for currencies with lagging interest rate increases.

10. Rising Expenses – Just about every expense category associated with operating a property will be under upward cost pressure. Operational-intensive properties that require a lot of headcount or energy consumption could be most affected.

As a corollary to No. 5, LaSalle said net leases will be preferred by investors, but tenants will be under new cost pressures that could affect their ability to renew or to expand. Long leases to real estate operators whose margins could be squeezed by both rising occupancy and labor costs are an example of the kinds of risk to avoid.

Michael Busenhart, Vice President Real Estate at Archer, tells GlobeSt.com that with the recent inflation increases, owners are feeling the benefit on the rental income side, but also feeling the pressure on the expense side.

“As multifamily owners look to maximize LOI, many are seeking an edge to curb expense spending,” Busenhart said. “To do this, they can review financials internally to notice increased trends, or use data that enables asset managers to benchmark their properties/portfolio against the competition to seek areas where they can improve against the overall market.”

 

Source: GlobeSt

Critics Question Push For Taller Towers In Fort Lauderdale

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Sky-high towers as tall as 500 feet could start cropping up all over Fort Lauderdale, critics fear.

It could happen if a controversial proposal goes through that would raise the height cap to 500 feet on projects that get special zoning. The new ordinance would apply citywide, not just in high-rise-friendly downtown, where zoning already encourages supersized towers. So far, the idea is getting a chilly reception.

“We are not Sunny Isles. We are not Miami. We are not New York,” said longtime resident Nancy Thomas. “I’d rather have it shorter and denser. If we get into this height request we’re going down the wrong path. We are going to start looking like Sunny Isles.”

John Burns, president of the Venetian Condo Association, also has reservations about making such a drastic change that would apply to the entire city.

“Once it’s there, everyone’s going to want it,” Burns said. “You could have 500-foot buildings popping up everywhere. It’s a dangerous path.”

Who Wants Taller Buildings?

Some are wondering what’s behind the push for taller buildings. Look no further than the plan for Pier Sixty-Six. Tavistock, the developer redeveloping the landmark site, wants to build three luxury condo towers that would rise 480 feet high in a neighborhood with a height cap of 120 feet.

“Proposing taller buildings with fewer residential units and less commercial uses will significantly reduce traffic, preserve views and create more open space — all things that we heard were imperative to our neighbors,” said Jessi Blakley, vice president of the Orlando-based Tavistock Development Company. “Our vision will make Pier Sixty-Six a destination gateway and icon once again.”

The developer revamping the Pier Sixty-Six property in Fort Lauderdale hopes to build three luxury condo towers that would rise to 480 feet. Two towers would sit on the south side of the 17th Street Causeway bridge and the third would sit on the north. The plan is not an option unless the commission changes the code to allow building heights of 500 feet outside the downtown area. (RENDERING CREDIT: Arquitectonica)

The vision is not an option unless the city commission changes the code to allow building heights of 500 feet outside the downtown area for projects that apply for Planning Development District zoning. The current code, in place since 2013, caps the height at 300 feet. The code would need to be rewritten, changing the height cap from 300 feet to 500 feet to pave the way for developers to build higher. And the change would require commission approval.

Outside downtown, a developer needs at least two acres to apply for the PDD zoning. Only half an acre is required for properties downtown. It was unclear whether that would change as well.

At a recent City Hall meeting, longtime resident Marilyn Mammano warned the commission they’d be opening up a can of worms by changing the code.

“No one is demanding taller buildings. This is being done at the developer’s request,” said Mammano, president of the Harbordale Civic Association.

Housing Costs ‘Just Crazy’

During the meeting, Mayor Dean Trantalis argued that allowing buildings to go higher would help build up Fort Lauderdale’s housing stock.

“We hear the drumbeat from the community: People say we’re overdeveloping, we’re overbuilding,” Trantalis said. “And at the same time people say the price of housing is just crazy. More development stabilizes the price of housing. We have to have a ‘Come to Jesus’ moment and decide if we are going to allow development to continue to come to this city.”

Commissioner Heather Moraitis countered that many of the projects are considered high-end and would not help boost affordable housing units throughout the city. The mayor and the commission suggested city staff seek feedback from neighborhood leaders and report back before any commission vote is scheduled.

“Let us not be the ones to decide,” Trantalis said. “Let the community decide.”

Staff is planning to present information in November to the Council of Fort Lauderdale Civic Associations, but is welcoming comments at any time, according to a city email dated July 15 that went out to neighborhood leaders.

Leslie Fine, whose condo sits on Fort Lauderdale’s Galt Ocean Mile, didn’t get the email but has a message for the city: This is a bad idea.

“This is not Dubai,” Fine said. “Why does everything have to be so tall? It’s not like people come here because we have tall buildings. It puts more stress on the streets, the sewers, the waterways, the storm drains. Those tall buildings can cast tall shadows. And the roads can’t handle the people we have now.”

Mary Peloquin, president of Council of Fort Lauderdale Civic Associations and a board member of the Coral Ridge Civic Association, did get the email.

“Everybody is concerned about this,” Peloquin said. “Tall buildings all sounds fine until they come to your neighborhood. Tall buildings make residential backyards not private. Tall buildings are great downtown but we don’t have any workable mass transit. And that needs to be fixed if we’re going to have a dense area downtown and in other areas.”

‘Only Way To Go Is Up’

Fort Lauderdale’s Regional Activity Center zoning paves the way for taller buildings and dense development downtown.

Construction cranes abound on Wednesday in downtown Fort Lauderdale. A new proposal would pave the way for 500-foot-high towers throughout the entire city. And the critics are already lining up. (PHOTO CREDIT: John McCall /South Florida Sun Sentinel)

The RAC has no height cap, but so far the tallest building downtown (100 Las Olas tower) stands at 499 feet, a foot under the 500-foot limit set by the FAA. That could change if the FAA says yes to new development requests to build towers closer to 600 feet.

Jim Concannon, president of the Sunrise Intracoastal Civic Association, says he understands the push to allow taller buildings. But he worries it could change the character of neighborhoods outside downtown.

“There’s no question that the city is going to be growing a lot,” Concannon said. “And the only way to go is up. But you’re losing that small-town character. By allowing 500-foot buildings to be anywhere in Fort Lauderdale, you’ve changed the character of the city.”

Local developer Charlie Ladd declined to say whether it was a good idea to change the height cap, but did say it’s important for the residents to be onboard.

“These are big changes to our city,” Ladd said. “We all need to be on the same page. We need to make sure we get it right when these other portions of the city look to redevelop.”

This week, Trantalis had more tempered comments about the whole plan.

“I think there needs to be significant community outreach,” Trantalis told the South Florida Sun Sentinel. “I’m not hearing a lot of support for it, but the process is still ongoing and we are trying to be objective about the issue. I don’t think there’s much of an appetite on the commission to change the ordinance since it would affect properties citywide. We realize the growth needs to focus on the downtown area and not impact neighborhoods that have long been established.”

Real estate analyst Jack McCabe says he would expect an outcry from residents across the board if the commission were to approve the plan. He pointed to the wall of condos that line the beach in Surfside.

“There’s so many condos so close together, the locals call it the wall,” McCabe said. “And you can’t see the beach by noon because of the shadow. If you could make a case that Fort Lauderdale is built out and they need 50-story buildings all over town, maybe then there’s a reason to change the rules. But people are going to be up in arms if all these 50-story towers start going up blocking their views and snarling traffic in an already snarled traffic system.”

 

Source: SunSentinel