Archives for August 2022

C&W pegs the possibility for a mild recession at 50%, but high-quality office, certain retail and multifamily will remain good bets.

CRE property values are likely to slump as economic growth slows and bond yields rise, according to a new analysis from Cushman & Wakefield, which pegs the average decline if a “mild” recession happens to clock in at around 20% over the next two years and range between 4% and 23% depending on property type.

But despite that, “without question, certain segments of the market will thrive over the next few years, easily outperforming our national forecasts,” Cushman’s Kevin Thorpe, Rebecca Rockey, James Bohnaker, and Rob Miller note.  But “we can’t emphasize enough that all real estate is intensely local.,” they say. “Not every product type or geography will follow the national glide path. Even within each asset class, a large portion will likely outperform our forecasts, and some will likely underperform. Within that volatility lies the opportunity.”

Cushman experts modeled four possible scenarios around the likelihood of a recession.  The first “soft landing” scenario, which is pegged at a 30% probability, would see the Fed successfully recalibrate the economy without triggering a recession.  GDP would then slow to around 2% this year and next.  The second scenario, upside growth, has a 5% shot of materializing and would require supply chain issues and the Russia-Ukraine conflict to quickly resolve.  Scenario 3, the “mild recession” model, is the one Cushman experts say is most likely to transpire (a 50% chance) and involves the Russian invasion of Ukraine continuing, resulting in a larger loss of oil supply and higher prices, and high inflation cutting into disposable income. This would see a recession by late 2022 or early 2023, but the underlying strength of consumers and business would keep the recession short and shallow.

Stagflation is presented as a fourth scenario, which would result in a “deep recession” by 2024, but Cushman experts peg the likelihood of that happening at just 5%.

Among the bright spots in a so-called “mild recession: high quality office assets, “the right retail” (think food-centered or grocery-anchored options), and multifamily, which is expected to see years of strong fundamentals ahead. Cushman experts recommend caution around e-commerce assets under this scenario, noting that “the sector is the most exposed to the rising cost of capital, meaning investors may want to monetize some low yielding core assets and keep their capital dry awaiting recap opportunities as debt maturities increase.”

“The fundamentals of the US economy are sound, which will help limit the magnitude and scope of a potential downturn,” the Cushman analysts write. “One of the most notable fundamentals is the strength of the consumer, which underpins 70% of GDP. US households still have over $2 trillion in excess savings to manage through a period of higher inflation and weaker income growth. Low debt levels, strong labor gains and wealth effects from higher home equity are also likely to insulate the consumer outlook. Moreover, healthy corporate and bank balance sheets will help mitigate job losses and keep the debt and credit markets functioning through the downturn.”

Source: “What To Expect for CRE Valuations If a Mild Recession Hits This Year“

While once institutional allocations were weighted towards retail and office, they have responded to long-term structural shifts and refocused on industrial, multifamily and data centers.

Institutional investors have shifted with the times and honed in on the sectors that have outperformed the broader commercial real estate market in recent years, with multifamily, industrial and data centers topping the list of investor preference according to the results of the first WMRE Institutional Investor Survey (brought to you by Yardi).

Survey results show that institutions are most likely to prefer investing in multifamily (67 percent) and industrial (47 percent), followed by data centers (36 percent).

“Since the GFC, multifamily and industrial have had tremendous demographic tailwinds, and COVID added after-burners,” says Jeff Adler, vice president, Matrix at Yardi. That sentiment also is reflected in sales data. Multifamily assets represented about 41 percent of all property transactions with $154.6 billion in sales during the first half of 2022, while industrial had the second highest volume at $74.6 billion, according to MSCI Real Assets.

Although office and retail have traditionally been considered part of the four major food groups for institutional investors, both office and retail rated low by respondents at 14 percent and 12 percent, respectively. The general premise driving demand for office was that people needed to go to one central physical location to do work, notes Adler. “COVID blew that apart. We’re still in the early innings of trying to figure out how to put all of that back together, and it’s not going to be the same as it was,” he says.

However, it is noteworthy that within the office world, there are two niches that are absolutely out-performing general office—life sciences and medical office, notes Adler. Life sciences rated favorably among one-third of respondents and medical office at nearly one-fourth. The challenge for institutions is that it can be difficult to access life sciences as it’s a very small segment of the overall office stock. Medical office also is performing well with strong demand drivers due to the baby boomer population that likely will have more demand for medical services as they get older. Although retail rated low in the survey, grocery-anchored centers continue to perform well, while the mall sector is working to reinvent itself and it does show signs of stabilizing, notes Adler.

Views on preferred property types also might reflect the evolution occurring within real estate portfolios. Traditionally, 1.0 executions were overweight in office and retail, whereas 2.0 executions have a greater emphasis on logistics and residential. According to says Bernie McNamara, head of Client Solutions at CBRE Investment Management, the focus for many institutions is currently on 3.0 portfolio strategies that focus on increasing allocations to logistics and residential as well as other growth sectors, such as self-storage and seniors housing.

When asked to select the top three investment vehicles institutional investors are most interested in, survey respondents rated direct investment in multitenant commercial and multifamily real estate assets the highest at 54 percent, followed closely by private equity real estate funds at 49 percent. Private placements with real estate investment managers and public REITs also rated favorably among 27 percent and 25 percent of respondents. Those vehicles least in favor were real estate mutual funds at 8 percent and CMBS at 7 percent.

Institutions typically view funds as an efficient way to get diversified access and exposure to certain sectors and subsectors, and then use direct investments where they have more control as a complement to those fund strategies, notes McNamara. In terms of other formats that are on the rise, more investors are taking an “all of the above” approach that helps them to reach target allocations, he says. For example, that might include deploying capital into public REITs. There also can be both tactical and strategic reasons why investors are embracing different vehicles, such as using public REITs to get access to growth sectors that might be harder to access at scale through direct investment, such as life sciences or SFR, he says.

Source: “Institutions Have Shifted to Multifamily, Industrial and Data Centers in Their Real Estate Allocations“

The state has hit a milestone in the approval and issuing of cannabis licenses, surpassing 1,000 since the Cannabis Control Division began issuing them last fall.

To date, 1,027 total licenses have been approved and issued.

Those numbers were shared by the division on Tuesday in a presentation to lawmakers on the Legislature’s interim Courts, Corrections and Justice Committee.

The update comes nearly half a year into the sale of adult-use cannabis, which has so far generated nearly $88 million in recreational sales for cannabis businesses. And it comes at a time when lawmakers and industry leaders are raising questions about equity in the cannabis industry.

“We’ve undid the alcohol monopoly and now we’ve created a super monopoly. Six (businesses) controlling the market,” said Sen. Joseph Cervantes, D-Las Cruces, referring to a group of legacy operators in New Mexico that controls a large share of the cannabis market. “I think what is unfair is we’re letting people believe they can get in the market.”

In CCD’s update, 292 licenses were issued to retail businesses, 188 to producers and 91 to manufacturers – the three main license types.

CCD began accepting applications for licenses late last year and began issuing licenses as early as September. But a big push in approvals came as April, the start of recreational sales, got closer.

Vertically integrated licenses – which allow businesses to grow their own plants, manufacture their own products and operate storefronts – accounted for 110 licenses, according to the data. And less common license types, including those issued to cannabis testing labs and consumption areas, accounted for five total approved licenses.

But New Mexico, unlike other states where cannabis is legalized either recreationally or medically, allows for multiple premises to be attached to a license – leading to what can account for more physical locations than what is shown in the number of total approved licenses. For instance, there are about 471 storefronts attached to the nearly 300 retail licences, according to CCD data.

The number of licenses approved over the past few months has given some industry leaders and lawmakers reason to praise the new industry. It has given others a reason for concern.

Ben Lewinger, the executive director of the New Mexico Cannabis Chamber of Commerce, said the aggressive timeline of the state in approving licenses for cannabis businesses and the fact that there is no cap is a win for those looking to get a fresh start in a new industry.

“We want a diversity of operators … for a variety of different customer experiences,” Lewinger said, adding that some adjustment may be needed as time goes on to keep the industry in good standing.

Andrew Vallejos, the director of the Alcohol Beverage Control Division for the state’s Regulation and Licensing Department, said putting a quota on the number of licenses will lead the cannabis industry down the same path as that of liquor – further benefiting a number of businesses in the industry that share the majority of the market.

Capping licenses, though, would require legislative changes, RLD spokeswoman Bernice Geiger said.

Sen. Katy Duhigg, D-Albuquerque, said there are risks both ways regarding cannabis licenses.

“While Director Vallejos is right that if we put a quota on licenses we’re going down that same path as alcohol, at the same time all we need to do is look around at the states that have unlimited licensure and see how those markets have flooded and how the bottoms have fallen out on them,” Duhigg said. “It shouldn’t come as any shock to anyone when our market floods because of our unlimited (cannabis) licensure, and a lot of people lose a lot of money.”

Duke Rodriguez, the president and CEO of Ultra Health, told the Journal the state has already gotten to a point where he can see more than 200 retail locations closing in the next year due to market saturation caused by the state having no cap on licenses.

“I tend to think of it as a very scary and ominous sign of what is ahead of us,” Rodriguez said.

Source: “Cannabis Licenses to 1,000 in New Mexico“

Repositioning, management, and knowledge are the three critical ways in which CRE investors can drive value in assets, according to Marcus & Millichap’s John Chang.

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,” he says. “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: “How CRE Investors Can Still Create Value in a Rising Rate Environment“