Archives for October 2022

Accelerated rent growth nationwide in the industrial real estate sector might not be so much tied to inflation, but rather vacancy rates, according to a new report from Cushman & Wakefield.

The current vacancy rate in comparison to the industrial construction pipeline as of Q2 2022 showed that there was almost 700 million square feet (msf) of space under construction with just under 26% of that space pre-leased, “leaving well over 500 msf of product currently without tenant commitments to be delivered over the next couple of years,” according to the report.

Cushman & Wakefield said that based on preleasing rates, “even if all speculative products were to hit the market immediately as vacant, the national vacancy rate would only tick up by 320 bps to 6.3%.”

Unexpected Outcomes for Occupiers

When examining rents, Cushman & Wakefield said the differences between asking rents (defined as the annual cost per square foot offered by the landlord or sub-landlord for leasing space) and taking rents (defined as the agreed upon rent to be paid at the start of the lease signed between the occupant and the landlord) and trends in those rents can cause unexpected outcomes for occupiers.

These factor importantly into investors’ returns. They’ve also created quite a bit of “jousting” between landlords and tenants for new leases and renewals, according to Craig Tomlinson, senior director & partner of Stan Johnson Company in Tulsa, Okla.

“Right now, the landlords have a clear upper hand, and owners of existing space are currently more lucky than good,” Tomlinson tells GlobeSt.com.

Developers Can’t Confidently Forecast Their Exit

“Build-to-suit and even spec developers are being forced to quote rental rates well above local market ‘ask,’ and prospective tenants are saying ‘yes,’ only to have the developer withdraw because they can’t confidently forecast their exit,” Tomlinson said.

“Developers dependent on fund-style equity have curtailed all projects they can; their sponsors are spooked and don’t want to place foolish bets late in the cycle.”

Tomlinson said that there “is really no economic factor even being seriously discussed that would cause rent rates to ease, borrowing costs to decline, or exit cap rates to retreat.

“Market-rate renewal provisions – the bane of most net leases – are now being insisted on by owners, with CPI floors as a compromise position.”

Asking and Taking Rents Mostly Increasing for Warehouses

Cushman & Wakefield said that on a national level, from 2010 to 2021, there has been a consistent trend of both asking and taking rents for warehouse/distribution space mostly increasing.

“And while both see periods of deceleration, asking and taking rent decreases tend to occur at different times,” the company said.

“Asking rents can remain sticky because owners are still listing at ‘hopeful rates’ vs. ‘taking rents,’ which adjust quicker to real market conditions. Or asking rents may stay elevated slightly longer even as the market slows because owners aren’t willing to drop the asking price, but they are willing to offer more concessions which are captured in taking rent.”

Cushman & Wakefield says that the divergence between the rates has begun to grow. Both average net asking rents and average net lease rates have grown, but the growth rate in taking rents has exceeded that of asking rents, especially in 2021. The difference between net taking rates and net asking rates was 28.2% at year-end 2021, up from a 12.8% spread in 2011.

Source: “Industrial Landlords, Tenants ‘Jousting’ Over Asking Rents vs. Taking Rents“

With property damage from Hurricane Ian currently estimated at $60 billion, it will likely be second only to Hurricane Katrina as the most destructive storm in U.S. history. But that estimate doesn’t take into account the larger economic damage from the storm, including the disruption to the already strained U.S. supply chain.

Past hurricanes can provide some insight into what kind of ultimate losses Ian will bring. For example, property damage from Hurricane Harvey in 2017 was initially estimated at $23 billion, but a year later an analysis that included overall economic damage brought the total cost to roughly five times that amount, at $125 billion.

Based on experience from previous hurricane events, it will likely take at least nine weeks for businesses in the region to return to pre-hurricane operations due to the damage to buildings and infrastructure, according to a report from globalEDGE. The report notes, however, that it took more than three years for Texas cities to fully recover from the damage inflicted by Hurricane Harvey, including disruption to business operations.

Ian, as a category four storm, has left a devastating impact on Florida’s manufacturing, agriculture and distribution sectors, which include 2,800 manufacturing facilities tied to aerospace, automotive components, chemicals, plastics and heavy machinery production industries. Florida is also the location for facilities belonging to about 7,000 producers of pharmaceuticals, medical devices, diagnostic devices and other products.

Meanwhile, the hurricane’s disruption to the supply chain will reach beyond Florida and South Carolina, the two states where the storm made landfall. Bordering states are expected to experience shortages in trucking capacity, as motor carriers reroute their resources to help assist with logistics and recovery efforts in areas hit directly by the storm.

Cargo imports and exports in the South were disrupted by port shutdowns and/or reduced port operating hours, notes Matthew Dolly, national industrial research leader at real estate services firm Transwestern. This happened in Tampa, Fla, Savannah, Ga. and Charleston, S.C. In addition, bridges and highways were closed due to damage from flooding and downed trees. As a result, resulting delays in product deliveries will continue until power is restored and critical repairs and clean-up are completed, Dolly says.

“Restoration of port activity was even more critical this time around, as leading up to Hurricane Ian an increased amount of shipping was being shifted to entry points on the East and Gulf Coasts, while the West Coast continues to tangle with supply-chain issues, labor negotiations and warehouse space constraints,” Dolly adds.

The Port of Savannah, for example, has been particularly impacted by this shift, with import demand doubling that of pre-pandemic levels and causing considerable congestion offshore. Florida has also experienced increased activity at its ports. Florida’s ports were also expected to benefit from the recent reshoring trend, as the state is ideally situated for manufacturing shifts from the Eastern Hemisphere to areas like Mexico and Latin America.

On a positive note, East Coast port shutdown resulting, including the ports of Miami and Charleston, were temporary, notes Richard Thompson, national director, supply chain & logistics, with real estate services firm JLL. Due to port hurricane protocols and ocean carrier policies of helping each other deal with such events, service was restored within 24 hours.

Still, the Tampa Bay/Fort Meyers region is a major e-commerce and logistics hub. Mapping supply-chain processes at its 4,500 facilities located in the storm zone, Santa Clara-based Resilinc, a provider of comprehensive end-to-end supply-chain resiliency solutions, projects about $20 billion in lost revenue for its customers alone. This figure is based on the storm’s substantial impact on operations and the expected long recovery period for their suppliers, reports globalEDGE.

All natural disasters impact the supply chain, but unlike earthquakes, hurricanes do offer companies some lead time to prepare for the potential onslaught, which is a huge advantage in overcoming resulting supply-chain challenges, notes Thompson. If companies heed warnings, it enables them to move employees, products, trucks and other equipment out of the affected region in advance and stage needed supplies and equipment, such as water and generators, nearby.

Logistics professionals must deal with a variety of supply-chain disruptions on a regular basis, and companies are getting more sophisticated in how they predict and respond to such risks, Thompson says.

“Fortunately, Hurricane Ian was predicted in advance. No one could understand its exact path or intensity, but you knew it was coming.”

Source: “How Much Hurricane Ian Disrupted the Supply Chain“

Some of the biggest names in the multifamily sector are celebrating flashy new redevelopments that transformed old office towers into gleaming, luxury apartments. But difficult floorplates, zoning regulations and expensive redevelopment costs all make it difficult for a wider push of office-to-multifamily conversions.

Brookfield Properties is charging market high rents for the over 700 apartments and penthouses at the four communities of Mercantile Place in Downtown Dallas, located between a Neiman Marcus flagship store and the new Main Street Park.

Redevelopments like this can give new life to office buildings that are no longer profitable—especially as many companies need less space for employees who are still happy to work from home.

In another recent example, American Real Estate Partners (AREP) acquired an office site in Alexandria, Va.’s Old Town district that it will redevelop into 200 apartments with 17,500 sq. ft. of retail and office space on the first floor.

According to AREP, “The acquisition included the simultaneous purchase of all condominium units in the office building from the seven owners. All office leases were restructured to allow for a deconversion of the office condominium and redevelopment into a mixed-use property.”

“This office to multifamily conversion acquisition is one of our core investment strategies and reinforces our ability to identify strong investments across diversified product types and markets to deliver value,” AREP Co-Founder and President Brian Katz said in a statement.

More offices being redeveloped

There has been a steady escalation of office-to-apartment conversions in recent years. Developers finished more than 7,000 new apartments in 2021 in renovated former office buildings, according to data from Yardi Matrix. That’s the largest number in recent years, topping the nearly 6,000 in 2020. From 2013 through 2019, developers averaged about 4,000 new apartments a year in old office buildings. Before 2013, developers rarely completed more than 1,000 a year, according to Yardi Matrix.

More office building are being redeveloped as older buildings become obsolete. New office developments like Hudson Yards in Manhattan offer faster Internet connectivity, improved indoor air quality and more natural light. Many older, office buildings can’t compete as the companies that rent space in them need fewer square feet—many employees still spend at least part of the week working from home in the aftermath of the coronavirus pandemic.

“Older assets without modern features have struggled, especially in urban cores,” says Alan Pontius, senior vice president and national director of the Marcus & Millichap’s office, industrial, and healthcare divisions. New office spaces, which often meets recent elevated benchmarks for both environmental and health and safety criteria, could earn rent premiums of up to 20 percent compared to older, unrenovated office space, Pontius says.

At the same time, demand for apartments has rebounded strongly in many of downtowns.

Office conversions are hard to pull off 

New apartments created in old office buildings are still just a tiny fraction of the new apartments finished every year—more than 300,000 in 2021, according to Census data.

“The key issue people do not understand is just how difficult and expensive these conversions can be,” says Jim Costello, chief economist at MSCI-Real Estate.

Office buildings often have large floorplates. Much of the space is far from a window, limiting how many bedrooms can fit on each floor. Developers struggle to find uses, like storage units, that can make use of windowless space.

“These projects are so few that it’s hard to generalize the trends,” says Jay Parsons, head of economics and industry principals for RealPage, based in Richardson, Texas. “There’s so much more buzz about it than there are actual real-life office-to-apartment conversions.”

Redevelopers may also find surprises in the walls that don’t match the original building plans, from asbestos and lead paint to forgotten fuel tanks.

A building that is still profitable as office space is unlikely to be redeveloped. “The only assets that should be viable to convert are those with low occupancy, yet that still have inherent land value,” says Costello.

However, once a building has failed as office space, local officials may be eager to help it find new life as redeveloped apartments. For example, former New York Governor Andrew Cuomo called for a change in regulations to permit commercial property owners to convert their buildings to residential uses in his State of the State address in 2021. Other cities, like Pittsburgh, have dedicated millions to help pay to redevelop commercial space to become apartments. Buildings that are historic landmark buildings can also receive historic rehabilitation tax credits from the federal government and many states.

“The sites that work are not specific to certain markets, it’s more about having the right type of building floorplate and tax incentivizes (like historical preservation) that help make these deals pencil out,” says Parsons.

Source: “Multifamily Developers Turn Some Dead Office Space into Apartments“