Archives for March 2024

Organized rings of fraudsters and other bad actors are using a range of sophisticated deceptive practices to obtain apartment leasing, according to a new survey of more than 400 property management professionals by RealPage.

More than 50% reported seeing diverse types of fake identity, income fraud or approval errors and just 17% currently have a portfolio-wide fraud prevention initiative in place and yet 97% of respondents report that reducing renter fraud is a top priority.

Just 22% have formal metrics for tracking rental fraud and its business impact and 73% say more than half of rental fraud is detected after residents move in.

These instances are reducing income and increasing costs by 10% to 20%, according to 77% of the respondents, who were surveyed in early January.

Another factor driving the trend is the wide availability of “how-to” information on social media that show how to exploit gaps in protection.

“Rental fraud has become increasingly sophisticated,” said Josh Albrechtsen, RealPage SVP and GM, Front Office. “With fraud coming from multiple directions, effective solutions must offer multifaceted verification, across data, device, document, and biometrics, leveraging AI and machine learning.”

Training employees to identify rental fraud is not getting it done, according to RealPage. Almost half of respondents (43%) said their site staff are not financially motivated to prevent it, according to the company’s release on the survey.

Common actions taken with fraudulent applications include fake or manipulated identities (58%); misrepresenting income (57%); and identity theft (53%).

“Research supports what the industry has long known – rental application fraud continues to be a sizable concern across all classes and sectors of the rental housing industry,” Bob Pinnegar, President & CEO, National Apartment Association tells GlobeSt.com.

“NAA is committed to working with industry stakeholders to address this risk, in large part by ensuring that housing providers retain the ability to effectively screen all prospective residents. Addressing the dangers associated with rental fraud is critical to the long-term viability of rental communities and managing risk for housing providers, their communities, residents and staff.”

National Multifamily Housing Council conducted a similar survey a few months ago.

“There has been anecdotal evidence of the rise in fraudulent activity over recent years, but now we have clear evidence of the staggering impact of these crimes on the rental housing market,” NMHC President Sharon Wilson Géno said in a release.

“While most renters are honest, those who are not are causing the cost of rental housing to increase for everyone. Additional delays in many jurisdictions in the lease enforcement process, even when there is clear fraud, incentivizes bad actors and means that this illegal behavior costs responsible renters even more. We call on lawmakers and courts to take action that will address this problem.”

Source: “Apartment Rental Fraud Becoming Increasingly Sophisticated“

The city of Mt. Pleasant, Mich., home to Central Michigan University, sought to develop a vacant and contaminated parcel of land adjacent to its city hall. After other developers walked away from proposed projects, Michigan Community Capital purchased the site and assembled a creative financing package to move the city’s vision forward. The result is Broadway Lofts, a four-story, mixed-use development that is city’s largest in 40 years.

Fully leased at the end of 2022, Broadway Lofts includes 48 residential units, 15 of which are income-restricted at 80% of the area’s median income, as well as two commercial tenants, GreenTree Cooperative Grocery and Isabella Community Credit Union. The project, honored in 2023 with the Jack Kemp Excellence in Affordable and Workforce Housing Award from the Urban Land Institute and two gold honors from the International Economic Development Council, offers an example of the power of public-private partnerships to breathe life into neglected or underused real estate.

Deciding What to Build

The city owned the parcel and had a very specific vision for a dense mixed-use project to extend the downtown and connect it with retail and restaurants nearby. Mt. Pleasant has an oversupply of older student housing consisting of large two- and three-bedroom units designed to be rented by the bedroom. So finding per-square-foot rental comps is highly challenging. But Broadway Lofts, being a downtown redevelopment project first and a housing project second, is some distance from much of this older stock. The housing type, location, build quality, and amenities of the Lofts have consistently set it apart in the market.

Financing

We utilized debt from National Cooperative Bank—a community development finance institution—for the source loan in the New Markets Tax Credit structure. New Markets Tax Credits were provided by Cinnaire and PNC Bank. Over 50% of the project cost was funded with a novel workforce housing loan made by the state of Michigan. Funding also came in the form of an environmental remediation grant provided by the Michigan Department of Environment, Great Lakes, and Energy, and tax relief from the city. All the sources were critical, but the workforce housing loan with a very low, interest-only cost was the key.

Key Success Factors

Ensuring the project wasn’t overleveraged made it an overall financial success— in a nonprofit, low-yield sense. The support provided to both the co-op and the attainable rents have helped keep the building full. Outside of the financial metrics, the real estate fundamentals apply: The location is excellent, adjacent to a river and a park. Having a 10,000-square-foot grocery on the ground floor and walkable access to downtown shops limits the need for residents to travel. And the energy efficiency and high-quality build of Broadway Lofts makes this one of the most attractive and affordable places to live in the city.

Challenges Along the Way

The project required a lot of public investment to right-size the economic challenges, as evidenced by the capital stack. On the construction side, it was on the site of a former sawmill and train yard. It had soft soil, was in a flood plain and had PFAS [per- and polyfluoroalkyl substances] and heavy metals. Both soil and groundwater contamination had to be remediated. The site was subject to an existing brownfield plan that had been bonded, but the underlying development had failed to materialize at least three times, so brownfield tax increment financing was not available. This meant that tax relief had to be balanced with the long-term carrying costs of the project and, ultimately, its ability to handle debt. Our team methodically worked with state and local partners to address each concern and overcome it.

The Win

The site went from a net drag on city general funds to a net positive for taxpayers. It boosted housing density downtown, reinforcing retail spending, and gave historically low-income populations a place to purchase healthy food. It set new comparable rents for follow-on developers to use when completing appraisals. The project has achieved all the bottom-line impacts that our team and the community anticipated.

Source: “From Vacant to Vibrant“

Each year, members of The Counselors of Real Estate vote on the 10 big-picture themes likely to have the greatest influence on real estate in the coming year. Although the Counselors’ 2023–24 list was released back in October, many of these themes have only magnified in importance. In the organization’s published report, CRE members with subject matter expertise offer their take on the issues. Here are highlights:

1. Geopolitics and the Global Economy

The conversation has shifted from a focus on global risks such as gas prices and commodities to pressing concerns about economic instability, according to Timothy H. Savage, Ph.D., cre, and Constantine Korologos, cre, both clinical assistant professors at the Schack Institute of Real Estate, New York University.

“The state of capital markets is creating a strong undertow to the economy,” Savage and Korologos say.

The list of stressors includes inflation, high interest rates, banking debt, and tightening liquidity, as well as the influences of artificial intelligence, migration trends, hybrid work and the reconfiguring of supply chains.

One of the highest risks, the authors say, is potential bank failures: “Loan delinquencies are now higher than they were at the start of the pandemic,” they warn, “and the expectation is that there are more defaults coming, especially in the office sector.”

2. Empty Offices

At the peak of the pandemic, 62% of all office workers were working remotely. Now, 58% of workers are now fully back in the office, while 29% are working hybrid schedules and 13% are fully work-from-home, according to WFH Research.

“As the future of hybrid work continues to unfold, the near-term focus is centering on calibrating hybrid schedules and setting new expectations for work that needs to be done in person,” says Maureen Ehrenberg, cre, CEO of real estate consultancy Blue Skyre.

Offices will need to be deemed “destination-worthy” and experiential, allowing people to do different types of work throughout the building, with sustainable, automated, and digital components and amenities that employees consider to be worth the commute.

“Those buildings in the line of fire are older B and C properties in central business districts, particularly those in poor locations and those that face costly capital projects for repositioning and decarbonization requirements,” Ehrenberg says.

“Now is not the time to sit back and wait and see how hybrid work trends play out,” she adds. “If the property doesn’t check the box in some critical way—location, access, convenience, tenant amenities or even an amazing view—owners need to start thinking about alternative strategies.”

3. Housing Shortage

The U.S. continues to face an overwhelming housing shortage that has resulted from decades of underbuilding, says Paula Munger, cre, vice president of research with the National Apartment Association.

“Progress will be bumpy,” Munger says. “Now that the market is seeing improvement in supply chain and inflation, developers are dealing with higher interest rates and higher construction costs that are making it more difficult to secure financing along with general economic uncertainty that is causing some developers to push the pause button,” Munger says.

In addition, uncontrollable operating costs, such as insurance and property taxes, will continue to impact bottom lines.

4. AI 3.0

Now that the genie is out of the bottle on AI, commercial real estate pros are contemplating its function and purpose for the industry.

Today’s advanced version of AI—“AI 3.0”—is integrating data analysis with new forecasting techniques, including probabilistic modeling and causation modeling. “Will a tenant renew in year three, four or five? We want to be able to predict with great accuracy what the most probable outcome is likely to be,” Savage says.

Ideally, AI 3.0 will merge massive databases into one clean data source that includes alternative data sets, such as sentiment data collected from chatbots, with traditional rent and vacancy data.

Proptech startups also will be reimagining the idea of data collection, Savage says. “They’re incorporating mind-boggling amounts of data, and they’re adopting probabilistic frameworks to think about the future.”

5. Labor Dynamics

“Everyone, everywhere, in nearly every sector is reporting that it is difficult to find skilled, willing and able workers,” says Kathleen Rose, cre, president of Rose & Associates Southeast Inc. Job market data consistently shows more job openings than available workers.

The dynamics go beyond demographics to include changes in technology, migration trends and worker behavior, she says.

“Employers are following the people and paying close attention to migration shifts. Traditionally, older generations set up their lives around where their job was located. Younger generations, including X, Y and Z, are . . . reversing the order, choosing their lifestyle and where they want to live first and the job second.”

6. Migration’s Impact

A great migration shift is being fueled by a fundamental human need: housing affordability, says KC Conway, ccim, cre, principal and founder, KCnomics, LLC. Businesses are following suit, moving out of high-cost, high-regulation states in favor of the Sun Belt and the interior of the country.

“Companies are looking for locations that have the workforce and the logistics infrastructure—rail, interstates and access to ports,” says Conway. Future plants to build electric vehicle batteries will be concentrated from the Great Lakes to the South. “Urban areas with density and lack of affordability are seeing outflows, and that trend is not likely to reverse,” he says.

7. Domestic Economy

“Because real estate is so focused on the ramifying effects of the housing economy, it is not a surprise to feel that we are choking on [the Federal Reserve’s] policy. But it’s important to remember the Fed’s dual mandate: price stability and full employment,” says Hugh Kelly, Ph.D., cre, principal of consultancy Hugh Kelly Real Estate Economics.

“While it’s always tempting to second-guess public officials… the real estate and financial industries need to look in the mirror, too. How is it that banks, whose primary business involves the management of interest rate risk, found themselves unprepared for the consequences of Fed tightening, its squeeze on spreads and the potential for disintermediation by depositors?” Kelly says.

“Likewise, how is it that commercial real estate investors accepted cap rate compression to the point where risk premiums virtually disappeared? In many ways, we once again find ourselves with Pogo’s confession: ‘We have met the enemy and he is us.’”

8. Supply Chain and Logistics

The galvanization of a more resilient, efficient supply chain will continue, coinciding with a reshoring boom of manufacturing focused on the interior and southern states, says Conway.

With over half of the U.S. GDP produced in “The Golden Triangle”—the Great Lakes to Texas to the mid-Atlantic hub—Conway predicts manufacturing companies will begin relocating to be near new FedEx, Amazon and Walmart e-commerce fulfillment locations in cities such as Memphis, Tenn.; Wichita, Kan.; and Huntsville, Ala.

“Cities that are going to benefit from that shift are those connected to a port by rail,” he says. “Cities that don’t have the logistics infrastructure and don’t have that connectivity don’t have a chance of being part of this new e-commerce economy.”

“A decade ago, about 60%–65% of all containerized goods were flowing through the West Coast ports of Los Angeles and Long Beach with 30% to 35% coming from the East Coast and Gulf Coast ports. Now that flow of goods has flipped,” he says.

9. Market Pricing Reset

Although markets are past their peak for the cycle, it remains to be seen where prices will settle in 2024.

“Although there is some acceptance [among sellers] that prices have dropped… owners are opting to hold rather than sell in what could be a trough of the market,” says Del Kendall, cre, senior director of SitusAMC’s appraisal and consulting operations. “So, there is a bit of a Catch-22 and a big barrier to assessing true values.”

Debt coming due before the end of 2025 will have “big implications for the transaction market,” Kendall says.

“Will refinancing challenges force lenders holding the debt—largely banks—to mark to market,” Kendall asks, “which will have a cascading impact on commercial real estate and financial markets?”

10. Infrastructure Investment

The need for robust infrastructure is now being met with significant funding through both the $1.2 trillion Bipartisan Infrastructure Law and the Inflation Reduction Act, which allocates $783 billion to improvement projects.

The country is legislatively committed to investing in major infrastructure projects. “Will investment be made with a… traditional view of infrastructure, with spending on megaprojects, such as highways, bridges, and pipelines?” asks Korin Crawford, cre, executive vice president with Griffin Swinerton. “Or will investment focus on forward-looking infrastructure needed to support new technologies, changing societal needs, and volatile environmental conditions?”

One opportunity, he suggests, lies in reimagining infrastructure the same way we are reimagining how we deliver products and services, with smaller-scale, decentralized facilities, powered by alternative energy sources.

Source: “Making Moves in a Complex Age“

Sharp reductions in value for office buildings have many waiting for a major collapse in commercial real estate (CRE), which in turn would damage city and state budgets and possibly threaten major bank failures. Thus far, borrowers and lenders have avoided the worst damage. But their delaying tactics may be coming to an end, with potentially dire consequences.

The fears became prominent through economic analyses from NYU’s Arpit Gupta and Columbia University’s Stijn Van Nieuwerburgh. Their 2022 research predicted a “$664.1 billion value destruction” in U.S. office real estate.

They and other economists, along with market watchers, have since predicted major losses in office values—a “deluge of debt,” a “severe crash,” a “$1.5 trillion crisis,” and other dire predictions.

Although commercial real estate values have taken a serious hit, we haven’t yet seen the predicted meltdown or “apocalypse.” As I wrote in Forbes in September 2022, “we are not in a commercial real estate apocalypse yet, but we all need to keep one eye on the danger.”

The lack of a total CRE meltdown led some to argue fears were overblown. There would surely be pain as banks restructured their loans, with second-class offices facing the biggest hit. But some analysts discounted the potential for deep harm.

In April 2023, CNBC’s Tim Mullaney published a thoughtful analysis of “the coming commercial real estate crash that may never happen.” He emphasized that many lenders seemed to be weathering the storm, with tenants continuing to pay rent and banks not defaulting on CRE loans.

In June, the Washington Post’s Natasha Sarin wrote “Why the commercial real estate crisis may not be as bad as you think.” She noted the CRE sector is not just offices (it includes apartments and warehouses, both doing well), and endorsed bank lenders “bolstering capital levels to safeguard against potential losses…before it’s too late.”

Now, in 2024, we are seeing a resurgence of fears about commercial real estate. Gillian Tett, in an excellent Financial Times column, notes that “little pain has been crystallised so far” in the sector. But she argues the bills are still coming due, and “it’s time to be honest” about the sector’s problems.

Unlike housing, where loans often are for 30 years, CRE loans usually have shorter maturities (ten years or less) , and need to be entirely refinanced when they come due. Many commercial loans were made during the recent period of historically low interest rates, so they now face a double whammy. The persistence of working from home has driven falling asset values due to declining demand for office space, and building owners also significantly higher interest rates when refinancing.

At the same time, banks don’t want to declare loans as nonperforming, because that hurts their balance sheets. So there’s been refinancing or restructuring on more favorable terms than some anticipated and perhaps more than the underlying economics justify—what some observers sarcastically call “extend and pretend.”

Tett cites a sobering analysis last year from Newmark Group, a major real estate advisory firm. Newmark saw dangers in CRE lending, with an overconcentration among small and regional banks, which tend to hold more CRE loans and also often are less well capitalized than the larger money center banks.

More recent data also indicate ongoing CRE problems. CommercialEdge monitors rent demand and prices for office space nationally, and they recently found average office rents fell 1.2% year over year. That’s not an impossibly bad number, but when coupled with falling asset values for office properties with less demand, and facing higher interest rates, it isn’t a pretty picture.

CommercialEdge also reports on sales of office buildings, and finds that “discounted office sales have become more prevalent.” Of course, there are sharp regional variations. Commercial rents in the Boston market shot up by 21.5% year-over-year, while rates in Chicago and Seattle fell by over 2%.

This reflects vacancy rates. Boston’s vacancy rate is listed at 12.2%, compared to the national rate of 17.9%. There are higher vacancies in tech-heavy cities like Seattle (22.5%) and San Francisco (24%) as firms there adopt more remote work-friendly policies.

A new research note from Goldman Sachs underscores the depth of the problem. Modifications and extensions of CRE loans—“extend and pretend”—have pushed more loan renewals into 2024. Investopedia reports CRE loans maturing “by the end of 2024” are “up 41% from a year ago.” The Goldman research note concludes that “office mortgages are living on borrowed time.”

So the warning lights for office loans are flashing red. There will be major opportunities for buyers to snap up buildings, especially second and third-class space, at highly discounted prices. But there simply may be too much office space to absorb, especially if banks are reluctant to lend.

There are troubling implications for the overall finance sector, and for city and state governments that depend on property taxes and economic activity generated by offices. My next blog will take a closer look at those two risks. But we may be coming to an end for CRE’s “extend and pretend” strategy, with gloomy economic consequences.

Source: “Troubled Commercial Real Estate—The End Of “Extend And Pretend?“