Archives for June 2022

There are other worrisome signs that liquidity may be starting to tighten for CRE borrowers.

The last time Mark Scott, president of Commercial Mortgage Capital, remembers a lender invoking the Material Adverse Change, or MAC, clause in a deal was during the Great Recession. Now, he’s hearing it more and more in conversations with capital providers. “I’ve had lenders email me and say the market is experiencing a MAC and we are now raising the rate on your loan from 3.5% to 4.5%,” he tells GlobeSt.com.  “It is definitely being invoked more now.”

There are other changes in the commercial real estate lending market that Scott says do not bode well for borrowers, or for liquidity in general.  Regional banks are no longer locking or committing to rates. Many have shuttered new originations, and several are reneging on term sheets and threatening to not honor commitments and /or re-trade and adjust previously agreed upon rates. Loans that used to be placed rather easily, say 60% LTV multifamily loans, are getting fewer bids.  “I’ve had several lenders tell me they have too much exposure to commercial real estate and multifamily and they are exiting the market,” Scott says.

To be sure, Scott is just one individual and even he says he is not talking about a mass exodus. But given where he sits—which is squarely in the middle of the commercial real estate market—his recent experiences are worrisome. Commercial Mortgage Capital provides loans between half a million to $300 million with an average loan size of around $30 million. Scott works with local, regional and national banks in addition to life insurance companies, debt funds and other sources of real estate capital. And examples of lenders exiting the market among this group abound, he says.

The source of this angst, of course, are the rising interest rates and the knock-on effect that is having on Treasury rates. On Jan. 1, the Treasury rate was 1.52%. On Wednesday of this week, it was 3.03%. A 151-basis point increase in less than half of a year is a big shock to the system, Scott says. “That is why lenders don’t want to lock in rates anymore. Instead, they are waiting five days before closing to lock in the rate, which means the borrower has no idea what rate it will get.” And with less lenders in the market, spreads are widening, increasing costs even more.

Basically, commercial real estate is no longer a pretty word anymore among the lender community, Scott says. “Six months ago, it was.”

Source: “CRE Lenders Are Dusting Off The MAC Clause Again“

Although office occupiers should have it easier with inflation, there is a catch.

There is “no question” that office occupiers have been the least impacted by inflation, according to one industry economist—but that doesn’t mean they’re immune from the challenges wrought by the current economic environment.

In a new analysis, Cushman & Wakefield’s Rebecca Rockey notes that since office occupiers are generally service providers, they’ve had it easier when it comes to inflation.  But there’s a catch: “they are experiencing no shortage of challenges as they adapt to work-from-anywhere and intense competition for talent that now has fewer city-edge borders,” she writes. “Companies are also struggling to commit to new pay models for remote-first or mainly-remote workers who can potentially have a much lower cost-of-living than non-remote workers in similar roles.”

And since occupiers generally dedicate between 30% and 70% of operating expenses to labor, with much of their value being derived from intangible assets like intellectual property, retaining and recruiting talent amidst the Great Resignation is even more vital, she says. What’s more, while wages are generally rising across industries at 6% year over year, finance and business services are posting below-average wage growth at 5% year over year, according to the Federal Reserve Bank of Atlanta.

“We have seen some examples, especially in high finance, of significant pay increases, but the impact on headline figures for office-using sectors has been muted thus far. Moreover, in today’s environment, employers are having to factor in benefits of flexible working as an additional and necessary perk to attract the best of the best,” Rockey says. “Even though companies have been reticent to announce official policies around compensation for similar roles across markets with highly varied costs of living, the reality is that hiring in a variety of locations with different labor costs provides an opportunity for firms to compete for talent (and provide higher wages) while still mitigating the overall effect in operating expenses.”

Rockey posits that a window of opportunity exists for companies who need more space or who have seen their leases roll since the pandemic. The US office market “remains the only major sector in a correction,” with negative absorption as of the first quarter and national effective rents down about 12.5% since the last quarter of 2019. Rockey says the best product is performing well, “commanding bidding wars and with high occupancy rates,” while “lower-quality, less well-located product is the weakest.”  Class A buildings are driving office absorption in many parts of the United States, particularly in the Sun Belt, according to the latest NAIOP Office Space Demand Forecast published by the NAIOP Research Foundation.

“Depending upon the type of space a tenant needs and where that space is located, the tenant may be confronted with highly bifurcated market conditions,” she says. “Many markets (four-fifths of those surveyed in April 2022) consider overall conditions to be moderately or extremely tenant-friendly, though.”

Last month, NAIOP said that the completion of new buildings may be partly to blame for the continued uptick in office vacancy. The organization projects that absorption of that space will continue to be positive. Overall net office space absorption in the last three quarters of this year is predicted to clock in just shy of 47 million square feet, with net absorption next year forecast to be 47.3 million square feet.

Cushman & Wakefield takes the position that occupiers should prepare for the “inevitable improvement” in market conditions as vacancy tops out and rents hit bottom this year and next: “the window of opportunity will not last forever,” Rockey concludes. “But for now, there is no question that office occupiers have been the least hit by today’s inflationary environment.”

Source: “How Inflation Is Impacting the Office Recovery“

Amazon was the first to announce plans to sublet warehouse space, but other Fortune 500 retailers are expected to return space to the market as well.

Over the last decade, first-mile warehouses have evolved from traditional, 31-ft.-clear-height facilities with 500,000 to 1 million square feet into 60-foot clear-height, automated, artificial intelligence-managed behemoths of well over 3 million sq. ft. spread over three mezzanine levels.

These larger, modern facilities have become the preferred choice by Fortune 500 e-commerce retailers, from Amazon and Walmart to Best Buy and Target. The larger, tech-enabled facilities have helped mitigate labor shortages and allowed retailers to stock sufficient inventory to meet surging online customer demand, especially in a world of supply-chain uncertainties and varying delivery times.

Amazon had been especially aggressive in leasing, buying and developing warehouse space to bolster its portfolio. But then the company surprisingly announced it had too much space, and would sublet up to 30 million sq. ft. of warehouse space or renegotiate leases.

That’s raised questions about whether overall demand for industrial space may finally be cooling. But a closer look at Amazon’s plans show that it is largely looking to shed traditional, mid-market warehouses. It’s a case where they’ve upgraded to newer, better facilities and are now freeing up older stock.

And they may not be the only company looking to do that. Other Fortune 500 retailers are looking at subletting traditional warehouses they committed to long-term, because they are not in close enough proximity to customers to be used for last-mile distribution and no longer meet the needs for first-mile use, explains Kris Bjorson, international director of Industrial Brokerage at JLL. He notes that these warehouses, which were originally designed for first-mile use, are now considered mid-market because cities grew around them so they are stuck in the middle between first- and last-mile use.

Bjorson adds that any return of warehouse space to the market is a positive, especially in markets with low or no vacancy.

And even the amount of space Amazon is talking about subletting in markets like California, New Jersey and New York, where the retail giant expanded during shop-at-home peak periods amid the pandemic, will have little impact on overall market vacancy rates, notes Matt Dolly, research director for Transwestern’s Strategic Accounts Program and Industrial Real Estate.

Even at the high end, Dolly points out, 30 million sq. ft. represents less than one-quarter of one percent of the U.S. industrial real estate inventory.

“That said, it does put the market on alert, “he adds, noting that e-commerce sales velocity slowed as the country opened up. Dolly says, however, that sales are still well above pre-pandemic levels, so any regression will likely remain above previous averages.

He notes, however, that some major retailers that underestimated supply costs may eventually dial back space occupied.

“An increase in the amount of durable goods and household purchases were made during the pandemic, but now consumers are likely to revert to a more normal pace of purchasing, especially during an extended period of high inflation,” Dolly explains. “If consumer demand dips, there could be an increase in vacant space once the goods that piled up are sold and restocking is no longer necessary.”

Demand for industrial space is still outstripping supply, so Bjorson doesn’t think that even if all Fortune 500 retailers return space to the market that it would impact the supply-demand imbalance or move vacancy rates much this year. He concedes that e-commerce sales are flat and inflation remains at a high annual rate, so vacancy could become a more relevant issue in 2023.

Dolly agrees, noting that many retailers are adding space for storage purposes as they stock up on goods in anticipation of continued supply-chain challenges. Logistics/transportation companies also continue to expand, he adds.

Dolly also notes that sublet space also will offer discounted rent opportunities in certain industrial pockets, but market players are still forecasting double-digit rent growth for the next year or so, especially for new construction.

Bjorson expects rent discounts to be in the 10- to 30-percent range, depending on the sublet term. He notes that sublets will benefit smaller e-commerce retailers and startups or be converted to other uses, such as manufacturing or product assembly. Bjorson says that tenants subletting space can afford to offer generous discounts because they had originally leased the facilities some years ago at lower rents and want this obligation off their books.

Neither of these experts believe that sublet space or a little market softening will impact new construction due to “flight to quality.”  Bjorson notes that Fortune 500 retailers are exiting these older warehouses to move to state-of-the art, automated facilities.

“There is still plenty of demand in the pipeline, and users and investors continue to desire modern warehouse space, putting older inventory at higher risk,” adds Dolly. He notes that industrial development also is needed where recent population shifts have occurred, as e-commerce will continue to grow—albeit not at a pandemic-driven pace.

The U.S. industrial market experienced 50 consecutive quarters of positive net absorption through the first quarter of 2022, and over the past few years, industrial real estate leasing velocity occurred at a pace never seen before, Dolly continues.  As a result, many projects under development are already pre-leased, which means solid absorption numbers over the next few quarters, he adds.

Dolly notes that Amazon represents +/- 5 percent of total U.S. logistics inventory and, at one point during the pandemic, accounted for more than half of all logistics real estate growth. “So for the first time in more than a decade, industrial market players, in some cases may have to proceed with caution.”

“Amazon’s real estate decisions, as always, are worth paying attention to as market momentum can change quickly,” Dolly suggests. “In weather terms, the Amazon news is more of a ‘watch’ and less of a ‘warning’ at this time.”

Source: “Amazon’s Plan to Sublease Industrial Space May Just Be the Start“

First in a two-part series.

The inflation we see first-hand is a result of pent-up demand not being met by supply, due to factors such as increased consumer spending and disrupted supply chains.

The industrial leasing market for value-added production and warehousing in the Borderplex region (El Paso, Juárez, southern New Mexico) is a microcosm of this phenomenon. I recently got to attend a couple of briefings by Christian Perez Giese, senior vice president/director of industrial and logistics at commercial real estate services company CBRE’s Borderplex branch, and picked up a lot of current information about industrial space in the Borderplex.

Speculative space, often referred to as “spec” space, is industrial space a developer constructs without necessarily having a contract with a tenant. The space is built on speculation that upon completion of the space, or shortly thereafter, the developer will recruit a tenant(s) to lease the space. Having spec space available allows developers and communities the ability to offer available product to companies needing to lease space in a relatively short period of time. In many cases, a company cannot wait the nine to 12 months it can take to construct new industrial space and deals are lost.

In Juárez, there is approximately 75 million square feet of industrial space, and active users are currently demanding another 3.6 million square feet. Juárez has been seeing companies from Asia setting up production operations to hedge their risk against supply chain disruptions, trade wars and rising logistics costs. Major Taiwanese companies have established new operations in Juárez or expanded their existing operations. Approximately 4 million square feet was absorbed in Juárez in 2021, with another 800,000 square feet having been absorbed in the first quarter of 2022, the second highest absorption in a quarter on record.

Currently, the vacancy rate for Juárez industrial space is 0.7%, which is a historic low. More than 5.5 million square feet of industrial space is currently being constructed, 3 million of which is spec space. If all the spec space were available today, vacancy rates would only increase to 2.7%, which is still well below typical market equilibrium. This construction activity is a strong leading indicator for upcoming demand in El Paso, Texas, and Santa Teresa, New Mexico. Historically, industrial lease rates have been similar on either side of the border in the Borderplex. However, Juárez has been underpriced for six to nine months, and lease rates are rapidly catching up to those on the other side of the border. Average asking lease rates in Juárez can now exceed $6 per square foot.

There is currently 63 million square feet of industrial space on the U.S. side of the Borderplex. More than 4 million square feet of space was absorbed in 2021. In the first quarter of 2022, another approximately 1 million square feet of industrial space was absorbed, which was a new record. According to CBRE, the vacancy rate in the El Paso region is currently 1.5%. Brokers believe that it could actually be as low as 0.5%, taking into account that some of the available space is functionally obsolete.

At present, there are 2.7 million square feet of spec space under construction, of which 1.5 million square feet is to be delivered in 2022. Of the total new spec space, 983,000 square feet is already leased or has a letter of intent in place. At present, 2.8 million square feet of space is being demanded by active users. Warehousing accounts for the majority of this demand. Transportation, logistics and third-party logistics firms account for more than 80% of recent leasing activity. In Santa Teresa, New Mexico, and San Jerónimo, Chihuahua, (immediately across the border from each other), more than 2.1 million square feet of space is under construction, of which 635,000 square feet is spec space. Lease rates for select spaces can now exceed $7 per square foot.

It could take a couple of years for the supply of spec space to catch up with the demand to return to what would be considered a normal market vacancy rate. If current market trends continue, the Borderplex region could face another 30% increase in rental rates by 2025.

According to Perez Giese, “A lot of land is being sold to new developers entering the market, so new space will be built. The demand for industrial-use land has driven prices to all-time highs in east El Paso. However, the Borderplex still has some of the best industrial land in the West, with prices well below other competitive markets.” The development boom is pushing growth east to Horizon City (far east El Paso) and west to Santa Teresa in New Mexico.

“In spite of land and rent price increases, the cost(s) of living and operating industrial buildings in the Borderplex are still comparatively low, which works to its advantage. In the future, we should see more manufacturing coming into the region that is not necessarily related to Mexico,” states Perez Giese.

Source: “Borderplex, Juárez Industrial Growth Off the Charts“