Archives for March 2024

With over 300 days of sunshine a year, New Mexico residents are used to waking up to the warmth of the rising sun. However, as the rest of the world also heats up, many environmental experts are worried about increasing temperatures impacting the nation’s water supply.

In Albuquerque, those concerns have yet to reach a boiling point. It’s a feat many water and development experts attribute to the area’s slow growth, coupled with a $450 million investment the city made in the 2000s to support future demand.

But with surrounding cities like Phoenix and Denver starting to feel the impact of increased growth on its water supply, the questions become: Does Albuquerque have a water advantage? Or is the Duke City one growth spurt away from joining in these Southwest struggles?

Investment in San Juan Chama project

New Mexico’s State Engineer, Mike Hamman, said that $450 million investment — the City of Albuquerque’s San Juan Chama project — has helped to preserve “groundwater for future development.” The project addresses Albuquerque’s depleting aquifers by transferring and treating surface water from the Colorado River Basin to the Rio Grande Basin.

Although construction on the San Juan Chama drinking water project did not begin until 2004, investigations into alternatives for importing Colorado River water into the Rio Grande for use by Albuquerque were underway as early as 1924, according to a 2019 report by the Albuquerque Bernalillo County Water Utility Authority (ABCWUA). Construction of the project finished in 2008.

The City of Albuquerque contracted with the federal government in the early 1960s for water from the planned project, which would divert water from tributaries of the Colorado River for use by communities in New Mexico, said David Morris, communications director at ABCWUA.

“The assumption was that some of it would seep through the riverbed and help recharge Albuquerque’s aquifer,” Morris said. “After a USGS (U.S. Geological Survey) report in the mid-1990s showed that the aquifer was under stress, city leaders, including ABCWUA COO John Stomp, began considering the possibility of directly diverting San Juan Water for drinking.”

Thus, to better prepare for future population growth, city officials approved a permit for the San Juan Chama project in the early 2000s that allowed the U.S. Bureau of Reclamation to transport water from the Colorado River into the Rio Grande via a system of diversion dams and tunnels. The project diverts water from three upper tributaries of the San Juan River (Rio Blanco, Navajo River and Little Navajo River). Upon diversion, the San Juan Chama water is transported under the Continental Divide to Willow Creek where it is stored in the Heron Reservoir.

As of today, there is 93,395 acre-feet of water stored in the Heron Reservoir, which is considered “very low” and is 41% of normal levels, according to Snoflo research.

After it’s released from upstream reservoirs, the water travels to the Rio Grande and is then diverted for treatment at a facility near the Alameda Boulevard bridge, Morris said. The water is then pumped through a $160 million treatment plant that purifies the water for distribution into the community, according to the ABCWUA website.

Despite its intentions, critics have worried the project could impede the state’s ability to satisfy its water delivery requirements to Texas under the 1938 Rio Grande Compact. A concern that is now waiting to be heard by the U.S. Supreme Court.

In the last 25 years, Albuquerque’s conservation efforts have reduced the city’s per capita water usage from 250 gallons per day to 125 gallons, Morris said. The San Juan Chama project, now the biggest source of drinking water, has also reduced groundwater pumping by more than two-thirds, he added.

“The more San Juan Chama water we can use, the more water stays in the aquifer,” he said. “This provides a rebound of the aquifer over time.”

And while these conservation efforts might have bought Albuquerque time, New Mexico as a whole is one of the driest states in the U.S., which means the topic of water will continue to intensify. In the coming weeks, months, and honestly, years, Albuquerque Business First plans to dive into the water conversation as its impact on business is set to rise.

Source: “After a quarter-century of conservation, does ABQ have enough water to grow?“

There was noted heavy demand for more space during the heights of the pandemic. When offices and schools were closed, along with cafes, libraries, and other places that might offer a place to work or study, people looked for larger living spaces. That could be purchasing a house out of a city, or it could also be leasing a larger apartment.

Renters’ choices are swinging back in the other direction now.

“In yet another example of apartment fundamentals returning to pre-pandemic norms, occupancy among unit types has rebounded back to typical pre-COVID patterns,” RealPage writes. “In particular, occupancy among the largest unit type – three-bedroom units – has softened, after surging to all-time highs earlier in 2021 and 2022.”

Pre-pandemic, the accustomed pattern of apartment occupancy was a split group of two. Total occupancy, one-bedroom occupancy, and two-bedroom occupancy were roughly the same, hovering something about 96%. Then three-bedroom and efficiency occupancies were about 70 basis points below.

The reason the second group could be below total occupancy levels is because there were far smaller in number, so they didn’t have a large on the total.

Then came the pandemic and patterns changed significantly. Two-bedroom rose to the highest occupancy levels. Slightly below, total, two-bedroom, and three-bedroom occupancies grouped together. Efficiency occupancies began to plunge below the second group, eventually falling to about 200 basis points beneath by January 2021, a year in from the start of the change.

The gap between efficiencies and everything else than began to close. A year later, January 2022, that apartment type was back to the pre-pandemic 70-basis point gap, but three-bedrooms continued to be close to one-bedrooms.

Starting in March 2022, one-bedrooms, two-bedrooms, and total occupancies continued in concert. Three-bedrooms began to separate out, falling downward about May 2022. By September 2022, the older patterns were largely reestablished. January 2024 saw everything back to where it had been.

“One-bedroom units logged occupancy of 94.1% in January, followed closely by 94.2% in two-bedroom units,” Real Page wrote. “Three-bedroom units and efficiency units were the underperformers again in January with occupancies of 93.4% and 93.3%, respectively.”

According to RealPage, and to commonsense, this wasn’t a surprise. Efficiencies were poor choices for many renters who had to work from home because they were more cramped for space. Three-bedroom units were a small portion of the total. An interest in more space by consumers pushed their usage, and therefore occupancy, upward.

But more space is more expensive. When need lessened, a significant portion of tenants likely shifted back to smaller units as well as efficiencies.

Source: “Another Multifamily Shift: Less Call for Three-Bedroom Units“

What is the first question CRE managers are asking these days? Alison Chave says it’s interest rates. Commercial real estate is a levered game. The sudden, steep rise in interest rates that took place particularly over 2022-2023, and subsequent volatility, was a real shock to many owners and impacted not only levered returns but created significant uncertainty for CRE owners as to future cash flows and values.

Chave, SVP and co-lead of debt capital markets at JLL, a global real estate services company, has seen the recent strain that higher borrowing costs and interest rate volatility has placed on CRE owners, managers, and lenders, and how it has affected pricing and liquidity. How is this playing out? While CRE managers are coming to terms with “higher for longer” interest rates, the rate hikes have made lenders and investors far more wary, and both are taking more of a ‘wait and see’ approach as they struggle to underwrite levered cash flows and market values with certainty. JLL has seen a marked drop in transaction and debt activity across commercial real estate investments since 2022: the market is much less liquid than during the frothy times of an artificially induced low interest rate environment during the pandemic.

In 2024, most lenders are really only lending to their existing clients, and CRE managers are paying significantly more attention to their debt levels, stress testing renewal rates and reaching out to lenders much earlier to see how much they can borrow and at what rate. Despite the broad trend of difficulty, however, she says that there is still plenty of capital available in the CRE space depending on the quality of the borrower and the nature of the assets.

Chave explains that the impact of debt cost on an asset depends on the timing of debt maturity.

“Most professional managers and owners will have staggered their debt maturities, but for those who didn’t and decided to take a five-year window in 2019-20, are facing rates that will have doubled” Chave says. “Those who took ten-year money in 2020 or 2021 when the rates were very low, will not only be ok, but are able to transact assets with low existing debt at favourable prices.

Notwithstanding the current stress in the market, Chave believes that commercial real estate can bear the high cost of debt saying, “we have done it before, and we will do it again.”  She believes there needs to be a reset in expectations in value, based on the higher cost of capital, and we are seeing this as 2024 rolls out.

Concretely, the amount investors are willing to paying for each $1 of cash flow is dropping, simply because more cash flow is needed for the debt – if you want the same levered returns as before, you have to pay less for an asset. Long term, Chave sees levered returns on real estate reverting to the mean, with capitalization rates at more normal and sustainable levels. However, there is very little data for this as most investors are in “wait and see mode”. Those who entered the market at an all-time high when interest rates were artificially high and had little expertise or cash to inject in times of difficulty will need to sell their assets when their debt matures. This creates opportunity.

Chave says that office remains the most challenged area, with an unclear direction in occupancy rates and an expected increase in non-institutional tenant defaults. While there is uncertainty around the future of offices, and a rise in lender watchlist for this asset class, Canadian institutional investors in particular are unlikely to default on their loans. She says that ,any real estate investors are asking her firm if they have distressed assets for sale, but significant levels of distress are simply not materializing.

Chave explains that while many smaller private owners with less cash in hand are in “choppy waters” she does not expect a huge wave of takebacks to hit the Canadian office market.

“Nobody wants that in Canada,” Chave says. “Most problem loans are being extended for a year or so, as lenders wait to see what’s going to happen with office use and when volatility will drop.”

Beyond offices, Chave notes that multifamily assets are still very much in favour. CMHC has facilitated solid financing programs that allow for up to 50-year amortization periods, low interest cost and up to 95% loan to value. Without those programs, she says, there would be very little happening in the financing of existing multifamily and construction of new multifamily housing.

Retail has recovered faster from the impact of the COVID-19 pandemic than office has, Chave notes. Lenders are now looking somewhat favourably on major retail assets like malls and suburban power centres, especially if borrowers can densify and add multifamily housing to their properties.

Chave sees opportunity and growth in student housing, data centres and life sciences etc. “These are nascent asset classes, need to be understood, but they do have a lot of reward potential”.  Going forward, Chave advocates for stronger understanding among investors. “You need to have somebody that understands the asset class and can explain the risks and rewards,” Chave says.

At the end of the day, the definition of the “high cost of debt” is highly dependent on which timeframe you are using. Current Canadian bond rates are still below the long-term averages. In the “new normal” or “back to normal,” there will be winners and losers, but Chave believes that ultimately real estate will remain an attractive asset class, even in today’s debt environment.

Source: “Can commercial real estate bear the high cost of debt?“

Expect continued resilience but on a muted scale for industrial assets in 2024, according to Newmark, which said in a recent report that economic uncertainty continues to exert pressure on consumers, developers, occupiers, and investors.

“Unpredictability in the global supply chain will drive long-term demand for industrial space due to the need for diversified sourcing and ports of entry,” according to Newmark’s National Industrial Market Conditions and Trends Report.

Acute global supply chain developments on leased industrial space in the short-term are likely to be a mild but net positive in 2024, Newmark said.

As for the sector’s capital markets, Q4 marked the sixth consecutive quarter of significant annualized declines in industrial capital markets volume, with users – a small slice of the pie – the only investor group to increase acquisitions in 2023 versus 2022, it said.

Cap rates have risen 100 basis points among private market industrial since the end of 2022. Cap rate and BBB bond yield measures were 5.4% at the end of 2023.

Among all CRE property types, the industrial sector has the lowest share of potentially troubled loans maturing over this timeframe even as record industrial loan maturities are coming due, according to Newmark.

“The larger challenge will come from debt service covenants where 47% of upcoming maturities have a DSCR of 1.25 times or less,” according to the report.

Securitized, debt finance has fallen sharply from its recent peak in 2021 amid a depressed, issuance market while insurance lending has picked up share in 2023. This occurred even more so in the second half of 2023.

“There are also signs of debt funds shifting allocations to industrial,” Newmark reported. “This is consistent with anecdotes coming in from the markets.”

Originations were down 13% year-over-year and 12% quarter-over-quarter in Q4.

However, “Looking forward, industrial liquidity, has good prospects for improving based on the sectors, strong, cash flow, fundamentals, particularly compared with other sectors competing for limited capital,” forecasted Newmark.

Source: “Industrial Expected to Remain Resilient This Year“