As more Americans start going shopping again, brick-and-mortar store owners are recovering from the plague with unexpected strength, reporting some of their greatest figures in years and planning expansions.
According to real estate services company Cushman & Wakefield, asking rents for U.S. shopping malls in the second quarter were 16% higher than five years earlier, while U.S. retail vacancies dropped to 6.1%, the lowest level in at least 15 years.
According to a Morgan Stanley survey, more stores opened than shuttered in the United States last year for the first time since 1995. Some analysts predict that trend to continue this year even as recession fears increase.
The retail real estate market’s recovery is the result of a painful, decades-long adjustment that saw hundreds of retailers file for bankruptcy, many storefronts go unoccupied, and a decline in the desire for enclosed malls. After several years of overbuilding, the pace of new retail construction has dramatically reduced over the last ten years.
Instead of developing new homes, the majority of developers prefer to repair aging homes. When they do start new developments, they are generally more cautious and obtain leases from tenants first before breaking ground. Companies that began as online-only businesses, like Warby Parker Inc., are increasingly using real estate to draw clients and spur development. According to financial documents, the retailer of eyeglasses added nine new locations in the second quarter, increasing its total to 178 outlets.
Additionally, many consumers have discovered they prefer shopping in stores for goods like apparel and food, despite being compelled to buy more items online at the beginning of the pandemic. This is a reassuring indicator for the long-term viability of brick and mortar retail.
Oversupply still affects other real estate sectors. The epidemic and the rise of virtual work have made an already difficult situation in the office sector even worse. According to some real estate specialists, it will probably take years for supply to decrease to the level of office demand that existed after COVID-19.
As businesses who made it through the difficulties of internet shopping and the pandemic aspire to expand, retail real estate is now profiting from years of minimal construction after going through its own tough reinvention.According to Brian Kingston, managing partner at Brookfield Asset Management, “we’ll have fewer new stores opening in the U.S. than closures for the first time in almost five years.” And an estimated 23 million square feet of space will be needed for these net new 2,600 stores.
One of the largest mall owners, the real estate company, reported that expenditure at its 132 U.S. malls is 31% above prepandemic levels.
According to Brookfield, Simon Property Group, and Macerich Co., operators of high-end, Class A malls, occupancy rates have recovered from previous drops to more than 90%, while many middle-and lower-quality malls are still having trouble.
High inflation, quickly rising interest rates, and the possibility of a recession might reduce retail sales and increase vacancies in the next few months. However, executives and analysts noted that retail’s improving performance throughout the pandemic shows the sector is better equipped than it has been in years to weather impending storms.
According to Chad Cress, chief creative officer of DJM, a real estate investment, development, and management company based in California, “coming out of COVID, our foot traffic and sales across all of our locations have improved, even above pre-Covid levels.”
Long before Amazon.com, difficulties in the retail sector existed. According to Ronald Kamdem, chairman of U.S. retail development, since the 1970s, the rate of increase in retail building has been four to six times that of population growth in the U.S. Morgan Stanley conducts research on REITs and commercial real estate.
According to data provider MSCI Real Assets, there is now about 22 square feet of retail space per inhabitant in the United States. Morgan Stanley calculates an even higher per-capita square footage than France and the United Kingdom—and nearly eight times China’s rate—Morgan Stanley calculates an even higher value of 23, more than any other nation.
According to Nick Egelanian, founder and president of retail advisory firm SiteWorks, when Americans moved to the suburbs following World War II, downtown shopping districts dominated by small businesses and family-run department stores lost their way to regional malls and retail chains. Later, developers hurried to erect large, outdoor shopping malls featuring big-box retailers.
For the most part, up until the Great Financial Crisis, we just kept building, said Brandon Svec, national director of U.S. retail analytics for data company CoStar.
When the recession hit in 2008, e-commerce was only beginning to gain traction among middle-class consumers. According to Morgan Stanley, more than 850 stores declared bankruptcy in 2008 and 2009.
Additionally, retail construction fell. Since 2010, less than 150 million square feet of new retail space has been produced annually by developers, which is half the amount that was delivered in both 2008 and 2009.
Retailers had been struggling for years with the increased popularity of online shopping by the time the epidemic struck, pushing consumers to turn to the internet for everything from groceries to workouts. According to the U.S. Census Bureau, e-commerce, which made up 3.6% of all retail sales in the first quarter of 2008, would increase to almost 12% by the same period in 2020. Counting Houses
The Census Bureau reported that the percentage of online retail sales decreased after reaching a peak of 16.4% of total sales in the second quarter of 2020. 14.3% of retail sales were made online in the first quarter of this year, up from 12.5% before the epidemic, but at a more slow rate of growth that shows consumers still prefer to shop in-person.
This year, according to Mr. Kingston of Brookfield, “retail sales growth in physical brick and mortar stores is actually expanding faster than e-commerce.”
Retail executives and analysts agree that the epidemic prompted businesses to speed up the integration of their online and offline services. Customers can now pick up or return online purchases from more businesses. More parking spaces are being set aside for curbside pickup by shopping center owners.
Some internet retailers are turning to real estate to attract clients as the cost of online advertising has gone up.
Todd Snyder, a menswear designer who started his brand in 2011, claimed that after opening his first physical store in Manhattan in 2016, his online sales in the New York metro area tripled within the first year.
“It’s a fantastic approach to increase brand recognition. Additionally, Mr. Snyder, who has since launched five more businesses, stated that it was a terrific way to receive customer input.
Instead of creating new stores, many real estate executives are renovating historic ones to appeal to contemporary consumers. The 46-year-old shopping complex that real estate investment trust Brixmor Property Group Inc. bought in 2005 in the Mamaroneck, New York, suburb of New York City, has just undergone a $13 million refurbishment.
One recent afternoon, customers were wheeling trolleys out of North Shore Farms, a neighborhood supermarket in the retail complex that took the place of the previous grocery chain, A&P, which shut down in 2015 after declaring bankruptcy.
Jennifer Mercer, 52, claims she visits the store frequently to stock up on specialty items such as Greek feta cheese and olives, as well as fresh fruits and vegetables.
I enjoy selecting my own produce. I enjoy looking around, “Ms. Mercer added. “I get ideas when I visit stores like this. They had prepared things, so I thought, “Oh, I’ll cook that.”
There are still issues with retail real estate. Some important tenants, like Bed Bath & Beyond Inc., are under intense financial strain and have made broad closure announcements. Retail in office-dependent districts is still having trouble since fewer people are shopping there because of remote work.
And the United States is still too detailed. According to Mr. Kamdem of Morgan Stanley, approximately one-third of the 1,100 currently operating malls and more than 10% of the 115,000 shopping centers will probably fail in the upcoming years and should be dismantled.
Nevertheless, he continued, business is better prepared than it has been in decades for any economic unrest. Though not to the same extent as the 2008 financial crisis, retail bankruptcies increased throughout the epidemic.
Although there will be a headwind, Mr. Kamdem predicted that losses will not be as great.
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.
As expected, the Federal Reserve increased the federal funds target by 75 basis points on Wednesday afternoon. The rate hike announcement is meant to both curb demand and bring down inflation in the upcoming months. The statement was met with an immediate response from watchers in the multifamily sector.
In particular, following the CPI data earlier in the month, this week’s rate rise was anticipated, according to Dave Borsos, vice president for capital markets at the National Multifamily Housing Council, who spoke with Multi-Housing News. As we move forward, investors will need to keep a careful eye on the rate of inflation and whether the Fed may start thinking about lower rate hikes. However, the Fed has made it plain that if inflation is high, rates will continue to rise until it is brought under control.
Compared to the single-family industry, the multifamily sector hasn’t been as negatively impacted by rising interest rates. Despite the robust demand we are now seeing, Borsos continued, “However, coupled with the larger economy, high-interest rates will have a negative influence on development if they endure for the foreseeable future.”
Ongoing adjustments
Jamie Woodwell, the vice president of commercial real estate research for the Mortgage Bankers Association, emphasized that the Fed is still fighting persistently high inflation by using the main tool at its disposal: interest rates. The detrimental effects of inflation can be apparent in multifamily construction. According to him, costs have increased over the previous year, making it more expensive to construct each new unit.
The drawback of the Fed’s activities, he continued, can also be seen in the fact that every increase in interest rates raises the cost of developing and financing apartment buildings and makes it more difficult for new deals to be financially viable. “Shorter-term rates have been significantly more impacted by the Fed’s policies than longer-term rates. However, since the start of the year, the cost of long-term borrowing has nearly doubled.
After a record-breaking first quarter for borrowing and lending, Woodwell continued, “As a result, we foresee a marked slowdown in the second half as developers, purchasers, sellers, lenders, and others adjust to the continuous changes in market circumstances.” It’s not that there isn’t enough loan or equity capital available at this time. The market is changing to reflect the conditions and interest rates of that funding.
Both debt and equity transactions can be liquidated. However, Kelli Carhart, head of multifamily debt production for CBRE, noted that capital is now more selective and has tended to favor lower-risk profiles. Financing significant debts is difficult in the current climate. Multifamily investment sales are expected to decline for the rest of 2022, but activity has remained steady at historical levels.
The market would continue to be impacted by headwinds including rising rates, reducing leverage and greater equity checks that reduce returns, she said. Investors are still anticipating changes in cap rates and an increase in interest rates.
According to Marcus Duley, chief investment officer of Walker & Dunlop Investment Partners, the rate hike has little to no immediate or direct impact on obtaining fixed-rate financing.
He continued that fixed-rate loans are impacted by increases in the yields for 7-year and 10-year Treasuries. Index rates, such as the SOFR or LIBOR, often rise in tandem with the Fed’s expansion of the Fed funds target range. “Floating-rate loans are getting more expensive, along with less proceeds based on actual DSCR limits and a substantially higher cost for lender-required interest rate caps, as a result of both rising index rates and lenders’ new demand for significantly bigger spreads.”
Greatest influence
Given that these transactions have frequently been financed with variable-rate debt, core market assets and value-add initiatives are most likely to be negatively impacted. According to David Scherer, co-CEO of Origin Investments, large negative leverage could be encountered by investors, making it difficult to meet debt servicing commitments. The build-for-rent (BFR) industry would benefit the most from the recent rate increase and other cumulative hikes, he claimed.
“There are actually millions of people who want to buy homes but are imprisoned as renters. They can no longer afford to purchase their first homes. The same housing dynamic is produced by BFR without the associated costs.
According to Carhart, the foundations for multifamily housing are still strong. Although mild rent hikes are anticipated, there is a strong demand for housing overall. She added that increased mortgage rates and the dearth of cheap single-family homes will favor multifamily, adding that “a scarcity of affordable housing will also continue to drive demand in that market.”
Transwestern’s Doug Prickett, senior managing director of research and investment analytics, concurred. According to him, demand in the rental sector should continue to be high as the alternative for-sale market becomes less accessible. However, new supply may also decline as a result of rising costs and dwindling construction financing options.
“Demand pressure on existing product will be exacerbated by an already existing lack of housing supply,” Prickett concluded. Observers of the multifamily industry expressed strong sentiments three months ago following another rate increase.
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Any medical facility appreciates positive improvements in the space’s condition. The fundamentals of medical office buildings are improving, which benefits operators, investors, and property owners alike.
The top 100 U.S. markets are covered in a Q3 2022 study on healthcare real estate by Colliers. The report’s executive summary stated that “Despite economic worries and industry obstacles, the medical office property sector (MOB) continues to grow, hitting record highs for asking rents, sales volume, and pricing over the past four quarters.” Demand is surpassing supply, there is little room for error, and capitalization (cap) rates are largely consistent. As a result, development activity is accelerating and demonstrating sector confidence.
But there is a catch: things aren’t looking so good for the healthcare sector, on which they rely. Price pressures remain present, and MOB owners may need to be monitored and given possible treatment options.
On the bright side, the top 100 metro areas had an average vacancy rate of 8% in the first half of 2022. This constitutes a 40 basis-point decrease from the same time last year.
The highest net MOB asking rentals in the top 100 were in Los Angeles, where they were $36.85 per square foot. This price is certainly an anomaly.
The research noted that none of the other top 10 metros had an average MOB rent of over $30 per square foot. The lowest costs in the top 10 didn’t include numbers, but a graph clearly demonstrated that four—Atlanta, Boston, Dallas, and Philadelphia—were much below the national average. “Boston and New York are the next highest, at $26.26 per square foot and $26.19 per square foot, respectively.”
Construction increased in an effort to keep up with demand; 14 million square feet were completed in the four quarters that ended in Q2 2022. This was an increase above the 13.7 million square feet from the previous year. More dramatically, from 30.9 million to 37.1 million square feet, MOB under development increased.
Additionally, investor demand was high—it reached a record-high $17.2 billion in the four quarters that ended in Q2 2022.
Since many individuals find it difficult to refuse medical care, MOB is substantially positioned to survive economic storms. The prices are also a concern for practitioners. That would suggest real estate overhead will also be under review. “In the face of lower income and, in some cases, operating losses, some providers are eliminating staff despite an overall shortage of employees in the healthcare industry.”
As the inflationary environment intensifies, multifamily deals with pre-existing loans and favorable interest rates will be the most popular in the coming months. Stabilized properties will also be in even greater demand because they can offer higher returns and more certainty, according to one industry veteran.
According to Otto Ozen, Executive Vice President of The Mogharebi Group, the asset class will continue to be a desirable inflation hedge because it has historically outperformed other asset classes from a yield perspective, and demand drivers are still strong given that the costs of homeownership are still staggeringly out of reach for many prospective buyers.
He claims that when mortgage rates increase, the affordability gap grows, raising the entry barriers for home buyers and ultimately pushing them into renting. Because of this change, the rental market will be robust and rental rate growth will outperform inflation.
At a panel discussion at GlobeSt’s upcoming Multifamily Conference in Los Angeles in October, Ozen will elaborate on these observations and provide more perspectives on what will make multifamily deals successful in the current environment. He says he’ll be keeping an eye on core inflation and interest rates going into 2023 to better understand transaction velocity. He mentions that value-add and opportunistic deals may start to slow down as the risk involved with these transactions increases as interest rates rise.
Investors with and without US-based bases foresee difficulties in closing deals in both the US and, to a greater extent, in Europe due to economic uncertainties. Foreign investors are less bullish about both regions than in prior surveys, but they are more positive about the US than Europe. Branson notes that, in contrast to overseas investors (67%), Americans (92%) are more gloomy about the “inevitability” of a US recession.
Another top goal for survey respondents was energy independence, and over two-thirds said they are currently actively working to increase their energy efficiency. Eighty-two percent of respondents to the study think that the need for investors to address an ESG agenda will increase as a result of the global energy crisis. Additionally, 59% of investors give priority to projects that have previously earned certain sustainability certifications, such as LEED and BREEAM.
In contrast to US-based investors (31%), who place a higher premium on getting rid of outdated or inefficient assets, non-US investors (43%) are more inclined to focus on capital spending for sustainability improvements.
Four of the major financial regulatory organizations—Office of the Comptroller of the Currency, Treasury, Federal Deposit Insurance Corporation, and National Credit Union Administration—published a proposed revision to a 2009 policy governing commercial real estate loan accommodations and workouts in the Federal Register at the beginning of last month.
The Federal Reserve has since released its interpretation of the policy with a comment period concluding on November 14, 2022.
The proposed statement was created in consultation with state bank and credit union regulators by the Board, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (NCUA), and is identical to the one that was previously made public.
The initial 2009 declaration followed the Great Recession and a significant shakeout in the real estate market, among other factors. The pandemic’s experience and the numerous revisions that came about as a result of business closures that left many owners and investors in a bind are incorporated into the present suggested edition.
Two important initial concepts are still supported by the proposed statement. One, even if the amended loans have flaws, lending institutions who use “prudent CRE loan accommodation” won’t face criticism for doing so. The second is that modified loans won’t be adversely classified if the borrower has the capacity to repay them on fair conditions because the value of the collateral is lower than the loan balance.
Such arrangements are described as tools “to mitigate adverse effects on borrowers and would encourage financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations during periods of financial stress” in a new section on short-term loan accommodations.
Former US Treasury Secretary, Lawrence Summers, reassured CRE CEOs that “if the vehicle’s moving faster, we need a firmer brake, but it doesn’t imply we’ll hit the wall before the car stops” on a day when a stubbornly high inflation rate dashed hopes for a smooth landing for the US economy.
Hessam Nadji, CEO of Marcus & Millichap, conducted a wide-ranging online debate on Tuesday. In it, Summers projected that the Fed’s ongoing rate hikes will soon lead to a “recession of choice” that will end the record-breaking employment creation of the previous year.
Summers stated, “The Fed seeks to limit it by constraining demand by hiking rates. We have constant inflation owing to a conflict between supply and demand. My best judgment is that the economy will enter a recession and that employment creation will slow down in the coming year.”
The economy, and the CRE sector in particular, is far better prepared to survive an economic crisis than it was in 2008 when the housing market crashed, according to the former Treasury director.
Summers said, “We won’t see something like 2008 again,” pointing out how much less indebted homeowners have, how the inventory is not overstocked, and how much stronger and more cautious lenders are now than they were before the sub-prime crisis.
Summers suggested that the recession would not start for a few months since fundamentals like consumer spending are still strong and have some capacity to increase.
“It’s important to keep in mind that there is still a significant savings overhang. According to Summers, $2 trillion was the amount of money that individuals were unable to spend because of the epidemic.
Only $300 billion of the total had been spent; more than half was still in checking accounts. That seems to me that customers will persist. Due to discounted salaries, I don’t believe they will run out of money to spend,” he remarked.
Summers advised CRE participants not to assume that “structural” developments, such as the increase in remote work and the boom in e-commerce, that have been triggered by the epidemic, will have a detrimental influence on the demand for CRE.
Even in a year or two when there is no employment growth, there will be significant ferment and opportunity in the CRE markets, according to Summers.
The former US Treasury Secretary adds “Many individuals believe that working from home will be awful. That is untrue.” According to him, the movement of people into new areas creates a need for real estate. He also said that the pandemic’s quick rise in e-commerce increased the need for warehouses exponentially.
Summers believes hybrid work is here to stay in the office sector, but he does not think it will have the same impact on office footprints as some may anticipate.
Many will travel far away from work as the need to live closer to the workplace lessens. He said employers will become a little more tolerant of workers working from home as they make improvements to their oversight of remote workers.
But if employees work three days a week, the employers will want them to come in on those days, so there won’t be as much of an influence on office footprints, according to Summers.
The former Treasury Secretary made a forecast that is a sweet relief to the commercial real estate industry, stating that CRE, with cap rates presently averaging 5.7% across asset classes, represents an attractive investment option when compared to equities and bonds.
In the upcoming months and years, “the position of CRE in portfolios is going to be bigger,” Summers said.
According to Summers, commercial real estate should have a bigger presence in many portfolios. It is very tax advantageous, and it seems even better after taxes.
“A bond currently yields 3.3 percent, and that is all it will continue to yield after 10 years. Property values are far more likely to increase over ten years. It will rise, not fall.” he continued.
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.
Commercial real estate experts won’t be overjoyed by the Federal Reserve’s September Beige Book, also known as the “Summary of Commentary on Current Economic Conditions by the Federal Reserve District.” However, the good news offers optimism for some reprieve in construction, while the bad news is already known.
First, the obvious bad: don’t expect an early end to interest rate hikes since “price levels remained substantially elevated,” which indicates that inflation is still occurring.
In spite of the fact that nine of the Fed’s 12 districts “reported some degree of moderation in their rate of increase,” indicating that at least the rate at which inflation was increasing had slowed, the report stated that “substantial price increases were reported across all districts, particularly for food, rent, utilities, and hospitality services.” That’s a crucial indicator that prices will finally stabilize. But it appears that is still a ways off.
“The Fed still has an inflation concern and is determined to front-load rate hikes as aggressively as possible,” says Jeffrey Roach, chief economist at LPL Financial.”If next week’s inflation report surprises positively, the chances of a 75-basis point boost later this month may grow.”
The Fed also pointed out that certain aspects of real estate still face difficulties. It was noted in the study that, “despite some reports of strong leasing activity, residential real estate conditions weakened noticeably as home sales fell in all twelve districts and residential construction remained constrained by input shortages. Commercial real estate activity softened, particularly demand for office space. “Loan demand was mixed; while financial institutions reported generally strong demand for credit cards and commercial and industrial loans, residential loan demand was weak amid elevated mortgage interest rates.”
The districts that specifically mentioned real estate included Boston, where the outlook deteriorated; Richmond, where activity was flat to slightly down, Atlanta, where there was a mix of commercial and residential real estate activity, Chicago, where construction and real estate declined slightly, and San Francisco, where residential activity slowed.
There were also some encouraging developments in the crucial field of materials. The report stated that lower fuel prices and a decline in overall demand helped to relieve cost constraints, particularly those related to freight transportation rates. However, manufacturing and construction input costs remained high. However, most contacts outside of the Federal Reserve system believed price pressures would last at least through the end of the year. “Several districts reported some tapering in prices for steel, lumber, and copper.”
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.
While CRE transactions may level off this year, investor sentiment is still positive, according to a recent Marcus & Millichap investor poll.
The headline index number of 159 in the mid-year poll is “somewhat similar to the path we witnessed in 2016,” according to John Chang of Marcus & Millichap, in which confidence somewhat dipped as rising interest rates bit into the market. But they’re not down as much as one might anticipate, he adds.
The index fell 12 points in 2016 and there was a flattening of CRE transactions. In what Chang refers to as a “very minor softening,” the index has dropped 11 points this year, and it might produce comparable outcomes.
According to him, “yes, the market is seeing a recalibration as investors redo numbers based on the increasing cost of capital, but the survey respondents aren’t telegraphing a substantial market change.”
The poll indicates that interest rates and inflation are the two main issues for investors. Almost 9% said they would buy more commercial real estate as interest rates rise, while more than two-thirds said they would not change their investment plans as rates rise.On the sell side, 77% claimed that the rate hikes had not changed their plans, and 11% claimed that they intended to sell more as a result.
The survey found that participants disregarded inflation even more. However, over 12% of respondents indicated they would buy more CRE. Twenty-four percent of respondents said they would buy less CRE. A higher percentage of investors overall indicated they would purchase more of the more inflation-resistant property types, such as flats, hotels, and self-storage, with 14.4% indicating they would do so.
In addition to rising interest rates, cap rates are anticipated to climb as well; according to 14% of investors questioned, cap rates will increase by 50 basis points or more during the next year. About 35% predict an increase of less than that, while 27% predict no change. According to Chang, yields and stability look appealing because there is still a lot of cash flowing into CRE.
Think about the fact that the year that just ended, in the second quarter of 2022, was by far the busiest for commercial real estate investment transactions ever, Chang advises. The upcoming year “will probably rank as the second most active year, even if activity slows down a little.
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.
