Archives for January 2023

Some dynamics of logistical and industrial space leasing are feeling pressures of inadequate supply, according to a panel of NAI Global industrial and logistics real estate experts meeting virtually.

Although demand pacing ahead of supply had become expected by partway through the pandemic — industrial with multifamily being the two darling property types for owners and investors — many markets have become weaker. A recent Cushman & Wakefield study found that industrial had shown signs of slowing down in the fourth quarter of 2022. Only five of 81 tracked markets posted double-digit quarterly increases, although some bright spots such as Charleston, Inland Empire, Phoenix, and Miami all recorded annual gains of 40% or higher. Coastal and port/population-proximate markets continued to see premium pricing.

The information coming out of the NAI panel may have represented some specific experiences and not broader and statistically representative findings.

But one panelist managing subleasing assignments in multiple markets said that one corporate client on three different occasions was able to raise rates on sublease occupiers. The primary occupant is splitting the increased rent profit with the landlord equally.

“The same thing is happening in another market covered by NAI Global, with the meeting participant saying that he had put a client in a building 18 months ago on a 7-year lease at $7.65 NNN,” the report said. “They experienced rapid growth during those 18 months and subsequently expanded into a larger facility resulting in them placing their original space on the market for sublet at $8.95 NNN. Currently, there are two companies competitively bidding on this sublet space who are willing to take it ‘as is’ and at the asking rental rate.”

More evidence of a lack of supply is in rental increases. “In Virginia, one of the NAI Global brokers reported a renewal in which the previous rental rate went from $7 a foot to $10 per-square-foot (PSF),” said the report. “The broker said they surveyed the market for relocation options but in the end, there were no viable options and the renewal deal was struck.”

Similarly, a client in New Jersey has been paying $6.50 a square foot but renewed at $14, “simply because the landlord knew the tenant’s choices for relocation were limited, and demand in the region is so high.”

And in Laredo, Texas, which is relatively close to big manufacturing plants in Monterrey, Mexico, the vacancy rate is effectively zero, with all new inventory being delivered in the first quarter expected to by immediately absorbed. “In fact, the broker said that all 2.8 million square feet scheduled for delivery this year will be absorbed before the buildings are completed,” said the document. Laredo reportedly has an industrial base of about 40 million square feet.

Source: “Tight Industrial Supply Turns Subleases Profitable“

An exponential increase in the cost of interest-rate caps—insurance that CRE borrowers with floating rates purchase to hedge against rate increases—may soon spawn a wave of property sales in an increasingly distressed market.

In 2019, the Mortgage Bankers Association estimated that up to one-third of all commercial property debt was floating rate, with most lenders requiring that borrowers hedge against an increase in the borrowing costs.

When interest rates were low, derivative contracts offering hedges on multimillion-dollar mortgages could be purchased for as low as $10K. Now—as the lion’s share of these insurance contracts are expiring—the cost of rate-cap hedges is as much as 10 times higher that it was a year ago, according to a report in the Wall Street Journal.

Few buyers who opted for floating-rate loans when borrowing costs were low anticipated they were going to have to rebuy a cap at the same time interest rates are peaking, the report said.

According to Michael Gigliotti, co-head of JLL Capital Markets NYC office, many property owners may not have the liquidity to pay the increased insurance costs. Gigliotti told WSJ he expects a surge in property sales this year from owners who chose to unload their assets rather than spend millions on a new rate cap.

“This is the margin call on the real estate industry,” Gigliotti said, warning that a flood of properties going on the block to avoid increased rate cap costs could turn into what he called a “first trigger” pushing down real estate values.

Interest rate caps typically enable a borrower to avoid paying additional interest rates beyond a fixed threshold. According to the WSJ report, speculative ventures, where investors acquire short-term, floating-rate debt to finance building renovations aimed at raising rents have the most exposure to the increased cost of rate-cap hedges.

Apartment owner Investors Management Group was cited as an example of the rate-cap conundrum facing property owners: in 2020, the firm took out a $24.4M loan on a 300-unit multifamily in San Antonio. The firm bought insurance that capped interest at 5%, with the hedge contract costing $22K.

The cap on the San Antonio apartment campus expires in September. The company estimates that purchasing a new two-year hedge will cost $1M—40% of the property’s annual net income.

Floating-rate mortgages on apartment buildings insured by Fannie Mae or Freddie Mac can require borrowers to put money into an escrow account to pay for a new rate cap when the old one expires.

A wave of property sales spawned by spiraling rate-cap costs would magnify an already intensifying credit crisis in commercial real estate. According to a new report from Bloomberg, almost $175B of global real estate debt already is distressed, four time more than any other sector in the global economy.

Rising interest rates and the accompanying economic downturn, which appears to be the overture of a looming recession, have created an expanding pipeline of potentially defaulting loans in an environment where property values and cash flows are under pressure in all global markets, Bloomberg reported.

Source: “Expiring Interest Rate Caps to Fuel Distressed Property Sales“

GFH Financial Group, a Middle East-based investment group, kicked off 2023 with an announcement that it had bought a majority stake in Big Sky Asset Management, a $2 billion U.S.-based real estate asset manager focused on healthcare real estate. The investment follows GFH’s May 2022 acquisition of SQ Asset Management, a leading specialist in the U.S. student housing market.

Singapore-based GIC is another major player that has remained active. Last fall, the global investment firm partnered with Oak Street to acquire STORE Capital in a $14 billion deal. GIC also is reportedly part of a group that bought a majority interest in a 41-property office portfolio from Griffin Realty Trust valued at $1.1 billion.

Both deals illustrate that while there has been a sharp drop in cross-border transaction volume over the past year, some foreign investors continue to make big market moves to expand their U.S. real estate holdings.

“One of the trends that we’re seeing, particularly with the large sovereign wealth funds, is that they have been expanding into buying platforms and portfolios and operating companies as opposed to just buying real estate,” says Riaz Cassum, executive managing director in the Boston office of JLL Capital Markets, Americas.

In addition to acquisitions, foreign investors are entering into programmatic development joint ventures as a means to deploy capital at scale. Tishman Speyer Properties and Mitsui Fudosan America—the U.S. subsidiary of Japan’s largest real estate company, recently launched a JV to develop and reposition logistics properties in urban U.S. markets. And Landmark Properties announced a $2 billion build-to-core student housing JV with Abu Dhabi Investment Authority, according to JLL’s Strategic Transactions Monitor.

Headwinds slow transaction volume

Such megadeals stand out in what has been a quieter pace of foreign investment sales over the past six months. MSCI Real Assets was reporting a four-quarter rolling total of $63.4 billion worth of assets being acquired by cross-border buyers through third quarter. However, that rolling total is buoyed by a huge fourth quarter 2021. The expectation is that annual 2022 results will adjust much lower once fourth quarter sales are tallied.

JLL’s research shows tepid cross-border transaction volume for the first three quarters of 2022 at $19 billion, and Cassum expects cross-border volume for the year to come in closer to $30 billion—roughly half the 2021 volume. Foreign investors are following much the same playbook as domestic players these days, notes Cassum. “What’s going on in terms of monetary policy and rising interest rates has caused capital, both domestic and cross-border, to be cautious and slow down investment activity until there is more clarity on how high rates are going to rise and whether that turns into a recession in different parts of the world,” he says.

In addition to higher interest rates and uncertainty that are weighing on underwriting, some foreign buyers are dealing with additional hurdles that include a strong dollar and higher hedging costs, says Darin Mellott, a senior director of Capital Markets Research at CBRE. The U.S. Dollar Index (DXY) rose by almost 20 percent against some of the world’s major currencies last year and remains up about 15 percent. That has been a material increase for some non-dollar denominated investors coming into the U.S., Mellott says.

The currency impact has been lessened for foreign investors that already have dollar-denominated investments that are either getting cash flow in dollars or selling assets and redeploying capital. “I don’t think the strength of the dollar has been an impediment to investment into the U.S. However, the dollar is strong because our interest rates are high, which means that hedging costs become more expensive,” says Cassum. In particular, hedging costs have gone up quite a bit for certain currencies, such as the Euro and the Korean won, which is an added factor weighing on transaction activity for those investors that do need to hedge.

Dry capital to deploy

Foreign investors still favor the U.S. for a variety of reasons, including its stability and risk-adjusted returns. The decline in sales is more of a timing issue rather than people that are staying on the sidelines, notes Tim Bodner, real estate deals leader at PwC US.  “If you look at the largest foreign investors, they are very active and have very aggressive plans for 2023 and moving forward,” he says. In fact, a number of foreign investors are maintaining, if not increasing, their allocations to U.S. real estate, he adds.

Historically, foreign investors have focused on trophy assets in gateway coastal markets. However, cross-border buyers are expanding their scope to include niche asset classes, such as student housing, healthcare and even marinas. “There has been so much appreciation in those traditional sectors that they think they might find more relative value creation opportunities in these alternative asset classes,” says Bodner.

Although foreign buyers still like the gateway markets, they are expanding their focus to include growing secondary markets, particularly in the Sun Belt. “I think there is going to be a two-pronged approach where they are going to play in both markets,” says Cassum. “We’ve seen that from the institutions that were historically only investing in New York, Boston and Washington, D.C. that will now go to Dallas, Austin, Denver and Nashville.”

Activity is likely to be slow in the early part of the year, but greater clarity on Fed policy and interest rates should give investors more confidence in underwriting deals in the coming year. “I do think that all of those conditions that we cited as headwinds won’t be as problematic coming into the new year,” notes Mellott. Hedging costs are coming off of some of the highs seen last year, and the dollar rally seems to be fading at the beginning of this year. So, currency issues don’t seem as problematic and could potentially improve. “I think foreign investors will be included in that broader market recovery,” he adds.

Source: “Mega-Deals Reinforce Foreign Appetite for U.S. Real Estate“

With hybrid work quickly becoming the norm, flexible office space has only risen in popularity coming out of the pandemic. The number of people working in coworking spaces, for example, hasn’t just continued to grow steadily—it’s more than tripled since 2015.

According to the hybrid workspace experts at Regus:

• 90% of employees want flexibility in where and when they work
• 30% of global office space will be flexible by 2030 (compared to less than 5% today)

Meanwhile, studies like CBRE’s 2022 Occupier Sentiment Survey show corporate demand for flexible office space is growing. Some 59% of respondents say flex space will make up a significant (10-50%) or very significant (50%+) portion of their corporate real estate portfolios within the next 2 years.

Here are 3 reasons companies are making flex office space an integral part of their corporate real estate portfolio.

1. As-a-service solutions are becoming the norm

‍Fortune Business Insights has projected that the global XaaS (Everything-as-a-Service) market will skyrocket from $545 billion in 2022 to $2,378 billion by 2029.

In fact, if you look at the shift towards as-a-service solutions across other industries, it should come as no surprise that more companies are viewing real estate as yet another cost center they can leverage on a pay-per-use basis.

Consider, for example, the movement from on-prem to cloud-based solutions.

Instead of buying, managing, and ensuring you have enough servers to cover your needs (and likewise—that you’re not wasting money on way more servers than you require), you can now:

• Work with a usage-based, as-a-service provider like AWS
• Reap valuable cost-management benefits
• Let AWS handle the logistical burdens of managing servers and everything else that comes with it

The same premise applies to flexible office space, which is sometimes called “space-as-a-service”. Here’s a telling take on the future of the office from thought leader Dave Cairns:

“The office industry is on a path to becoming Spotify. Eventually we’ll all carry the ‘office’ in our pockets but at the moment the traditional office is experiencing a ‘Napster’ moment [with] the customer of the office (employees) desiring, and actually purchasing workspace like we used to download songs on Napster, on-demand.”

2. Flexible office space offers multiple benefits

‍Considering real estate is one of the largest line items on a company’s cap table—and especially considering the looming recession, and the general disinterest around returning to the old model of office-based work—organizations gain multiple benefits from adopting flex space solutions.

‍Flex space helps companies roll out and manage activity-based working (where specific events trigger real estate expenditures)

Usage-based workspace solutions unlock significant savings from traditional office rent, upfront capital costs, facilities operations, maintenance, and ongoing management

Remote employees are empowered with the agency to choose their workplace between WFH or at a flex space

‍3. Space-as-a-service supports multiple use cases

It’s commonly said that real estate shouldn’t be a one-size-fits-all approach. For any given company, there may be a variety of flex space needs. These flex spaces provide different engagement models and support a variety of different use cases.

Coworking spaces for individuals

‍Most people prefer to balance WFH with other workplaces. A survey by Slack of 9,000 workers in 6 countries found that only 13% prefer to always work from home if given the choice.

Still, you can expect usage frequency and types of coworking experiences to vary with factors like:

• Job function
• Phase of life
• WFH office setup
• Distractions and obligations at home
• Commuting ability and distance

In markets like New York, for example, where there are more than 450 coworking spaces across the 5 boroughs, generally poor WFH environments—and an easy commute—mean coworking spaces are frequently packed.

Many of these people attend coworking spaces to complete heads-down tasks and may not even be meeting in-person with other colleagues. These coworking spaces also provide people an ability to connect with others in a professional environment and break up the potential solitude of WFH.

Flex spaces for teams

Many companies use flex spaces to facilitate team get-togethers.

Whether it’s a departmental, leadership, geo-specific, or cross-functional gathering — or even an all-company offsite — there are several ways companies leverage flex space for team meetups:

1. Rent a conference room or event space
2. Purchase a bundle of flex space memberships or day passes
3. Combine these two approaches to support both individual work and collaboration

Snagging a more private arrangement, meanwhile, is a great way to make flex space feel like your personal company office for a designated time period.

Source: “3 REASONS COMPANIES ARE ADDING FLEXIBLE OFFICE SOLUTIONS TO THEIR CORPORATE REAL ESTATE PORTFOLIOS“