Recession in 2023 CRE in Good Shape to Sail Through It

Former US Treasury Secretary sees "substantial ferment and opportunity" for CRE markets in coming contraction.

On a day when a stubbornly high inflation rate threw cold water on everyone’s hope for a soft landing for the US economy, former US Treasury Secretary Lawrence Summers assured CRE executives that “if the car’s going faster, we need a stronger brake, but that doesn’t mean we’ll hit the wall before the car stops.”

In a wide-ranging online discussion hosted by Marcus & Millichap CEO Hessam Nadji on Tuesday, Summers predicted that continued rate increases by the Fed soon will create a “recession of choice” that will bring the unprecedented job growth of the past year to a halt.

“We have incessant inflation due to a collision between demand and supply, and the Fed intends to contain it by restricting demand by raising rates,” Summers said. “My best guess is that the economy will go into recession and we’ll have a year of contraction of job growth.”

But the former Treasury chief said the economy—and the CRE sector in particular—is in much better shape to weather an economic downturn than it was in 2008 when the housing market collapsed.

“We won’t see something like 2008 again,” Summers said, noting that homeowners are much less leveraged, inventory is not overbuilt and lenders are stronger and much more careful in underwriting mortgages than they were during the sub-prime crisis.

Summers signaled that it may take a few months for the recession to materialize because fundamentals like consumer spending remain robust—and still have some room to grow.

“It’s important to remember that there’s still a big savings overhang. The amount of money that people couldn’t spend during the pandemic is $2 trillion,” Summers said.

“Only $300 billion of that has been spent, and more than half of it is [still] in checking accounts. That tells me that consumers will keep going. I don’t think they’ll run out of room to spend because of devalued paychecks,” he said.

Summers counseled CRE players not to assume that “structural” trends that have been unleashed by the pandemic—including the rise of remote work and the surge in e-commerce—will impact negatively on the demand for CRE.

“There will be substantial ferment and opportunity in CRE markets, even in a year—or two—when you won’t see job growth,” Summers said.

“Many people think it will be bad if people work from home. That’s wrong. When people go to different places, their migration becomes a source of real estate demand,” he said, adding that the rapid expansion of e-commerce during the pandemic created an exponential demand for warehouses.

Regarding the office sector, Summers thinks hybrid work is here to stay, but he does not believe it will have as much of an impact on office footprints as some may be projecting.

“A lot of people will go substantially remote. Employers are going to get better at monitoring remote work and they’ll become a bit more accepting of work at home,” he said.

“But if people come to the office three days a week, the employers will want everyone to come in on the same three days, so that will have less impact on office footprints,” Summers said.

In a prediction that is sweet music to the ears of the commercial real estate sector, the former Treasury Secretary said CRE—with cap rates currently averaging 5.7% across asset classes—remains a compelling investment opportunity compared to stocks and bonds.

“The role of CRE in portfolios is likely to be greater” in the months and years to come, Summers said.

“For a large number of portfolios, there should be a larger place for commercial real estate,” Summers said. “It’s substantially tax-advantaged, and on an after-tax basis, it looks even better.”

“A bond is 3.3 percent and that’s all it’s going to be at the end of ten years. The value of the property is vastly more likely to appreciate [over ten years]. It will go up, not down,” he added.

 

Source: Recession in 2023 CRE in Good Shape to Sail Through It

https://www.creconsult.net/market-trends/recession-in-2023-cre-in-good-shape-to-sail-through-it/

US Apartment Sales Outpace Last Year Despite Higher Interest Rates

Analysts Have Mixed Projections on Whether Momentum Can Carry Through Fourth Quarter

U.S. apartment sales during the past nine months have outpaced last year but some analysts say it could fall short in the fourth quarter of reaching 2021’s record level.

Apartment sales volume totaled $174.4 billion through the end of September, led by a record second quarter of nearly $75 billion, according to CoStar data. Third-quarter sales were lower than last year but roughly on par with 2019.

Last year’s sales followed a 2020 pandemic-induced lull. Rent growth boomed in the back half of 2021 to help drive investor interest in apartments.

Rising interest rates this year haven’t seemed to quell the appetite of investors for apartment deals even as rent growth is softening. But to match last year’s record volume, fourth-quarter sales would have to hit $87 billion, which would make it the second-highest quarter ever behind last year's fourth quarter of $115.1 billion in deals, according to CoStar.

That's one reason industry analysts and executives have mixed predictions on how apartment sales will shape up for the rest of the year.

Transaction volume probably will slow in the fourth quarter “with the cost of debt up significantly and Treasuries rising at the fastest rate since the 1980s,” Sam Tenenbaum, head of multifamily insights for Cushman & Wakefield, said in an email. But he added that “it’s worth noting that through August, we saw more transactions close in 2022 than in any full year other than 2021.”

Jay Lybik, CoStar’s national director of multifamily analytics, said there’s zero chance that fourth-quarter sales will put this year on par with last year.

Inflation

On the other hand, Brad Case, chief economist for Northern Virginia-based apartment developer Middleburg Communities, said in an email he’d be surprised if higher interest rates did much to inhibit rental housing investment.

“First of all, borrowing costs will continue to increase because — and to the extent that — inflation continues to be high and macroeconomic conditions continue to be strong,” Case said.

Rental housing is one of the only avenues with inflation protection because strong macroeconomic conditions tend to mean more people decide to get their own place and form households, increasing demand, Case said.

Demand for rental housing is expected to outstrip supply through the rest of this year while construction only increases moderately, according to Berkadia's 2022 Mid-Year Powerhouse Poll. Berkadia, one of the largest U.S. multifamily lenders, surveyed more than 120 investment advisers and mortgage bankers about what to expect for the remainder of 2022 and released the results in August.

Most of those polled said despite strong rental demand, higher interest rates and inflation are affecting local markets. According to the poll, investor interest was strongest in the Southeast and weakest in the West.

In addition, the majority of respondents believe that long-term investments will be most attractive to institutional clients in the next one to two years, according to Berkadia.

 

Source: US Apartment Sales Outpace Last Year Despite Higher Interest Rates

https://www.creconsult.net/market-trends/us-apartment-sales-outpace-last-year-despite-higher-interest-rates/

Multifamily Conversions Could Be a Lifeline for Chicago's Ailing Hotels

Turning Distressed Downtown Hotels Into Apartments May Just Be Their Highest, Best Use

For most areas in downtown Chicago, the precipitous drop in office occupancy is devastating to more than just the office landlords. Fewer downtown workers equal less demand for retail tenants and for hotels relying on midweek business travel.

By year-end 2021, Chicago hotels’ revenue per available room, or RevPAR, was down 40% compared to 2019, with that performance ranking in the bottom third of the top 25 U.S. markets tracked by STR, CoStar Group's hospitality analytics firm. It doesn’t help that six hotels — making up over 3,400 keys and 2.5 million square feet of inventory — are 90-plus days delinquent on their loans and in special servicing or foreclosure, such as the JW Marriott Chicago and the Palmer House Hilton.

To solve Chicago's hotel inventory problem, owners and investors should consider converting some of these assets to multifamily use.

Looking at what's happening in the downtown apartment market, it makes sense. Demand downtown is at peaks never seen before, with 3,800 units absorbed year over year. The Loop business district and adjacent submarkets command some of the area's highest rents at $2,834 per unit and the most compression in vacancy rates with a 3.6% decline, posting a 5.5% overall rate.

Yet development here appears to be tapering off, with only 3,600 units under construction this quarter, most of which will be completed by 2023. For context, this is below the 10-year average of 5,000 apartments built per year. As such, this amount represents the smallest percentage of multifamily space under construction in the area since mid-2011. There is certainly room for growth.

Missing Business Demand

Meanwhile, downtown Chicago’s hospitality demand is heavily reliant on large citywide conventions, conferences and corporate tourism, all of which have yet to bounce back. Chicago’s challenges in regaining its business travel, and therefore pushing up its hotel occupancy rates, are driven by a multitude of factors that stymie the local hospitality sector’s profitability and cash flow.

Year to date through June, market RevPAR is still 14% below 2019 levels. And office occupancy levels are still only 42% of those reached before the pandemic, according to security tech firm Kastle Systems' Back to Work Barometer. Combine this with increased hotel operating expenses, heightened labor union-related costs, diminished leisure and business travel, and increased fears of recession and discretionary spending dips, and the outlook for Chicago’s downtown hospitality sector is less attractive when compared to urban markets whose occupancy demand is more diversified.

Converting distressed hotel buildings in Chicago certainly comes with challenges that go beyond the necessary space reconfigurations and specific guidelines for preserving the facades and decor of architectural treasures. There is competition from new multifamily construction and proposals far along in the pipeline. At last count, there were another 4,000 units developers hope to deliver by the end of 2023.

However, the potential to turn an underperforming hotel into a thriving multifamily complex is still supported by today’s demand and by key stakeholders, from politicians and city planners to developers experienced with this kind of commercial real estate transformation. Hotel amenities such as parking, pools, restaurants, bars, and dry cleaning and laundry rooms are virtually plug-and-play options for residential use. Mechanical, electrical, and plumbing upgrades and changes should be relatively easy compared to an office-to-multifamily conversion. Some local examples of successful transformations were when the 100-room Seneca Hotel & Suites became the 268-unit Seneca apartments and when the single-room occupancy hotel The Carling was renovated to its current incarnation as the 80-unit Carling Hotel apartments, an affordable housing property.

 

The greatest reason to convert, of course, is the potential upside for investment returns. Year to date, the average three-, four- or five-star apartment building in Chicago sold for $361,000 per unit and $313 per square foot. The average downtown Chicago hotel sold for $155,000 per unit and $147 per square foot. The roughly $200,000 per unit and $170 per square foot differential could result in a solid profit margin from a stable multifamily investment, even after factoring in conversion costs. If one considers the Seneca conversion mentioned above, where the property increased its unit count almost threefold, the creative developer has an opportunity to create more usable, profit-making square footage within a project.

 

 

Source: Multifamily Conversions Could Be a Lifeline for Chicago’s Ailing Hotels

https://www.creconsult.net/market-trends/multifamily-conversions-could-be-a-lifeline-for-chicagos-ailing-hotels/

Chicago Unveils Effort To Create Hundreds of Affordable Apartments in Converted Office Buildings

Mayor Offers Tax Breaks, Other Incentives for Adaptations of Buildings in City's Longtime Financial Corridor

Chicago officials are soliciting proposals to convert vintage office buildings into hundreds of affordable apartments on a stretch of the city’s one-time LaSalle Street financial corridor that in recent years has lost large tenants to new developments.

The city is offering several types of financial incentives, including tax increment financing, to developers willing to set aside 30% of the units as affordable in a residential conversion, Mayor Lori Lightfoot and other officials announced.

If the plan succeeds, it could become a national model as large cities grapple with the effects of COVID-19 on central business districts.

The long-expected initiative is designed to address two challenges in Chicago’s Loop business district, which have taken on greater urgency since the onset of the pandemic in early 2020: high vacancy in older office buildings and a low supply of housing with below-market rents.

"There is nearly 5 million square feet of vacant commercial space on the LaSalle Street corridor, but not a single unit of affordable housing," Lightfoot said in a statement. "Diversifying this corridor is an essential component in our strategy to restore LaSalle's vitality, create more neighborhood-serving retail, and foster a more inviting pedestrian environment in the heart of the Loop that will benefit all Chicagoans."

Chicago wants to create more than 1,000 new residential units in historic office buildings on and adjacent to LaSalle, with 300 units that meet affordable-housing standards. Officials also want to see vacant retail spaces converted into neighborhood amenities such as locally-owned grocery stores and restaurants.

The city also is looking into potential changes to the street’s infrastructure to make it more pedestrian-focused, according to the statement.

Business First

LaSalle Street is known for its canyon of historic skyscrapers, anchored at the south end by the Chicago Board of Trade Building. In recent years, LaSalle has lost large tenants, including Bank of America and BMO Financial, to new skyscrapers along the Chicago River and, farther west, to Fulton Market developments.

The pandemic’s effects on the area have been studied extensively, including an Urban Land Institute report, the city’s “Central City Recovery Roadmap” study and input from groups including real estate professionals and the Chicago Loop Alliance.

Chicago’s initiative “is a direct response to the need for a coordinated and comprehensive strategy that repositions the street as one of the most innovative, equitable and forward-thinking thoroughfares in the country,” the city’s planning commissioner, Maurice Cox, said in the statement.

“As one of Chicago’s most architecturally compelling and transit-served corridors, there should be more mixed uses and far more economic activity both inside and outside of corridor properties,” Cox added in the statement.

Now the city wants to move fast to line up proposals. The Chicago Planning Department scheduled an Oct. 18 conference for interested developers, and it plans to pick as many as three winning adaptive reuse proposals following a Dec. 23 deadline.

The selected projects would be eligible to submit plans requesting some combination of TIF funds, historic tax credits, low-income housing credits, and tax credits for energy efficiency upgrades.

The city said it already is in contact with property owners that are considering residential conversions, have a building up for sale or would be willing sellers, but city officials will not seek acquisition authority for privately owned buildings.

Architecturally Significant Buildings

Preference will be given to conversions involving architecturally significant buildings. Most of the LaSalle corridor already is on the National Register of Historic Places as part of the West Loop-LaSalle Historic District, and seven buildings are Chicago landmarks, according to the city.

No specific financing models or dollar figures are outlined in the city’s invitation for proposals document.

Applicants are expected to already own the building or provide confirmation of a contract to buy it, which can include contingencies. Proposals also should include plans to accommodate or relocate existing office tenants.

To be eligible, buildings must be located on LaSalle or within a block to the east or west, from Washington Street to the north and Jackson Boulevard to the south.

Chicago’s planning and housing departments and downtown Alderman Brendan Reilly of the 42nd Ward will review proposals, which then will be presented to the Community Development Commission for recommendation to the City Council.

Selected developers will have the option of selling or leasing the affordable portion of their buildings to an authorized affordable housing agency.

“This is a major step in helping revitalize an important corridor in Chicago’s central business district,” Reilly said in the statement. “I look forward to reviewing the final proposals and working alongside Mayor Lightfoot to reinvigorate and redevelop the heart of Chicago’s economic engine."

Upping Requirements

Chicago in recent years has increased the threshold for the Affordable Requirements Ordinance to require new residential projects to provide 20% of the units at affordable rents.

Yet conversions of existing buildings don’t trigger ARO standards unless they require a zoning change or other action by the city.

That has meant that a developer could buy existing offices and covert them to residential without providing any affordable units. One such example was the recent conversion of a 13-story office building at 29 S. LaSalle into 216 apartments.

Under the city’s new plan, a developer still could convert a building without providing any affordable units. The Lightfoot administration hopes the multiple layers of funding available will offset the loss of market rents enough that developers will lean toward affordable projects.

Details of the plan are emerging not long after Google’s announcement in July that it plans to buy and occupy the 1.2 million-square-foot James R. Thompson Center at 100 W. Randolph St., which is expected to bring thousands of new workers to the Loop and revive a formerly state-owned building in need of extensive repairs.

Chicago-based Prime Group, which is involved in the Thompson Center redevelopment for Google, is involved in one office-to-residential conversion already in the works.

Prime Group bought the Helmut Jahn-designed building for $105 million, with Google agreeing to later buy the redeveloped building from Mike Reschke’s firm for an undisclosed price.

Reschke’s Thompson Center deal came as his firm also was finalizing an approximately $118 million purchase of two buildings on and alongside LaSalle that BMO Financial is in the process of vacating.

The $105 million payment to the state for the Thompson Center included $30 million in cash and title to one of the former BMO buildings, a 37-story tower at 115 S. LaSalle where Illinois employees will move from the Thompson Center. That building was valued at $75 million in the exchange.

 

Reschke has said he plans to convert at least part of the other structure, a 23-story building at 111 W. Monroe St., into apartments. In August, he said Prime Group planned to invest about $80 million in switching the top 10 floors to about 275 apartments, with the possibility of converting the entire building to residential if office leasing remains soft.

Source: Chicago Unveils Effort To Create Hundreds of Affordable Apartments in Converted Office Buildings

https://www.creconsult.net/market-trends/chicago-unveils-effort-to-create-hundreds-of-affordable-apartments-in-converted-office-buildings/

Chicago's Apartment Demand Fundamentals Offer Upside Stability to Investors

The Chicago multifamily market features some of the most steady and stable demand fundamentals in the United States. Over the past five years alone, Chicago increased its occupancy levels and households and doubled its rent growth returns, all while population growth declined in absolute numbers.

 

Source: Chicago’s Apartment Demand Fundamentals Offer Upside Stability to Investors

https://www.creconsult.net/market-trends/chicagos-apartment-demand-fundamentals-offer-upside-stability-to-investors/

Housing Market Outlook: Builders Could Stop Construction Due to Expense Falling Demand

 

• Despite falling demand from homebuyers, experts have maintained that the US real estate market is healthy.
• But recent data on homebuilding highlights a dark storyline brewing.
• Builders are feeling the pain of tanking demand and are slowing down new construction, fueling a vicious cycle.

For months economists and housing experts have maintained that the US housing market is in relatively good standing despite a decline in affordability and buyer demand.

While it's not the foreclosure crisis of 2008, today's real estate market also has a dark side.

It all stems from the fact that fewer and fewer Americans can afford to buy the limited homes available, especially as interest rates rise. Homebuilders are feeling the pain of tanking demand and are slowing down housing construction — contributing to the housing crisis vicious cycle.

Peter Schiff, the chief economist at investment company Euro Pacific, told his more than 800,000 Twitter followers that soon "new home construction will almost completely shut down."

"That's because it will be too expensive to build new homes that most buyers can actually afford," he said in a tweet. "The housing market will consist almost exclusively of existing homes that will sell for less than the cost to replace them." Although dramatic, Schiff's pessimistic tweet may foreshadow what's to come in the real estate market.

In July, residential housing construction plummeted 9.6% to an annualized rate of 1.4 million units, according to the Census Bureau. The decline marked the slowest rate of home construction since February 2021 and highlights how rising costs are leading to less affordable housing options for Americans.

"Affordability is the greatest challenge facing the housing market," Robert Dietz, the chief economist at the National Association of Homebuilders said in a housing report. "Significant segments of the home buying population are priced out of the market."

Indeed, higher housing costs have dampened affordability for many Americans. Data from the US Census Bureau shows that an increasing number of people are falling behind on their rents.

Americans have a volatile economy to blame for surging housing prices. Inflation and interest rate hikes have increased the costs of everything from construction to mortgage lending. It has made it harder for builders to construct more low-cost homes and as a result, buyers' ability to afford home purchases. This has led to increased rental demand and ultimately higher rents across the nation — it has also created a downturn in the US real estate market.

With fewer people competing for homes, the real estate market is losing steam. In July, nationwide new home sales fell to a six-year low, declining to just 511,000 units. During the month, existing home sales — a measure of sales volume and prices of existing housing inventory — declined for the sixth consecutive month, falling to a two-year low as only 4.81 million units were sold.

In August, Diane Yentel, the president and CEO of the National Low Income Housing Coalition, testified in front of the US Senate Banking committee that the nation's housing ecosystem has taken a turn for the worse.

"Pre-pandemic millions of extremely low-income households — disproportionately people of color — struggled to remain housed and more than half a million people experienced homelessness," she said. "Now as resources are depleted and protections expire, low-income renters are faced with rising inflation, skyrocketing rents, and eviction filing rates are reaching or surpassing pre-pandemic averages."

As emerging data points to a possibility of a housing recession, Yentel is not alone in her concerns — more economists are giving warnings.

"The whole housing sector is now in retreat," Ian Shepherdson, the chief economist at Pantheon Macro, "told Forbes, adding that housing construction will likely continue falling until early 2023 — and that could mean the US housing affordability crisis is just getting started.

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Source: Housing Market Outlook: Builders Could Stop Construction Due to Expense Falling Demand

https://www.creconsult.net/market-trends/housing-market-outlook-builders-could-stop-construction-due-to-expense-falling-demand/

Sunny with a chance of headwinds: CRE forecast, according to its leaders

 

If you don’t like the weather in Chicago, wait a few minutes…it’s likely to change.

Another thing that is seeing a fair amount of change is the overall sentiment for CRE in Chicago. Last year’s DePaul Real Estate Center Mid-Year Report found that 60% of industry participants were generally optimistic about the industry as they looked ahead. But in 2022? The DePaul-ULI Chicago Report found that 65% are trending toward concern when looking at 2H2022.

Headwinds have gained steam locally, nationally, and internationally, as professionals are concerned about construction costs, labor issues, inflation, interest rates, and speculation of a recession. There’s also less confidence that related issues like crime and the effectiveness of the local political system can be resolved quickly or easily. But through it all, one asset class has remained largely untouchable. Industrial.

According to DePaul, Hugh Williams, Principal, MK Asset Brokerage, and Director of Entrepreneurship/Strategic Relationships for Sterling Bay, when asked about the health of the market, pointed to Prologis’ initial offer to acquire Duke Realty. Prologis was offering a premium, plus upside.

“When you see that, and with vacancies in the sub 4% range, it signals strength and optimism,” Williams said. “We are at one of the high water marks. No one knows if we are at the top, but over the recent long-term, the strength of the market has only gone in one direction, and new baselines have been established.”

That’s not to say the market is exempt from concerns, though. Even the strongest markets must remain creative and be willing to approach issues a little differently. CRG President Shawn Clark noted that, on a recent project in Country Club Hills, the increasing cost of steel prompted CRG to purchase the necessary steel for the 1,033,450-square-foot building before they closed on the 70 acres of land, based on the report. But if the steel had been purchased as typical, the cost would have been more than double.

From the perspective of Molly McShane, CEO of The McShane Companies, “Going from just-in-time to just in case is a real strategy businesses are using, and it is driving demand. As long as that continues, the market is in a good place.”

So while it’s true that there are concerns about the remainder of 2022, 50.9% said they are bullish or optimistic about market conditions in 2023. And despite headwinds, there are investors who continue to believe in the future of Chicago. DePaul said while it may be based, in part, on a “right corner, right project” viewpoint, there remains an appeal about Chicagoland and a belief that all issues will soon be resolved.

 

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Source: Sunny with a chance of headwinds: CRE forecast, according to its leaders

https://www.creconsult.net/market-trends/sunny-with-a-chance-of-headwinds-cre-forecast-according-to-its-leaders/