From Inflation To War Here's What CRE Experts Saw Coming (And Didn't) In 2022

CRE Experts' Predictions For 2022 Were Way Off — And Right On

Many in the commercial real estate world started the year with the global ripple effects of the omicron variant top of mind. But as pandemic restrictions in much of the world have lifted – with the notable exception of China – new concerns have come to dominate conversations about CRE.

While some in the world of commercial real estate predicted economic headwinds after 2021's surprisingly strong year, few were prepared for the volatility of 2022.

Chief among them is the Federal Reserve's rapid pace of interest rate hikes in response to historic inflation, which appears to be finally cooling from this year's record highs.

The factors leading to runaway inflation, including Russia’s invasion of Ukraine, continue to play a role in the real estate sector in ways that weren’t foreseen in January.

Some early predictions proved incorrect: Despite the seemingly mounting political consensus, 1031 exchanges and the carried interest tax loophole were not ended by President Joe Biden’s marquee infrastructure bill. And despite continued industrial demand and the mushiness of today’s office market, developers have yet to trade suburban office parks for warehouses.

In January, Bisnow polled CRE experts for their takes on what would be the dominant trends of 2022. Below, we break down what they got right and what they missed.

Correct prediction No. 1: Rising inflation will compound rising construction costs, resulting in a slowdown or cancellation of some developments.

 

One of the most dominant storylines this year was inflation reaching the highest levels in decades, fueled in part by rising housing prices. The rapid increase in the cost of goods this year forced construction projects with tight budgets back to the drawing board.

In January, Behring Co. founder and CEO Colin Behring correctly predicted that inflation would mix with already rising costs for materials and labor to create bracing construction headwinds, adding: “Projects that were already struggling will be shelved for the time being.”

But Behring also predicted that “only certain areas and asset types will be affected materially,” which proved too optimistic of an outlook. Even the “darlings of real estate,” industrial and multifamily properties, saw their outlooks dim this year due to persistent inflation, Moody’s Senior Economist and Director of Economic Research Thomas LaSalvia told Bisnow in September.

The true effects of today’s difficult economic environment are expected to ripple into 2023. Dodge Construction Network expects the number of multifamily units under construction to be up 16% in 2022 compared to the previous year, but it expects a 9% decline in 2023 due to the effects of rising costs and turbulence.

Correct prediction No. 2: The hotel market will hit new records in 2022. 

Revenue per available room and average daily rates for hotels nationwide have surpassed pre-pandemic records, propelling the sector to an improbably strong year. Between 2020 and 2021, transaction volume rose from $8B to roughly $40B, and the sector appears poised to come close to $40B again this year, if not a bit below it, said Wei Xie, the East Region research lead for JLL.

That recovery, which Xie called “remarkable,” emphatically outpaced the hotel sector’s recovery following 9/11 and the Great Financial Crisis, despite the choppy credit markets in the latter half of this year.

“It took a substantially longer time period to go from the bottom to the peak” in previous crises, Xie said. “I think it's the remarkable speed in terms of recovery, which is driven by the fundamentals.”

The hotel investment sales market appears to be cooling. Despite the sheer volume of trades this year surpassing 2019 levels, the third quarter began to see properties selling at discounts compared to high points set earlier this year, according to a report from LW Hospitality Advisors. The firm predicted a near-term downward pressure on values, though it noted the cost of borrowed funds remained relatively low.

“A tremendous amount of equity earmarked towards the lodging sector remains available, and asset sales are anticipated to continue at a robust albeit reduced pace,” the report found.

Whiff No. 1: Industrial developers will target large office campuses as new sources of industrial development opportunities.

 

151 and 153 Taylor St. in Littleton, Massachusetts, where an office building was demolished and replaced with an Amazon distribution center.

Despite rising distress in gateway office markets around the country, industrial developers have yet to target such properties for redevelopment in a concerted way. In fact, the industrial market faced headwinds of its own, in part because e-commerce giant Amazon acknowledged it had overbuilt capacity by late summer. The subsequent pullback impacted dozens of properties and led to anger in cities like Philadelphia that had bet on Amazon as a job creator.

Even in the mid-Atlantic region centered around Washington, D.C., which is facing some of the most dire warnings about its central business district of any major market in the country, there were zero industrial adaptive reuse projects of large office campuses, according to CBRE Mid-Atlantic Research Director Stephanie Jennings. Jennings said developers are instead targeting struggling retail properties, which are more plentiful along the Baltimore-Washington corridor and elsewhere.

In many places, an office-to-industrial conversion would likely require a zoning change. That is something Xie said municipalities aren't incentivized to do, given the economic benefits of office workers.

Whiff No. 2: The end of 1031 exchanges and the carried interest tax loophole will cause headwinds for CRE.

In the end, it was the great threat that wasn’t — despite early drafts of the Inflation Reduction Act of 2022 removing the carried interest tax loophole often used by some of the largest CRE investors, a proposal that would have closed the loophole was carved out of the final version of the bill thanks to an agreement with Arizona Sen. Kyrsten Sinema.

1031 exchanges were also safe after the world of commercial real estate rallied in favor of the longtime program, ensuring firms can continue to avoid capital gains taxes on certain sales.

And despite a prediction that new spending from the infrastructure and Covid relief bills would have little effect on commercial real estate, there may be some positive knock-on effects as federal dollars are disbursed, said Collete English Dixon, executive director of the Marshall Bennett Institute of Real Estate at Roosevelt University.

“Infrastructure that is used to improve transit systems and water systems and things like that, those are ... improving the environment in which the real estate industry operates,” Dixon said.

Surprise No. 1: The Russia-Ukraine War impacted energy prices, supply chains, and commercial real estate writ large.

 

CRE professionals could be forgiven for failing to predict Russia’s invasion of Ukraine early this year, but pricing in the war’s costs as it drags on has become unavoidable. Impacts on the supply chain and energy, in particular, have helped fuel inflation and negatively impacted property types like data centers.

Many countries around the world moved quickly after the invasion to impose sanctions on Russian billionaires, seizing properties in places as disparate as Baton Rouge, Louisiana, and London. The war also forced companies to make decisions about doing business in Russia, with several firms, including CBRE, Savills, and Knight Frank, shutting down their Russian offices.

The flight of millions of Ukrainian refugees has also put a strain on local housing markets. In Ireland, the influx of roughly 200,000 Ukrainians put pressure on lawmakers to consider a vacant homes tax and temporarily house refugees in camps. In the United States, a nonprofit network that formed first to handle an influx of Afghan refugees broadened its embrace to welcome Ukrainian refugees, sometimes bending the rules for the sake of accommodation.

Surprise No. 2: The Federal Reserve went on an aggressive interest rate hiking campaign.

Though some saw rising inflation on the horizon, few predicted how forcefully the Federal Reserve has responded. The streak of four consecutive increases of the federal funds rate by 75 basis points is the most aggressive campaign of rate hikes since the stagflation era of the 1970s and 1980s. It has already contributed to a 13% decline in values across U.S. commercial real estate.

Roosevelt University's English Dixon said the market had already begun pricing some level of inflation and interest rate hikes into deals, acknowledging the hypercharged market in 2021 was at least in part a pandemic-era fluke. But she said the Fed caught the industry off guard.

“The extent of that increase, how big it was, how consistent it was, it was like, ‘Whoa, give me a second here, I've got to catch my breath,’” English Dixon said. “It hit everybody.”

There are some signs the campaign may be easing as the year winds down. The year-over-year increase in the consumer price index was 7.7% in October, down from 8.2% the month prior, a sign that the higher interest rates may be starting to have the Fed’s desired effect on inflation. That has led some to predict that the Fed may not institute another 75 basis point hike at its next meeting on Dec. 13 and 14.

There are also some signs that Federal Reserve Chairman Jerome Powell may be willing to back off his aggressive interest rate campaign soon as the market adjusts, English Dixon said. If so, that would make the aggressive campaign that began in March a defining but unique characteristic of 2022.

“I think a lot of times, you just consider how many levers you have and if that was the only one you think is effective. But it was just too harsh,” English Dixon said. “I think it will be unique this year. At least, God, I hope so.”

 

Source: From Inflation To War Here’s What CRE Experts Saw Coming (And Didn’t) In 2022

https://www.creconsult.net/market-trends/from-inflation-to-war-heres-what-cre-experts-saw-coming-and-didnt-in-2022/

Off-Market Multifamily Sellers Are Leaving A Ton Of Money On The Table

Off-Market Multifamily Sellers Are Leaving A Ton Of Money On The Table

Marketing a property can increase the sale price by up to 23%, which runs counter to the idea that off-market deals can achieve higher values because a buyer will be more aggressive to seal a trade.

The perception is when a seller has one buyer vying for an asset, that buyer is more aggressive and willing to pay a premium because they don’t want the seller to get into a bidding war for the property. Our research found the opposite.

This is a sign it is in the best interests of owners to undergo a marketing campaign for their properties. Growing allocations from institutional investors toward real estate are still driving a sizable pool of investors into bidding for multifamily assets, and a full campaign is what drives the premiums.

The job of a broker to create a competitive environment on behalf of the seller. Putting a building on the market determines the strongest buyer.

That may not be necessarily based on price alone. If one buyer has a higher-priced offer but weak financial backing, versus a buyer with a stronger track record, taking a lower offer is the way to go. It’s our job to give the seller those options and we do that by marketing properties and generating the highest number of qualified offers possible.

There are numerous case studies where a seller received an off-market bid, put it on the market, and the off-market buyer still bought the asset but at a higher price.

 

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https://www.creconsult.net/market-trends/off-market-multifamily-sellers-are-leaving-a-ton-of-money-on-the-table/

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Co-living the solution to rising apartment rents?

Illinois Real Estate Journal recently spoke with Chicago-based Structured Development and Mark Goodman & Associates to round up the year and discuss up-and-coming trends as they relate to their most recent projects.

Multifamily/Mixed-Use
With thousands of units delivered this year alone, some might call it a year for the books. The market itself remained strong, with rent up about 9% in Chicago YOY. Because of the delay in units being delivered. As a result of continued economic roadblocks, rent is predicted to remain robust throughout 2023.

Trends included an emphasis on co-living and mixed-use, and Chicago-based Structured Development is working on a project that encompasses both, according to Mike Drew, Founding Principal.

As part of The Shops at Big Deahl, a $250 million mixed-use, mixed-income complex being built in Chicago’s Lincoln Park, Structured Development is adding three new multifamily buildings sited on a half-acre, newly constructed park at 1450 N. Dayton St., bounded by Blackhawk, Dayton and Kingsbury Streets.

One of the buildings, Common Lincoln Park, is a 10-story, 400-bed co-living community—the first of its kind in the neighborhood—that will offer one to four private bedrooms per shared apartment, each furnished, and will include a shared kitchen and living space, as well as in-unit laundry. Many of the units will have en-suite bathrooms and all residences will share access to a fitness center, community lounge, screening room, and the building’s various coworking spaces, built to accommodate the increase in people working from home.

Although the units are market rate, co-living is more affordable by nature. Drew said the typical monthly rent of a unit in the building is about $1,500–1,600, versus $2,300–2,500 per month for a comparably-sized studio in the same neighborhood. It’s convenient living, especially for newcomers to the market or young professionals looking for a community-based, social atmosphere.

Another draw? Shorter leases are offered portfolio-wide, with the average term length between 10 and 11 months.

Common Lincoln Park is expected to come online in a few months for occupancy in April 2023, but the journey to build hasn’t always been smooth, as has been the case with many projects across Chicagoland.

According to Drew, Structured Development took a hit after buying the portfolio due to a higher construction cost, but considering the continually rising inflation rate, the price was locked in at the right time.

Office
Office in Chicago has been slow to bounce back, but the numbers have improved since the beginning of the year, with occupancy up 5–10%. More recently, leasing agents have experienced lulls in demand, but most people share the same belief: it will come back with a new strategy from both owners and users.

Mark Goodman, President of Chicago-based Mark Goodman & Associates, said the key to a successful office building going forward is a well-rounded and unique amenity package, like that offered in newer, higher-quality assets like Fulton Market’s 167 Green Street, a 645,000-square-foot dog-friendly building with a hospitality-inspired lounge, rooftop garden, and on-site parking, to name a few. 167 Green Street even has a full-size basketball court, an extreme amenity, but it sets a standard, nevertheless.

Mark Goodman & Associates is currently working with a company that surveys employees to identify the demands that will differentiate their projects from others, but Goodman added that the responsibility doesn’t fall solely on the building owner. It’s up to the businesses, too, to establish a company culture that attracts employees to the workspace.

“Employees are unable to form an attachment to where they work,” Goodman said, “if they don’t have a relationship with their co-workers” that goes beyond the screen.

But this might sort itself out in time as businesses continue to figure out what works and what doesn’t. Some aren’t requiring people to work in office at all, while others are, and many maintain the option that the latter will perform better across the board. How long it will take for businesses to share the same view is unknown.

“That’s not the case now because employees want flexibility, but if businesses that require in-office attendance perform better than those that don’t, eventually that will begin to take hold,” Goodman said.

 

Source: Co-living the solution to rising apartment rents?

https://www.creconsult.net/market-trends/co-living-the-solution-to-rising-apartment-rents/

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One of the Biggest Multifamily Real Estate Deals in Chicago History

In one of the biggest multifamily real estate deals in Chicago history, New York-based Emerald Empire bought the local portfolio of Pangea Properties in a sale exceeding $600 million.

Pangea, one of the city’s largest landlords, is unloading its Chicago properties which include about 7,500 units across more than 400 buildings that its co-founder, longtime area businessman Al Goldstein, worked to assemble in the wake of the Great Recession. He focused mostly on acquiring distressed properties in the South and West sides of the city, buying some of them for less than $20,000 per unit. Since then, the firm has sold very few buildings.

The seller’s move to cash outcomes at a significantly higher price per unit exceeding $75,000, according to a person familiar with the deal. Neither Emerald nor Pangea would confirm the exact price tag. The parties entered into a contract in early May, according to a joint statement from the companies. Pangea’s Indianapolis and Baltimore holdings of thousands more apartment units were not involved in the transaction.

“Emerald has been impressed with Pangea’s operations and long-term strategy for some time,” Emerald principal Moshe Wechsler said in the statement.

Pangea employs about 500 people, its CEO Peter Martay said, and they will be kept on to manage the properties for Emerald.

For Emerald, the acquisition marks a significant expansion of its Chicago-area holdings, which already included multiple multifamily properties in both the city and the suburbs, including the four-story, 37-unit Onyx at North Shore property.

Some of the structures of Emerald’s newly purchased portfolio are similar to its existing Chicago assets but now extend into the South and West sides of the city. The portfolio Pangea is moving on from is primarily mid-market to formerly rundown buildings with dozens of units. The firm, however, invested in renovating its properties while they were under its ownership.

While details of the loan haven’t yet been made public or disclosed by Empire, the sale is being financed by an Arbor Realty Trust team, including Hamir Ramolia and Maurice Kaufman.

The deal moved forward even as Pangea is being sued by tenants in a Cook County Court complaint that was brought over the summer. While the suit is still pending and no major decisions have yet been made on the next steps for the case, it alleges Pangea risked the safety of tenants by ignoring requests for repairs and racking up thousands of city code violations, including for infestations of rats and insects and failing to provide working heating in the wintertime.

Pangea said at the time that the allegations were unfounded. The lawsuit had no impact on the real estate transaction, the parties said.

 

Source: One of the Biggest Multifamily Real Estate Deals in Chicago History

https://www.creconsult.net/market-trends/one-of-the-biggest-multifamily-real-estate-deals-in-chicago-history/

CRE Beware: Niche Markets, Specialized Talent Will Win Big In 2023

In the weeks following a tough round of cost-cutting and layoffs, there’s plenty to lament in the commercial real estate industry, but for certain niche markets, property types, and service lines, these recessionary market conditions present a set of opportunities in the coming year.

Funding and investment will shy away from the battered office market and toward alternative opportunities, such as asset and portfolio management, distressed assets, and housing alternatives.

The money will also follow firms and brokerages with adequate talent and experience to tap into these smaller sectors and those with the management expertise to make the most of existing portfolios as deal counts decline, according to analysts and industry leaders.

“These niche sectors are becoming mainstream in the sense that people see them truly as a place to invest," said Anita Kramer, senior vice president at the ULI Center for Real Estate Economics and Capital Markets.

But these concentrated sectors often have limited room for growth, increasing competition between a larger pool of investors looking to branch out and perhaps chase the same deals, Kramer said.

“The options are shrinking, but the right option can be very good,” she said. “There’s a sense that these opportunities aren’t as big as the major sectors.”

Existing portfolios, placed under more pressure to perform, will help shape the job market, and firms will hire differently, said Spencer Burton, Stablewood Properties partner and head of real estate developments.

The economic and interest rate environment has placed many investors in a wait-and-see mode, suggesting that there will be a higher value placed on the performance of asset managers and portfolio management, especially in the near term, he said. Moving into a new cycle will also place more value on those who can work with debt and distressed property.

“The big opportunities for 2023 will be in forced asset sales and distressed debt,” Bullpen CEO Tyler Kastelberg said. “We're hearing more and more murmurs about sponsors being required to put more cash into a deal in order to refinance it out of a bridge loan into long-term debt. When they can't come up with the cash, they are forced to put the property on the market. Per some of my broker contacts, this is becoming more and more common.”

This means asset managers are going to “be the star of the show,” he said, as distressed assets typically require a greater degree of management and a steady hand to turn around.

Another risk factor portfolio owners will seek to mitigate is climate change, BREEAM U.S. Director of Operations Breana Wheeler said. Investors, especially those operating in high-risk regions with older, less stable assets, will seek to remedy these risks by allocating increased capital toward retrofit projects that improve operational efficiency, mitigate physical climate risks, and address transition risks. like potential obsolescence and rising insurance costs.

“This will be especially important to investors as legislation passed in 2022, like the Inflation Reduction Act, and new regulations looming for 2024, like the pending enforcement of Local Law 97, concurrently amplify the fiscal penalties and financial rewards associated with heavy building emissions and emission reduction,” Wheeler said.

Amid these different sources of uncertainty, the relationship between tech, data, and real estate, specifically how better data analysis can support or supplant decision-making in an industry that likes to think it runs on experience and intuition, will put data scientists in much higher demand, Burton said. It has been a consistent theme in CRE hiring outlooks, especially during downturns, that the industry’s slow adoption of tech and desire for more certainty means data-driven decision-making is becoming more vital.

“It's kind of a reshuffling of the deck as we move into a new cycle,” Burton said. “Your growth is going to come from noncore subtypes, so if you’re an employee with those skills, there’s a real opportunity.”

Self-storage is one of many niche property sectors expected to see rising investment in 2023.

Burton pointed to self-storage, student housing, build-to-rent, and single-family rental, as well as manufactured housing, as subsegments in which demand, in many cases due to a growing rental population, will increase the need for specialists in alternative housing types. There’s increasing demand for the institutionalization of these subtypes, so those who understand the financing behind these transactions will be very busy.

“We think of real estate in terms of strategy, sponsor, and structure: Strategy is someone who understands the property types and opportunities,” he said. “A sponsor is someone who understands how to operate the property, and structure is an individual experienced in the capital and capital stack. It’s going to be all of the above that have opportunities over the next decade.

The growing need for rental properties will also continue to fuel growth in multifamily, AmTrustRE President Jonathan Bennett said. Space constraints will mean that entrepreneurial developers will need to work with municipal and zoning boards to increase potential development sites that feed the country's housing stock and focus on conversions.

“As the conversation around office-to-multifamily conversions progresses, we can definitely expect to see traditional commercial developers shift a portion of their focus to apartment properties,” Bennett added. “Investors and developers without a significant multifamily track record will likely seek to partner with multifamily specialists that already have the expertise needed to successfully take on apartment development, or look to hire internally and expand their company’s core competencies from the inside out.”

Industrial, a powerhouse during the pandemic e-commerce boom, has seen retrenchment in recent quarters, but Kramer predicts more focus on the complexities of reshoring supply chains and building up backstock of supplies to overcome any supply chain hiccups.

Another aspect of industrial that shouldn’t be overlooked is manufacturing and onshoring, Burton said. From a real estate standpoint, the growth in new factories and manufacturing centers will require specific land acquisition and construction and development, but he also predicts more business for business development and location specialists, as well as those who understand how to build new housing for the growing workforces these centers will attract.

And finally, the office shouldn’t be completely written off. While there will be plenty of Class-B and C spaces, especially in certain central business districts struggling for tenants, there’s still a healthy, albeit limited, appetite for trophy office space. Footprints will be smaller due to large shifts to hybrid work, but the sector has become highly bifurcated, ULI’s Kramer said, with tenants seeking smaller, higher-quality spaces. Brokers who can understand new workplace realities and deliver on the need for high-end, shorter-term, quick-to-activate leases will do well, as well as designers and architects focused on spec offices and renovations.

“In addition to highly amenitized workspaces, companies will be interested in flexible lease terms for an office where they can expand or condense as needed, without compromising best-in-class features, to help them weather continued changes in the workforce and the broader economy,” Inspired by Somerset Development President Ralph Zucker said.

 

 

Source: CRE Beware: Niche Markets Specialized Talent Will Win Big In 2023

https://www.creconsult.net/market-trends/cre-beware-niche-markets-specialized-talent-will-win-big-in-2023/