Archives for March 2023

The roiling of banking has generated shockwaves that are hitting other industries, like CRE. At first, it was a question of whether rent payments would come in from the tech startups doing business with Silicon Valley Bank. Then concern about what the Fed might do about interest rates came in. A consortium of large banks saving First Republic promised even more volatility. Credit Suisse became COD Suisse and needed a quick rescue, which happened when UBS took it over.

Enough discombobulation? Don’t you bet on it. Today’s new concern is real estate-based bonds. Whether MBS or CMBS securities could get the legs swept out from under them, taking a lot of value with them, came up in a Wall Street Journal article.

The short take is that some of the banks — SVB, of course, but probably others — had loaded up on not just 10-year Treasurys but real estate-based bonds, like MBSs issued by the agencies, Fannie Mae and Freddie Mac, as well as CMBSs. If those bonds hit the market, suddenly getting written down in value and then on top of that dumped in a fire sale, the glut, whatever the size, could push down the value of all similar bonds. And they may well hit the market because, when a bank like SVB gets closed down and goes into federal receivership, the FDIC is required to get back as much value as possible, which includes selling off the bonds.

Take SVB for a moment. According to the bank’s 2022 annual report, by the end of last year, it had $6.6 billion in agency-issued MBS, another $678 million in agency collateralized mortgage obligations (CMO), and about $1.5 billion in CMBS. That may not sound bad, but that was the available-for-sale, or AFS, category. The ones regularly marked to market.

The troublesome aspect and the held-to-maturity, or HTM, securities: $57.7 billion in MBSs, $10.5 billion in fixed-rate CMOs, $79 million in variable-rate CMOs, and $14.5 billion in CMBS. That’s $82.7 billion.

“For sure there will be sharks that smell blood in the water and will buy discounted assets for cheap,” Brad Werner, a partner and leader in assurance, accounting, and tax consultancy Wipfli’s CRE group, tells GlobeSt.com. “Regional banks will for certain tighten as oversight autocorrects and interest rates continue to rise.”

The real pain has already started in CMBS. “The market for commercial mortgage-backed securities is actively seizing up,” Werner adds. “CMBS is a significant portion of the office financing market and February sales volume of those securities just dropped 85%. The most distressed sector is likely to be Class B office buildings going forward, particularly those that have floating rate adjustable loans, which have essentially made the assets unprofitable relative to operating yields as rates have increased. Yields have been impacted negatively by the staying power of remote work and the flight to quality Class A assets. When you add that smaller domestic banks finance approximately 67% of commercial real estate deals and are under increased pressure in the wake of the SVB debacle, that adds for a pretty scary environment in commercial office real estate.”

Source: “Bank Jitters Could Cause a Real Estate Bond Mess“

Dive Brief:

• The tally of corporate defaults this year through Feb. 28 was at its highest since 2009. Retail led the way, with seven out of 23 defaults, or 30% of the global tally, through the end of February, S&P Global Ratings said in a report this month.
• Retail “continues to face challenges from logistics, labor, and supplier cost inflation, all squeezing margins for both retailers and their suppliers. Nearly half of retail issuers rated B- or lower have negative S&P outlooks or credit watch implications. As a result, “further downgrades as well as a potential increase in defaults” is possible, S&P said.
• Bankrupt companies are increasingly seeking reorganization over liquidation. According to a separate S&P report, 78.4% of corporate entities that filed for bankruptcy through February sought reorganization, the highest in at least 14 years. 

• Dive Insight:

  Logistics, labor and supplier cost inflation continue to hurt the retail sector’s bottom line.

  The report’s authors, led by Nicole Serino, said U.S. defaults were over 2.5 times higher than at this time last year — 16 at the time of the report’s publication versus six in 2022. “Given our expectation that economic conditions will continue to deteriorate through 2023, we expect the U.S. speculative-grade corporate default rate could reach 4% by December.”

  Serino told Retail Dive that the consumer products and retail sectors “have a large number of weakest links — issuers rated ‘B-’ or lower with either a negative outlook or CreditWatch—which are 8x more likely to default than overall speculative-grade issuers.”

  Non-traditional forms of defaults such as selective default, where a company is in default on certain types of financial obligations but not others, are trending upward. “From what we have found from other periods of economic stress, the percentage of selective defaults was pretty similar from previous years,” Serino said.

  “[A]s consumers pull back on consumption as higher cost of living pressures cut into savings buffers, retail margins will be squeezed as their ability to pass through higher input costs to protect margins has diminished,” Serino said.

  In a separate recent report, S&P also noted that companies are increasingly turning to the courts and to bankruptcy and reorganization. The report by Chris Hudgins of S&P noted that “companies from the consumer staples sector overwhelmingly favored reorganization over liquidation in 2022 and year-to-date 2023, with 85.7% of filings seeking reorganization.”

  Through Feb. 28, S&P said 87 of the 111 bankruptcy filings it recorded were Chapter 11 filings.

  S&P noted that companies in the consumer staples sector favored reorganization over liquidation in 2022 and year-to-date with nearly 86% of filings seeking reorganization. Party City, Serta Simmons, Bed Bath & Beyond and 99 Cents Only Stores are among the retailers that have either defaulted or filed bankruptcy so far this year.

  Analysts with PwC had a similar take, saying the slowing economy may drive a rise in bankruptcies. Macroeconomic factors that emerged in 2022 shifted consumer behavior and created higher cost borrowing conditions.

  At the same time, market liquidity has declined but operational challenges persist, which affects organic cash flow generation, PwC said, citing its analysis of Refinitive, LCD and FRED data. And as these circumstances likely continue “we can expect to see a sizable increase in restructuring activity as borrowers run out of levers to pull and lenders choose not to extend further accommodations,” PwC said.

  Sarah Wyeth, retail and restaurants sector lead with S&P Global Ratings, told Retail Dive that loans increasingly have stiffer terms.

  “When financial markets are volatile, lenders are less likely to offer amenable terms. Negotiations will be more difficult in today’s environment than they were in 2021,” Wyeth said.

  Source: “US retail sector leads corporate defaults: S&P Global“

Beginning in the late 1950s and throughout the 1960s, a generously funded federal highway program carved large swaths through countless neighborhoods and cities across the country. In Rochester, N.Y., an extension of the national highway system known as the Inner Loop displaced hundreds of homes and businesses as it encircled the city’s downtown. In New Orleans, an oak-lined boulevard gave way to the Claiborne Expressway, an elevated freeway offshoot of I-10. In Seattle, one freeway cleaved the city in two as an elevated companion along Elliot Bay cut off the city’s downtown from its stunning waterfront.

Similar stories played out in Dallas, Atlanta, Baltimore and dozens of other American cities as states fulfilled the mandate of the Interstate Highway Act of 1956. While the freeways connected core cities to emerging suburbs and to other cities, their urban manifestation split neighborhoods while displacing over a million residents and businesses—largely, but not always, in low-income areas—and left depressed property values and underproductive land in their wake.

In 2021—65 years after the Interstate act—the federal government created a program with the intention of helping cities, their residents, and business communities repair some of the damage from divisive infrastructure. Included in the 2021 Infrastructure Investment and Jobs Act, the Reconnecting Communities program provides $1 billion over five years for communities to explore whether and how to remove or restructure underused, outdated or decaying highway segments and thereby allow for surrounding neighborhoods to revive and redevelop. The U.S. Department of Transportation website calls it “the first-ever Federal program dedicated to reconnecting communities that were previously cut off from economic opportunities by transportation infrastructure.” Grants under the program can go to local governments and community- or business-led organizations for planning and design work, or to transportation agencies for capital improvements. Plans that become ripe for action down the road could be eligible for construction funding from several other pots of federal transportation dollars.

When USDOT began accepting applications in September 2021, “it was as though the flood gates opened,” says Ben Crowther, advocacy manager at America Walks, a national nonprofit that is tracking response to the program. “I attended one DOT informational webinar that had about 5,000 participants.”

Applying cities are as diverse as they are far-flung. A sampling: In Dallas, a business-led coalition is looking to replace a decaying 1.4-mile stretch of elevated freeway with boulevards, “transforming the surrounding 245 acres [of ] empty parking lots and undeveloped land into a mixed-income, mixed-use neighborhood that will generate jobs, create affordable housing, and improve the quality of life.” The city of Buffalo, N.Y., put in for a planning grant to fill the trench created by the Kensington Expressway and restore a historic parkway designed by Frederick Law Olmsted. Baltimore is seeking to remove an uncompleted, 1.4-mile segment known as the “Highway to Nowhere” and redevelop areas of West Baltimore. Similar moves are afoot in Tulsa, Okla.; Minneapolis; Detroit; and Portland, Ore.

Precedents offer inspiration

While Reconnecting Communities is the first formal program to revitalize areas devalued by federal highway construction, several communities have made such moves on their own in recent years. Best-known, perhaps, is San Francisco’s removal of the double-decker Embarcadero Freeway after it was damaged in a 1989 earthquake. It was replaced by a boulevard and streetcar line, and the more than 100 acres of waterfront land gave way to a new public plaza and promenade, as well as dense commercial development and multifamily housing. In Milwaukee, the removal of the Park East Freeway—part of an uncompleted downtown loop—in the early 2000s opened 24 acres of intown property for redevelopment. Similarly, New York City replaced the West Side Highway with a waterfront boulevard.

More recently, Seattle in 2019 saw the demolition of the double-decker state Route 99 along the downtown waterfront. Since then, millions of private and public dollars have been pouring in to create new roadways, plazas and multifamily and commercial development. Mike McGinn was the mayor of Seattle when the state began work to replace a seismically vulnerable viaduct with a tunnel, the culmination of more than a decade of contentious debate over whether to replace or simply remove the waterfront scar.

“One of the reasons the debate went on as long as it did was because there were competing business interests,” says McGinn. “On one side you had port and related interests worried about highway capacity, and on the other side you had the downtown businesses and property owners, who recognized that the noise, pollution and visual blight of the highway were terrible for property values.”

Coming off that downtown success, Seattle is seeking a Reconnecting Communities grant to explore the conversion of another section of Highway 99, through the South Seattle neighborhood of South Park. Removing the highway segment “would free up 40 acres of much-needed land for affordable housing, grid reconnection, green space, and small businesses,” according to Seattle planning director Rico Quirindongo.

In Rochester, a second wave

Completed in 1965, Rochester’s Inner Loop was built to encircle downtown Rochester in a bid to reduce the traffic concerns of the time, says Erik Frisch, the city’s deputy commissioner of neighborhood and business development. “By the late 1980s, only a couple decades later, people started asking questions about whether it was needed and raising concerns about the impact it was having on surrounding neighborhoods.” It took till the early 2010s, though, for the political and funding stars to align so that the first two-thirds of a mile of the freeway trench, known as Inner Loop East, could be filled and converted to a boulevard, and formerly bisected side streets could be reconnected. That project restored six acres of land to tax rolls and allowed the city to solicit proposals for what became seven block-size parcels for redevelopment.

“We were looking for income diversity,” says Anne Dasilva Tella, Rochester’s director of development. “Our goal was to reintegrate the divided neighborhood, increase residents, and activate the ground floor with uses that serve the residents,” such as a laundry and daycare. Several multifamily projects have delivered more than 250 affordable apartments and a similar number of market-rate units. The adjoining Strong Museum of Play, a regional and national attraction, led a project to create a hotel, green space and playground as well as a parking garage. The redevelopment “is a big win for this city,” says Frisch. “From a transportation standpoint, traffic is smooth, and we’ve seen more people walking and biking, which indicates a healthy neighborhood.”

Inspired by the success of the East loop, Rochester has secured state funding to remove another 1.5 miles, freeing up 24 acres for redevelopment. “The success of the east side made it inevitable that the north would come out, too,” says Suzanne Mayer, co-leader of Hinge Neighbors, a community-based organization that applied for a planning grant from Reconnecting Communities, with the city’s blessing. While the East loop results are impressive, the north section has a larger transformation potential, uniting affluent and low-income sides of the freeway in a much more populated area. “One of the major concerns when we started meeting with neighbors about the north Loop was gentrification and displacement,” says Shawn Dunwoody, the other leader of Hinge and a noted local artist. “They were afraid they would get a yoga studio and a high-end coffee shop and that would be it.”

Neighbors also wanted to make sure there were opportunities for homeownership and for smaller developers to participate, as well as spaces for small, locally owned businesses, Dunwoody adds. The planning grant would allow Hinge to coordinate an effort to develop recommendations for how to achieve those goals.

In New Orleans, dueling proposals

Claiborne Avenue was the oak-lined Main Street of the largely Black Treme neighborhood when, in the 1960s, much of it was replaced by the elevated Claiborne Expressway. Today, the decaying edifice is crying out to be replaced or removed. Those options are the subject of competing applications to Reconnecting Communities. Louisiana’s transportation department, which owns the highway, put in for half of a $95 million proposal to remove two to four ramps while shoring up the structure, fixing drainage issues and making aesthetic improvements.

To activist and urban designer Amy Stelly, “The elevated highway needs to come out.

“Either way, the state doesn’t need Reconnecting money to do it. They can use existing transportation sources,” says Stelly, executive director of the Claiborne Ave Alliance design studio. Stelly’s group submitted for its own planning grant. “Our proposal is to test all the ideas, from complete removal to ramp removal, and model the traffic,” she says.

“Some want to leave a section as a memorial or convert the viaduct to a park. We say, subject all [ideas] to quantifiable performance standards and see what gives us the best bang for the buck. We want a complete plan to rehabilitate the corridor.

“Our vision is that Claiborne could be restored as a boulevard, as part of our robust network of boulevards,” Stelly says. “I’d love to see some infill development that is affordable, smaller footprints for small businesses, spaces that allow entrepreneurship to take hold. We have to make the place for people who want to come work in the neighborhood, and there are many.”

To former Seattle Mayor McGinn, who these days leads America Walks, it makes sense that today’s efforts to reclaim city neighborhoods are gaining steam. Older facilities are reaching the end of their design life, and many have become obsolete or never lived up to their intended purpose. “At the end of the useful life of a piece of infrastructure, when you do the math, it usually comes out in favor of removal over replacement.” Removing highways is good for cities, not only for quality of life for nearby homes and businesses, McGinn says. It also restores land to the tax rolls and allows improvements that bring still more revenue. “Go to any city and what’s right next to the freeway? Usually parking lots, or other low-value land uses,” he says. “As soon as people can open the windows and walk on the sidewalk, the property values go way up.”

Source: “Forging New Paths“

Sustainability in the built environment is an expansive industry and currently enjoying its time in the spotlight due to increased pressures from communities and governmental bodies to combat climate change. From building design initiatives such as net zero and electrification to renewables and green building certifications, it can be a complicated and overwhelming field to navigate.

Building owners and property managers may question if they are pursuing the correct programs to minimize their organization’s negative impacts on the environment. With all the initiatives, buzzwords, and fancy awards surrounding these initiatives, there are energy efficiency strategies available to buildings that cut through this noise – strategies that are cost-effective, quick to implement, widely abundant, and result in an immediate reduction in building greenhouse gas emissions.

The Threat

Approximately 28% of global carbon dioxide (CO2) emissions are generated from existing buildings, making the sector a prime target for improvement strategies. The climate change saga is at a point where we are working just to limit global warming to a surface global temperature increase of 1.5⁰C. The goal is no longer to avoid the negative impacts of climate change because that opportunity has already come and gone. What we can do as an industry is to help avoid the potentially more catastrophic consequences of climate change that appear inevitable if global temperatures increase above and beyond 2.0⁰C. The Intergovernmental Panel on Climate Change (IPCC) published a report to highlight the consequences of global temperature increasing from 1.5⁰C to 2.0⁰C:

• Impacts associated with forest fires and the spread of invasive species (high confidence).
• Risks from droughts, precipitation deficits, and heavy precipitation (medium confidence).
• Risks to marine biodiversity, fisheries, and ecosystems, and their functions and services to humans (high confidence).
• Risk of sea ice-free Arctic Ocean during summer and the irreversible loss of many marine and coastal ecosystems (high confidence).
• Risks associated with saltwater intrusion, flooding, and damage to infrastructure (high confidence).

No other global issue is quite so all-encompassing when considering the potential consequences, and the changes required from every major industry to mitigate its negative impacts.

The Landscape

To combat climate change, there has been a notable increase in green building program participation as organizations attempt to mitigate their facility greenhouse gas emissions and gain notoriety for their sustainability practices. While each program has its own specific objectives, they have the common goal of promoting and recognizing efficient, healthy, and sustainable buildings. The most prominent programs include:

• LEED: Administered by the USGBC, the Leadership in Energy and Environmental Design (LEED) certification program is the most widely used green building rating system in the world. Available to virtually all building types, LEED provides a framework for healthy, highly efficient, and cost-saving green buildings. LEED certification is a globally recognized symbol of sustainability achievement and leadership.
• WELL: The WELL Building Standard is a vehicle for buildings and organizations to deliver more thoughtful and intentional spaces that enhance human health and well-being.
• ENERGY STAR: ENERGY STAR certified buildings save energy, save money, and help protect the environment by generating fewer greenhouse gas emissions than typical buildings. To be certified as ENERGY STAR, a building must meet strict energy performance standards set by EPA.

Additionally, active involvement with emerging standards, such as ESG (Environmental, Social and Governance) is a necessity as organizations may encounter financial consequences for not participating. Public concern over the worsening effects of climate change will continue to drive environmental policy in a direction that brings awareness to these programs.

The current suite of popular green building programs delivers a wide range of benefits to participating organizations. These include sustainable and efficient designs for buildings, healthy and comfortable tenants, recognition, and accountability among peer organizations and the public. These programs are here to stay and will only become more integral to the building design, construction, and management processes in the future. Building owners and operators are highly encouraged to review these programs and take inventory of existing and proposed building stock to identify opportunities to pursue green building certifications.

The Issue

The importance of green building programs cannot be understated; however, when it comes to combating climate change, it is but one of many tools organizations need to use to reduce their greenhouse gas emissions. In relying too heavily on these programs, companies may be overstating their commitment to sustainability and the positive impacts they are having on the environment.

This is usually not intentional, but simply the result of pursuing awards and accolades over taking less recognized direct action to implement energy efficient solutions. Organizations need to ask themselves if their efforts have been in pursuit of appearing green rather than being green. If it is the former, what insights can we provide to those organizations that might have fallen into the green washing trap? How can we help ensure an organization’s sustainability efforts are not smoke and mirrors and that all avenues for building efficiency are being pursued?

The Answer

To reiterate, green building programs are highly recommended and should be pursued where possible. The issues arise when these programs are pursued, and other readily available energy reduction strategies are ignored. This is the disconnect that can often occur between sustainability recognition and sustainability itself.

For example, a commercial building with LEED, ENERGY STAR, and WELL certification is not guaranteed to be operating efficiently. That can be a big problem for building owners looking to reduce greenhouse gas emissions and energy costs. Many green building programs are inherently passive, meaning there is no active monitoring of existing building stock beyond benchmarking. The energy use intensity of a building can provide good metrics for determining the need for energy efficiency improvements but does not provide insight into specific low-hanging energy efficiency measures.

One solution is to pair participation in green building programs with direct action through building optimization and retro-commissioning programs. Retro-commissioning (RCx) is a process that optimizes building energy performance through the identification and implementation of low to no-cost energy efficiency measures, which can often be implemented without the installation of any new equipment.

This process can take less than a few months, is extremely cost effective, and can be initiated and occasionally revisited without any administratively intensive processes. RCx also avoids the rigidity of capital grade energy efficiency improvements, which are often dictated through long-term budget planning.

The retro-commissioning services umbrella also includes monitoring-based commissioning (MBCx), a more advanced form of RCx involving the installation of analytical software to constantly monitor building performance and provide automatic alerts on opportunities for energy efficiency improvements and maintenance requirements. This technology gives buildings the confidence that all avenues for performance improvements are being pursued.

The retro-commissioning process is so essential to building operations and energy efficiency that some states are beginning to require larger commercial buildings to participate in retro-commissioning studies every so often. Until it is a requirement in every state, it is crucial that RCx be promoted and implemented wherever possible. These overall efforts can only succeed when high-level sustainable design and management initiatives and practices are paired with direct quantitative action to improve building performance.

Source: “A PRACTICAL GUIDE TO RETRO-COMMISSIONING IN THE AGE OF CLIMATE CHANGE“