Archives for August 2023

Retailers are performing very well — maybe as good as they’ve performed in the last 10, 15, 20 years – pretty much across the entire retail perspective, according to a news video released this week by Marcus & Millichap.

Daniel Taub, Senior Vice President/National Director – Retail and Net Lease Divisions, said it doesn’t mean that there aren’t issues, but overall, the sector and most industries within retail are performing very well.

Taub attributes that to virtually no net new development of any note, compared to prior to the great financial crisis in 2008-09, leaving a supply-demand issue.

Vacancy rates have continued to decline, coming close to one of the lowest levels seen in a long time. Rents are going up, meanwhile, moving consistently above the average prior to the pandemic, with ranges depending upon location and use.

However transactions have not returned to a normal level due to the economic uncertainty and volatility in the capital markets, Taub says.

“We are seeing sellers with deal fatigue, as well as buyers at the same time are understanding that they aren’t going to get these massive discounts because retail overwhelmingly is a well-performing asset class.

“Based on what clients are telling us, as buyers and sellers, we should see a slow, but albeit gradual increase in transactions in the retail environment for net lease single-tenant retail, and multi-tenant retail of most shapes and sizes, maybe with the exclusion of the mall category.”

There are some exceptions, of course, such as Kimco’s acquisition of RPT this week.

But the most active investors today in both net lease single-tenant and multi-tenant are focusing on smaller deal sizes, Taub said.

The reason is they’re either paying all cash, or there is better access to debt, according to Taub, even though that debt costs more today.

In net lease retail, that could be deals priced between $3 million and $4 million and less. In unanchored and anchored multi-tenant retail, that could be between $6 million and $15 million, he said.

Source: “If Retail is Flourishing, Why are There No Large Deals?“

As rent growth slows nationwide, some markets are now more favorable for renters based on long-term pricing trends, according to researchers at Florida Atlantic University and two other schools. In such places, rents are trading at a slight discount, relative to their historical trend, according to the Waller, Weeks and Johnson Rental Index, a subsection of FAU’s Real Estate Initiative, which measures what the average rent is in the 100-most populated metro areas compared to where rents should be based on historic rental pricing trends.

For example, rental markets in Western states are seeing their rental premiums decline or return close to their historical trends. Case in point is Boise, Idaho, where the average rental is priced at a .04%. discount, relative to its historical trend, which would give renters a slight bargain on a typical unit in the area. In other nearby Western markets, the discounts and premiums hover near that. Sacramento, Calif., renters would probably get a 0.2% discount; in Las Vegas it would be a .39% premium; in Spokane, Wash., a .40% premium; in San Francisco, a .62% premium; in Stockton, Calif., a .66% premium; in Phoenix, a .99% premium; in Colorado Springs, Colo., a 1.55% premium, and in Seattle, a bigger 1.98% premium. In the Midwest, the same trend is happening in Minneapolis where there would be a .83% premium.

All these markets are the most ideal for a renter based on long-term rental pricing trends, according to Ken H. Johnson, Real Estate Economist with FAU’s College of Business. “Since many of the rents in these areas are either below or close to long-term historical trends, renters in these markets are not overpaying,” he said.

However, researchers offered a caveat: trends remain local and not every individual market is becoming more affordable for the renter cohort.

Yet, it indicates that “rents have settled in many markets and are back to where they should be based on historic rents for a given market,” said Shelton Weeks of Florida Gulf Coast University. “For example, Sacramento has historically faced housing affordability issues and these issues continue. Now, however, rents are returning to typical levels, more in line to local norms rather than being dramatically overpriced.”

Some markets still require renters being more patient of the trend happening in their area. Examples are in Florida and on the East Coast. Charleston, S.C., has the highest premium in the country at 10.72%, followed by Knoxville, Tenn., at 10.31%, New Haven at 9.02%; Akron, Ohio, at 8.86%; Cape Coral, Fla., at 8.76%; Madison at 8.48%, El Paso at 8.45% and Hartford at 8.19%.

Although two Florida cities remain among the most overpriced rental markets nationwide, according to Johnson, he thinks the Live Local Act should help by encouraging development of multifamily housing and getting premiums down when supply increases. The Live Local Act is a statewide workforce housing strategy designed to increase the availability of affordable housing opportunities by providing funding for workforce housing, according to the Florida Housing Finance Corporation’s website. 

Source: “More Markets Are Favoring Renters“

There continues to be a disconnect between CRE buyers and sellers as both sort out the current economic climate, existing loans, interest rates, and the relative value of maintaining long-term perspective.

John Chang, Marcus & Millichap, said in a recent news video that prospective buyers keep telling him that commercial real estate prices are too high.

Meanwhile, sellers fall into two camps. There are the ones who are motivated because they have an issue with the underlying loan, they have some sort of ownership issues or it’s simply time to harvest the asset.

And there are those who aren’t motivated because they don’t have an impending debt issue or any real pressure to liquidate the asset.

“The sellers in the first group are generally moving to a market clearing price, while the owners in the second group, obviously won’t come to market at all, because they believe their property will be worth more in the future,” Chang said.

This disconnect has slowed sales activity. Marcus & Millichap reports that the total number of commercial real estate transactions over $1 million in the first half of this year is down a dramatic 41% compared to last year, but it has still seen nearly 30,000 properties trade hands in the first half of 2023 priced at $1 million plus.

Chang said that’s about the same as during the first half of 2015, and it’s about 20% higher than the 20-year average transaction velocity.

“So obviously there’s not a total disconnect between buyers and sellers,” he said. “Transactions are still getting done.”

Granted, most of the velocity is in the lower price tiers, Marcus & Millichap finds.

In the first half of this year, 87% of the transactions were between one and $10 million which is the highest share since 2010 when the US was coming out of the global financial crisis.

“This reflects the greater share of activity being done by private investors, the lower leverage requirements by lenders, and the greater lending liquidity at lower price points,” Chang said.

He said that buyers who are still on the sidelines keep saying the same thing: Why invest in commercial real estate when I can get 5.5% on a six-month treasury? And most commercial real estate properties on the market are offering a cap rate below the cost of debt.

Most commercial real estate loans are running within the 6% to 7% range, while the cap rates on most properties coming to the market are somewhere between the mid 5% to low 7% range.

“For many investors, that math just doesn’t work,” Chang said.

But given that almost 30,000 commercial real estate deals were done in the first half of this year, some are figuring this out.

Chang offered five reasons investors still see opportunities in commercial real estate and why they’re still buying properties.

For one, investors believe interest rates will come down at some point in the next couple of years and they’ll be able to refinance at a lower rate.

Secondly, the property being purchased might have an assumable loan that still has some term left that keeps the going-in rate on the debt below market, and the numbers still pencil.

Third, there are still value-add deals. Even if the going-in cap rate seems low, for the right investor there may be upside potential they can tap into through property upgrades, changes in leases, bringing in new tenants, creating management or cost efficiencies, or some other unique strategy.

Fourth, the buyer sees local, metro, or neighborhood-level changes coming in the future that will change the property’s dynamics. For example, the property may be in a neighborhood that the investor thinks will gentrify over the next few years.

Finally, the investor is thinking long-term. They’re considering where the market, sub-market, and property will be positioned in five to seven years or at some other anticipated exit point.

They may be looking at demographics, migration trends, employment trends, barriers to entry, barriers to the addition of new supply, or some other structural change that will affect the property.

“Today we’re moving back into what I would consider to be a more normal real estate investing climate where expertise, relationships, and knowledge carry a higher value,” Chang said.

“Investors have to be able to look at the asset and see a specific reason to make that acquisition. They have to see upside potential and unique market dynamics that will favor that property going forward.

“That makes market information, insight, and expertise particularly valuable.”

Source: “Are CRE Prices Too High? It Depends on Your Mindset“

While recent economic and market indicators remain mixed, commercial real estate continued to slow down in July. Interest rates have risen at the fastest pace in decades, although inflation dropped to 3.2%. In the meantime, the banks have already reported tighter standards and weaker demand for all commercial real estate loan categories, according to the Federal Reserve’s July Senior Loan Officer Opinion Survey. With the recent U.S. credit downgrade, getting a CRE loan could become even more challenging.

The most recent CRE data suggest that more CRE spaces become available for lease. Apart from the retail sector, vacancy rates have increased compared to a year ago in the office, multifamily, and industrial sectors. While net absorption in the office sector has remained negative for almost a year, the number of additional available spaces for lease continues to grow. Multifamily rental costs are rising more slowly with the completion of the record-high number of apartment buildings under construction. While the industrial sector has been booming for years due to e-commerce, it may stabilize as net absorption moves closer to the pre-pandemic level. However, the industrial rental cost is more than 7% higher than a year ago. Finally, although e-commerce accounts for 15% of total sales, the retail sector remains strong. The retail vacancy rate remains lower than the previous year and the pre-pandemic level.

Here is how each commercial real estate sector performed in July of 2023.

The record-high number of delivered units has further increased the availability of space in the multifamily sector. During the past 12 months ending in July, there has been a 27% increase in delivered units compared to the preceding year. As a result, vacancy rates have seen a 1.3% rise compared to the same period last year. Nevertheless, absorption has set on an upward trend in July, recording a 7% increase compared to a year ago. The multifamily sector is expected to remain strong compared to the other CRE sectors, owing to favorable demographics, a strong job market, and low housing affordability due to higher mortgage rates.

Even with the conclusion of the pandemic, people are not rushing to return to offices. In the meantime, the amount of office space delivered to the market remains above the average level of the last ten years. These factors, along with remote technology advancements and flexible workspaces, contributed to 58 million more vacant than occupied square feet of office space during the 12 months ending in July. As a result, the office vacancy rate rose to a record high of 13.5%. The increasing number of offices under construction and further technological progression suggest upcoming challenges as the office sector adapts to the changing working arrangements and needs.

While the industrial sector of commercial real estate has slowed down from its record high last year, it returned to the pre-pandemic levels. Net absorption is nearly 40% lower than the previous year.  The additional industrial spaces entered the market, along with reduced demand, have increased the industrial vacancy rate to 5.4% and moderated rent growth to 7.2%. Nevertheless, rental costs for industrial spaces continued to escalate faster than in the pre-pandemic era.

Due to the emergence of e-commerce, the “traditional” retail sector has been challenged over the past decade, with the pandemic decreasing activity even further. However, the retail sector remained more robust post than pre-pandemic. The vacancy rate has been unchanged for the last four quarters at 4.2%, the lowest among all CRE sectors. With inflation easing further and interest rates to stabilize later this year, the demand for retail space is expected to remain robust.

Hotel demand has continued to surge, resulting in heightened occupancy rates and an uptick in room rates. The hospitality sector has notably rebounded, experiencing an additional boost in hotel revenue that COVID-19 restrictions and quarantine protocols had previously impacted. The revenue per available room (RevPAR) is now more than 13% higher than its pre-pandemic level. As both business and leisure travel regain momentum, the demand for hospitality spaces will maintain its upward trajectory throughout the year in 2023.

Source: “August 2023 Commercial Real Estate Market Insights“