Archives for November 2023

In the realm of commercial real estate transactions, acceleration clauses play a pivotal role. They are integral components of loan agreements, which can potentially impact the borrower’s financial standing significantly. Understanding and navigating acceleration clauses can be complex, but with a comprehensive grasp of their implications, borrowers can make informed decisions and mitigate potential risks.

An acceleration clause is a contractual provision that allows a lender to demand the full repayment of an outstanding loan balance under certain conditions. Typically, these conditions include default on payments, bankruptcy, or a breach of other terms in the loan agreement. The purpose of an acceleration clause is to protect the lender’s interest by enabling them to recover their funds in the event of a borrower’s financial distress or non-compliance with the loan terms.

The presence of an acceleration clause in a commercial real estate loan agreement can be a double-edged sword. On one hand, it provides a safeguard for lenders against default risk. On the other hand, it can place a significant financial burden on borrowers who may be unable to repay the entire loan amount immediately upon the lender’s demand. Therefore, it is crucial for borrowers to fully understand the implications of an acceleration clause before entering into a loan agreement.

When navigating acceleration clauses, it is essential to pay attention to the specific triggering events outlined in the loan agreement. These triggers vary from contract to contract and may include missed payments, insolvency, or even the sale of the property without the lender’s consent. By being aware of these triggers, borrowers can take proactive measures to avoid activating the acceleration clause.

Furthermore, it is also crucial to understand the concept of ‘cure periods’. A cure period is a specified timeframe within which a borrower can rectify a default or breach of contract to prevent the activation of the acceleration clause. Cure periods provide borrowers with an opportunity to resolve issues without the immediate threat of full loan repayment. However, the length and conditions of cure periods can differ greatly between contracts, making it vital for borrowers to familiarize themselves with these details.

In some cases, acceleration clauses can be negotiated. Borrowers may be able to negotiate the terms of the clause, such as the specific triggers or the length of the cure period, to make them more favorable. However, the success of such negotiations largely depends on the lender’s flexibility and the borrower’s bargaining power.

Legal counsel can be invaluable in understanding and navigating acceleration clauses. Experienced real estate attorneys can help interpret complex contractual language, identify potential risks, and negotiate more favorable terms. They can also provide advice on how to manage an acceleration clause should it be triggered, potentially saving borrowers from severe financial distress.

In conclusion, acceleration clauses are a critical aspect of commercial real estate transactions that borrowers must navigate carefully. By understanding the implications of these clauses, identifying the triggers, familiarizing themselves with cure periods, and seeking legal counsel, borrowers can protect their interests and ensure a smoother transaction process. Despite their complexity, acceleration clauses can be managed effectively with the right knowledge and preparation.

Source: “Navigating Acceleration Clauses in Commercial Real Estate Transactions“

According to the latest research from CBRE, the commercial real estate lending market is beginning to stabilize, with borrowing costs appearing to have peaked, even as transaction activity remains subdued.

The CBRE Lending Momentum Index, which tracks the pace of CBRE-originated commercial loan closings in the U.S., declined by 3.0% from Q2 2023 and 47.9% when compared with the strong loan volume in last year’s third quarter. The index closed Q3 2023 at a value of 187.

“While capital markets headwinds continue, we are seeing signs that lending conditions may be stabilizing for certain asset classes,” said James Millon, U.S. President of Debt & Structured Finance for CBRE. “Credit is gradually loosening, cap rates are resetting higher and the Fed’s rate hiking campaign may be near the end, which collectively could pave the way for an uptick in deal volume in the second half of next year.”

Banks accounted for the largest share of CBRE’s non-agency loan closings for the sixth consecutive quarter, originating 38.4% of the total in Q3 2023, down from 43.3% in the previous quarter. Construction loans comprised about half of Q3 2023 volume, while one-third were for refinancings and the rest supported property acquisitions.

Life insurance companies accounted for 33.5% of origination volume in Q3 2023, up from 26.8% in the previous quarter, predominantly in fixed-rate acquisition and refinancing loans for multifamily, industrial and retail assets.

High short-term borrowing costs continued to constrain alternative lenders such as debt funds and mortgage REITs, which accounted for 27.5% of Q3 2023 loan volume. Collateralized loan obligations (CLO) slowed to just $6 billion for the first nine months of 2023, down substantially from $27.3 billion over the same period in 2022.

CMBS conduits accounted for less than 1% of non-agency loan volume in Q3 2023, compared with 3.7% in Q2 2023. Industrywide CMBS origination reached $26.4.year-to-date through Q3 2023, down substantially from $64.4 billion for the same period last year.

Underwriting criteria changed slightly in Q3 2023. The average underwritten cap rate rose by 16 basis points (bps) to 5.68%, while the average loan-to-value (LTV) ratio increased to 61.4% from 58.3% in Q2 2023. Higher interest rates translated to loan constants averaging 6.72% in Q3 2023, up 79 bps year-over-year.

Government agency lending on multifamily assets totaled $29.8 billion in Q3 2023, up from $27.8 billion in Q2 2023. CBRE’s Agency Pricing Index, reflecting average fixed agency mortgage rates on 7-10-year permanent loans, rose 23 bps in Q3 2023 and 103 bps year-over-year to 5.64%.

Source: “Commercial Real Estate Lending in U.S. Shows Signs of Stabilizing in Late 2023“

Residential rental concessions are hitting a two-year high with 30% of listing offering at least one concessions, according to Zillow based on its own rental listings. The previous recent high was in February 2021, where 37% of listings offered concessions.

Because the data set is all through Zillow, it would be considered self-selected and so unlikely to be statistically representative of the entire country. However, it also is a large number of rental listings and not something to be ignored offhand.

There has been an ongoing trend this year of more landlords and property managers relying on concessions as a marketing technique. They work with the assumption that resulting downward pressure on realized rents is worth the tradeoff for lowering vacancy rates and maintaining revenue.

Zillow’s own data showed that 23% of listing in January 2023 offered concessions like some number of months in free rent or parking. That continued to move upward to 28% in March before sliding to 25% in June. But then the percentages keep climbing to the current number.

Of the largest 50 rental markets in the U.S., 43 had more rental concessions this year than in 2022. “Concessions are often rising most in markets where multi-family construction is booming,” the report said.

In March 2023, a report from Berkadia showed how concerns about slowing apartment demand and falling apartment rental rate growth was manifesting in concession and lease renewal dynamics.

Redfin in September 2023 had an analysis on how multifamily rents were still incredibly high in an historical setting and yet creating the conditions for concession costs.

“A year ago, you really didn’t see concessions in the market. Fast forward to today, and they are far more common, with landlords offering from one to three months free in an effort to attract new tenants without lowering their asking rents,” said Jon Ziglar, CEO of Redfin-owned RentPath, in prepared comments. “Higher-end properties are beginning to see pressure in certain markets as a significant portion of new units coming online are in the higher end and luxury segment. We are still seeing a lot of competition for more affordable units due to less new supply, as well as increased pressure on consumer wallets limiting the ability to stretch for that higher level experience.”

“Zillow’s rental market report shows 3.2% year-over-year rent price growth in October, much closer to normal 3-5% annual growth than the peak of 16.9% in February 2022,” the company wrote. “Though October was the first month since that peak where annual rent growth accelerated, it remains to be seen whether this is the beginning of a recovery in annual rent growth back toward longer-term averages, or more of a stabilization. More rentals offering concessions may be a signal that rent growth is set to level off.”

Source: “Apartment Concessions Undercutting Rising Rents“

There is more pain to come in the office real estate market across the U.S., with maturing debt needing to be refinanced and a wave of expiring leases, but there is also what may seem at first brush to be a counter-intuitive message being sent to top tier companies by real estate intelligence company CoStar Group: prepare for an office space shortage.

You read that right: amid a commercial real estate market across U.S. downtowns being described in apocalyptic terms, CoStar sees a shortage on the horizon, with one key caveat for top companies to bear in mind.

CoStar’s call of an upcoming office space shortage is predicated on a look at the current data on leasing and construction activity compared to recent market history. As office occupiers scrutinize their footprints more carefully, and in the months ahead leases that were executed before the pandemic continue to approach expiration, newly constructed buildings aged 0-3 years are proving to be the winners. They have attracted over 175 million square feet of net new occupancy since the beginning of 2020, an average of 12.7 million square feet per quarter. By comparison, the quarterly average from 2011-2019 for similar properties was 11.7 million square feet. From 2008-2010, during the Great Recession, the quarterly average was 13.6 million square feet.

“Modern, premium office space remains in demand, just as it has historically, even during difficult economic times,” said Phil Mobley, national director of office analytics at CoStar Group.

And the supply will increasingly not be there to support the demand. Currently, buildings aged 0-3 years comprise 2.4% of office inventory in the U.S. While that is in line with the average from 2015-2019, Mobley says construction has slowed dramatically. Less than 30 million square feet has broken ground in 2023, making this year the lowest for construction starts since 2011. Today, there is about 200 million square feet of office space in buildings aged 0-3 years, but that figure will be under 150 million by early 2026 and under 100 million by the middle of 2027. At that point, it will represent only about 1% of inventory. Even in the aftermath of the Great Recession in 2013-2014, buildings aged 0-3 years never represented less than 1.3% of inventory.

“The very type of space that tenants have historically demanded most — even during recessions — will be in short supply,” Mobley said.

This isn’t to say there won’t be more headlines about trophy buildings being sold at discounted values. But those transactions also mean that now is a time when tenants are getting good deals. The number of new lease transactions is higher this year on a quarterly basis than the 2015-2019 period. Deals are smaller in square footage – which explains why overall market vacancy is up – and expiring leases are part of the reason for the uptick, too. Still, the deals are “highly concentrated” in the premium space, Mobley said.

Meanwhile, landlords of iconic, trophy buildings are offering sweeteners, from bigger contributions to custom buildouts to the number of months offered rent-free. It’s not clear how long that will last, though. As more top buildings are sold at depressed values, investors mark down the value of property holdings, and bonds go bad, new owners can make their finances work with attractive terms to tenants. But for building owners who will need to refinance in the near-term, that game is ending. Case in point: a recent deal for the City of Los Angeles to occupy multiple floors in the iconic Gas Co. Tower, a deal which would have comprised 11% of new quarterly leasing activity in the market, was rejected by bondholders.

Billionaire real estate investor Jeff Greene explained his bet on new towers in West Palm Beach, amid the correction he sees coming for much commercial real estate in the next two years, in the following way during a recent CNBC interview: “There will just be office buildings with no tenants whatsoever in markets where brand new building will get the tenants. … Some of the older buildings just won’t have any tenants at all, and if there’s no tenant at all for a prolonged period of time, that paper [the bonds] will be worth next to nothing.”

The U.S. housing market never recovered from the financial crash as measured by the inventory levels today, one factor responsible for pushing up home values across the country. But Mobley says there is a better parallel for the office space crash: the retail washout, which was overbuilt, and has not been built much since e-commerce disrupted the sector. While Class B malls are still sitting vacant, high-end “experiential” retail is not.

“That’s the parallel for office,” Mobley said.

CoStar estimates there is still over half of leases executed before 2020 set to expire. “As companies face these renewal decisions, they are now laser-focused on utilization,” he said. That implies a world in which tenants may need less space, but as they continue to make the case for the world of work to return to pre-pandemic in-person collaboration, competition for the best square footage in the market is heading higher.

For companies facing lease expirations that believe in the notion of the office as a tool to help maximize workforce effectiveness and, as a result, want to be in premium locations  — and not the 10-20 year-old iconic buildings but the newest properties – some of the best opportunities are now, Mobley said.

Source: “The looming office space real estate shortage. Yes, shortage“