Archives for March 2024

CHICAGO (March 15, 2024) – The National Association of REALTORS® (NAR) today announced an agreement that would end litigation of claims brought on behalf of home sellers related to broker commissions. The agreement would resolve claims against NAR, over one million NAR members, all state/territorial and local REALTOR® associations, all association-owned MLSs, and all brokerages with an NAR member as principal that had a residential transaction volume in 2022 of $2 billion or below.

The settlement, which is subject to court approval, makes clear that NAR continues to deny any wrongdoing in connection with the Multiple Listing Service (MLS) cooperative compensation model rule (MLS Model Rule) that was introduced in the 1990s in response to calls from consumer protection advocates for buyer representation. Under the terms of the agreement, NAR would pay $418 million over approximately four years.

“NAR has worked hard for years to resolve this litigation in a manner that benefits our members and American consumers. It has always been our goal to preserve consumer choice and protect our members to the greatest extent possible. This settlement achieves both of those goals,” said Nykia Wright, Interim CEO of NAR.

Two critical achievements of this resolution are the release of most NAR members and many industry stakeholders from liability in these matters and the fact that cooperative compensation remains a choice for consumers when buying or selling a home. NAR also secured in the agreement a mechanism for nearly all brokerage entities that had a residential transaction volume in 2022 that exceeded $2 billion and MLSs not wholly owned by REALTOR® associations to obtain releases efficiently if they choose to use it.

NAR fought to include all members in the release and was able to ensure more than one million members are included. Despite NAR’s efforts, agents affiliated with HomeServices of America and its related companies—the last corporate defendant still litigating the Sitzer-Burnett case—are not released under the settlement, nor are employees of the remaining corporate defendants named in the cases covered by this settlement.

In addition to the financial payment, NAR has agreed to put in place a new MLS rule prohibiting offers of broker compensation on the MLS. This would mean that offers of broker compensation could not be communicated via the MLS, but they could continue to be an option consumers can pursue off-MLS through negotiation and consultation with real estate professionals. Offers of compensation help make professional representation more accessible, decrease costs for home buyers to secure these services, increase fair housing opportunities, and increase the potential buyer pool for sellers. They are also consistent with the real estate laws in the many states that expressly authorize them.

Further, NAR has agreed to enact a new rule that would require MLS participants working with buyers to enter into written agreements with their buyers. NAR continues, as it has done for years, to encourage its members to use buyer brokerage agreements that help consumers understand exactly what services and value will be provided, and for how much. These changes will go into effect in mid-July 2024.

“Ultimately, continuing to litigate would have hurt members and their small businesses,” said Ms. Wright. “While there could be no perfect outcome, this agreement is the best outcome we could achieve in the circumstances. It provides a path forward for our industry, which makes up nearly one fifth of the American economy, and NAR. For over a century, NAR has protected and advanced the right to real property ownership in this country, and we remain focused on delivering on that core mission.”

“NAR exists to serve our members and American consumers, and while the settlement comes at a significant cost, we believe the benefits it will provide to our industry are worth that cost,” said Kevin Sears, NAR President. “NAR is focused firmly on the future and on leading this industry forward. We are committed to innovation and defining the next steps that will allow us to continue providing unmatched value to members and American consumers. This will be a time of adjustment, but the fundamentals will remain: buyers and sellers will continue to have many choices when deciding to buy or sell a home, and NAR members will continue to use their skill, care, and diligence to protect the interests of their clients.”

The National Association of REALTORS® is America’s largest trade association, representing more than 1.5 million members involved in all aspects of the residential and commercial real estate industries. The term REALTOR® is a registered collective membership mark that identifies a real estate professional who is a member of the National Association of REALTORS® and subscribes to its strict Code of Ethics.

Source: “National Association of REALTORS® Reaches Agreement to Resolve Nationwide Claims Brought by Home Sellers“

In 2024, we anticipate that the commercial real estate industry will continue to face distress with some stabilization. This alert focuses on three subsets of the commercial real estate market: retail, office, and multi-family. Each subset has its own outlook. We predict that the retail industry will likely see fewer bankruptcy filings than in 2023, but the distress in office space and multi-family will rise.

Retail

In 2023, we saw well-known brick-and-mortar stores filing for bankruptcy including David’s Bridal, Serta, Tuesday Morning, Bed Bath and Beyond, Party City, Soft Surroundings, and Rite Aid. We anticipate a more stable outlook for the retail industry in 2024. While the retail industry may be more stable than in 2023, we anticipate that discretionary spending will remain low in 2024, leading to continued distress for non-essential retailers. Discretionary retailers with maturing debt, inefficient footprints, or a weak online presence may be particularly vulnerable. Our “watch list” for 2024 includes JOANN, Express, Rent the Runway, Petco, and The Container Store.

Office

Office space vacancies are at a historic high. It is anticipated that Class B and Class C office space vacancies will continue to rise through 2024. These vacancies will continue to exacerbate the financial distress that these entities are facing with maturing debt. However, Class A office space has maintained occupancy rates and consequently avoided financial distress. Some communities are seeing the conversion of Class B and Class C office space into residential apartments, but the viability of the conversion is challenged by the high cost and structural limitations of the building. Class B and Class C office space will continue to face financial distress in 2024, and creative solutions may be the only option where guarantor liability makes property owner bankruptcy an unreasonable avenue.

Multi-Family

We anticipate a rise in distressed multi-family properties in 2024. Attributing to the distress are rising debt costs, an increase in supply, and the slow growth in rent increases. Currently, the cities with the highest delinquency rates on loans are San Francisco, New York, DC, and Houston. Overall, the demand for multi-family residences remains high as people move towards urbanization, but older multi-family units have been unable to keep pace with newer properties leading to increased vacancies. With more than $1 trillion in multi-family debt due to mature through 2028, 2024 may be the start of an avalanche.

The commercial real estate industry has faced difficulties since the pandemic disrupted occupancies and introduced a new virtual method of work and play. What were once thought to be temporary changes in behavior have become the new norm as working from home and online shopping are an everyday reality. The factors leading to the distress outlook in 2024 have been brewing since the pandemic, and the commercial real estate industry must adapt to these changes to continue to prosper amongst change.

Source: “Will Commercial Real Estate Sink or Swim in 2024?“

Office vacancy rates have climbed sharply in the wake of the pandemic after falling steadily in the decade before, reaching a record 13.1 percent last year, according to data from the Treasury Department’s Financial Stability Oversight Council (FSOC), citing analytics firm CoStar.

“At the midpoint of the third quarter of 2023, the national office vacancy rate hit a record high of 13.2 percent, a full 370 basis points higher than at the end of 2019,” CoStar analyst Phil Mobley wrote in a third-quarter analysis.

“The recent reset in office demand has rocked U.S. markets,” he added.

Private equity firm KKR’s Real Estate Finance Trust, a property investment vehicle with money in commercial mortgages, is a recent example: Its stock lost a quarter of its value in early February on news that it would cut its dividend on an office loan loss.

Delinquency rates for commercial mortgage backed securities are on the rise in recent months, though they’re still well below highs reached in the immediate aftermath of the pandemic and the fallout from the 2008 financial crisis.

“The decline in office property demand may take time to stabilize as tenants navigate remote-work decisions and adjust how much space they need,” according to the latest FSOC report. “In addition, a slow return to densely populated urban office centers could reduce the desirability of office properties located there and even nearby retail space.”

Powell delivered much the same message to the Senate Banking Committee last week, going so far as to declare that there will be failures among smaller and regional banks that have made commercial real estate loans.

“This is a problem we’ll be working on for years more, I’m sure. There will be bank failures,” he said.

“It’s not a first-order issue for any of the very large banks. It’s more smaller and medium-sized banks that have these issues. We’re working with them. We’re getting through it. I think it’s manageable, is the word I would use,” Powell said.

Investors are heeding Powell’s warnings about the sector but they’re also taking them with a grain of salt, arguing that traditional liquidity crises of the sort that took down Silicon Valley Bank and Signature Bank last year are unlikely to result from the losses.

“I think Powell’s statement was a little simplistic,” Westwood Capital managing partner Daniel Alpert told The Hill. “There will be disruptions. How those resolve themselves, either with help from the government or outside capital, I believe is going to be very, very different than what we saw with the three banks [last year] and certainly what we saw with any of the other crises.”

The pressure on banks due to commercial real estate exposure isn’t something that “happening overnight,” he added, describing the situation as a “slow-moving train wreck” that allows time for asset repricing.

Still, short sellers are moving quickly to make a profit off the miscalculations.

One investment plan shown to The Hill pertaining to a real estate investment trust (REIT) aims to take advantage of the REIT’s swollen balance sheet before rising interest rates and lagging rent growth slashed the value of its assets.

The proposal said the REIT’s properties would face a reevaluation “in relatively short order.”

Whether or not banks fail as a result of their real estate losses and prompt another government intervention like the line of credit set up for the financial industry by the Fed last year may not be the biggest economic question stemming from the crunch on office and retail real estate.

Rather, the longer-term effects on commercial construction and on the way that land is used in U.S. urban centers may prove to be the most salient macroeconomic issues to face policymakers resulting from the rise in remote work.

“We’re not going to see a lot of commercial construction in the economy for a decade or two,” Alpert said. “That’s a big negative on a macro level.”

Commercial real estate loans for construction and land development have tapered off in recent months after surging during the pandemic recovery and appear close to a possible cycle peak.

Total construction spending has also dipped slightly in recent months after a post-pandemic high, though major recent investments in manufacturing construction could fill the gap left by office projects.

The work to repurpose empty offices and to redesign downtown business districts in accordance with the decreased demand for in-person work is also underway in many parts of the country, experts told The Hill.

“There are some silver linings to this in terms of the shift in land uses in commercial real estate markets,” said urban planner Alice Shay of Buro Happold Cities in New York.

“COVID really shifted our view of how a city can operate and where its centers of gravity are. In New York City, the outer boroughs have really flourished with people working from home, spending their dollars in local districts.”

While strictly remote work has fallen in popularity since the years when the pandemic made it a necessity, hybrid work increasingly appears to be a lasting effect.

In February, about 28 percent of paid work days in the U.S. were work-from-home days, down from more than 60 percent at the height of the pandemic but quadruple their level before the pandemic, according to the national Survey of Working Arrangements and Attitudes from Stanford University.

Notably, the prevalence of remote work in the researchers’ data appears to be stabilizing at current levels.

“The pandemic permanently increased work-from-home,” they noted in multiple versions of the survey.

A 2023 survey by public opinion research agency Pew found that 35 percent of workers who can work remotely choose to do so all the time. That’s up from 7 percent before the pandemic, though down from its peak of 55 percent in 2020.

Labor productivity within the workforce also appears to have normalized along with the shifting trend toward remote work. After surging along with many other economic metrics during the post-pandemic recovery, productivity relaxed, then rose again, and is now in line with longer-term trends.

Source: “The commercial real estate time bomb“

Municipalities have long used incentives to spur investments they hope to see in their cities, or to solve for a persistent problem they’ve deemed requires private-sector participation.

Now, city officials are introducing or expanding upon programs to encourage office-to-residential conversion projects in America’s downtowns in the wake of a weak post-pandemic office market. With the national office vacancy rate hitting a record 19.6% at the end of the fourth quarter, and a key source of tax revenue dwindling as office building values decline, it’s become a top priority for elected officials and economic developers to figure out how to make more conversion projects happen.

The projects aren’t easy.

Based on physical characteristics alone, it’s estimated that 60% of office buildings are poor candidates for conversion to residential use, according to a 2021 algorithm developed by design and architecture firm Gensler. There’s also the state of financing on the building in question, the kind of investment that’ll be needed to bring the building to a new use, and how much a nearly empty office building could trade for. Developers frequently say it needs to trade at a deep discount if it’s earmarked for conversion.

Still, the desire to see more housing — and to see obsolete office buildings reimagined to make them revenue-generators once more — is top of mind nationwide. Affordability continues to be a serious challenge for homeowners, with the monthly mortgage payment on a typical U.S. home up 96% from early 2020, according to Zillow Group Inc. data. That’s thanks to rapidly rising mortgage rates since 2022 and record-high home-price appreciation during the pandemic. And, while the rental market has slowed, many U.S. metros saw double-digit percentage gains in rental-housing costs during the pandemic, and a record-high 22.4 million renting households are considered cost-burdened.

To spur office conversions, mechanisms like tax-increment financing, tax abatements and tax waivers are being proposed or are already in play in cities across the country as ways to reduce the cost of converting office buildings into housing or other private-sector uses, such as a hotel, lab or data center.

While incentives are typically viewed as deal-sweeteners, those working on conversion projects today argue they’re more of a necessity than a bonus for a lot of conversions to make sense, especially given the current capital markets.

“It’s absolutely critical,” said Steven Paynter, building transformation and adaptive-reuse leader at Gensler. “There are very few other options to getting these projects moving at the moment at any kind of scale. The high interest rate on, especially, construction lending … is a dealbreaker for the projects.”

CBRE Group Inc.’s data on conversions shows an uptick in the number of office conversions underway nationwide since the Covid-19 pandemic but no evidence of a windfall, said Julie Whelan, global head of occupier thought leadership at CBRE.

“We know more housing is needed,” Whelan said. “It’s just that fulfilling that demand in the way that it needs to be fulfilled is very difficult to make work when you’re putting numbers down on paper.”

The Goldman Sachs Group (NYSE: GS) had similar findings in a recent analysis it did on the financial feasibility of converting office buildings into residential units. It found about 0.4% of office space had been converted into multifamily units on an annual basis before the pandemic, which rose only to 0.5% in 2023.

In many conversions, either the housing being added into a former office building has to rent or sell at a certain price (usually top-of-market), or the upfront basis — the cost of purchasing the building — has to be low enough that the project makes sense financially, Whelan said.

That’s difficult in many cities because office building trades haven’t necessarily reached those ultra-low levels yet. So, without aggressive incentives at the municipal level, a lot of conversions won’t pencil, Whelan said.

At the same time, she added, most downtowns aren’t lacking in luxury housing. Instead, affordable housing is what’s badly needed, and that usually requires some degree of subsidy, even for a traditional, ground-up development.

Goldman Sachs, using a discounted cash-flow model, also found current acquisition costs for struggling office towers are still too high for a conversion into a multifamily building to be financially feasible because of how much it costs to do that conversion.

Nationally, the average price of what Goldman deems as nonviable office buildings — those built before 1990, haven’t been renovated since 2000 and have a vacancy rate higher than 30% — has fallen 11% since 2019. In the hardest-hit cities, average transaction prices have declined by 15% to 35%.

If an office building is acquired for $307 per square foot (the average transaction price of nonviable offices, according to Goldman’s model) and the cost to convert it to a new use is $280 per square foot (slightly above average for a typical conversion cost), that project would result in a $164 loss per square foot if high-end multifamily units added in that building are rented at $4.50 per square foot. That means current office prices would need to fall by about 50%, or about $154 per square feet, for conversion costs to pencil, according to Goldman.

On the financing side, there’s a limit right now on banks’ willingness to lend to commercial projects, Paynter said. He added that the risk tolerance among lenders to take on conversion projects, which can come with unexpected costs and delays, has also been diminished.

Many capital sources won’t invest in a conversion until it’s significantly underway or close to completion. A five-story office building in downtown Newark, New Jersey, that’s being converted into a 92-unit residential development recently obtained a $22 million loan from Northwind Group. It was underwritten at the 70% or 80% completion stage, said Ran Eliasaf, founder and managing principal at Northwind.

“A conversion is a complicated execution,” he said. “It typically takes longer and costs more than what developers underwrite.”

Federal incentives available for conversion projects

In October, the White House issued guidance on how existing federal programs could be leveraged in the conversion of office buildings into other types of development, especially housing. The guidance includes programs from the Department of Transportation, the Department of Housing and Urban Development, and the General Services Administration.

Developers say while the programs are a good start, being able to put those incentives to work is another matter.

Paynter said the spirit of the guidebook is a good one, but there are a lot of fine-grain details and challenges in figuring out what the rules are for applying those programs to conversion projects.

“Because these programs weren’t really set up to deal with housing creation, there are some oddball requirements,” Paynter said. “It’s not as simple as everyone had hoped.”

Some developers are concerned about how long it might take to put that capital to work even if their deals qualify for any of the programs.

Since the pandemic, Keystone Development and Investment has waded into the conversion game. The West Conshohocken, Pennsylvania, company historically has been a significant office investor. It recently completed a conversion of the historic Curtis building in center city Philadelphia into life sciences space. It now is pursuing a conversion of several floors at The Washington — another historic building in Philadelphia — into luxury housing, in addition to converting a suburban office building it owns on a mall property in Plymouth Meeting, Pennsylvania, into housing.

Michael Brookshier, vice president of development at Keystone, said the company to date has leveraged traditional tools such as state historic tax credits for its conversions. But with higher interest rates and construction costs, new and different types of incentives are being considered by the developer.

Among the incentives offered in the White House guidance, Keystone is considering two DOT programs. Brookshier said that’s primarily because those programs don’t carry an affordable-housing requirement — Keystone is developing market-rate housing in its conversion deals — and many of the firm’s properties are close to mass transit, with the DOT programs specifically intended to incentivize new housing near transportation.

Echoing Paynter, Brookshier said because the programs are newly being used for housing conversions, everybody is still figuring out how they’re going to work. And with 2024 being a presidential election year, there’s potential risk the programs could go away if there’s a change in administration after November.

But the biggest challenge Brookshier sees with leveraging federal incentives for conversions is the time it could take for them to be deployed for projects his firm is pursuing right now. From letter of intent to closing on the financing, that could take 12 to 18 months, he said.

“I have a project I’d like to close on in March and June of this year, so [that] doesn’t work from a timing perspective,” Brookshier said. “On the flip side, there are projects I’d like to build in the future, so maybe I should get the application in so I have things in process … but at that point, you’re predicting the future.”

It also would be useful if there were one simple process to submit applications for federal incentives being offered, Paynter said.

Eric Stavriotis, vice chairman of advisory and transaction services and leader of the location incentives group at CBRE, said it’s most helpful when a developer can sift through a basket of incentives to figure out which ones make the most sense for their particular project. That could range from a tax-increment financing structure to the ability to use city transportation dollars at a former office site so as to make the property more accessible for residents instead of daytime office workers.

From conversations with CBRE clients, Stavriotis said it doesn’t seem the federal guidance alone is spurring deals.

“The old axiom applies here: All politics are local,” Stavriotis said. “Most of what we’re seeing nationally is that the assistance that is moving the needle for a developer — usually a private developer that’s looking to do a project — is oftentimes more local in nature than federal.”

Federal money can be an important part of a project capital stack, but many of those funds are channeled through the state or local level, even if it has federal origin, Stavriotis said.

Local and state officials propose incentives

San Francisco arguably has one of the nation’s bigger office-market problems. That metro’s office market ended 2023 with an eye-popping record-high vacancy rate of 35.6%, according to CBRE. Yet conversions haven’t taken off in San Francisco, even with 12 out of 36 buildings in the city’s downtown having been identified as good candidates for conversion, according to a 2022 study by Gensler.

Local developers and land-use attorneys say a number of initiatives have been proposed at the state and local level to try and spur those projects, but more is needed.

“This is classic economic development,” said Jack Sylvan, founder and principal of SDG LLC and the director of think tank San Francisco Bay Area Planning and Urban Research Association (SPUR). “The public invests in order to catalyze the private development, and that’s what San Francisco needs in this moment.”

Voters earlier this month were asked to weigh in on a measure known as Proposition C. If approved, the measure would waive a San Francisco transfer tax for projects that convert office buildings into housing.

But even before the vote, Prop C was deemed in an economic-impact report by the city controller’s office to be a largely insignificant measure to spur conversions. It determined the cost savings from waiving the transfer tax for those projects would be worth about $33,500 per unit for apartment projects and $9,000 per unit for condo projects, the San Francisco Business Times reported. It also projected it would take the city 29 years and 102 years, respectively, to recoup the revenue it foregoes from waiving the transfer tax in those projects.

As of last week, the outcome on Prop C was still too close to call, although “yes” votes had a slight edge.

Speaking ahead of the March 5 voting, Sylvan said it’s not that waiving the transfer tax itself will lead to a lot of conversions. Rather, it’s just one of many tools needed to make conversions feasible.

Sylvan said he’s estimated that between legislation passed by the city of San Francisco last summer that streamlined planning requirements and Prop C, if it were to pass, those measures would solve about one-quarter of the feasibility gap per unit in conversion deals. SPUR estimates there is a current feasibility gap of $267,000 per unit.

Another measure being closely watched in San Francisco and elsewhere in California is at the state level.

California Sen. Scott Wiener last month introduced State Bill 1227 that would give developers converting office buildings into new uses in downtown San Francisco a temporary exemption from the state’s Environmental Quality Act and also would expand a tax exemption for those projects from strictly affordable housing to also include workforce housing.

Sylvan said the measures collectively “are no silver bullet” but they start to unlock the potential for projects to begin and for capital to be reinvested in downtown San Francisco real estate.

“If you’re waiving fees, you’re waiving fees that would never be charged because nobody is doing anything with that building,” Sylvan said. “It’s basically foregoing [a tax] that [the city] would never have collected. It doesn’t exist but for the conversion.

“To me, that’s the most important piece of the policy conversation,” he said. “Yes, you are providing an incentive, but the city isn’t giving anything up because it wasn’t going to get anything [if] a building sits [empty].”

Conversions call for more than incentives

Beyond financial considerations, San Francisco is not unlike other U.S. cities in having inclusionary housing requirements that Sylvan said could be a barrier for conversions. That means even if more incentives become available, it could still be a challenge to get conversion deals done without policy changes, he said.

Other requirements can add cost and risk to conversion efforts. For example, converting an office building to a residential use may trigger earthquake-related code requirements, which could necessitate significant seismic upgrades, said Caroline Chase, a partner at law firm Allen Matkins Leck Gamble Mallory & Natsis LLP, who specializes in land-use law.

“That would likely include a substantial seismic upfit [and] that could hinder projects from moving forward,” she said.

She added that SB 1227 has prevailing-wage and skilled/trained workforce requirements associated with it that could create challenges and added costs for construction workforce.

The hurdles to converting office buildings in San Francisco into new uses are but one example in one city — albeit one of the more challenging markets to turn obsolete office inventory into new uses. But what’s stymying projects there illustrates how policy and regulation change are a significant piece of the puzzle in getting conversions anywhere in the U.S. across the finish line.

In some places, it’s simply how long it takes to get a project through a city land-use and planning department. Those focused on downtown revitalization and development say making that process more streamlined is one way to get projects approved quicker and provide greater certainty to developers embarking on already risky conversion deals.

Nolan Marshall, executive director of the South Park Business Improvement District in Los Angeles, said in a recent interview a lot of municipalities have struggled to streamline their regulation process.

“You have to disentangle the process and make it easier for people to get permits for capital to flow in your community, and flow in a fast way,” Marshall said. “It’s challenging enough to figure out how to do a conversion from an office building to a residential building. If it takes a developer 12 months in L.A. — and that’s being optimistic — [and] it takes them five months in Austin, Texas, that capital will flow to Austin, Texas.”

Paynter said state and local governments have the ability to move more effectively and quickly than the federal government, even if they are smaller-scale efforts. But in many places, he said, local programs on the whole are overly complicated.

Both Paynter and Whelan cited Calgary, Alberta, Canada as an example of a government with a relatively simple conversions program, including the clarity that’s provided around incentives.

Calgary says it currently has 13 office buildings actively being converted, and four under review, into new uses. In cities across the U.S., there were only 42 office conversions actively underway in September that were expected to be finished in 2024, according to CBRE.

“In talking to developers, the two terms that come to mind are certainty and ease,” Whelan said. “The lack of certainty in this whole process, given the risk and expertise associated with these projects, is holding some developers back from doing these projects.”

Source: “New incentives aim to jumpstart conversions of office buildings. Here’s why they won’t be a silver bullet.“