Archives for September 2022

With a third large interest rate hike last week, an increasingly tough financial environment is starting to crush property owners’ willingness to spend on environmental compliance and green improvements.

“A lot of people are value-engineering their projects, figuring out how you can get costs down, because these costs are on the rise — and unfortunately, sometimes ESG components of projects are on the chopping block,” Rafi Goberstein, CEO of the PACE Loan Group, said at Bisnow’s National Finance Summit last week.

Goberstein told the story of a developer who had planned to install solar panels atop a 400-unit multifamily building in Minnesota, but had to scrap the plans as costs escalated.

“As we go through the process of getting the bids … the costs came too high and [the panels] got scratched this summer,” he said. “Which is really, really a bummer to see that happen.”

Since the onset of the pandemic, project costs have increased as supply chain hurdles, materials shortages and inflation put project feasibility under pressure. Those dynamics have been a headache for CRE investors, developers and owners alike, but have been disastrous for smaller investors and landlords.

Now, with rising interest rates and the industry bracing for a recession, some are placing their environmental commitments on the chopping block. YuhTyng Patka, a partner at Duval & Stachenfeld who represents borrowers and lenders on PACE financing, told Bisnow that one borrower she represents in New York City is seeking around $15M from the program, which is designed to fund sustainability upgrades.

“As interest rates have started increasing, my client is starting to rethink their strategy,” she said. “It’s not because they’re not interested in the energy-efficient space. It’s more the economic drivers, the rising interest rates … It doesn’t make business sense for them to continue proceeding with what they had originally planned.”

Building energy-efficiency company Ecosave has worked with building owners in Australia, Europe and multiple states within the U.S., and even in more climate-conscious countries, sustainability upgrades are usually “all about finance,” Ecosave founder and Chairman Marcelo Rouco said.

Rouco recalled a recent meeting with a French company that has 200 manufacturing plants in the U.S. and is trying to meet its environmental target of reaching carbon neutrality by 2050. The first question asked, he remembers, is what the company is willing to pay to meet that goal.

He said the company responded that improvements needed to pay for themselves within three years.

“So even in the countries that are supposed to be more advanced, it still boils down to the money,” Rouco said at the summit.

That attitude isn’t uncommon, Nuveen Green Capital CEO and co-founder Jessica Bailey said. Many CRE companies have started making bigger, bolder environmental commitments over the last 18 months, she said, but few are talking about how to progress toward those goals.

“Very few are starting to operationalize and put the blueprint in place towards that 2040 future in which my building portfolio is net zero,” Bailey said. “It’s not enough just to put out the statement. You’ve got to do the work, you’ve got to go through and do the audits, and look at the roofs, and figure out where solar fits, and all of the things that are quite difficult.”

Planning for the building upgrades necessary to meet ambitious environmental goals is a time- and capital-intensive process for owners, operators and investors. For many, additional financing is necessary in order to pay for building upgrades that go beyond switching out older lightbulbs for LED options: switching out older heating and cooling systems for heat pumps, or adding solar panels, takes months and can cost tens of thousands of dollars.

After three swift federal interest rate hikes this summer, coming in at 75 basis points apiece, some property owners are wondering if they can still afford to make the upgrades they had hoped to.

“As banks start to reprice the cost of debt, and as insurers start to reprice insurance given climate risks, those things are going to impact just fundamental drivers of the NOI of a real estate asset,” McKinsey & Co. partner Brodie Boland told Bisnow in an interview.

Boland, whose work involves talking to real estate investors, operators, services firms and proptech firms about how to reach their climate goals, says most CRE players view getting ahead of climate risks as a necessary investment. And while many companies have rapidly accelerated their decarbonization plans over the past three years, what happened to those commitments during the pandemic is indicative of how a recession may impact CRE’s environmental commitments.

“If you’re an owner of office real estate or retail real estate, and you’re struggling through the pandemic, you’re really looking critically at every element of your [profit and loss statement] and trying to figure out what is necessary,” he said. “I think for some, that did reduce the importance of some of the quote-unquote ‘optional’ elements of ESG.”

Advancing energy goals is broadly seen as an investment worth making to not only fight climate change, but to combat rising energy costs, supply chain hurdles and the effects of Russia’s invasion of Ukraine, Savills North America Director of ESG Consultancy Hyon Rah said. Additionally, regulations like the Securities and Exchange Commission’s proposed ESG reporting rules and local measures like New York City’s Local Law 97 and Boston’s BERDO are spurring building owners into action, she said.

“I am seeing a lot more activity and requests for things like installing solar panels, assessing the portfolios to see what is feasible to actually install as much as possible,” Rah said. “Cities like Boston, New York, D.C., have really stringent requirements for building performance that you cannot just dodge. It’s the law and you’re going to face fines if you don’t meet certain requirements.”

But smaller building owners, without as much capital to deploy, are already struggling. Those difficulties will likely only increase as borrowing gets more expensive.

Lincoln Eccles is one such property owner. Prior to the pandemic, he had been seeking a way to put solar panels on the roof of his 14-unit rent-stabilized property in Brooklyn — but once the pandemic hit, those plans were no longer feasible, he said. Then, a few weeks before the end of the heating season in spring 2021, his building’s oil boiler broke.

Eccles set about trying to find a replacement, either for the oil boiler or for a steam equivalent. During the spring and the summer, he called suppliers as far west as Chicago — but amid the supply chain crisis, he was unable to find a replacement before the winter set in, he said.

He wound up paying for space heaters for his tenants for last winter, and is now wrapping up a heat pump installation with energy-efficiency company BlocPower. But Eccles said only some tenants paid rent or received emergency financial assistance during the pandemic, so he wasn’t able to pay his property taxes on time — let alone repair his building easily.

“It’s just been touch-and-go for a while,” he said. “I’m balancing around close to half a million dollars in debt.”

Still, experts are hopeful that the Inflation Reduction Act, featuring 30% tax credits for installing green energy measures into buildings and setting aside billions of dollars for green retrofits and building weatherization, will help struggling CRE players push past the current economic hurdles.

The overall push toward ESG is unlikely to be reversed by an economic downturn, but owners who spend beyond their means installing long-term upgrades could face short-term financial pain.

“In another recession, I think it’s going to be not an overall decelerant on climate-related activity, I think it’s going to be a separator,” McKinsey’s Boland said. “Those who have figured out how to do this in a value-creating way, and those who haven’t.”

Source: “Some Landlords Hitting Pause On Sustainability Projects As Costs Skyrocket“

After recovering rather quickly from the pandemic, the co-working sector is now growing at an accelerate rate. A more geographically distributed workforce and commonplace hybrid work policies are benefitting flex space operators, according to industry insiders.

While the flexible office space market contracted during the pandemic, it has now stabilized and the sector’s major players are beginning to grow their portfolios again, as demand for flexible office space increases, notes Laura Sidney, managing director, Americas agile practice, with commercial real estate services firm CBRE.

Major co-working providers are reporting increasing occupancy quarter-over-quarter this year, with some quoting occupancy upwards of 70 percent in primary markets, Sidney, notes. WeWork, for example, reported that its occupancy rose to 73 percent in the second quarter of 2022, which is comparable to the level recorded pre-pandemic, in the fourth quarter of 2019. Meanwhile, Switzerland-based International Workplace Group (IWG) reported a 17.7 percent increase in revenue growth in the first quarter, totaling $782 million, which it attributed to booming demand for suburban co-working spaces. IWG currently has co-working operations in 300 U.S. cities under two brands, Regus and Spaces. In June, the co-working giant announced plans to open 500 to 700 additional U.S. co-working facilities in smaller markets under different brands.

At the same time, what’s happening in the co-working sector is “a mixed bag,” says Michael Lirtzman, head of office agency leasing, U.S., with real estate services firm Colliers. “We have seen some co-working absorption and activity in non-CBD core locations, both suburban and on the periphery of downtown hubs. But in dense, urban cores, occupancy still varies by metro, with Sunbelt locations outperforming traditional gateway cities.”

While most major co-working operators managed to stay afloat through the pandemic and reposition themselves as providers of alternative workspaces for both small and large companies, a few struggled and were forced to shut down. Los Angeles-based CTRL Collective, for example, filed for Chapter 11 bankruptcy earlier this year after downsizing from multiple locations to just one in Pasadena, Calif., which remains open for business. And at the end of August, The Wing, a co-working operator aimed at professional women, announced it would shut all its locations as well.

As traditional office occupancy remains in flux, many landlords are incorporating flex or co-working spaces into their own portfolios. And large, global real estate brokerage firms, including JLL, CBRE, Cushman & Wakefield and Newmark, view flex space as the future of the office market and have taken stakes in co-working operations. Cushman & Wakefield, for example, has partnered with WeWork, CBRE acquired a 40 percent share in Industrious, and Newmark acquired Knotel.

JLL established its own Flex by JLL platform in 2021 and now has 10 locations in the U.S., in addition to two in the U.K. and three in Australia. The company recently announced its first ground-up, 15,407 flex and co-working facility in Secaucus, New Jersey, in partnership with Manulife U.S. Real Estate Investment Trust. Scheduled to open in the second quarter of 2023, the new Flex by JLL space, located within an 11-story office building in the Harmon Meadow mixed-use complex, will offer flexible private offices, co-working spaces, meeting rooms, team suites and virtual offices.

According to a report from The Business Research Company, a market research and intelligence firm, the global co-working industry is expected to grow from $13.60 billion in 2021 to $16.17 billion this year, for a compound annual growth rate of nearly 19 percent. It is projected to continue to grow at a rate of 17 percent annually to more than $30 billion in 2026. The report suggests that growth in the co-working sector directly correlates with the growing number of start-ups globally, as they drive demand for co-working space.

With many entrepreneurs now worried about higher interest rates, sinking tech stocks and an uncertain outlook for the economy, that uncertainty is causing start-ups to lease co-working spaces rather than make long-term traditional office space commitments.

But according to Sidney, flexible office space providers are also seeing a significant increase in interest from larger, enterprise firms, across many different industries. “Our recent internal survey showed that historically traditional users, such as those in financial services and professional services, are adopting flexible office spaces and plan to increase [them], in some cases nearly doubling their usage of this asset type by 2024,” she says.

According to CBRE’s 2022 office Occupier Sentiment Survey, 59 percent of U.S. occupiers say flexible office space will be a significant part of their portfolios within two years. As a result, Sidney says that flexible office providers have upgraded their offerings recently, responding to the needs of larger, enterprise clients. “The latest evolution is how flexible office providers accommodate desk sharing,” she adds, noting that with hybrid work policies in full force, organizations may need a suite with 30 desks to accommodate 45 employees. “Finding a way to offer this additional access without nickel-and-diming tenants, but still managing occupancy at the location is top of mind.”

Co-working operators have adapted fairly well to flexible and hybrid office set-ups, as they tend to be slightly more nimble than direct landlords, adds Lirtzman. He notes that certain operators and locations have performed better than others, but there is still a rightsizing happening in many markets, with a number of co-working operators who overexpanded in 2017-2020 now shedding locations.

According to the latest office report from CommercialEdge, at the current moment, five markets account for about one-third of all flexible office space nationally. Manhattan leads the way, with an estimated 15 million sq. ft. of flexible space, followed by Los Angeles with roughly 8 million sq. ft., Chicago with about 7 million sq. ft., Washington, D.C. with 6.5 million sq. ft. and Dallas, with a little over 5 million sq. ft.

Source: “The Co-Working Sector Is Set for a Major Boost. But There Will Still Be Growing Pains.“

In our post-COVID era, a new trend is emerging in retail that is changing how these businesses operate. Retail stores that have traditionally only been seen in shopping malls are now moving out and finding new opportunities to establish standalone storefronts, and vice versa.

There are a few reasons this is happening: COVID brought on a new paradigm of shopping that accelerated the shift to doing everything online rather than going to the store. Many bricks-and-mortar retailers had to close physically and pivot quickly to offer online ordering/pick-up at store options. Foot traffic in these malls decreased as stores closed and consumers went into lockdown. As a result, many of these large spaces were converted into warehouses that Amazon now uses for their e-commerce business. However, with the worst of COVID far behind us, we’re now seeing a reversal in some of these trends.

Malls shifting to experiential and entertainment

Historically, shopping malls were an ideal location for retailers to operate. Consumers would often head to their local mall for a whole day and spend time walking around and seeing all of the different store fronts within the mall. But now that this shift in retail is happening, malls have had to pivot and focus on the entertainment and experiential aspect to help draw in consumers.

With gyms, entertainment (like movies, gaming centers, amusement parks, ski slopes, water parks, etc.) and a wide array of dining options, malls are trying to bring people in through unique experiences, as many brand name stores are on their way out. The American Dream Mall in East Rutherford, N.J., is an example of this shift. In efforts to compete with online shopping, the mall features a 300-foot Ferris wheel, an indoor ski slope, an amusement park and a topline food court, in addition to traditional retailers.

New life and opportunities for retail brands

There are quite a few advantages for retail stores that have chosen to move out of shopping malls. Mainly, rents may be cheaper for brands that choose to make this move. Also, businesses have more flexibility on their hours of operation, as they are no longer under the mercy of a mall’s hours. Parking is also much easier, as standalone stores often have their own dedicated parking lot and spots, versus at a mall where it can be quite a hike for people to reach a specific store from the parking structures.

Many businesses that have decided to make this shift away from the mall have seen great success with this new model. Talbots and J. Jill are a couple examples of businesses that are mainly off-mall and appeal primarily to an elderly demographic. The company Signet has closed 395 stores in the last year and plans to close another 100 this year, while shifting 33 stores to off-mall locations. Bath and Body Works, Torrid and The Buckle are a few more companies that are moving away from malls and establishing new locations at standalone properties. For companies finding success as a result of doing this, these brands are able to increase their conversion rates of sales and do it all with a lower overhead cost.

In addition to bricks-and-mortar locations, open-air centers grew in popularity. During COVID, high-quality open-air malls became more valuable as people were offered convenience and safety. American Eagle, Sephora and other chain retailers are expanding and relocating to these open-air centers for lower occupancy costs, increasing their sales.

However, malls still offer a significant amount of benefits, like convenience, a wide-ranging customer base, favorable foot traffic and large parking lots. In fact, there are some retailers—typically big-box ones—that are finding success moving from standalone stores into malls. Target is one that comes to mind as a business that is taking the huge spaces left by some businesses and thriving within that model. Owners are investing in these big-box retailers as an anchor tenant to increase their leasing power.

From the retailer’s perspective, it’s important to remain in good relationships with malls to keep their options open—after all, there are still many benefits that come with being located in a traditional mall. So, while the industry is seeing a shift, malls are clearly not going anywhere—they will simply adapt.

The changing city demographics

During the peak of COVID, Sunbelt cities like Austin and Raleigh, and other places such as Miami, saw an influx of residents looking for warmer weather and larger spaces, while their former hometowns in the North were in serious lockdowns. Part-time residents became full-time, and the traditional seasonality of the shopper evaporated. For example, in Miami, retailers prepared for winter migrators, who increased foot traffic in stores. In the summer months, where migrators returned to their cooler climates, shops became less occupied.

During COVID, people moved full-time to places like Miami, and stores became busier year-round. However, with the COVID vaccine and reopening of stores, restaurants and schools, “flight” cities like New York and Boston, which experienced a dramatic decrease in population, are now seeing residents return, along with new people moving in. This is driving retail growth in areas like Manhattan’s Upper East Side, Hudson Yards and SoHo, which have resumed their place as shopping hubs for locals and visitors alike.

The climate ahead for retailers

Retailers that are reevaluating the health of their retail real estate portfolio would do well to consider the changing demographics. Malls used to primarily serve a purpose for retail and entertainment, and still do, but need to be more cautious about their location as populations have changed drastically in the past few years. Malls need to shift to become more of an entertainment destination, and retailers have to decide how to best move forward and meet this changing market.

Source: “How COVID-19 Changed Retailers’ Site Selection Strategies“

Trying to determine and act on the next construction material that reaches high-scarcity levels is confounding the construction industry, according to a new Construction Outlook report from JLL.

“Volatility around materials is hitting developer’s wallets at a higher rate than initially anticipated earlier this year,” according to the report.

JLL said it expects materials prices overall this year to rise by 18%, up from its 12% forecast made at the start of 2022.

“Delays are pretty much universal at this point,” Andrew Volz, JLL Project and Development Services Americas research lead, said in prepared remarks.

“Developers will need to rework how they traditionally do projects as ‘design, bid, build’ no longer works.”

Volz said that where previously materials purchasing was the last step in the “design, bid, build” process, that order has flipped.

“Project managers are sitting in on the design phase with engineers, and once they have a general idea of spec, they are placing orders for materials,” he said, adding that by the time the design phase is complete, they often are still waiting on those materials ordered six months earlier. “Just getting your hands on stuff is almost more difficult than paying for it,” he says.

Most Work ‘Design, Bid, Build’ Simultaneously

Lisa Tamayo, Vice President of Development at BLT Enterprises, tells GlobeSt.com, “With the recent post-pandemic shifts in regulatory processes, progressively tightening construction and operational constraints, supply chain setbacks, and inflating labor and material costs, navigating the intricacies of the changing development environment is challenging.

“We’ve found that proactively establishing a cohesive, experienced team of development professionals, including designers, architects, contractors, and market researchers is the foundation to successfully accomplishing any large-, or small-scale, build-out project in today’s climate.

“A comprehensive team working in-step can determine the ideal design strategy, account for fluctuating materials costs, and lay out reasonable timelines to execute the project while minimizing costs and maximizing efficiency.”

Tamayo said that hands-on management of the development team, along with forward-looking market analytics and practical budgeting, ensures that realistic expectations are met and communicated across each individual project.

“We can no longer operate in a ‘design, bid, build’ structure as many development professionals have habituated. But rather, the construction process has become more fluid, and requires rigorous management and communication throughout the life of the project.

“These once-linear steps are now approached as a simultaneous process that needs to be well-thought-out yet flexible to pivot depending on availability and cost of materials.”

She said that new deliveries can be expected to come online at a slower pace than previous decades, likely to become the new normal through the next decade.

Logistic Mismanagement Being Rewarded, ‘Unfortunately’

Trac Bledsoe, the custom development lead at The Practice Companies, tells GlobeSt.com that the significant impact of rising costs on new projects cannot be overstated.

“Projects underway late in 2021 and into 2022 have been unable to adjust in a manner adequate to solve for a 25% to 30% or more price increase — projects were fully designed and often permitted by the time construction cost challenges were identified.

“Projects going forward have limited options outside of stopping or reducing scope as many of the drivers of the cost escalation are fundamental components, such as roofing, mechanical units, transformers, etc.

“Logistic mismanagement in the manufacturing sector by suppliers is, unfortunately, being rewarded in the current market with increased pricing and higher margins which adversely affect our healthcare providers and the overall market.”

Contractor Pricing Adjusted Every 30 Days

Rod Lockard, Director of Construction, DXD Capital, tells GlobeSt.com that contractor pricing is now adjusted every 30 days with final pricing based on the date of delivery instead of offering guaranteed maximum pricing contracts.

DXD Capital has exercised a couple of creative solutions to mitigate rising material costs, Lockard said.

The first is negotiating with vendors to deliver higher upfront deposits in exchange for a capped price.

“Getting more money in the hands of our vendors initially has helped them agree to pricing free from last-minute price hikes,” he said.

A second strategy that has allowed DXD to alleviate increasing steel prices was to buy the steel needed for a project in bulk ahead of schedule.

“A project’s steel is currently stored in a yard about one mile from the construction site,” Lockard said.

“While the yard rental represents a cost, it is estimated to be 1/10th of what the price might have been to have it delivered when it will be needed this coming fall.”

Some Bids Valid for Only 48 Hours

Steve Hardy, principal at Gaspee Companies, tells GlobeSt.com that rising costs coupled with labor shortages makes underwriting a redevelopment more and more challenging.

“When seeking estimates or bid prices, some subcontractors are offering up bids for work that may only be good for 48 hours,” Hardy said. “These conditions also make it hard to negotiate long term leases with tenants who have specific build out and TI packages tied to those leases.”

Be Ready for Last-Minute Changes

Steve Sommer, executive general manager and president of New York Construction at Lendlease, tells GlobeSt.com that over the past year, building material shortages have extended supply chain horizons twofold, or more, depending on the material sought to procure.

“This creates pressure to secure materials as soon as possible to avoid unnecessary delays and future price volatility,” Sommer said, “because external factors can impact the cost and timeline of a project so dramatically, it’s a tremendous benefit when the ownership, design and construction teams are able to communicate early on, as it expedites decision-making and improves communication as the project progresses, which is helpful if any last-minute changes need to be made.”

Ask Subcontractors What Materials are Susceptible

Tom Prasky, head of construction, Americas, at Unispace, tells GlobeSt.com, that according to a recent analysis by Unispace, the average cost of construction inputs has risen 14.5% over the last 12 months.

“Engage subcontractors early to identify materials which may be susceptible to supply chain issues,” Prasky said. “Come up with comparable products/ materials that are locally available and less susceptible to pricing volatility.”

Maximize Onsite Storage Space

Justin Pelsinger, COO, Charney Companies in New York City, tells GlobeSt.com that, due to the rising cost of construction, his firm has been putting deposits down on construction materials much earlier in the procurement process than previously to lock in agreed upon pricing.

“Additionally, rather than wait for deliveries, we have opted to maximize storage space on site and accept materials as early as possible so that we don’t get hit with any transit related delays or increased pricing.”

A Bigger Strain on Smaller Contractors

Erin Sykes, real estate advisor, NS chief economist, LEED AP, tells GlobeSt.com that this issue is affecting smaller contractors more than larger ones.

“Larger construction companies have the capital to purchase and warehouse materials for upcoming projects versus their smaller counterparts that are only able to purchase the materials specific to an upcoming job,” Sykes said. “This will further split the industry and makes it almost impossible for younger organizations to gain market share.”

Source: “Why the Once-Routine ‘Design, Bid, Build’ Process is So Out of Whack“