High-ranking Fed officials have recently been nagging observers, warning that markets should not expect a quick end to higher interest rates. This idea could be a concern for commercial real estate.
Esther George, the 40-year Federal Reserve veteran and head of the Federal Reserve Bank of Kansas City, told the Wall Street Journal that bringing down inflation without a recession could be near impossible.
George remarked, ” I’m looking at a labor market that is so tight, I don’t know how you continue to bring this level of inflation down without having some real slowing, and maybe we even have a contraction in the economy to get there.”
Fed Governor Christopher Waller has been cautioning that better-sounding news on the consumer price index when the October statistics came out has caused the “market to have gotten way out in front on this.”
Although on Wednesday he stated, “Looking toward the FOMC’s December meeting, the data of the past few weeks have made me more comfortable considering stepping down to a 50-basis-point hike. But I won’t be making a judgment about that until I see more data, including the next PCE inflation report and the next jobs report.”
Waller continued, “If the FOMC were to step down to a 50-basis-point increase, it is important to remember that this would still be a very significant tightening action—in other words, just pulling back on the rate of ascent a little bit. At this angle of ascent, with policy already in the restrictive territory, the federal funds rate can still be increased quite rapidly with several 50-basis-point increases, a pretty aggressive path for policy.”
Susan Collins, president of the Federal Reserve Bank of Boston, was the most enthusiastic of the three when she spoke to the Journal earlier this month. Collins stated that the primary point he wanted to emphasize is still bringing inflation back to its target range. “We’re going to have to tighten further and then hold for some time. I am optimistic that there is a pathway that would not require a significant slowdown. And I’m happy to talk a bit more about that, recognizing that there are some key risks and that both inflation and unemployment are very costly and that those costs are not equally distributed.”
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Expect the Federal Reserve’s latest 75 basis point rate hike to have little effect on the commercial real estate transaction volume, which is already down year over year.
According to new analysis from Marcus & Millichap, trading activity in recent months has fallen short of but is near same-quarter figures in 2019. However, according to the firm’s analysts, the compounding impacts of numerous interest rate hikes have made it increasingly difficult to conclude commercial real estate purchases. This constancy will help investors come to an agreement and close deals more readily if interest rates stabilize at a new, higher level, the author writes.
The Fed will probably wait until there is solid evidence that inflation is returning to the 2 percent objective before putting a stop to rate hikes, which leaves the door open in 2023. Experts in the CRE industry believe this is when the rate increases will end.
With cap rates recently dropping into the mid-seven percent range, senior housing also offers relatively strong yields. And the deals are coming in thick and fast: in the first seven months of 2022, Walker & Dunlop sold $1.3 billion worth of senior housing and long-term care facilities, breaking all previous records. However, experts predict that labor concerns and increased operational expenses will continue to be challenges for the sector.
According to Julie Ferguson, executive vice president and senior living at Ryan Companies, the ownership and financial structure of a company [may affect] whether they’re able to manage through a fall in operating margin. There will be owners who, if their lease-up is not proceeding as planned or if their expenses exceed their budget, will not be able to contribute further working capital to projects. Given the numerous factors that go into these choices, it is difficult to predict whether there will be more or fewer of them in 2023.
The SVN Vanguard team can help with your Commercial Real Estate needs. We can help you find the ideal commercial property for sale or lease. Interested in discussing a sale leaseback? Contact us.
During the recent GlobeSt. market state panel discussion The panelists at the net leasing national fall event concurred that price discovery is now taking place. Will Pike, vice chairman and managing director of CBRE, said on the panel, “We are bullish on retail, but we have a pricing disparity we have to work through.” Price discovery is widespread. Pike said we have to see what happens with the Fed during the next meeting. I think we are in the second or third inning of that. He said that the primary groupings are likely to transact in the market if they have a specific purpose to sell or if they have debt coming due.
The director of investments and managing director at W. Gino Sabatini P. Carey concurred, pointing out that although deals aren’t being made right now, they aren’t being written at W. P. Carey. Price discovery is taking place right now, but ultimately someone will have to act and the market will be moved.
He noted that the disconnect results from sellers still wanting yesterday’s pricing. “I don’t know how you’re going to accomplish a 6% cap rate if you can’t borrow below 6%,” the speaker said.
However, depending on which side you are on, there are organizations out there with money to invest, according to Gordon Whiting, managing director of Angelo Gordon. If you are a seller, you probably want to make a deal right now. Being a buyer makes you slightly more cautious. Do you intend to buy a leveraged asset? Can you survive this market? It is a more complex market.
“It also depends on how you view the investment if you are a buyer,” he continued. Since I’ve been doing this for several years, 40% of people see net leasing as a credit investment, 40% see it as a real estate investment, and the remaining 60% don’t really know or care and just appreciate the return.
The sale-leaseback market is one area that Brandon Flickinger, chief investment officer of bridge net lease at Bridge Investment Group, is observing. They continue to submit numerous offers, he claimed, but very few of them are accepted.
The SVP and national director of the retail and net leasing businesses of Marcus & Millichap, Daniel Taub, a panelist, noted that there is a significant distinction between institutional and private client money. It has a subtlety to it. “Even in the face of volatility and rising interest rates, we are conducting business with a range of REITs today,” he said.
The same is true for several PE firms that operate in the sector, Taub continued. I’d argue your private client is more impacted. Taub said, “Our organization has done more than 2,000 transactions with perhaps 450 lenders.” It depends on what kind of money you have—private, institutional, short-term, long-term—that is factoring into the transactional activity. The smaller lenders are still around, but they are reaching their capacity because the terms have definitely altered. Simply put, they lack the larger banks’ depth and breadth.
The SVN Vanguard team can help with your Commercial Real Estate needs. We can help you find the ideal office property for sale or lease. Interested in discussing a sale leaseback? Contact us.
2022 will be remembered as a gloomy year for apartment investors. Following more than ten years of inexpensive debt, we are seeing the end of that era. The Federal Open Market Committee has raised interest rates five times so far this year. The prime rate rose to its highest level since 2008 in September, and further hikes are expected. The committee predicts that interest rates will be at least 4.25% or even 5% by the end of the year. Apartment investors are hesitating since this is the fastest increase in interest rates since the 1980s.
The second half of 2022 has witnessed a reduction in deal volume, according to Taylor Avakian, an associate vice president at Matthews Real Estate Investment Services and an authority on the Los Angeles multifamily market. He says the excessive increase in interest rates is having a major impact on investors. The majority of buyers secure financing, and with interest rates now two full points higher, returns are suffering, he claims. From his experience working with a wide range of investors, including family offices and institutional buyers, Avakian believes that all types of investors are being more cautious.
The Financial Community Is Split.
The level of investment activity is declining, although not uniformly. When interest rates rise, private investors are more at risk because they use the debt markets more frequently and have fewer capital options. According to Avakian, “This has a huge impact on mom-and-pop owners who have owned these buildings for decades.”
As opposed to early in the year, when 1031 exchange buyers were driving activity, they are now slowing down their buying. Avakian notes that because buyers are now obligated to put up more equity to offset increased rates, many of these “would-be” transactions are no longer making sense.
The Winds Are Against High-End Multifamily.
With rising interest rates, Class-A properties are most at risk. According to Avakian, higher-end assets are already experiencing price drops. Prior to the upticks in rates, Class-A apartment properties were trading at 3% or high 2% cap rates. Avakian says that no longer makes sense to anyone. He adds, “Investors would rather put their money in bonds at 4% than a 3% multifamily class-A building.”
As borrowing rates climb, investors have chosen to invest in affordable housing instead. “I think a lot of investors are moving in that direction and incorporating affordable housing into their portfolio,” says Avakian.
Investors have high hopes for the near future. Avakian and his clients anticipate better prospects and pricing over the next six months. Keeping your eye on the ball and your head in the game is time well spent. He concludes, “If a deal makes sense today, write an offer.”
The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for multifamily properties for sale.
The National Multifamily Housing Council brought up a bill that was submitted to the House and Senate last year but is probably too late to be implemented.
The Revitalizing Downtowns Act, also known as S.2511 in the Senate and H.4759 in the House, was presented by Sen. Debbie Stabenow (D-MI) and Rep. Jimmy Gomez (D-CA) at the end of July 2021.
If the bill had been passed, it would have offered a tax credit for repurposing outdated office buildings. For approved office conversions, developers would have been permitted to deduct 20% of their conversion-related costs.
Prior to the alteration, the building would have needed to be in use for at least 25 years. A space could be converted by a developer or owner for “residential, retail, or other commercial use,” subject to a number of restrictio
ns. For instance, 20% or more of the building’s units have to be rent-restricted and only open to those with incomes that are 80% or lower than the median for the area. A state or municipal government agreement might have included a building as well.
The bell was referred to a committee in both chambers. Together with a group of business allies, NMHC claimed to have written to Congress in support of the incentive and to suggest some changes, such as allowing REIT participation, extending the incentive beyond office buildings, and allowing states to use tax-exempt Private Activity Bonds to further reduce financing costs. It could also be a good idea to forbid the conversion of historic apartment buildings into other types of commercial property from receiving such a credit.
The core concept is excellent. Particularly in the US, there is a severe lack of housing in many areas. The costs of conversion are substantial. It takes time for old structures that were originally constructed as offices or for any other purpose to be converted into homes or, probably, any other kind of property. If major blocks of the converted units are low-income housing, as would seem only acceptable, finances, especially in times of high rates, might prevent a conversion from being profitable. The building of more housing, which is sorely needed, might be encouraged via tax incentives.
However, NMHC acknowledges that there is little probability of this occurring. In light of the upcoming midterm elections, authorities are reluctant to adopt positions that could harm their chances of winning reelection. Additionally, the National Defense Authorization Act and a hefty budget measure to avoid a partial federal government shutdown are mentioned by Politico.
That still leaves a ton of things that were started but never finished. It’s unlikely that something that didn’t attract enough attention to warrant a hearing will now receive a blaze of attention.
Given that, CRE experts might encourage their elected officials to think about this in the upcoming year. Some suggestions are resubmitted each year. There are some of those that do eventually pass.
The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for multifamily properties for sale.
In one section of its Fall 2022 Sentiment publication, LightBox mentioned fears about inflation and a recession for CRE investors. But perhaps the focus should have been on the fundamentals of economics when it came to an analysis of the office sector later in the text, because one dynamic initially seemed strange.
As LightBox pointed out, the office sector’s first half in 2022 compared to the same period in 2021 displayed an odd dynamic: volume was significantly up but prices were significantly down in a number of countries.
Except for the Bay Area, in which all areas had an increase in sales volume, most cities experienced a decrease in PSF pricing, the company reported.
Multifamily cap rates, which have been steadily falling during the pandemic, are being squeezed by the rising cost of capital.
This will ultimately put pressure on the sector’s property values, according to new research from Moody’s Analytics. “Without continued unprecedented rent growth, the darling multifamily asset class likely carries the most risk of value decline while the benchmark US Treasury rate is on the rise.”, analysts warn.
Cap rates have remained static even if Q3 has now started to show a little increase for industrial, office, and retail. According to Kevin Fagan and Xiaodi Li of Moody’s, ” For multifamily, cap rates have continued to decline, which, along with tremendous rent growth, has propped up multifamily values compared to equities and other investments.” However, the multifamily sector will ultimately see fewer buyer offers and higher property yields due to the rising cost of capital and growing worries regarding ex-ante exit cap rates. Therefore, pressure on multifamily property values will come from the Fed raising rates and the banks doing the same with loan interest rates.
Moody’s economists point out that rising 10-year treasury rates have driven CMBS loan interest rates significantly higher than in prior months, and both are expected to keep growing. But while the cap rate for industrial properties began to rise in Q3 2022, multifamily rates kept falling. Fagan and Li state that “cap rates with tight spreads are highly likely to increase under the upward pressure of rising interest rates.” They add that this raises the question of how much rent growth is required to stop a decline in value. As of Q3, spreads between cap rates and loan interest rates for the sector were clocked at 0.76%.
If a CRE investor wishes to leave in five years and the cap rate increases from 5% to 6.5%, they claim that the average annual rent growth must be higher than 5.4%. The exit value would be less than the current value in that case. Even while multifamily growth rates from Q3 2021 to Q3 2022 were 8.2% annually, a sustained average growth rate of 5.4% is significantly higher than any previous record.
In the end, the pair claims that narrow cap rate spreads and rising interest rates are “warning indicators.”
Fagan and Li assure, “We will keep a close eye on those numbers.”
The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for multifamily properties for sale.
Why not diversify your assets while holding on to your profits by deferring taxes on the sale of your property?
This is but one potential advantage of UpREITs and DownREITs, largely underutilized instruments that can offer an additional means of deferring the capital gains taxes incurred from an asset transfer. In that regard, they are similar to 1031 exchanges, but given the aim that the current government has set for like-kind exchanges, investors should be aware of Up and DownREITs. Let’s examine each in greater detail.
A partnership that is still the owner of the real estate is below the REIT in an UpREIT (the “up” stands for Umbrella Partnership). As a result, the REIT does not really have title to the properties; rather, it only owns a stake in the underlying partnership. In contrast, a DownREIT will buy some properties outright and have a stake in a lower-tier partnership that controls the assets directly.
For the purposes of this discussion, let’s concentrate on UpREITs, even if most of what we’ll discuss also applies to DownREITs. Such a transfer of assets is not regarded as a taxable event under existing tax laws. Naturally, this changes if and when the partner transforms their portion of the assets they brought to the table into REIT equity shares. The gain must then be acknowledged. This implies that the investor has the option of timing in addition to the tax deferment. Naturally, this assumes that the REIT in question is a publicly traded REIT.
However, both have significantly greater transaction charges, and the closing is more difficult. Also, keep in mind that REIT equities are simply that—stocks—and not necessarily real estate. Remember that they closely track the S&P 500 as equities rather than more traditional real estate performance indicators such as interest rates.
But let’s get back to the advantages, one of which is asset diversification. For instance, all of your risk is present if you own just one piece of real estate. You effectively diversify that risk over all the properties in the portfolio, including yours, by donating that property to the REIT and getting operating partnership (OP) units in the REIT. This is, unsurprisingly, a significant draw for new participants.
Liquidity is another factor to take into account when choosing UpREITs over 1031s or conventional deals. A standard transaction may take up to 90 days to monetize, if you’re lucky. In contrast, it may just take a few days or weeks to convert OP units and sell the resulting shares.
Three other benefits must also be taken into account. Freedom from managerial obligations comes first. The success of the REIT is predicated in large part on the staff’s ability to effectively and efficiently manage an asset. REITs come with staff to handle those tasks.
Predictability and simplification come next . The owner of an OP unit can count on routinely occurring cash distributions in sums comparable to the cash flow from a single property. They are merely getting a check in exchange for their donation. Additionally, take into account the basic reporting obligations for REITs. No other sector, it can be said with confidence, does as good a job of informing its investors as the REIT sector does.
In light of the risks to the viability of 1031s and the current state of the economy, investors seeking a relatively safe haven vehicle should pay more attention to the benefits of Up and Down REITs.
The topic of whether conversions could succeed frequently arises in any discussion about housing shortages in a CRE context. Take a look at all the office supplies that are waiting for someone to return to work. How about solving two issues at once: the demand for housing and the desire to make existing office stock profitable? Let’s convert buildings, turn them into flats, and rent them out.
Anthony Orlando, an assistant professor at CalPoly Pomona, and Chris Cunningham, a research economist at the Federal Reserve Bank of Atlanta, have examined the possibility of office conversions meeting housing demand for the bank.
In spite of the Fed, there are still concerns. Many office buildings won’t ever be suitable for uncomplicated housing conversions. It can be challenging to make them physically functional if they are not rectangular with corridors leading to rooms on either side or if there are columns everywhere. Who would desire a windowless flat in the heart of a structure? There are also some localities that oppose conversions because they earn more tax money from corporate use and need the money desperately.
Leaving that aside, they both brought up some interesting issues. For instance, “SupplyTrack revealed that an average of 2,300 multifamily units were built monthly out of previously used office, warehouse, or industrial space between 2007 and 2019.” Existing structures make up 3% of total housing units in buildings with five units or more, or historically, 10% of newly supplied multifamily housing, existing structures make up 3% of total housing units.
For conversions to significantly alter the housing supply, they would need to soar into the air.
A different argument, though, was even more convincing. A significant portion of the work-from-home market, which is influencing the office market, is hybrid work. According to the researchers, “Hybrid work may boost productivity or increase the surplus for employees, but it may not actually free up much conventional office space.” This is because if people are still coming in, especially if significant numbers of them do so on particular days, businesses will still need places to put them. The two wrote that “[t]he hybrid approach appears to be delaying the wholesale conversion of offices to rental.” In any event, it doesn’t seem realistic that office conversions will soon slow rental growth.
The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for multifamily, industrial, office, retail, and general commercial properties for sale.
