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Commercial Real Estate Investor Sentiment Signals A Changing Outlook

As we round the halfway mark of 2022, dynamics are shifting in the commercial real estate investment environment.

Preliminary data from SitusAMC Insight’s second quarter 2022 institutional investor survey shows changing preferences among property segments.

Compared to the previous quarter, the percentage of investors selecting industrial as the best property type over the next year plummeted from 47 percent to 11 percent, citing major concerns that the sector is overpriced. Apartment was the most favored segment among investors; 56 percent of investors ranked apartment as the best sector, up from 21 percent last quarter.

Skyrocketing mortgage rates are putting a crimp in single-family affordability, resulting in strong demand conditions for apartments. Several investors also remarked that apartments were the best inflation hedge among the property types. Retail appears to be making a comeback, with investor preference for the sector climbing to 33 percent from just 11 percent last quarter, citing opportunity for yield plays. Investor sentiment on office, on the other hand, is extremely bearish; no investors selected it as the top property type, with the sector falling from 16 percent in first quarter.

SitusAMC is seeing these sentiment shifts play out in their client work. After so many quarters of seemingly unstoppable growth, the industrial sector is starting to show initial signs of a slowdown, even though fundamentals are still strong. While rents are still growing in most markets and investors are still anticipating widespread above-inflationary rent growth and are underwriting to these assumptions, it is unrealistic to expect another quarter of 8 percent to 12 percent rent growth. Meanwhile, the buyer pool for industrial has been shrinking since the beginning of the year, and some of the larger portfolios are not being financed or traded.

Some Value Deterioration

The value driver for apartments in the second quarter was market rents and rent growth. There is still very strong sales activity, but, as with industrial, there are fewer investors at the table when the bidding reaches the best and final round. Regardless, the fundamentals remain very strong. For the first time in several quarters, low-rise apartments are performing better than garden apartments. Suburban is still outperforming urban, but some urban locations are showing signs of growth.

Investment rates are not decreasing across the board— they are very specific to the assets and the submarket. Gateway markets are lagging but improving. New York is the leader of the gateway markets, and Chicago is seeing improvements in rent growth, which is translating into some value improvement. San Francisco is starting to produce positive indicators as well, and Boston and Seattle are experiencing growth momentum. SitusAMC Insight’s proprietary multifamily affordability indexes indicate improved affordability in gateway markets vs. affordability deterioration in non-gateway metros.

SitusAMC’s retail valuations were slightly up in second quarter. Leasing activity has picked up, with many reflecting short-term mid-pandemic leases that are expiring and being renewed. A couple of large deals involving grocery-anchored centers have signaled very strong cap rates, in the low-to-mid 4 percent range, in strong markets like San Diego and Miami. However, these rates were negotiated at the beginning of the year when the debt markets had not yet changed.

Some SitusAMC clients are repricing their assets down slightly because of the debt market environment. In addition, recent strong retail sales are unlikely to continue as inflation erodes consumers’ disposable income and redirects spending to everyday necessities like gasoline and food. Retail outlets that provide essential goods, such as neighborhood and community centers with grocery anchors, will likely maintain steady income streams. Malls could be hurt by the decline in nonessential spending.

Office values remained relatively flat in the second quarter; most of the increases in values seen were owing to contractual rent increases. Overall office values are skewed, however, by strong growth in life science. SitusAMC is seeing many tenants downsizing. Daily office occupancy is mired around 40 percent, and it might not exceed 60 percent in the long term. There has been a flight to quality as employers try to attract top talent during a tight labor market.

On the bright side, near-term market rent growth has steadily increased over the past year, however, and is getting closer to the standard 3 percent. The strongest growth markets continue to be in the Sun Belt and the suburbs, which are doing better than CBD and gateway markets, but rents are increasing in those areas, as well. There have also been a lot of early renewals—near 10 percent, the highest level since 2015—though this is partly due to leases that expired during the pandemic and were renewed on a short-term basis.

Source: Commercial Property Executive

Industry News, Money

Commercial Property Sales Up 183% Across South Florida

Commercial property purchases have shown few signs of slowing down after a banner year, according to a recent report from JLL Capital Market’s Miami office.

South Florida commercial real estate transactions rose to $25 billion in 2021. That’s a 183% increase from the $8.8 billion in transactions across Miami-Dade, Broward, and Palm Beach counties recorded the year before.

The momentum has spilled over into this year. In the first three months of 2022, JLL recorded $6 billion in commercial real estate transactions completed across the tri-county area industry-wide, up 51% from the first quarter of 2021. (Data from the first quarter of 2022 is preliminary and subject to change, a JLL spokeswoman told the Business Journal.) This sharp rise in deal activity could be found across the industrial, multifamily, office and retail sectors.

Danny Finkle, senior managing director of JLL’s Miami office, credits the new wave of transactions to Florida’s “business-friendly environment and excellent quality of life.”

“Institutional investors have recognized this cultural shift and are tailoring their investment criteria to target markets like South Florida,” Finkle stated in a recent JLL release.

A significant portion of the property sales centered on multifamily housing. In 2021, there were $14.69 billion in real estate transactions involving residential rentals, an increase of 277% from the previous year. In the first quarter 2022, there have been $2.75 billion in trades involving South Florida apartment buildings, a 76% hike compared to the year-ago quarter.

In the office sector, there were $5.38 billion in trades in 2021, a 235% jump from the year prior. In the first quarter of this year, there have been $1.05 billion in office sales, a year-over-year increase of 10%.

Meanwhile, retail property transactions rose 136% in 2021 year over year to $3.88 billion in South Florida. Then another $1.28 billion of retail transactions took place in the first quarter of this year, a 186% hike compared to the year-ago quarter.

As for industrial, sales volume increased 63% from the previous year to $2.3 billion in 2021. In the first quarter of 2022, a total of $908.29 million in industrial transactions took place, a 76% leap from the year-ago quarter.

Companies and well-off individuals have been migrating to South Florida in greater numbers due to the region’s popularity, weather, and lack of income taxes, brokers and developers have told the Business Journal. It’sa trend that’s expected continue through the rest of 2022, making South Florida a prime spot for investment. Multifamily properties likely saw the biggest increases because rents are surging at a faster rate in the Miami area than almost any other metro in the U.S.

The migration has tipped e-commerce into overdrive, creating a shortage of warehouse and distribution space as companies seek to fulfill the orders of a humming economy amidst a continuing supply-chain crunch.

JLL stated that its Miami office handled 121% more investment sales, debt, and equity transactions in 2021 than the year before. To accommodate that growth, JLL promoted Cody Brais, Kenny Cutler and Max La Cava to director status.

Headquartered in Chicago, JLL has 3,000 capital market specialistsacross 50 nations. The data in JLL’s report was supplied from Real Capital Analytics, a New York-based real estate analysis company that has recorded $40 trillion in commercial real estate transactions since its founding in 2000.

Source: SFBJ

Industry News

This Asset Class Posted The Largest Price Growth In 2021

In a surprising twist, suburban office achieved the greatest price growth at 14.8% of all CRE asset classes over the last year, besting investor favorites multifamily and industrial.

John Chang of Marcus & Millichap notes that the price growth in the sector reflects three factors: “a pricing bounce, a disproportionate share of well-leased properties in the sales data, and some investor speculation.”

Unlike the price gains notched in multifamily and industrial, suburban office appreciation is not well supported by rent growth, which was only up by 0.6% or vacancy rate change.

“Part of the gain is an anomaly,” Chang says. “Suburban office prices dipped last year in the early stages of the pandemic, so part of the gains are the property types simply recovering losses. Second, the sales market has been dominated by well-leased properties—high-quality tenants with long-term leases in place. The sales composition is a bit different and there were fewer weaker assets in the deal mix that would normally drag prices down.”

Chang also says investors are taking note of the widely-held belief that to facilitate employees’ return to the office, companies will have to open locations closer to people’s homes.

“A lot of workers, especially millennials relocated to the suburbs because of the pandemic, and a new trend is forming. Investors are positioning ahead of that curve buying low rise suburban buildings,” Chang says. “Investors are betting on history repeating itself. A significant portion of suburban office stock was built in the 80s when baby boomers migrated there. It looks like millennials are in the process of making that same move.”

The second fastest price growth, according to data from Real Capital Analytics, was in apartment properties, which came in at a 14.7% increase. These values are supported by a 90 basis point vacancy reduction through Q2, Chang says. And again, investors have millennials to thank.

“Investors are pursuing multifamily properties because of demographics,” Chang says. “The aging millennials are now entering their thirties en masse, which is driving household formation up aggressively. Basically, there are so many millennials trying to move out on their own that there are simply not enough housing units to meet the demand. That trend is expected to run five years of longer, supporting the underlying thesis for multifamily investment.”

Industrial came in third, with price gains of 13.6% over the last year. That reflects average rent growth of 5.9% over the last year and a 30 basis point vacancy drop to 5% nationally, as well as cap rate compression of about 20 bps.

“Industrial properties have drawn increased investor attention over the last couple of years as e-commerce thrived during the pandemic,” Chang says. “The supply chain issues of recent months have also brought forth the importance of industrial property as businesses are stockpiling increased inventories to mitigate shipping and delivery risk. Industrial real estate has one of the strongest investment outlooks like investors penciling in aggressive rent gains into their valuation models.”

Source: GlobeSt

Industry News

25% Of U.S. Malls Are Expected To Shut Within 5 Years. Giving Them A New Life Won’t Be Easy

What is going to happen to America’s dead malls? That’s a million-dollar question plaguing retailers and real estate developers.

With a report circulating earlier this month that the biggest U.S. mall owner Simon Property Group has been in talks with Amazon to convert some shuttered Sears and J.C. Penney department stores into fulfillment centers, many industry analysts have been pontificating on the future of malls as logistics hubs.

The consensus seems to be that turning old retail space into new warehouses might not be so easy, even though it might seem like a logical solution. Demand for logistics buildings is skyrocketing as e-commerce sales balloon. But the hurdles include the need to have properties rezoned, which could be met with pushback from local municipalities.

“Just because retail space has gone vacant or remained fallow does not mean that it is automatically a good candidate for repurposing into industrial space,” the head of Moody’s Analytics commercial real estate economics division, Victor Calanog, said in a report just released. “One cannot simply build industrial buildings in areas zoned for commercial use. Often, that requires rezoning areas — a long and tedious process with a low probability of success. State and local governments typically tax industrial properties at anywhere from half to two-thirds the rate of commercial properties, so municipalities have little incentive to rezone areas from commercial to industrial use, as they will collect less tax revenues.”

Demand for various commercial real estate asset types is expected to shift noticeably because of the coronavirus pandemic, with more people now working from home, flocking to the suburbs for space and buying online things they used to browse for in stores.

According to data pulled by Moody’s Analytics REIS, apartment development in the U.S. is expected to be down 15.6% in a post-Covid-19 world. Office development is set to drop 10%, it said, while retail falls 15.7%. Industrial development, meantime, is expected to pick up 3.6%.

The firm did find five markets where it said it would make the most sense to covert vacant retail space into warehouse space, based on where retail has been underperforming and where warehouse demand is hot. Those are: Central New Jersey, Northern New Jersey, Long Island, Memphis and Detroit.

But shopping malls are likely going to be shuttering in suburbs all across the country, as store closures grow in number and landlords capitulate. Another new report out this week from Coresight Research estimates 25% of America’s roughly 1,000 malls will close over the next three to five years, with the pandemic accelerating a demise that was already underway before the new virus emerged.

The malls most at risk of going dark are classified as so-called B-, C- and D-rated malls, meaning they bring in fewer sales per square foot than an A mall. An A++ mall could bring in as much as $1,000 in sales per square foot, for example, while a C+ mall does about $320. There are roughly 380 C- and D-rated malls in the U.S., according to an analysis by the commercial real estate firm Green Street Advisors. It has said malls rated C and below “are not viable retail centers long term.”

CBL & Associates, a Tennessee-based mall owner that has a number of B- and C-rated malls in its portfolio, has said it plans to file for bankruptcy by Oct. 1, highlighting just how much pressure these landlords are facing. Even high-end malls are under pressure, though. No one is really immune. An upscale mall owner in Miami, Bal Harbour Shops, is currently moving to evict the luxury department store chain Saks Fifth Avenue for not paying rent since mid-March. It owes Bal Harbour roughly $1.9 million, according to court documents.

“Despite being given months to honor its past due rental obligations and despite Saks’ impressive post-COVID sales at Bal Harbour Shops, Saks steadfastly refused to make any effort to pay any part of its rent,” Bal Harbour Shops President and Chief Executive Matthew Whitman Lazenby said in a statement. “Bal Harbour Shops has worked tirelessly to ensure our business and our tenants can survive and thrive in this environment. Regrettably, this injudicious behavior has left us with no other option than to terminate the Saks lease and sue to evict Saks from Bal Harbour Shops.”

A representative from Hudson’s Bay-owned Saks was not immediately available to comment.

About 90% of occupants in U.S. malls are either experiential tenants like movie theaters, or department store chains and apparel retailers, according to the Coresight analysis. This makes malls the most vulnerable type of shopping centers to the Covid-19 impact, it said, compared with other properties like strip centers that have grocery stores and outlet centers that offer consumers bargains.

During the pandemic, movie theaters and clothing shops have faced long windows of being closed, while consumers could still flock to strip centers for food, cleaning products and other essentials. In some states, such as New York and California, movie theaters remain closed to this day. And so with minimal revenue coming in, these are the businesses that are most likely requesting rent reductions, or not paying rent at all.

Mall developers had up until now been courting entertainment companies like Dave & Buster’s and iFly indoor skydiving, and restaurants like Cheesecake Factory, to lessen their dependence on shrinking retailers. But those businesses have also not fared well in an age of social distancing.

So, if not warehouses and entertainment complexes, analysts have pondered other potential use cases for so-called dead malls: Churches, medical facilities, office spaces and even apartment complexes.

But even office space is a risky bet now, as the working-from-home trend could become permanent for some. Workers in JPMorgan Chase’s corporate and investment bank, for example, will cycle between days spent at the office and at home, keeping the ability to work remotely on a part-time basis. The world’s biggest Wall Street bank by revenue has said it could shutter backup trading floors located outside New York and London as a result of the move.

The outdoor retailer REI is also looking to sell its recently completed corporate campus in suburban Seattle, shifting instead to more satellite offices, as a result of the pandemic.

“Unfortunately, this whole Covid thing has thrown the experiential pitch out the window,” Moody’s Calanog said in a phone interview. “Until we resolve this pandemic, I suspect we are going to be in a holding pattern with hollow retail space. Then we will see what the most viable format is.”

View the CNBC news video ‘How Shrinking the American Mall Will Impact Local Tax Revenue‘ below.

Source: CNBC