Archives for June 2022

Rent payments could be underpriced by anywhere from 85% to 134% when leases roll.

Renters of industrial properties are facing sticker shock in the current inflationary environment, with national effective rent growth expected to increase nearly 23% year over year in 2022.

“Although industrial has a reputation for shorter lease terms, the reality is that the weighted average lease term for industrial is around five to seven years, much like it is for office,” write Cushman & Wakefield economists Rebecca Rockey and James Bohnaker in a new analysis. “Many of the leases that are rolling today are therefore significantly underpriced on the tenant side, especially with escalations that may have been negotiated five to seven years ago.”

And depending on the escalations occupiers have incurred, Rockey and Bohnaker say the market value of rent payments could be underpriced by anywhere from 85% to 134% when leases roll.

“In many markets, particularly those that have development constraints due to physical land features, land scarcity or zoning laws, rent pressure will be much more significant than the national average,” they say. “Any expectation that these rent pressures fundamentally shift is misplaced…The probability that rents decline, let alone decline by enough for costs to stay flat, is extremely low. Not every industrial-logistics occupier has a lease rolling this year or next, but eventually all occupiers who rent real estate will face these conditions.”

So what’s an industrial occupier to do? Cushman & Wakefield data shows that in two-thirds of major industrial markets they cover, tenants are renegotiating leases earlier than they historically otherwise would have. And “in 55% and 33% of markets respectively, occupiers are looking at new submarkets at similar or longer distances than in the past, perhaps indicating awareness that today’s energy and transport cost issues are episodic but real estate costs are lasting,” the economists say.

Another 30% of markets report that tenants are exploring build-to-suit options to better control costs, while 20% of markets say technology and automation are “increasingly part of the calculus. “

“It’s important to remember in addition to facing an incredibly tight current labor market, occupiers need to prepare for the loss of a significant segment of the current workforce as one-fifth of logistics workers will reach retirement age this decade,” the analysis notes. “Leveraging robots, autonomous vehicles, blockchain technologies and more will help occupiers become nimbler in their supply chains, which will help lower variable expenses and mitigate risks in the long run.”

The warehouse automation market is expected to grow by 1.5 times by 2025 to $37.6 billion, according to Newmark.

Source: “Industrial Tenants Face Sticker Shock Amid Spiraling Inflation“

Interest in CBD location remains high, despite increasing popularity of the suburban office sector.

More people are searching for available office space now than before the pandemic, in what analysts at CommercialCafe are calling “a much more encouraging outlook” for the sector.

After declining substantially in 2020, searches for office space for rent followed a positive pathway in 2021, while nearly a quarter of respondents surveyed by the firm said they were looking to downsize their overall office footprint. Around 23% said they’d like to be the sole tenants in a building, while another 23% said they were looking for a better deal in terms of price per square foot. And 16% said they were looking for larger office spaces.

“Once again, the data gives credence to the argument that remote working hasn’t made offices obsolete—as news of big companies either investing in prime real estate, renewing, or expanding their leases has continued to pour in,” the CommercialCafe report states.

In addition, tenants appear to be looking for more outdoor spaces and better safety measures. Though half of those surveyed said their preferences haven’t changed much or at all, 12% say they’re seeking more natural light and outdoor amenities, while 10% said indoor environment monitoring and sanitation was a priority. An additional 7% said they’d like subletting to be an option in their lease agreement to maximize flexibility in a post-COVID world.

CommercialCafe also noted that interest in CBD location remains high, despite increasing popularity of the suburban office sector.  What’s more, tenants appear to be staying put in their existing cities.

“In the first months of 2020, real estate professionals were gearing up for changes to their clients’ office location preferences due to significant outpourings of population across major U.S. cities, as well as uncertainties regarding the nature of the work schedule to be adopted by various companies (full return to the office, fully remote or hybrid),” the report notes. “However, while answering our survey, a clear majority (76%) of those looking for an office space said they were doing so within the same city. Furthermore, of those, 45% would like to move to a location near their city’s downtown or central business district.”

About 43% of respondents say they are aiming for a “full return” to office, though that number appears to wax and wane depending on COVID-19 surges. CBRE has increasingly noted that a modern hub and spoke model has emerged through flexible office providers as companies reconsider their footprint.

“Most of our clients are telling us that they are actually looking to consolidate into locations—partly for efficiency reasons, but also because if people are going to be expected to come together when they’re in the office, then coming all into the same office as much as possible is probably the best way forward down the line,” said Julie Whelan, Global Lead of Occupier Thought Leadership at CBRE.

Some of those large organizations are engaging with flex office providers that are scaled across the US and globally to create on-demand models or all-access subscription passes for their space.

And while office usage is up—hitting 40.5% nationally in April, the highest since the onset of the COVID-19 pandemic in 2020—the future is still a bit fuzzy.

“As (return-to-office) plans ramp up, we expect office physical utilization to climb at least in the short run,” write Moody’s Analytics researchers Xiaodi Li, Victor Calanog and Kevin Fagan.  “However, a multitude of surveys and early indications from initial post-COVID-19 work arrangements, it is likely that some workers will average around two days less in the office, which may ultimately form somewhat of a fuzzy ceiling at around 60%, with continued wide variance by office market, firm industry, and individual job type.”

Source: “And Now, Some Good News: More People Are Searching For Office Space Than Before“

Like all of business, nothing is certain, but some pros are eyeing the conditions and readying themselves for an unwelcome surprise.

Years ago, there was a novel called Been Down So Long It Looks Like Up to Me. Could it be time for a commercial real estate sequel: Been Up So Long It’s Bound to Look Down?

Between possible early signs of a recession, commercial property sales beginning to slow, and increasing financing costs and pressures, there’s the natural question of how long elevated prices can last.

“The debt capital markets are in the driver’s seat,” Nitin Chexal, CEO of Palladius Capital Management, tells GlobeSt.com. “Leverage is falling, and interest rates are rising. Prices have only one way to go in the short term: down. It may take some time for sellers to acknowledge this sea change, but it is coming.”

The “increase in financing costs for CRE investments and development have not yet been matched by corresponding reductions in the pricing expectations of sellers of CRE properties and development sites,” Eric Maribojoc, director of the Center for Real Estate Entrepreneurship at George Mason University School of Business, tells GlobeSt.com. But pent-up consumer demand and accumulated savings “will in turn delay any slowdown in rent income and space demand for CRE which is what leads to declining values.”

Adil Hasan, director of real estate at Yieldstreet, sees multifamily as stronger given “record transaction volume and value appreciation post-covid” fueled by low financing rates and massive investor capital inflows. “Yieldstreet does expect the rent growth to slow down eventually over the next year or two but the previously realized rent and net income growth would stabilize the property at attractive yield on cost,” he says.

But “buyers requiring high levels of leverage have become less aggressive and sellers are increasingly preferencing buyers” who don’t depend on financing, says Nick Stein, managing director of portfolio management at Sentinel Real Estate Corporation.

Office could feel more pain, given data and insights into changing corporate use of offices. “There are weekly anecdotal reports of companies cutting back expansion plans and /or reducing their square footage,” says Harold Bordwin, principal and co-president of Keen-Summit Capital Partners. “The implications of this drop in property values will be profound.”

Michael Silver, CEO of Vestian, agrees. “The competition for tenant renewals, lease extensions and relocations is becoming more fierce every day,” he says. Many owners have jacked up tenant concessions by 50% over those of six months ago. “The total net effective rent is going down by 20-30%, interest rates are rising and prices for CRE will also drop 20-30%.”

On the industrial front is news that Amazon would drop about 10 million square feet of warehouse space. “In my personal opinion this is where the pendulum swung too far one way,” says Grant Pruitt, president and co-founder of Whitebox Real Estate. “Two of the three big drivers of demand in industrial real estate were increased e-commerce demand and the need for increased inventory levels to mitigate shortages.” While stores are open again, Pruitt sees e-commerce as continuing its growth, and also thinks that concerns about office might be overstated.

In general, “there is some concern about construction costs and whether rising lease rates can keep pace,” according to Adam Roth, executive vice president of industrial services at NAI Hiffman.

One other potential headache is in senior housing, where “consumer disposable income and cost pressures … tie to trends in senior housing, which is definitely experiencing significant wage inflation and cannot cut costs/services in the same way that hotels have,” according to Alex Killick, managing director at CWCapital Asset Management. “Similarly, we get the sense that some senior housing may reach a limit on where rents can be charged, limiting their ability to pass on the increased expenses.”

Source: “Are CRE Price Drops Coming?“