Archives for October 2022

The Fed “has pushed us into an inflection point,” according to one industry watcher, and “may be oversteering” as additional rate hikes loom before year’s end.

“I think the Fed may be oversteering,” Marcus & Millichap’s John Chang says in a new analysis. “Think back a year ago…inflation was already rising rapidly but the Fed held to its position that inflation was transitory. They kept their foot on the accelerator with quantitative easing until they started to back off in November…even then, they phased it out over a four-month span. The Fed was holding interest rates down until March of this year. Now they’re swerving in the other direction.”

Chang notes that Fed Chairman Powell has made the possibility of economic pain quite clear in his messaging since last August. And American business is taking note: in a recent survey of CEOs by KPMG, 91% said the US will face a recession in the next 12 months (though they also remain positive about their three-year outlook). Chang notes that the overall CEO confidence level has been showing “a pretty healthy decline” as well, though it remains higher than when the world entered the COVID-19 pandemic or the Great Financial Crisis. Small business confidence and consumer confidence are also showing weakness.

“None of them are screaming recession, but they do merit monitoring,” Chang says. What’s more, the ISM Manufacturing Index also fell to 50.9 last week and is at its lowest level since May 2020. Job openings data also showed a million fewer unfilled jobs: in July, there were 11.1 million job openings and in August there were 10.1 million unfilled positions. All told, there are still about 4 million more openings in the US than people looking for work.

“We are not in a free fall or even a contraction, but it does appear that the employment market, like the manufacturing index, while still positive but not as strong as it was a month or two ago.,” Chang says. “A lot of this will be driven by the Federal Reserve. Arguably, the Fed has been oversteering. That implies the Fed will go through with their telegraphed 75 basis point increase in November unless there are substantive changes in the economic readings.”

And for CRE, this means likely continued upward pressure on interest rates as well as slowed hiring, rising unemployment, and spending and inventory reduction.

“If those things happen, it would weigh on demand for most types of commercial real estate,” Chang says. “I’m not sounding the alarm, but a modest recession is becoming increasingly probable, and uncertainty is rising.”

Source: “This CRE Analyst Says the Fed is Oversteering“

Demand and rent growth for apartments slowed in the third quarter, in a sign of a potential overall slowdown for commercial real estate more generally, though industrial demand continued unabated

“While the industrial boom continues to show no signs of stopping, multifamily absorption and rent growth are decelerating,” writes Nadia Evangelou of the National Association of Realtors in a new report. “Multifamily absorption in the last four quarters was below the pre-pandemic levels, in the range of 60,000-70,000 units. In the meantime, rents rose year-over-year at a slower pace, by less than a double-digit percentage. However, multifamily housing demand remains relatively strong. Considering rising mortgage rates and home prices, people may be forced to rent for longer due to decreasing affordability.”

NAR notes, however, that government data appears contrary, showing that rent growth is actually accelerating. But because the Consumer Price Index uses data from the Consumer Expenditure Survey to determine the level of prices for goods and services — and since most renters responding to the survey report rent they locked in at an earlier time  –”rent changes may take months to show up in government data,” Evangelou says. “In contrast, the private sector publishes the listed rents – current rent prices. Thus, government data will likely show a decelerating trend in rent prices after several months.”

Office also continued to struggle in the third quarter, with 1.34 million more square feet of office space was vacant and placed on the market than were leased during that period.

“Although more people returned to their offices, after four quarters with positive net absorption, demand for office space dropped as net absorption turned negative again,” Evangelou says. “As a result, the market’s net demand for office spaces decreased relative to supply, and the vacancy rate rose to 12.4% in Q3 2022 from 12.3% in the previous quarter. Meanwhile, the office sector has the highest vacancy rate across all sectors of the commercial real estate market.”

Some bright spots? Retail, which enjoyed positive demand for a seventh consecutive quarter, and industrial, which registered a net absorption of nearly 425 million square feet in the last twelve months ending in Q3 2022.

Source: “Where CRE Is Beginning to Lag“

September created an opportunity for malls to take a significant step forward, with signs that some of the economic headwinds were dissipating, according to a report this week from Placer.ai.

However, there is still ground to make up, the data analyst firm said, as visits to malls of various types showcase “resiliency.”

During September, visits were down 0.9% at indoor malls compared to 2021, and they were down 1.8% at OALCs and down 4.5% at outlet malls.

For indoor and outlet malls, those figures are improvements compared to July and August.

“But gaps remain,” according to the report. “While the numbers aren’t bad compared to last year, comparing them to 2019 leaves a lot to be desired.”

Placer.ai reported that during September, visits were down 10.1% at indoor malls, 10.2% at OALCs, and down 11.3% at outlet malls, compared to 2019.

A Week in Sept Indicates Optimism

But traffic is improving, lately. A look at the weekly data shows visits ticking up as of the week of Sept. 19.

Compared to the previous week, visits then were up 2.6% at indoor malls, 1.7% at OALCs, and 2.5% at outlet malls — a good sign as the holiday season approaches.

At Simon Malls, Laura Schwartz, Regional Vice President, tells GlobeSt.com that her company continues to invest in its properties, bringing in new retailers, adding additional product types and maintaining our properties.

“We’ve seen particularly strong traffic at centers such as Burlington Mall and Northshore in the Boston market that have recently gone through extensive redevelopments,” Schwartz said.

Year-Over-Year Data Must Be Referenced

David Greensfelder, managing principal of Greensfelder Real Estate, tells GlobeSt.com that while shopping malls may be attempting to position themselves for the holidays, the task may be as futile.

“Owners as sailing into a storm: larger forces are going to carry the season, and it’s going to be difficult to steer an individual mall’s performance in light of them,” Greensfelder said.

“Consider that the economy is sending mixed signals such as month-over-month consumer confidence index numbers being at odds with continued inflation and higher borrowing costs.

“While retailers’ excess inventory (created by supply chain disruptions) and related price reductions may be driving some shoppers to stores, it’s important to focus on year-over-year numbers and not at what happened last month or two months ago.

Greensfelder said that the year-over-year numbers confirm that mall footfalls are down compared with 2021 and certainly before the pandemic, fundamentally changing how we shop for goods and services, particularly for commodities.

“The trend of consumers ‘trading down’ and retailers rightsizing their fleets (ie. closures) confirm this hypothesis,” he said.

Greensfelder pointed to trends that seem to be positively impacting some malls include the strength of urban areas, digitally native brand growth (particularly those where there is a hybrid digital and bricks-and-mortar strategy), and fitness.

“Those positives are dampened by malls benefiting less from luxury brand bounce-back, and restaurant visits (all categories) being flat to down,” he said.

Preserving the ‘Heart and Soul’

Doug Ressler, manager, business intelligence, tells GlobeSt.com that shopping malls have been defined as “the heart and soul of communities” and have been under severe pressure from the proliferation of e-commerce and other forces.

“In-person shopping providers are leveraging technology to help their consumers engage the new range of mall experiences before, during and after a visit,” Ressler said.

Tech-driven experiences include or will include:

• Interactive kiosks that deliver product information and promotional messaging;
• Smart touch screens that could help keep shoppers in stores longer and buying more;
• Interactive wayfinding that helps shoppers pick up items acquired through BOPIS (buy online, pick up in store);
• Systems that combine digital signage and IoT sensors for queue management and emergency notifications;
• Large digital video walls that deliver news, weather, ads and other content;
• Augmented and virtual reality tech that lets customers digitally test products.

Moody’s: Malls Must ‘Dynamically Serve Consumers in Digital Age’

According to Moody’s report The Mall of the Future: How Regional Malls Will Survive a Rapidly Changing Retail Industry issued in September, malls will need to revamp their business models and tenant mixes to survive.

It starts with “dynamically serving consumers of the digital age” although brick-and-mortar stores will continue to be a critical part of retailers’ strategies.

“That is particularly true for regional malls, since among brick-and-mortar property types, the traditional mall is most directly disintermediated by e-commerce,” according to Moody’s.

Regional malls will continue to exist – and many estimate that roughly one in five of the over 1,000 US malls will remain as malls, Moody’s said – but the “mall of the future” will have a diverse set of draws beyond conventional department store anchors.

Implementing an “omnichannel” strategy is now critical, not optional, according to the report.

Online sales as a share of total US sales will grow further, however, a large majority of retail sales will still occur in physical stores, Moody’s said.

“Even where online sales do supplant in-store sales, e-commerce is becoming less cannibalistic and more intertwined in a holistic approach to retailing,” according to the report. “This involves integrating the traditionally siloed tasks of sales, marketing, customer service, and inventory management across all digital and physical channels to form efficiencies and connect with customers by every means possible.”

Regional Mall Business Model Shifting

Successful mall operators will aim to drive rent and foot traffic beyond the traditional model of department store anchors. To do so, it must rethink how to use primary spaces, according to the Moody’s report.

“The limited number of traditional retailers available to backfill mall vacancies, especially large anchor spaces, means landlords must be willing to look to certain national big box retailers, entertainment businesses, sporting goods, high-volume restaurants, or some mix of alternative uses such as logistics, residential, medical office, or service-based retail,” it said.

Shorter term lengths and mall performance contingency provisions will force landlords to share more in the risks of their tenants, according to Moody’s.

“Some malls will fail because operators will not have (or choose not to deploy) the capital to do necessary reformatting. All of this makes it ever more important to have a sophisticated, well-capitalized mall operator to survive the rapidly changing retail world.”

Give What Online Shopping Can’t Give ‘You’

J. Wickham Zimmerman, CEO of Outside the Lines, tells GlobeSt.com, that it is unsurprising that malls are experiencing a resurgence after the public has been spending so much time at home over the past 2.5-plus years.

“The desire to reconnect with the world around them and return to a more ‘normal’ way of life is palpable,” Zimmerman said. “As consumers seek the experiences that they have been missing all these months, it is incumbent upon retail center owners and operators to provide environments that deliver what people cannot get from online shopping.

“An essential part of these environments are amenities like outdoor water features that draw in visitors, provide dazzling and beautiful displays, and help drive foot traffic for these venues.

“With the holidays approaching, water features at retail centers can present spectacular holiday-themed shows, lighting, and effects that captivate shoppers and make these centers true destinations for locals and visitors. The addition of water features has a positive impact on retail sales, while increasing property value and providing a safe place for people to gather in the post-COVID era.”

Source: “Malls Can Still ‘Change’ In Time for the Holidays“

Here’s a bad combination of factors in the office segment of CRE: most businesses expect a recession in the near future, and although office vacancy is about 15.1%, occupancy is somewhere between 43% and 44%.

The former means that corporations will expect to cut costs to lessen the impact of a recession. The latter kicks in because if your company doesn’t seem to need something it has been paying for and saving money is a critical strategy, cutting those extraneous costs would seem a logical conclusion.

That flips the pressure onto the already suffering office sector. Owners need tenants, unless they have a better idea of how to use the space they must pay for—including taxes—and support. When corporate outlooks on economics are reserved at best, that can mean being less discriminating. But short-term thinking can make for longer-term pain.

Tenant Risk Assessment, a CRE consulting firm, says that while 50% to 60% of a tenant rating is typically fiscal credit risk, there are many more issues at play, for example, legal and regulatory risk, key man risks, and sanctions risks. But there is also another type: industry risk.

Not all companies in an industry are alike, but there are frequently trends worth watching. “Oil and gas is probably the headline in terms of volatility and the whipsawing of credit profits changing more rapidly you might think,” says CEO Brad Tisdahl. It’s a good reminder that the energy business is often cyclical. Prices and profits rise and fall with macroeconomic conditions.

A recession will push down energy demand and economic activity slows. The bigger the recession, the more oil and gas can feel an impact. Remember that on April 20, 2020, West Texas Intermediate crude bottomed out at -$40 a barrel. There was such a glut in the market that buyers were running out of room to put the oil they had to take delivery of due to futures contracts.

“Every client we have that has oil and gas tenants are all very familiar with the movements of the industry and are sensitive to it, too,” Tisdahl says. “They don’t want to be the ones writing a huge lease for a company that isn’t going to be around in five years.”

Energy isn’t the only industry to watch. Tisdahl notes that the tech sector, “whether more established big tech or newer venture backed companies” has seen “a pretty significant change in that sector in the last six or seven months,” driven by monetary policy. “These lofty projections a lot of companies were making, they’re having to reassess the growth presumptions they have. They’ve gone into cost containment and savings mode.” Many are looking at layoffs and possible reconsiderations of their space use, “either seeking sublease space or putting their own space into sublease.” For startups, watching cash burn rates is critical because it’s unclear when more investment might be available.

Life sciences is beholding to external capital, but also is more resistant to changes in economic conditions. During the pandemic, money started to flow into the sector.

“A lot of companies in the space are looking for expensive lab space or office space,” Tisdahl says. But there is a cost for landing clients, as buildouts are expensive, with high tenant improvement allowances. “In life sciences, you’re looking at TIs that are north of $200 a foot,” he says. “We’re still seeing that space moving. It’s not necessarily growing as quickly as it was six or nine months ago, but it’s still growing.” But then their individual financial futures are uncertain as it takes “maybe five to seven years for FDA approval, authorization, or commercialization.”

Source: “In Challenging Times, Do the Right Checks on Your Tenants“