Archives for July 2023

The U.S. commercial real estate sector is grappling with ongoing challenges as the post-pandemic environment reshapes traditional business models. According to a recent report by credit rating agency KBRA and Reuters, the delinquency rate for commercial mortgage-backed securities (CMBS) has surged, with nearly $12 billion in loans becoming newly delinquent. This rise in delinquency, fueled by the shift in work patterns and consumer behavior, poses significant concerns for the industry’s stability and recovery.

One of the primary factors influencing the rise in delinquency rates is the transformation in work patterns triggered by the pandemic. The post-pandemic era has seen a significant increase in remote work arrangements, prompting businesses to reassess their office space needs. As a result, the demand for office properties has weakened, leading to higher delinquency rates on office-related CMBS loans. In July alone, office loans accounted for approximately 35 percent of newly delinquent loans, amounting to $898.4 million.

Similarly, the rapid growth of online shopping has impacted the retail sector, which has also experienced a surge in delinquencies. Retail property loans constituted the second-highest share of delinquencies in July, standing at 26.4 percent or $683.4 million. The decline in foot traffic and changing consumer preferences have placed additional strain on retail businesses, leading to payment difficulties.

The third segment significantly affected is mixed-use properties, designed for both retail and office purposes. These properties made up 23.7 percent of the newly delinquent loans, equivalent to $613.9 million. The combination of reduced foot traffic for retail and decreased demand for office space has amplified the challenges faced by this particular category.

As the delinquency rates climb, more loans are moving into the category of “special servicing,” where they receive increased attention and management due to the heightened risk of default. The total special servicing balance on multi-loan CMBS has surged to $14 billion, marking the largest rise since August 2020.

Regional banks, acting as CMBS special servicers, are encountering increased demand for their services as the number of delinquent loans grows. This rise in demand has resulted in a surge in special servicing fees, as seen by KeyBank’s subsidiary, KeyBank Real Estate Capital. CEO Chris Gorman reported a record-setting performance for two consecutive quarters in special servicing fees.

The prolonged stress in the U.S. commercial real estate sector raises concerns about the stability and recovery of the market. The continuous rise in delinquency rates over four consecutive months, culminating in a total delinquency rate of 6.44 percent, underscores the urgency for proactive measures to mitigate the situation.

The surge in delinquency rates within the U.S. commercial real estate sector serves as a stark reminder of the lasting impact of the pandemic on traditional business operations. As the shift to remote work and online shopping continues to reshape the landscape, various segments of the commercial real estate market will continue to feel the strain for some time.

Source: “Report: U.S. Commercial Real Estate Faces Mounting Stress as Delinquency Rates Surge“

When you walk into the 30,000-square-foot space that constitutes Rockbridge’s new headquarters in Columbus, Ohio, there’s a good chance you won’t realize you’re in a private hospitality investment firm.

The entrance resembles a high-end restaurant or hotel, designed to be a beacon of the company’s culture. High ceilings, dim lighting, potted botanicals lining the entrance and a neon “Welcome to Rockbridge” sign set the tone for the rest of the space. Other areas, including one with a brick fireplace donning inserts for freshly cut wood, bookcases and barrel chairs arranged in a circle perfect for spurring conversation all seem to say, “this is your space.” It’s built for collaboration.

“We approach our office like we do our hotels—with a keen focus on the public space. We have a simple guidepost—to create space where people want to be,” says Jim Merkel, CEO and co-founder of Rockbridge. “A full third of our space is public and collaboration focused, and I was nervous about that. It felt a little bit risky.”

But the risk has paid off, he says. “Our team feels at home and brings their families here to see our office, and the next generation of team members want to be here.”

Merkel’s thriving in-office culture is a stark contrast to what many other entrepreneurs are experiencing. Headlines in top business magazines, newspapers and online articles highlight the struggling commercial office sector, pointing the blame at employee desires to remain working remotely.

That’s putting it lightly.

“Property investment has plummeted. Leasing activity has dropped. Delinquencies have surged, and maturing mortgage loans face starkly higher refinancing rates. Large global firms plan to reduce office space as the trend toward remote work that accelerated during the pandemic persists,” Investopedia said, noting in the article’s headline that “Warning signals in U.S. commercial office markets haven’t stopped flashing.”

“One of the great things about hospitality is it has always had to be consumer focused. You’re serving needs, but it’s also a consumer product that people get to choose daily,” Merkel says. “As a result, hospitality is a business model that has stayed on the cutting edge and has continued to evolve and stay relevant.”

Adapting to meet consumer needs has not been a part of the commercial office model. While the business world has changed, the office model hasn’t yet needed to evolve to keep up. Those days are over, as the ways in which business was conducted 20 years ago are no longer relevant today. Generational changes from Boomers to Gen X, Millennials, and Gen Z means each think and behave differently, and this is true of the commercial office model. The needs and desires of companies and team members have changed.

“It is important to evolve and invest in all real estate types to continue to be relevant with what the consumer is looking for today, which is difficult, capital intensive, and takes time,” Merkel says. “You can’t just wave your hand and have a relevant physical product. As a result of a lack of investment and obsolescence of commercial office space, it is facing some meaningful challenges.”

Mixed Use Building Demand Has Increased

The evolution of real estate in retail, office and housing has shown an enhanced interest in hospitality and in building a brand around a physical space. One example of other real estate looking to hospitality, Merkel says, is apartment and hotel projects that are becoming mixed use with retail, restaurants and a bustling local economy beyond a person’s living space, creating a sense of place.

Building owners should take note.

Apartment buildings and hotels that are “destinations” are piquing the interest of younger generations, who say they want to be there because it offers them more than just a place to live. It offers community. The same could be true for commercial office buildings.

“People like to think in absolutes, and the fact is commercial office buildings are under-evolved. They’re not obsolete,” Merkel says. “There’s been a massive transformation in how people work and in how they view offices, and the office market has not evolved or transformed fast enough to deliver what people want.”

Hospitality Continually Reinvents Itself

Hospitality has been through transformations. If you think back to the late ’80s and early ’90s, it was a period of “boom and bust,” there were a lot of obsolete properties as consumer demand decreased. There was an excess of under positioned and oversupplied properties at times of slower demand growth.

Over the last two decades, traditional hotels have given way to boutique, designer and lifestyle hotels. Millennials turn work trips into mini vacations. Social media, new ways to book rooms, technology, peer reviews and new players in the market have continued to evolve our industry and create positive disruption.

Today, company leaders are seeing shadow spaces in their own real estate portfolios that they’re forced to deal with because of the transformation in remote work. Some companies have millions of square feet of space that aren’t being used.

“COVID didn’t create these trends, but it accelerated them toward team member needs and the ability to work more flexibly,” Merkel says. “Team members want ways to manage their work and personal lives better, and a lot of companies have struggled to evolve.”

People Desire Community

People like to live, work and play as part of a community, and now, they can “literally curate just about anything in the world in the palm of their hand, and this is what newer generations are accustomed to,” Merkel says.

Even with their work, people desire belonging to a community. That’s part of why Airbnb’s “Live like a local” campaign—with guidebooks that highlight local neighborhoods—was so successful, Merkel said. It efficiently connected people to a destination where they could explore somewhere new, but more like a local than a tourist. It made people feel like they were part of a community.

The campaign also validated that people want to have something unique and special, and they want to share it with friends. These trends are making their way to the commercial office market, Merkel says.

“If you look at what we did with our office, we’re enhancing our team’s experience by leveraging a hospitality approach—focusing on a hotel experience—providing communal spaces, collaboration, learning, cultural events, on-site fitness, and more,” he says. “You can no longer hire thousands of people and throw them into a cube farm and expect that to satisfy your workforce. The experience matters.”

Even those who like to work independently want to be proud of the company they work for, so companies are going to have to focus on the experience to get more sophisticated and savvier in how they create those places, and the physical environment will be a big part of that, Merkel says.

Company Leaders Must Invest in Relationships

Merkel says his office space and in-office culture are thriving because it creates a concentration of people and brand while investing in relationships and regular gathering.

Moving forward, company leaders and those who want to attract the best talent must think about the office as a place to bring people together, even if they’re working flexibly. If a building is empty, it probably means the office space isn’t aligned with what companies and team members need. It doesn’t mean it can’t be aligned, Merkel says.

“The human condition and what makes us happy is feeling connected with other people, and you can never replace that.”

Perhaps a hospitality mindset is exactly what the reinvention of offices today need.

Source: “Look To Hospitality For The Future Of Commercial Real Estate And In-Office Work“

Due to work-from-home and hybrid work options and the appeal of more affordable lifestyles, many people have left big cities behind and are calling less costly, less congested smaller markets home. In such places, the desire for a work-play balance becomes more of a reality than just part of a wish list.

And where are all these people moving and living, not to mention investment dollars flowing? Dozens of small markets nationwide, according to July 2023 stats from RealPage Analytics.

It reports that smaller markets are the only ones out of 150 markets surveyed that registered investment growth over the past year. Moreover, of the 19 markets that achieved an investment dollar volume increase year-over-year, all but three were small markets.

At the top of the list for annual change and a staggering 2,672% increase YoY, was Midland/Odessa, Texas, with more than $125 million in apartment transactions. The reason for this huge surge may be its location where the “energy” economy is dominated by oil and gas production, though that has posed some downside, too. At No. 2 was Salisbury, Md., close to Washington, D.C., and Baltimore with a 609% growth YoY. It experienced $58.5 million of apartment deals transacted in that same period, which the report indicated was important for a city with a population of just under 415,000 people.

The next tier of markets saw investment dollar volume increase closer to the 100% to 200% range and included Spokane, Wash., Madison, Wis., Buffalo, N.Y., Shreveport, La., San Jose, Calif., and Eugene, Ore. San Jose was one of the three large markets that made the top 20 list.

Some of these markets are located within a commutable distance from a larger metro, yet they are also big enough to be self-contained with amenities and other positive factors. Madison, for example, has a big university with many activities and a reputation as one of the country’s best college “towns,” plus accolades for its bucolic charm.

Buffalo, often maligned because of its bad snowy weather, offers numerous positive reasons to live there: the country’s largest residential garden tour each July that’s free; a recently remodeled art museum, the Buffalo AKG Art Museum; Buffalo Botanic Gardens; Frederick Law Olmsted designed park; several Frank Lloyd Wright homes turned museums, and Midwestern charm as its state’s farthest Western city. It also has an affordable housing inventory for those who want to invest in homes rather than go just with apartments.

The next six markets on the list–New Haven, Conn., Omaha, Neb., Manchester, N.H., Lubbock, Texas, Little Rock, Ark., and Springfield, Ill.—all achieved investment growth of closer to a strong 10% to 40% YoY. Here, too, there are countless advantages to living and investing in these markets. New Haven is home to Yale University with a top medical center and school; Little Rock’s main museum, the Arkansas Museum of Fine Arts, just gained an overhaul by starchitect firm, Studio Gang, and the city also counts the William J. Clinton Presidential Library among its attractions.

Cincinnati appeared at No. 15 as the second of three large markets that experienced an increase in investment dollar volume with a strong gain of 9.2% over the past year. Stockton, Calif., Wichita, Kan., Naples, Fla., Milwaukee, Wis., and Salinas, Calif., finished the list, with Milwaukee appearing as the last of the three large markets that saw investment growth.

Source: “Smaller Apartment Markets Become a Great Investment Opportunity“