Archives for October 2023

Global unrest, economic uncertainty and eroding home affordability are among the top issues facing the real estate industry over the next year, according to The Counselors of Real Estate’s annual report, “Top 10 Issues Affecting Real Estate(link is external).” Each year, CRE surveys 1,000 real estate experts to gauge the emerging issues that could have the most significant impact on all housing sectors, particularly the commercial market.

“This past year has been challenging for some and opportunistic for others as the economy, office market and innovation continue to evolve and impact the market,” says CRE Global Chair William McCarthy. “Additionally, the housing shortage and infrastructure issues continue to cause disruption. This next year will be crucial to real estate. All eyes are on the future as we navigate these disruptions with a purpose for developing solutions.”

Here are the top issues affecting real estate over the next year, according to CRE’s list.

1. Political unrest and the global economy. The real estate market is facing a turbulent economy and sagging office sector, which are exacerbated by inflation, slowing GDP growth, high interest rates, bank stress and rising geopolitical concerns involving Russia, China and elsewhere. “We still have mixed macroeconomic signals in the economy, which contributes to an overarching uncertainty on where things are headed,” the CRE report cautions. Still, these risks “don’t necessarily mean the sky is falling. However, it is critical to face the realities of the risks as real estate industry participants navigate key decisions and evaluate strategies.” The report calls for a micro-focused lens on the local landscape, since opportunities could vary tremendously from market to market.
2. The influence of hybrid work. Employers are recognizing that office space needs to become “destination-worthy” to bring workers back. This may even include hosting special events with food trucks that coincide with in-office days or creating patios and outdoor seating to help with employee retention. “If that property doesn’t check the box in some critical way—location, access, convenience, tenant amenities or even an amazing view—those owners need to start thinking about alternative strategies,” the report notes. In some cases, this could mean exploring reuse of obsolete office buildings as conversions into residential units, senior housing, health care facilities or hotels.
3. The housing shortage. The U.S. continues to face severe housing shortages, which has been pinned on decades of underbuilding. Research from the National Association of REALTORS® and Rosen Consulting put the housing deficit at 5.5 million units. Higher interest rates and ballooning construction costs are complicating calls for more multifamily units. The market for single-family homes also is facing higher costs. “The imbalance between supply and demand has contributed to a huge run-up in home prices in recent years, although pricing has started to stabilize—and even decline—in some markets,” the report notes. “Access to affordable housing has huge implications for real estate investors, economic growth, healthy communities and the need for people to live somewhere.”
4. Artificial intelligence. Access to real-time data, improved analytics and forecasting has become critical to investors as they weigh which properties they want to acquire, sell or hold. Artificial intelligence is helping to deliver that data, and recent advancements, including the much-hyped ChatGPT, are being applied to real estate. “The big innovations in commercial real estate will come not from ChatGPT but from the large number of proptech start-ups that are reimagining the idea of data collection,” the CRE report notes. “They’re incorporating mind-boggling amounts of data, and they’re adopting probabilistic frameworks to think about the future.”
5. The labor shortage. Finding skilled workers remains a challenge for numerous industries. The labor shortage has grown for a couple of reasons: an aging population of baby boomers who left the workforce in what became known as the “Great Resignation,” and new employment trends emerged among young professionals with unique views about the workplace. “The labor market has significant downstream implications for real estate,” the report notes. “Jobs drive demand for real estate, and populations also shift to where jobs are located.” Younger generations are choosing their lifestyle first and their job second—a reversal from previous generations. This is forcing employers to take note of migration shifts. Also, young professionals are showing a preference for entrepreneurship and remote or contract work.
6. Migration. Housing affordability has been a prime reason for migration shifts away from urban areas, particularly on the West Coast and in the Northeast, the report notes. U-Haul’s Growth Index shows the top cities for inbound moves over the year are in more affordable places like Ocala, Fla.; Auburn, Ala.; Surprise, Ariz.; Madison, Wis.; and Myrtle Beach, S.C. Businesses are following the migration patterns and relocating from high-cost states to the Sun Belt region or interior parts of the country. “That shift has significant implications for the real estate industry in terms of growth opportunities, as well as the challenges ahead for property valuations, surplus space and obsolescence created in areas where populations are declining,” the CRE report notes.
7. “Real estate Armageddon.” The economy, interest rates and inflation are making up what the report warns is a “real estate Armageddon.” The Federal Reserve’s funds rate is at its highest level since 2007 after a series of rate hikes over the past year. Owners, investors and developers across commercial real estate markets are feeling the effects of higher capital costs, tightened lending and the looming $1.5 trillion U.S. debt that is to mature by the end of 2025. Further, rising interest rates and high prices are shaking up both commercial and residential real estate markets, contributing to a decline in transaction activity. Urban economies may be at particular risk. “We are still in the throes of the late COVID era, and the disruption on major urban economies has yet to run its course,” the report cautions.
8. Supply chain, logistics and U.S. onshoring. The pandemic uncovered supply chain shortfalls, and companies are now reworking supply chain routes that once relied heavily on the West Coast. “The heart of America’s logistics infrastructure lies in the Golden Triangle,” the report notes, highlighting the interior section of the country that runs from the Great Lakes down to Texas and over to the mid-Atlantic. Charleston, S.C., is now the fastest-growing port in the country. “The remaking of supply chains coincides with a reshoring boom of manufacturing, and much of that growth is again focusing on the interior and southern states,” the report notes. The key drivers for new supply chain meccas are affordability, access to a growing workforce and logistics infrastructure, such as access to rail, roads and ports. This shift is creating “massive growth” and ushering in a “new e-commerce era” that is less reliant on urban areas.
9. Pricing reset. As costs for capital increases, cap rates and property values tend to decrease. However, the pricing reset the market has been waiting for has been slow to materialize, CRE notes in its report. “A key hurdle is that buyers and sellers are still in a standoff. Sellers are holding out for values at or close to what was achievable prior to the interest rate explosion. Meanwhile, buyers believe values are much lower based on higher capital costs.” Repricing, however, could have major implications on commercial real estate and financial markets and will continue to play out in the second half of 2023 and into 2024, the report says.
10. America’s aging infrastructure. The costs to repair and upgrade the nation’s aging infrastructure remains a concern. There’s money to help: $1.2 trillion in the Bipartisan Infrastructure Law and $783 billion in the Inflation Reduction Act. But CRE says it also creates an opportunity to rethink what types of infrastructure are needed. For example, the report notes: “Do you spend $5 billion to upgrade one regional power plant, or do you spend that $5 billion to build 20 smaller-scale decentralized power facilities? Those smaller facilities could be customized to generate power from alternative sources, whether it is solar, wind or waste, to energy, as well as change the way power is delivered.” The report also calls for local governments, cities, counties, private corporations, nonprofits, foundations and other associations to work together in helping to develop a new line of thinking about infrastructure at the local level that can support future population and economic growth.

Source: “Top 10 Roadblocks for the Real Estate Market in 2024“

The office sector has faced significant challenges since the pandemic, with U.S. commercial mortgage-based securities, or CMBS, having seen default rates jump by nearly a factor of four since the pandemic.

But there’s also been a fundamental shift in how the submarkets of central business district and suburban offices act — and they make up 90% of the overall category — as a new report from Trepp CRE Research indicates. The shift is in those same CMBS default rates.

In the past, from at least 2016, peaking in mid-2017, and then on to December 2019, there was always better performance in CBD office than suburban. Looking at that peak for a moment, a category of all office soared to about an 8% default rates. The highest CBD office went was a brush with 5%. Suburban offices topped 18%.

Starting in late 2019, the differences between suburban and CBD shrank, with the former being a little above 3% and the latter below 2%. As of August 2023, CBD office was up to 6% and suburban, about 5% — a complete inversion.

It might be a matter of volume. “Looking at loan originations for the office sector as a whole, the volume has diminished from last year, with suburban loans hit particularly hard,” the report says. “Both urban and suburban loan originations decreased from 2022, with originations for urban falling to $1.6 billion from $3.8 billion, and the original balance of suburban loans falling to just $182 million in 2023 from $1.7 billion in 2022. The suburban drop is especially notable considering that the average loan size is less than one-third the size of urban areas.”

The data immediately raises a question of whether there has been a quality self-selection as lenders have sharply raised their standards. It could be that the big reduction in suburban office loans meant only the ones with stronger financials were funded, cutting what had been greater loss levels through more stringent underwriting.

Trepp addresses this in part. Urban offices generally had had conservative debt yields and loan-to-value ratios. LTV was roughly 10% lower in 2023 compared to a trailing five-year average. Issuers have required about 15% debt yield in 2023 rather than the older norm of 10% to 11%.

“These numbers highlight the difficulty of potentially refinancing as these loans mature,” they wrote, with more than $90 billion in loans to mature in the current quarter. Office composes 22% of the total, the biggest percentage.

Source: “CBD Office Once Held the Distress Advantage Over Suburban. No Longer“

LOS ANGELES—During a recent capital and lending session at the GlobeSt. Multifamily Fall Conference, experts discussed the evolving financial landscape. They reflected on the period from 2011 to 2012 when rates remained relatively stable, with 2020 seeing a significant drop due to the impact of Covid-19. By March 2022, the focus shifted to tackling bridge loans and other financial challenges. The panelists provided updates on various aspects of capital and lending, including debt renegotiation, value-add multifamily acquisition, redevelopment opportunities, and the effects of increasing interest and cap rates.

Moderator Malcolm Davies, founder and senior managing partner of WAY Capital, inquired about how the industry has been dealing with the challenges posed by interest rates. Panelist Laurie Morfin, senior managing director at NewPoint Real Estate Capital, explained that her firm had to get creative in helping clients with cash-in refinancing, particularly since many had initially underwritten to a 4-point exit. “We had to think about rate locks,” she noted. The market dynamics had changed rapidly, prompting the need for close attention to rate fluctuations. Morfin also mentioned that some clients were considering selling their properties.

Jeff Burns, a senior managing director at Walker & Dunlop LLC, expressed his anticipation for the end of 2023, describing it as a tumultuous year in their industry. At the year’s outset, their primary focus was to transition clients from floating rate deals. They had a brief window in the spring when the 10-year rate briefly hit a low, enabling them to shift clients to five-year fixed-rate loans. However, the extreme volatility in the treasury market throughout the year made deal management challenging. Rates fluctuated rapidly, making it difficult to assess the viability of deals for their clients.

Burns mentioned that they even had clients explore the sales market but found cap rates to be less favorable. The team was actively assisting clients facing upcoming loan maturities.

Panelist Bryan Shaffer, principal and Managing Director of Slatt Capital, emphasized the industry’s struggle to endure until 2025, highlighting the limited options available in the current market.

Source: “How the Multifamily Industry Survived 2023“

For five straight months apartment rents have dipped, with the latest numbers for September showing that overall prices were down 0.7% year over year, according to Realtor.com. It found that median asking rents in the 50 largest metros dropped to $1,747, down $29 from the peak seen in July 2022.

It is now more economical to rent than buy in nearly all of the major U.S. markets, according to Realtor.com Chief Economist Danielle Hale, although she notes that rent prices have remained well above pre-pandemic levels. Overall, rent has increased by 24% since July 2019, according to Realtor.com numbers.

The rental market is grappling with two opposing forces, Hale tells GlobeSt.com: strong demand especially as home ownership has moved out of the reach of many people and an abundant level of supply that continues to enter the market. Going forward, she says, “it is tough to say whether the demand or the supply will be the bigger influence on price.”

Currently, of course, the market trend is favoring renters. Median asking rents for two-bedroom units dropped for the fifth consecutive month, also by -0.7%, followed by a fourth straight month of declines for one-bedroom units, at -0.3% and a third consecutive month for studios at -0.5%, according to Realtor.com. Median asking rents for larger units remain the most elevated from pre-pandemic levels, with two-bedroom units renting for $403 more per month than they did four years ago, a 26.3% increase. Meanwhile, rents for studios are dropping at a slightly faster pace year-over-year than larger one-bedroom units.

How these dynamics will play out next year remains to be seen. Hale believes that rents will continue at a moderately soft pace for the better part of 2024. “The abundant supply will be the dominant factor, but not overwhelmingly so,” she says.

Source: “What Apartment Rent Growth Will Look Like in 2024 According to One Economist“