Archives for March 2024

Commercial real estate is facing a do-or-die moment.

The realm of commercial real estate is wading through a quagmire in several significant markets throughout the nation, with grave declines in market value shadowing the low occupancy rates. Notably, some buildings are weathering a staggering 40%-60% devaluation, with landmarks like Chicago’s 300 W. Adams and Boston’s 1200 Crown Colony Drive seeing a precipitous drop of 80%-90% in market value.

Real estate companies are seemingly encased in amber, reluctant to revitalize their holdings with the infusion of new technology and intelligent amenities. Reasons vary, from the stark absence of capital to a misguided belief in the market’s cyclical nature—a belief that the dip is ephemeral, and a resurgence to pre-pandemic levels is just around the corner. Yet, such prognostications are proving myopic.

The unabated erosion of market values and the diminution in property worth suggest that we are witnessing not a fleeting downturn but a profound recalibration. A deluge of vacated spaces has precipitated a second wave, the “deluge of debt,” putting a strain on real estate and banking firms alike. More frequently, keys are being surrendered to lenders, as ownership becomes a game of pass-the-parcel with these “hot potatoes” that no one desires to hold.

The puzzle, however, lies in the lack of deep analysis of these faltering properties. Is there not a viable, cost-effective strategy to reinvigorate them into profitable ventures? In every portfolio lurks the potential for a “hot potato” and the dread of being the firm left in possession is palpable. These concealed liabilities are now emerging more conspicuously, from downtown districts to suburban office parks.

The realization that a building is a sinking ship should trigger aggressive strategies to offload the asset before it’s too late. Yet, many real estate entities are lagging, clinging to the anticipation of the market’s natural buoyancy that will elevate them out of troubled waters in the coming quarters. This assumption that a return to “business as usual” is on the horizon has held sway in the past, but the current reality defies such optimism.

The market’s steadfast departure from “business as usual” is not only reshaping portfolio landscapes but also affecting the banks and impacting the economic fabric of the cities in question.

Cities with inattentive leadership may find themselves blindsided by this growing concern. The impact on property tax-derived revenue streams, given the halving of market values, poses a grave question for municipal tax assessments.

Emerging technologies beckon as a beacon for tenants, yet they demand a supporting infrastructure capable of sustaining them. The “strategic triad” for 21st-century performance—power, pipes, and processing—must be entrenched in the building’s design to allure the new generation of tenants.

The requirements of cutting-edge GPU chips, essential for expansive AI operations, highlight a burgeoning need for power—a need that is beyond the reach of the current capabilities of many buildings and data centers. This urgent need for a reassessment is paralleled by the necessity for ample broadband connectivity; without it, a building is on a fast track to obsolescence.

In the final reckoning, a building that lacks the crucial three Ps—power, pipes, and processing power—in a redundant and robust system is destined to become an undesirable asset. As property owners and financial institutions scramble to offload these “hot potatoes,” the question lingers: who will be left holding the bag?

Source: “Navigating the Choppy Waters of Commercial Real Estate’s New Dynamics“

NAIOP pinpoints 2025 as when the industrial market will start to expand.

It estimates that quarterly net absorption of industrial space will average 14 million square feet per quarter over the next two years, or 62.8 and 49.1 million square feet in 2024 and 2025, respectively.

This forecast represents a relative “cooling” trend following what had been a protracted period of above-average industrial absorption following COVID-era demand shifts that accelerated the need for distribution space to meet consumers’ increased preference for home delivery.

After two years of absorption that significantly exceeded long-term averages, industrial net absorption in 2023 totaled just 93.7 million square feet compared with a record high of 486.6 million square feet of completions.

Such a supply-and-demand imbalance is usually a cause for concern.

“The effect has been to bring balance back to an industrial market that had been substantially undersupplied since 2020,” according to the report.

The national availability rate ended 2023 at 7.1%, significantly above the post-pandemic low of 4.6% seen in the second quarter of 2022, but right in line with the lows experienced from 2015 through 2020.

NAIOP said anecdotal evidence suggests some tenants will seek to take advantage of a softer rental market to expand their footprint more aggressively than in 2023.

Adrian Ponsen, national director of U.S. industrial analytics at CoStar Group, pinpoints mid-2025 as when US industrial net absorption will pick up notably.

“We have seen some positive economic trends in the past six months,” Ponsen tells GlobeSt.com. “US goods imports and inventories have stabilized after being cut during most of 2023. If retail goods spending continues to hold up well, business inventories and US imports will likely revert to their long-term growth trend soon, which will mean more goods flowing through distribution centers across the country.

“However, most industrial tenants will need to see these trends persist for several months before they take a more offensive stance regarding their space needs.”

As an aside, Ponsen said that higher mortgage rates are also keeping home sales very low, weighing on sales by companies that sell furniture, appliances, and building materials and leading to distribution center closures in these categories.

“Those headwinds look set to continue weighing on the market through 2024,” he said.

Clarion’s latest baseline forecast expects that 2023 will be the trough for U.S. industrial net absorption and 2024 could see the industrial vacancy rate peak as market supply falls sharply.

“Our forecast model expects gradual improvements to net absorption which should stabilize above its historical long-term average, averaging 1.6% of stock over the next two years,” Pedro Niño, Senior Vice President, Research & Strategy, Clarion Partners, tells GlobeSt.com.

Demand for Class A warehouses has remained robust, even during last year’s pullback, and construction starts have fallen over the last five quarters which should bring balance to the market, according to Nino.

He said that net absorption is unlikely to reach recent averages because of the unprecedented demand during 2021 and 2022, but with lower expectations for a hard landing, and now that the Federal Reserve has signaled an end to rate hikes, some uncertainty should be removed from the market, particularly for large institutional occupiers that tend to make leasing decision with longer-term views such as population and consumption shifts, supply chain optimization and resiliency, and the need for well-located modern stock.

Source: “Industrial Market Will Resume Expansion in 2025, Experts Say“

Dual announcements yesterday gave industrial real estate’s long-term prospects a significant boost, specifically those facilities that cater to EV and semiconductor manufacturing.

In one development, the Environmental Protection Agency issued new tailpipe pollution limits that ensures the majority of new passenger cars and light trucks sold in the US by 2032 are all-electric or hybrids. The rule phases in limits to the amount of pollution allowed from tailpipes over time so that in eight years more than half the new cars sold in the US would have to be zero-emissions vehicles for carmakers to meet the standards.

In the other, Intel described plans for a $100 billion investment to build and expand factories in four US states after it secured $19.5 billion in federal grants under the CHIPS Act and expects another $25 billion in tax breaks.

Within three years it plans to build “the largest AI chip manufacturing site in the world”, near Columbus, Ohio, according to CEO Pat Gelsinger and also will revamp sites in New Mexico and Oregon and expand operations in Arizona.

These announcements highlight why advanced tech and EV manufacturing has become so important to industrial real estate’s long term growth.

According to CBRE, bulk lease transactions comprised seven million square feet of the 7.9 million sq. ft. of EV-occupied space leased in H1 2023, representing 163% year-over-year growth.

It also says there are 15 markets where over one million square feet of industrial space was leased to EV occupiers in the last five years, with the top five being Chicago, Detroit, Central Valley, Silicon Valley and Memphis. These deals total 28 million square feet, representing 73% of all EV leasing deals over this time period.

These investments are already affecting the industrial pipeline for 2024, a separate report by CommercialEdge finds.

For instance, Phoenix is poised to deliver the most new industrial supply nationally this year with 42.5 million square feet and of the five largest projects underway in the metro, two are manufacturing properties — TSMC’s chip plant and Lucid Motors’ EV factory.

Then there is Savannah, which has just under 30 million square feet of new industrial space in the works, placing it third nationally – more than half of it is due to Hyundai’s mammoth EV manufacturing plant, which will total 17 million square feet.

Meanwhile Austin’s largest developments currently being built are both manufacturing facilities: Samsung’s semiconductor factory in Taylor, Texas, will total 6 million feet of space, whereas Tesla’s 1.4-million-square-foot battery cathode building is being added to its Giga Texas factory.

Source: “Yesterday Was A Good Day for Industrial Real Estate“

During the pandemic, industrial properties were probably the hottest ticket around. The need to distribute and sell products at physical arms-length, the sharp explosion e-commerce, the shutdowns of businesses — logistics, warehousing, and the development of distribution and storage were obvious tools to address the issues.

That led to a rush of demand and, as a result, increased supply, with almost 1.2 billion square feet in the U.S. created in the last two years. But as things have normalized, there’s been an impact. As CBRE recently noted, things have begun to slow, as might have been expected, especially with higher interest rates.

“Total annual industrial leasing activity fell to 790 million sq. ft. in 2023 from a record 1 billion sq. ft. in 2021 and was not enough to offset the large amount of new supply,” they wrote. “As a result, the overall industrial vacancy rate jumped by 180 basis points (bps) last year to 4.8%, returning to near its 10-year average of 4.7%. Developers predictably became more hesitant to break ground and construction starts fell to 46.3 million sq. ft. by Q4 2023 from a quarterly average of 102.5 million sq. ft. in 2022.”

Quarterly industrial construction starts since the pandemic reached a high of 117.1 million square feet in the third quarter of 2021 and bounced around until the third quarter of 2022. Then they started to rapidly fall away: 85.8 million square feet in Q4, 68.2 million in 2023 Q1, 65.9 million in Q2, 47.8 million in Q3, and 46.3 million in the last quarter of 2023.

Conditions turned uninviting for many developers, with interest rates quadrupled between January 2022 and now; capital partners increased their return-on-cost requirements; potential returns on investment therefore dropped; banks pulled away from lending, leaving higher cost sources as the alternatives; and lower LTV ratios means less leverage and more equity.

And so, CBRE expects average quarterly industrial construction starts to remain less than 50 million square feet through 2024, compared to the 100 million square feet in 2022. After a record 612 million square feet of construction completions in 2023 — buoyed by the heavy starts in 2022 — will fall to less than 300 million square feet in both 2024 and 2025.

Will things eventually begin to reverse themselves? CBRE says yes. The drop in starts and completions take pressure off the markets and allow them “to absorb the excess space that was delivered over the past two years.” The projects that do start now with less competition will gain an advantage when the absorption is over and demand again requires new space.

Source: “Higher Interest Rates, Lower Demand Equals Less Industrial Construction“