Archives for May 2023

On my recent investors call, a question was raised about the downward shift in the demand for the U.S. dollar, especially the petrodollar, and the potential effects on real estate values.

While the U.S. currency is the most reliable globally and represents 90% of the world transaction volume, by comparison, the Chinese yuan currency represents nearly 1% of global transactions and the British pound, the euro and Japanese yen combined represent the remaining 9%. Yet the fact is that the U.S. dollar dropped by as much as 15% compared to foreign currencies and precious metals. Namely, gold has jumped to $22,000 per pound, representing a 20% increase.

Today, more than ever before, we must understand the macro global environment and its potential impacts on the local economy, and while I can argue that a drop in dollar value can have both positive and negative impacts on real estate, the proper answer requires a more careful examination of the asset class, its underlying mortgage and the market fundamentals where the asset is located.

To say it differently, a well-capitalized, well-positioned asset in a major gateway city will hold and even see an increase in value because foreign demand is incentivized by the discount arbitrage caused by the low currency exchange rate.

However, this is never clear cut and properties will suffer from the expansion of cap rates and higher cost of capital. Let’s look at a few examples.

When the dollar loses value, inflation often rises because the prices of goods and services increase. Historically, real estate has served as a hedge against inflation, as property values tend to increase with or even outpace inflation. This is because the cost of construction materials and labor goes up, making it more expensive to build new properties. As a result, the value of existing properties may also rise to keep up with the increasing costs. We have seen it across the board, mainly in multifamily properties that we are developing in multiple markets. The rise in inflation has increased rents and, in turn, the value of our assets. Of course, the cost to build and the carry interest rates have increased as well, but the positive impact we’re experiencing far exceeds the negative (increase in cost vs. increase in property value). A good example is our 600 Dania Beach Boulevard project. We have seen construction cost rise by as much as 17% factoring in additional time and reserves for interest rate. To set that, rents have gone up by 34%, and the value of the asset increased from $105 million to $140 million in a short period of time, while we project cap rate expansion at the exit by 20 basis points to account for the higher cost of capital for a potential buyer.

Another factor we are evaluating is the growing demand for foreign capital. Nearly 80% of the funds Astor Realty Capital deploys are foreign and currency fluctuations are always on our minds. A weaker dollar makes U.S. real estate more attractive to foreign investors as their purchasing power increases, creating increased demand that may result in higher real estate prices, particularly in prime locations and popular markets.

A falling dollar may lead to higher interest rates to counteract inflation as central banks try to stabilize the economy. Higher interest rates can, in turn, lead to higher mortgage rates. This might decrease the demand for real estate, lead to a slowdown in the growth of real estate values, or, in some cases, a decrease in property values, depending on the supply and demand dynamics at play. Long-term, fixed-rate mortgages are a safe hedge. However, the vast majority of our projects are financed with short-term debt that’s exposed to fluctuations. To reduce the risk, we pay additional sums to cap rates at reasonable levels. In Dallas we locked in a 3.6% interest rate loan while we bought a 5.75% rate lock to protect our asset from wild interest rate hikes. This happened in the first quarter of 2022. Had we not bought the rate cap, the asset would have been negatively affected as the increase of SOFR since has gone up by 400 basis points and our ability to service the debt would have been impaired.

Ultimately, the impact of a falling dollar on real estate values depends significantly on local market conditions and the overall economic situation. Astor invests in the top 12 MSAs, with a heavy concentration in Miami and South Florida, Dallas and greater Texas, Brooklyn and the suburbs of New York City. These locations are fundamentally strong due to factors such as employment, local industries and population growth that will have a more substantial impact on real estate values than currency fluctuations.

In conclusion, a drop in the value of the dollar can have both positive and negative effects on real estate values. While it may lead to increased demand from foreign investors and serve as a hedge against inflation, it can also result in higher interest rates affecting affordability and demand. Local market conditions and economic factors will ultimately be critical determinants of how your real estate value is affected by fluctuations in the dollar’s value.

Source: “How Is the Dollar’s Drop in Value Impacting Commercial Real Estate Investment?“

A new report from Goldman Sachs says that the family offices they surveyed were largely maintaining or increasing their exposure to real estate.

This is part of a greater pattern of “risk-on” allocation planned increase over the next 12 months. On average, 9% of funds were being put into real estate and infrastructure.

The report was based on surveys of 166 institutional family offices with net worth of at least $500 million.

“With the flexibility to invest across the risk spectrum, family offices have maintained a largely consistent approach to more aggressive allocations as they seek superior returns,” Meena Flynn, co-head of global private wealth management and co-lead of One Goldman Sachs Family Office Initiative, said in the report. “Planned risk-on allocations tell us they see strong opportunities to capture added alpha. This patient, strategic, long-term orientation is often an advantage in managing and preserving generational wealth.”

“Within real estate, 30% of family offices reported that they plan on increasing exposure to the residential sub-sector over the next 12 months, with another 30% looking to maintain their exposure,” according to the report. Goldman saw a focus on multifamily because it has natural demand throughout business cycles and because it’s considered a good hedge against inflation. That is true particularly now when an undersupply of housing stock in the U.S. combined with higher interest rates makes it less likely people can purchase their own homes.

According to WealthManagement.com, many family offices have capital on hand to put to work, with real estate being one asset class that can have tax advantages while producing cash flow. They are, however, being cautious at the same time given the churning in the banking sector.

One way those two inclinations come together is bargain shopping. High-net-worth families and a few well-heeled developers have been bargain-hunting for Manhattan office-buildings and making an increasing share of purchases, according to Savills. Many are making snap decisions to purchase properties at significant discount. But that may be something of an anomaly.

Going back to the Goldman Sachs report, only 7% of family offices plan to invest more in office space and 4% in retail; 12% and 10% respectively plan to reduce their exposure. At the same time, there is “continued interest in warehouses and logistics centers that support the shift to e-commerce and onshoring” with 13% of family offices saying they plan to increase their exposure to industrial and 28% saying they wish to maintain it. “Other secular themes include towers and data-storage centers that enable digitization, assets related to renewables and sustainable food production, and lab facilities dedicated to biotech innovation.”

Source: “Many Family Offices Increasing Allocations to CRE“

Understanding pricing of any kind in CRE — properties, building, insurance, financing — has become extremely difficult. Lowered transition volumes and quickly changing economic and financial factors have made the process incredibly difficult.

But when it comes to seeing how investors are pricing opportunities, Trepp suggests looking at an investment’s spread-to-Treasury bonds. There is a deep sense in that as Treasurys are so often part of calculating a risk-adjusted return. They are the typical measure of safety.

Vivek Denkanikotte at Trepp points to a pair of spread indices that are applicable to CRE and real estate capital markets. The first is the comparison of AAA-rated senior commercial mortgage-backed securities (CMBS) bond trading on secondary markets to Treasurys. The second is CRE loan spreads quoted by portfolio lenders.

Spreads increase when perceived risk increases, a self-fulfilling prophecy. If investors think risk is greater, they want more money for taking the risk, which means a broader spread. And, as follows, when perceived risk decreases, spreads decrease. Investors of course would like to keep the extra money when things are safer, but given the nature of markets, others will come in and take a deal away with better terms, something akin to a Dutch auction, when the price keeps dropping until someone takes the bid.

“Since CRE loans compete for capital with other risk assets such as corporate bonds, lenders will often use yield spreads for bonds traded on the secondary market to help set pricing for loan quotes, even if the loans will be held as part of a portfolio rather than securitized,” Denkanikotte wrote.

For example, as a few banks failed and investors become understandably concerned, the spread between AAA CMBS bonds and Treasurys expanded from the 100s of basis points to upwards of 170, a jump that Trepp pegs at 30 to 40 basis points. The spreads have calmed some but are still elevated.

Regarding CRE loan spreads from portfolio lenders, Trepp has seen the results in its work tracking lending spreads by portfolio lenders by property type.

“Of the four property types covered by Trepp-i, it is no surprise that office loans have seen the largest increase in spreads, increasing almost 25 basis points from the beginning of March through mid-April,” Denkanikotte wrote. “Interestingly enough, loan spreads for multifamily, previously seen as the most stable property type, have also widened quite notably increasing by 20 basis points over the same period.”

Retail and industrial spreads were up by about 14 basis points over the same period.

Source: “Understanding Where Investors Are By Examining Spreads“