Archives for August 2022

Over 1,800 companies re-shored production in 2021, setting a new record for re-shoring activity, notes The Reshoring Initiative. These companies are looking for logistics facilities, warehouses and distribution sites.

The COVID-19 pandemic made U.S. manufacturers painfully aware of risks posed by off-shore operations and their dependence on the global supply chain to move their products back to U.S. markets. As a result, many are either planning or already reshoring or near-shoring their production facilities.

In recent months, trade disputes and the war in Ukraine have only added fuel to this trend, notes Richmond, Va.-based Brewster Smith, senior vice president of supply chain solutions at Colliers.

“I don’t think the trend is prompted by any macroeconomic fears, since manufacturing reshoring will be inflationary in and of itself,” Smith adds, citing the higher cost of producing domestically. On the other hand, the climate crisis and, more recently, the risk of China decoupling from U.S. trade relations over the Taiwan situation may add further stimulants for reshoring activity.

According to a recent report from research firm Statista, between 2010 and 2021, 44 percent of re-shored jobs were returned to the U.S. from China, 21 percent came back from Mexico and 10 percent from Canada. A 2021 report from The Reshoring Initative, a non-profit established to promote reshoring manufacturing jobs, reported that 860,000, or 78 percent, of the 1.3 million jobs returned to the U.S. since 2010 were moved over the last two years due to both private business and federal push for domestic manufacturing of essential goods.

In fact, manufacturing jobs re-shored to the U.S. exceeded jobs that were off-shored by 100 percent for the second consecutive year. Near-shored and re-shored manufacturing facilities are moving to Mexico, Latin America and U.S. “right-to-work” states, according to Smith.

Over 1,800 companies re-shored production in 2021, setting a new record for re-shoring activity, notes the Reshoring Initiative report. About 60 percent of companies that offshored production based their decisions on the cost of wages, freight prices or land costs. The Reshoring Initiative, projects that U.S manufacturers will re-shore another 400,000 jobs by the end of 2022, a 35 percent increase over last year.

Manufacturers are most likely to re-shore or near-shore manufacturing facilities for high-value products with complex production processes that require a highly skilled labor force, according to Smith. These include products such as semi-conductors, rare minerals, electric car batteries and infrastructure products. Just this week, Intel and Brookfield Asset Management announced a $30 billion partnership to build new chip-making factories, the first of which is planned in Arizona. Before this latest announcement, Intel, GM and Siemens were already collectively investing more than $80 billion in U.S.-based manufacturing operations.

On the other hand, products with more commoditized production processes, such as injection molding and printing or stamping, will most likely remain in China, says Smith. According to the Reshoring Initiative, more than 5 million U.S. manufacturing jobs remain offshore.

Semiconductor chip manufacturing is poised to experience expansion in the U.S. in the near future. Even before the Biden administration allocated $53 billion to support the domestic manufacture of semiconductor chips via the CHIPS Act, industry leaders were already exploring options here. In addition to Intel building new factories near Columbus and Phoenix, the Taiwan Semiconductor Manufacturing Company is also developing a new plant in Arizona. Samsung is investing $17 billion in a new semiconductor plant in Texas, says Al Pontius, San Francisco-based vice president and national director for office, industrial and healthcare with commercial real estate services firm Marcus & Millichap. Meanwhile, Micron Technology, an American producer of computer memory and data storage, is planning to invest in U.S. operations as well.

Examples of other industries on-shoring production include Paratek Pharmaceuticals, which produces the NUZYRA tablet stateside, as well as many aerospace companies, such as SpaceX and Blue Origin.

The Biden Administration provided $600 billion in the 2022 federal budget to support U.S.-based manufacturing jobs. Other federal initiatives, including the America Creating Opportunities for Manufacturing, Pre-Eminence in Technology and Economic Strength Act, the United States Innovation and Competition Act, and President Biden’s Build Back Better Agenda, provide funding and other support aimed at improving supply-chain resiliency, which is boosting re-shoring activity.

Additionally, the Administration’s Inflation Reduction Act provides incentives to boost both manufacture of renewable energy infrastructure and the market for these products, including tax breaks for purchasing electric vehicles (EVs) and huge incentives to manufacture solar panels, wind turbines and next-generation batteries. The act would benefit companies developing EV and storage batteries, solar panels and related devices by reducing the cost of manufacturing and thus increasing end-user demand for these products, according to Pontius.

Public sector support always helps a private sector initiative, says Smith. He notes, however, that the most immediate incentive for re-shoring is improved supply-chain resiliency and inventory availability—a major issue for manufacturers due to global supply-chain disruptions.

What’s ahead

The biggest high-value manufacturing boom on the horizon is in EVs. Five to seven EV plants with adjacent EV battery production facilities are already underway in the U.S., and even more are in the planning stages, according to Matt Jackson, executive managing director, brokerage, with commercial real estate services firm JLL.

General Motors, Hyundai, BMW and Toyota are all expanding U.S. production operations mostly to accommodate EV production, says Pontius. GM, for example, is spending more than $4 billion to expand its EV and battery production plant in Michigan, and Toyota is building a $1.3 billion battery plant in North Carolina.

The biggest issues with re-shoring right now are the higher cost of labor, which means higher prices for products re-shored, and a labor shortage. As a result, Smith notes that manufacturing operators re-shoring production are exploring automation technology as part of their manufacturing strategy to help reduce labor requirements and mitigate the cost of higher U.S. wages.

Factors contributing to site selection decisions include the availability of land for development, as well as a large pool of skilled/specialized labor and well-developed transportation infrastructure, says Pontius. He notes that the Southeast, Southwest and Midwest are attractive to automotive makers and related industries because they already have a labor base experienced in this industry and well-developed transportation infrastructure. The South and Southwest provide access to seaports and the Mexican border, while the Midwest provides sizable rail infrastructure for transporting goods nationally across the Canadian border.

For these reasons, Ohio, Michigan, North Carolina, South Carolina, Arizona and Texas have been popular options for new manufacturing facilities. At the same time, new manufacturing facilities comprising one million sq. ft. or more are also planned in California, Oregon, Colorado, Florida and parts of the Northeast, Pontius adds.

Cities in these regions with proximity to rail hubs and port facilities are the most likely to see both new manufacturing and warehouse development, according to a report from commercial real estate services firm Savills.

Overall, most of the growth in re-shored manufacturing is happening in markets with growing populations, business-friendly state governments and close proximities to major logistics hubs, says James Breeze, senior director and global head of industrial & logistics research at CBRE. He cites Phoenix, Central Texas, Alabama, South Carolina, Georgia and North Central Florida as such markets.

On the ground, re-shoring activity is generating competition for industrial properties between manufacturers and logistics users, as those types of buildings can serve either purpose. Growth in manufacturing is also increasing demand for warehouse space in these regions, as companies want to locate warehouses as close to production as possible to either store raw materials or distribute finished products. Placing distribution centers near the point of manufacturing also saves money on transportation costs, Breeze notes.

As more companies onshore or near-shore operations to the U.S. or other North American markets, supply chains will adjust, placing more emphasis on rail and roadways, according to Pontius. This will likely benefit metros along these transportation links, most notably San Diego, San Antonio and Detroit. All three are located near key border points that serve as launch points into other U.S. regions and nearby gateway metros. Vacancy has already fallen to multi-decade lows in San Diego and San Antonio, while availability is also contracting in Detroit, even amid a recent elevated level of development.

Source: “The Surge in Re-Shoring Activity Continues, Creating More Demand for Industrial Space“

Poor water stewardship poses a real financial risk for investors.

For years, you’ve been diligently turning off the faucet each time you brush your teeth. You’ve replaced harsh cleaning chemicals with more natural alternatives and even installed a low-flow showerhead. What more can you do to preserve our planet’s finite supply of water?

Although the aforementioned individual efforts are laudable, household usage accounts for just 11% of global water withdrawals each year. The real culprits, i.e., those that can contribute most to preserving our water resources, are companies. Although there are many reasons that corporations should evaluate their water management practices, we’re focusing here on the financial risks of poor water stewardship. Without further ado, here are three that may well rain on investors’ parades:

Reduced (or costlier) production capabilities and supply chain disruptions, which have the potential to dramatically impact companies across all industries. After all, water is essential for the cultivation and production of raw materials, the manufacturing process, and the distribution of products. In fact, the far-reaching effects of climate change–induced water scarcity can already be observed in Europe, where a summer of severe droughts has threatened livestock production and crop yields. Vital waterways such as the Rhone, Danube and Po rivers are drying up, hampering transportation of goods and impeding nuclear energy production.

The timing, arguably, couldn’t be worse for a continent that’s already grappling with soaring inflation and energy shortages following Russia’s invasion of Ukraine earlier this year. But nature waits for no one, and the effects of our collective procrastination are now yielding notable economic effects in the form of elevated shipping costs, supply shortages and likely production cuts. Some economists have warned that dry conditions in Germany, long considered mainland Europe’s economic powerhouse, could stall the country’s overall economic growth by as much as half a percentage point this year.

Legal action and reputational damage, as companies are taken to task for their roles in excessive water usage or contamination. Recent research has indicated that half of the United States’ waterways are now so polluted they are considered “impaired,” meaning they are unsafe for swimming, fishing or drinking. Among the contaminants garnering increased public attention are per- and polyfluoroalkyl substances (PFAS), commonly referred to as “forever chemicals” because they don’t break down easily. These man-made substances, which have been linked to a variety of negative health impacts in humans and animals, are now so ubiquitous that they can be found in even the most remote areas of the world.

As awareness of PFAs grows, so too do efforts to hold companies accountable for releasing these harmful chemicals into surrounding waterways—more than 1,200 PFAS-related lawsuits were filed in the United States last year. Corporate defendants could subsequently find themselves embroiled in protracted litigation, spending considerably on legal defense, settlements, judgments and crisis management communications. For some companies, the financial risks are formidable—well-known chemicals manufacturer 3M devoted 15 entire pages in last year’s annual report to its PFAS-linked legal exposures.

Stranded assets in water-stressed regions, often emanating from inaccurate projections regarding water availability and access, failure to implement appropriate risk mitigation and stewardship plans, and/ or unfavorable regulatory responses. Stranded assets, in case you were wondering, are those that no longer generate revenue for a company. They often transpire as a result of adverse environmental conditions (yes, that includes drought) or significant disruptions in terms of consumer demand, regulatory activity and technological innovation.

Again, this isn’t a hypothetical scenario: Some major publicly traded companies have already seen their assets become albatrosses as a result of water-related events. One particularly prominent example is that of mining behemoth Barrick Gold, which spent two decades and billions of dollars attempting to get its once-touted Pascua Lama mining project underway. This Andean project, straddling the borders of Chile and Argentina, was met with dogged and unrelenting opposition from environmental groups and local stakeholders concerned about its destruction of nearby glaciers, as well as depletion and contamination of local water supply. These concerns were seemingly not unfounded and in 2013, upon determining that Barrick Gold did not have adequate protocols in place to prevent water pollution, a Chilean court imposed a $16 million fine and ordered that the company suspend construction on the project (cue class action lawsuits from irate investors). Last month, drawing a line under the sorry saga, Chile’s Supreme Court ratified the definitive closure of Pascua Lama project.

Far from being a cash cow, Pascua Lama has become a cautionary tale for other companies, and its fate now hangs in the balance. Barrick Gold is currently exploring whether the Argentine side of the mine remains viable, but for now, the project represents an extremely expensive thorn in the company’s side.

What is the role of financial advisors in addressing the water crisis? 

Financial advisors, who are well positioned to help their clients identify and manage water risks in their portfolios. Given the politicized and polarized nature of recent dialogue surrounding environmental, social and governance (ESG) investing, some advisors might be hesitant to raise such issues with their clients. However, regardless of clients’ political inclinations, there’s a chance they are already experiencing the day-to-day effects of prolonged prevarication on water issues. Droughts might be affecting their livelihoods. Water pollution may be impacting their ability to enjoy much-loved hobbies such as fishing, scuba diving or boating. They might even have good reason to doubt that their home water supply is safe for consumption.

Importantly, advisors wishing to help clients target the encroaching water crisis are not merely limited to ESG funds, which have contributed to skepticism of the broader sustainable investing movement (particularly when it comes to a lack of transparency concerning these funds’ underlying selection criteria). Direct indexing solutions instead allow advisors to customize portfolios to clients’ specific values, financial preferences and tax situations. Many such platforms also afford investors the flexibility to decide whether divestment or engagement is their preferred impact approach; indeed, some independent shareholders have been lending recent support to proposals that urge disclosure and mitigation of water risks.

The time to act is now—the water crisis is not a nebulous, theoretical concept. It’s here, and it’s already having profound social and economic impacts. As other industry participants have observed, “by failing to account for water security in financial decision-making, financial markets are contributing significant financial flows that are increasing exposure and vulnerability to water-related risks across the global economy.” Advisors shouldn’t be afraid to discuss this financially material issue with clients; it’s part of their fiduciary duty.

Source: “Three Reasons Advisors Should Care About Water Resources“

As interest rates rise and the outlook for the economy at large remains uncertain, CRE investors who depend on debt have had to reassess their strategies. That’s impacting the property types they might consider for acquisition.

Rising interest rates are changing the calculations for real estate investors who rely on debt to make their acquisitions. Some asset classes work better than others in this environment, but a lot of the sentiment about what’s worth buying continues to be shaped by the dynamics in place since the start of the pandemic.

In general, there won’t be as many investment sales deals with higher rates, according to Jim Costello, chief economist, real assets, for data firm MSCI. The more risk-friendly lenders in the debt fund world have pulled back with interest rate increases, he says.

“That could impact certain sectors that were requiring a little bit of higher leverage to make things work,” Costello notes. “In September, we will have a ton more data on who is lending on what for the first half of the year. What we’ve been hearing from folks is a pullback by debt funds as interest rates spike.”

Buyers and sellers also remain far apart on expectations at the moment because buyers don’t want to pay yesterday’s prices for assets, Costello says. If owners have a low cost of debt and cash flowing, there’s no reason for them to take a loss.

“The numbers just don’t work to pay the price that someone paid in 2021 for an asset if you’re facing lower LTVs at a higher coupon rate,” Costello says. “A buyer isn’t going to jump in as aggressively while there’s some more uncertainty about what the income might look like, given the uncertainty about the economy.”

Jeremy Thornton, an executive vice president with commercial real estate services firm Colliers, says he’s never seen so much buyer retrade activity in his 23-year career. Buyers have gotten under contract, only to come back prior to closing with significant price adjustments tied to the increase in interest rates. “They went under contract on levered returns based on the fact that their financial assumptions were X,” Thornton says. “Now that interest rates have gone up significantly, they are not able to get those levered returns anymore, so they are coming back to the sellers for price reductions.”

A significant number of investment sales is being delayed, dropped or renegotiated by buyers to lower prices in light of interest rate increases, according to Jay Olshonsky, president and CEO of brokerage firm NAI Global. He notes that it doesn’t make sense for an investor to purchase a property at a 4 percent cap rate with interest rates going up to 5 or 6 percent unless it’s an all-cash transaction.

“However, there remains a significant amount of capital to be placed in real estate assets, so we are probably in an environment in which the debt-to-equity ratios are changing, yet investing in commercial real estate won’t stop,” Olshonsky notes. “It will migrate into different product types.”

As interest rates “begin to bite,” there’s going to be greater consideration given to property fundamentals and sector resilience when making investment decisions, according to Darin Mellott, senior director of capital markets research at commercial real estate services firm CBRE.

One intelligent strategy for dealing with a rising rate environment is to borrow for a long term at fixed rates, says Scott Singer, principal and co-lead of the tri-state debt and equity finance group with real estate services firm Avison Young. If you have a property that you intend to hold for 20 years and improve to increase its value while expecting to be in an inflationary environment over that long term, borrowing now at a fixed rate and amortizing as little as possible allows you to wait as long as possible to repay those dollars.

Another approach is to focus on properties where there’s an operational opportunity to increase value at a greater rate than what you expect the inflation rate to be, Singer notes.

“One of the risks of a short-or-medium-term inflationary market is that if interest rates are significantly higher when you need to refinance your property and your income level has not risen dramatically at the property, then the sizing of the refinanced mortgage may be not be high enough,” Singer says. “For borrowers who don’t have a 20-year horizon, then it’s necessary to look to properties where there is a business plan to increase the cash flow at the property dramatically in order to outpace inflation.”

In the following gallery, we look at what different property sectors can offer highly-levered investors under these new market conditions.

Funds and REITs that built up massive war chests are taking steps to make deals despite current uncertainties over optimal real estate pricing.

Many well-heeled real estate investors pushed pause on buying assets in recent months to get a better read on how pricing is shifting across all property types and how they might have to alter strategies or restructure capital stacks to move deals forward. Once pricing stabilizes, many market insiders believe all-cash and low-leverage buyers are best positioned to be the first movers off the sidelines.

Sales activity has slowed over the past few months, and many brokers are seeing less for-sale inventory on the market. Sales data for June shows a 4 percent year-over-year dip in transaction volume to $68.4 billion, according to MSCI Real Assets. And many are bracing for a bigger decline in the July sales data.

“We are seeing a bit of a wait-and-see approach now, but I don’t expect to see that in the back half of the year. There is still a lot of money that is trying to get into solid assets, especially the industrial and multifamily space,” says Erik Foster, a principal and head of industrial capital markets at Avison Young in Chicago. “Those folks who don’t use leverage as much are the ones that are likely going to be the ones to deploy their capital first, and potentially more aggressively,” he says.

Although not all investors have hit the brakes, buyers are moving more cautiously. “There is plenty of capital out there, but it is more selective,” says Chinmay Bhatt, a senior managing director and founding member of Berkadia’s JV Equity & Structured Capital group.

According to PwC, dry powder levels remain at all-time highs, with increasingly higher levels being raised through private vehicles such as non-traded REITs and private equity funds. Following a record year of capital raising in 2021, Robert A. Stanger & Co. reported that non-traded REITs raised $12.2 billion in capital during the first quarter of 2022, with the largest share continuing to go to Blackstone ($7.8 billion), followed by Starwood ($2 billion). Meanwhile, according to Preqin, North America-focused private equity funds across asset classes, including real estate, held $1.85 trillion in dry powder as recently as September 2021.

Cash and low-leverage buyers in particular are going to be less impacted by higher debt costs. For example, the average leverage across the more than 3,200 properties and 27 funds that make up NCREIF ODCE Index is 22 percent. REITs also remain relatively well-capitalized. Many REITs de-levered following the Great Financial Crisis and also can tap the bond market for debt rather than relying on traditional property-level mortgage financing.

Changing capital stack

Another byproduct of rising interest rates and uncertainty creeping into the market is that lenders are pulling back on leverage. “While most investors do not want to reduce leverage, some have because of the change in value for office assets,” says Russell Ingrum, vice chairman of capital markets at CBRE. That being said, the market is at the beginning of de-leveraging, and it is not equal. “All assets and all markets are not seeing the same outcomes. The worst affected are markets with significant increases in vacancy,” he says.

In many cases, leverage has dropped below 70 percent, which is creating demand for alternative capital sources to fill that gap with subordinate debt, equity or alternative finance sources such as tax credits.

Bhatt and his team focus on the equity part of the capital stack, including sourcing JV equity and preferred equity for multifamily, student housing, single-family rentals and build-to-rent communities. In most cases, they’re casting a wide net, often reaching out to double the capital sources, to find the right investor. “While people are being a little more selective in the joint equity space, deals are still getting done,” he says.

Joint venture capital has seen a slight shift in cost of capital. A few months ago, value-add and core-plus multifamily deals were being done with 8 percent to 9 percent preferred returns in waterfalls and now that has gone back to 9 percent to 10 percent and above. “So, there has been some change, but it hasn’t been dramatic,” says Bhatt. “I would say that people are not willing to take lower returns today in the joint venture world. If anything, it is the same or higher.”

Preferred equity also might be a good solution for some sponsors as the cost of capital is fairly competitive with subordinate debt. Over the last 30 years, pricing of that preferred equity capital has ticked slightly higher, but not as much as debt costs have increased. There is a lot of preferred equity in the market, and that competition has kept pressure on pricing. “There are dedicated preferred equity pools of capital and there also are joint venture pools of capital that are now looking to put money out on the preferred equity side to get money out the door,” says Bhatt.

The bar to get a deal through an investment community today is higher, notes Bhatt. “However, there is still great real estate out there to buy and very relevant projects that should be built, and it’s a function of finding the right strategy on the debt side, as well as the right group on the equity side to piece together the puzzle to make it happen,” he says.

Buyers look for creative solutions

Buyers also are finding some creative workarounds to higher interest rates, including looking at more loan assumptions. Some of the fixed-rate debt executions that were put in place in 2021 or 2020 now look attractive in light of today’s higher rates. “What we’re seeing is that our developer/operator clients, as well as our equity sources, are willing to get creative to make deals work,” says Bhatt. For example, Berkadia is currently working on lining up financing for a large portfolio deal where a large part of the capital stack will be an assumption of existing debt.

However, the challenge is that existing low-cost debt may be an incentive for owners to hold onto existing assets. “Most owners we are speaking with are talking to us because they have a near-term debt expiration themselves, so they are unable to pass along their current cost of debt capital,” says Ingrum. Especially for office owners who have term on their loan, it makes more sense to wait for a better environment, he adds.

Another important point to note is that higher debt costs are not the only factor causing some buyers to push pause on acquisition strategies, says Ingrum. “While investors are tapping on the brakes, it is more nuanced and likely due to recession rather than interest rate fears,” he says. In particular, institutional capital has been pivoting away from office for two years due to pandemic uncertainty. “You can price through interest rates, but it is difficult to price through a recession,” he says.

Low leverage buyers and cash buyers have largely retreated to other product types and that decision has nothing to do with interest rates.  It is all based on concerns about the office market generally and concerns about relative performance to the ODCE Index, says Ingrum. “If your peers are migrating to industrial, multifamily and single-family rentals, then you feel compelled to do the same,” he says. However, as institutions have pulled back from office, it is opening up buying opportunities for private capital and 1031 investors, he adds.

Another positive for the transaction market is that buyers and sellers are starting to see prices move. The list prices from a few months ago compared to where properties are actually being put under contract and closing today, especially for value-add deals, has declined between 8 percent to 15 percent, notes Bhatt. Those discounts are helping to offset the higher capital costs. “Sellers for the most part are starting to realize that we’re in a different marketplace today, and if they want to transact, it’s going to be at a different number than what they had in mind a few months ago,” he says.

Source: “Is Dry Powder in the CRE Space Ready to Move Off the Sidelines?“