Archives for October 2023

The e-commerce boom that began in the early days of the pandemic helped send demand for industrial real estate to never-before-seen heights, but as growth has normalized, a rebalancing has taken shape, according to CommercialEdge’s latest 2023 U.S. industrial market report.

E-commerce sales volume exploded in 2020, a shock that reshaped retail as we knew it. While growth cooled in subsequent quarters, the gains made during the pandemic are now entrenched.

E-commerce sales volume has increased by 74% since the first quarter of 2021, although almost half of those gains were made in the initial spike in the second quarter of 2021. During the second quarter of this year, there was a total of $277.6 billion in e-commerce sales, according to the Census Bureau, an increase of 2.1% over the first quarter and 7.5% year-over-year.

While on the surface, these numbers look robust, there are caveats. From 2010 (when the Census Bureau began providing the data series) to the first quarter of 2020, e-commerce sales grew at an average rate of 3.6% per quarter. Following the initial COVID-induced spike, that average is just 2.2%. It is also important to note that these numbers are not inflation-adjusted, and increasing prices account for a portion of the growth. Still, e-commerce’s share of core retail sales (excluding motor vehicles, their parts and gasoline) has increased from 14.2% in the first quarter of 2020 to 18.4% in the third quarter.

CommercialEdge Senior Manager Peter Kolaczynski says, “Naturally, construction is going to slow compared to levels from the COVID explosion, but we see e-commerce as a consistent driver for sustainable and normalized demand through the rest of the decade.”

Even as online sales growth has normalized, it continues to drive significant demand for industrial space because e-commerce operations require much more logistics space than traditional brick-and-mortar. Prologis estimates the additional space necessary for online sales to be three times higher due to “piece picking, product variety, direct-to-consumer shipping and the need to process returns.”

While Amazon made waves when it paused on canceled large fulfillment centers last year, traditional big box retailers are still in the process of adding those spaces. Wal-Mart recently opened a 1.5 million automated fulfillment center, the second of four such announced projects that will allow the company to reach 95% of the population with one- or two-day shipping.

CommercialEdge expects e-commerce to remain a considerable driver of growth in the industrial sector for the foreseeable future. Both multi-million-square-foot facilities and small-scale in-fill centers for last-mile delivery will be necessary for retailers to provide customers with a quick and efficient omnichannel experience. Many existing retailers will look to consolidate brick-and-mortar operations and streamline logistics networks, further fueling demand for space, the U.S. industrial property outlook predicts.

Source: “Industrial Market Rebalances as E-commerce Growth Normalizes in U.S.“

The Biden administration is unrolling new guidelines on how federal programs and funding can be leveraged to convert vacant office properties into other uses, chiefly residential.

The White House on Oct. 27 unveiled the series of measures aimed at making it easier for building owners to convert their properties, with a special emphasis on projects that reduce a building’s carbon emissions.

Some of those guidelines could give developers the ability to leverage billions of federal dollars to make conversion projects a reality in downtowns, rural main streets and other areas across the nation.

Among the actions being taken:

The federal government also is releasing a guidebook with information on how 20-plus federal programs can be used to support conversions. The White House says it plans to host workshops this fall for local and state governments, real estate developers, owners, builders, and lenders on how to use federal programs for commercial-to-residential conversions.

DOT, the Department of Energy and U.S. Treasury additionally are providing information and technical assistance for groups interested in leveraging their programs to finance conversions. For example, DOE’s toolkit gives examples of how the federal Inflation Reduction Act can finance conversions through its loans, guarantee programs and tax incentives.

The White House in a statement said it is encouraging state, local, tribal and territorial entities to identify public tools and land-disposition opportunities to facilitate conversions and also encouraged the private sector to figure out how to build capacity for conversions.

The National Association of Counties is seeking to help counties looking to support conversions of commercial properties to residential use in their jurisdictions. It will identify counties actively pursuing projects and will hold a series of listening and informational sessions.

The American Planning Association, the Lincoln Institute of Land Policy and Harvard University Graduate School of Design also will work alongside planning directors of the 30 largest U.S. cities to figure out new programs on commercial-to-residential conversions.

Conversions are a challenging undertaking

The White House’s announcement comes at a critical time for cities and municipalities facing a mounting problem.

The U.S. office vacancy rate grew to 20.1% in the third quarter, according to Jones Lang LaSalle Inc. Sublease space continues to rise, growing by 3 million square feet on a quarterly basis in Q3, according to JLL. Meanwhile, absorption remains negative, with more space being vacated than leased. Net absorption nationally in the third quarter was -20.8 million square feet, according to Cushman & Wakefield plc.

With $1.9 trillion in commercial real estate debt maturing in the next four years, it’s inevitable more buildings — especially, but not exclusively, dated office towers — will go into foreclosure or, at minimum, face challenges at refinancing. As office buildings and other commercial properties see their values slashed, the cuts are expected to extend to the coffers of local governments reliant on those property taxes as a key revenue source.

But converting office building into other uses, such as residential units, is a tricky, expensive and complicated endeavor.

A working paper by the National Bureau of Economic Research estimates about 15% of office buildings in commercial districts of the 105 largest U.S. cities are physically suitable for conversions. But that share decreases to 11% when eliminating properties that have a substantial share of long-term tenants in place and buildings considered relatively clean.

The commercial real estate market has been largely frozen this year, as interest rates and constrained capital markets have made building sales of most commercial property types difficult to achieve. The NBER paper indicates conversions from office space to residential are feasible if office towers change hands at their new fair-market values.

“Since the latter values are substantially depressed from pre-pandemic valuations, inducing existing building owners to sell at such reduced prices is likely to be a challenge,” the researchers wrote. “Due to the negative externalities associated with suboptimal use, there is a rationale for policy intervention to encourage such conversions.”

The paper identified several federal sources that could be leveraged for office conversions, including the U.S. Environmental Protection Agency’s $27 billion Greenhouse Gas Reduction Act, which needs to be spent by September 2024.

Source: “White House unveils office-to-residential conversion guidance that could unlock billions for projects“

LOS ANGELES—Interest rates represent just one of the many factors impacting the development of multifamily housing, as highlighted by Daniel Doyle, Chief Operating Officer of the Beach Co., during a recent development session at the GlobeSt. Multifamily Fall Conference. He shared, “Our plan for this year was to kick start four projects, but as of mid-November, we’ll only be closing on one of them. You can imagine the disruption this creates for our workflow and all associated operations. The current state of the capital markets has frozen many of our plans and severely limited our capabilities.”

James Holloway, principal at Home Communities, expressed his hope to close on three, maybe two, more projects next year if they are fortunate. He said, “Interest rates have essentially put everything on hold, making things financially unviable at the moment.”

Holloway explained that the rental income in certain areas, such as the South, falls short of supporting the increased costs associated with new developments.

Adam Perry, partner and SVP of Development and Construction at Cityview, emphasized that lenders currently hold significant leverage, resulting in a slow-paced environment for the industry.

Michael Broder, CEO and co-founder at RCKRBX, added that in this challenging environment, it’s imperative to assess your risk tolerance and identify opportunities aligned with the market’s unique needs. He said, “Understanding what people are looking for and how it can fulfill a specific market need is where opportunities can be found in today’s market.”

When moderator Scott Sullivan, principal of Relativity Architects, asked about strategies to minimize risk on these projects, Doyle pointed out that risk varies from person to person. He asked, “Is it the risk to the physical asset, to the people residing in the building, or to the owner/investor? Since our developments are coastal, we must take extreme measures to mitigate all these risks and incorporate factors and criteria that eliminate them. Ultimately, our goal is to reduce insurance costs by including them in the upfront capital.”

Holloway added that he’s witnessed property insurance costs increase by as much as 30% compared to a few years ago. He recognized the necessity of living through the cycle and doing their best to mitigate risks, with the hope of better times ahead.

Perry noted that the industry is inherently tied to risk. He said, “The most prudent step right now, in terms of managing risk, is to proactively engage with your lenders. If you don’t, they might start repossessing your properties. It’s inevitable, so the earlier you establish a relationship with your lender and relationship manager, the better.”

Broder pointed out the challenge of using historical data to make decisions about future projects. He stressed the importance of assessing the performance of an asset and stress-testing it to understand its potential in alignment with the evolving demands of the market from the project’s inception.

The White House announced a plan on Friday to help commercial property owners — with a focus on office — convert buildings to residential use.

“These announcements will create much-needed housing that is affordable, energy efficient, near transit and good jobs, and reduce greenhouse gas emissions, nearly 30 percent of which comes from the building sector,” a Biden administration fact sheet noted.

However, an initial review by GlobeSt.com of the available documents suggests that the announcements and actions look to open existing programs to conversion projects and don’t provide net new funding, which means more competition for the same funds.

Quoting a Council of Economic Advisers post that mentioned a 30-year high national office vacancy rate “placing a strain on commercial real estate and local economies,” the administration said it would be “sparking investment through new federal funding and repurposing property” though the following ways:

• The Department of Transportation released new guidance on “how the Transportation Infrastructure Finance and Innovation Act (TIFIA) and Railroad Rehabilitation & Improvement Financing (RRIF) programs – which combined have over $35 billion in available lending capacity for transit-oriented development projects at below market interest rates — can be used to finance housing development near transportation, including conversion projects.” DOT also has guidance so transit agencies can more easily repurpose properties for affordable housing, including conversions.
• The Department of Housing and Urban Development has an updated notice on “on how the Community Development Block Grant fund, $10 billion of which have been allocated during this Administration, can be used to boost housing supply – including the acquisition, rehabilitation, and conversion of commercial properties to residential uses and mixed-use development.” The department is “also accepting applications for the $85 million Pathways to Removing Obstacles to Housing program, which includes the development of adaptive reuse strategies and the financing of conversions as eligible activities.”
• The General Services Administration is promoting its Good Neighbor Program to sell surplus federal properties that might be appropriate for residential conversions.
• The Department of Energy has a “toolkit” of technical and financial guidance for using various tax deductions and credits that can apply to residential conversions.
• The Treasury Department is reminding developers, investors, and owners about multifamily construction tax deductions.

The White House additionally published a guidebook for commercial-to-residential conversions, which includes a list of “federal loan, grant, tax credit and technical assistance programs across seven agencies that can be used to convert commercial properties to residential use.”

Although the information will be useful to CRE professionals performing conversions and having it compiled in a single place, it’s not clear that any of the programs previously explicitly excluded such activity.

Source: “White House Unveils Plan For Residential Conversion Push“