SVN | Research Economic Update 09.29.2023

1. INTEREST RATE DECISION/ECONOMIC PROJECTIONS

At its September 20th meeting, FOMC officials left their benchmark interest rate unchanged, just their second pause since they began tightening rates in March 2022.
Markets and onlookers were well-prepared for the decision, with futures markets pricing in a no-hike scenario in September for the past several weeks. Like their recent pause in June, officials leaned their decision on recent data, expressing a need to “proceed carefully” in determining the direction and magnitude of the policy decisions moving forward.
Key officials have signaled their expectation that at least one more rate increase will occur before the year’s end. In its accompanying Summary of Economic Projections, the Fed’s dot-plot forecasts an additional 25 bps hike in 2023 before two cuts in 2024. Notably, this month’s projections indicate two fewer rate cuts in 2024 compared to their last projections released in June.
The Fed’s projections also revised up expectations for 2023 end-of-year economic growth, forecasting GDP to rise 2.1% this year.

2. CONSUMER CONFIDENCE

US consumer confidence fell to a four-month low in September, eroded by resurging concerns around inflation and a potential US recession, according to the latest data from the Conference Board.
Consumers continue to shift towards a more pessimistic outlook despite relatively upbeat views about the present day. One of the components of the Conference Board’s index—the present situations index— which assesses consumers’ opinions on current business and labor market conditions, rose slightly during the month. Meanwhile, the expectations index, based on consumers’ short-term forward outlook on those same conditions, has fallen for back-to-back months.
After recession fears reduced throughout the summer, they are evidently on the rise again. According to the report, consumer fears of an “impending recession” ticked up slightly during the month.

3. HOME SALES & PRICES

Sales of new single-family houses in the US fell 8.7% to a seasonally adjusted annualized rate of 675,000 properties in August, according to the latest data from the US Census Bureau.
The decline in August is in line with recent mortgage rate movements, which have continued to rise in September and could signal further downside effects to demand on the horizon.
The Midwest witnessed the most significant decline in sales on a percentage basis, dropping -17.2%, while the South saw the steepest rise, climbing by 7.5%.
The median price of a new single-family home sold was $430,300 in August, down from $440,300 one year ago.

4. INDEPENDENT LANDLORD RENTAL PERFORMANCE

On-time rental payments in units operated by independent landlords remained robust in September 2023, with 82.6% of tenants completing their monthly payments on time, according to the latest data from Chandan Economics.
Despite sliding slightly from August, September’s national on-time payment rate remains above its 12-month average (82.4%). Currently, it stands 241 bps higher than September 2022 — reflecting the sector’s arch of continued improvement.
September’s forecast full-payment rate, which takes on-time payments, late payments, and expected late payments based on historical trends, came in at 92.7% — decreasing by a marginal 19 bps month-over-month.
Western states continue to hold the highest on-time payment rates in the country, led by Colorado (92.6%), Utah (91.5%), Arizona (88.3%), North Dakota (88.1%), Washington (87.7%), and California (87.1%).
Small multifamily (5-49 units) rental properties held the highest on-time payment rates of all sub-property types in September, coming in at 83.2%.

5. DALLAS FED MANUFACTURING INDEX

According to the latest data from the Dallas Fed’s manufacturing Index, manufacturing activity—which has fallen consistently over the past year— accelerated its decline in September.
The Dallas Fed index serves as a helpful barometer for nationwide manufacturing activity. September was the first month since May that the decline in activity has accelerated and signals a continued deterioration in business activity even as recession fears have reduced in recent months.
Meanwhile, the production subindex of the report rebounded by nearly 20 points in September and climbed to its highest index reading of 2023. The New orders subindex of the report also rose during the month but remained in contraction as consumer demand continues to soften, but at a slower rate compared to earlier this year.
The shipment subindex also moved higher and close to zero— a level consistent with neither expansion nor contraction.
An uncertainty gauge of the index also saw a notable increase, in line with recent sentiment movements in small business optimism and consumer inflation expectations.

6. BEIGE BOOK SUMMARY

According to the Federal Reserve’s most recent Beige Book summary, contacts from most bank districts reported modest economic growth to end the summer.
Consumer spending on tourism was stronger than expected, though many expect the surge to trail off as the fall begins and consumer savings rates seemingly dwindle.
Retail spending continued to slow, especially on non-essential items. New auto sales expanded in many districts, but this was more linked to increased inventory and availability rather than increased demand. The next edition of the Beige Book, due out in mid-October, will better reflect the impact of the recent United Auto Workers (UAW) strike, which began on September 15th.
Manufacturing contacts across several districts noted improved supply chain activity and a better ability to meet existing orders, but most districts saw a decline in new orders over this period.
Single-family homes were the one sector where supply did not increase, indicative of the significant inventory constraints the housing market has felt following its pandemic-era boom. Construction activity has risen in recent months, but several districts note that the construction of affordable housing units remains underwhelming relative to demand.

7. POTENTIAL ECONOMIC IMPACT OF UAW STRIKE

On September 15th, the United Auto Workers initiated a strike against the three major unionized US car manufacturers, GM, Ford, and Stellatis—striking all three for the first time in history, with potentially significant short-term implications for the US economy.
Beyond the implications for the manufacturers and their workers, downstream effects from the strike include potential car dealer shutdowns, exacerbating existing car inventory shortages, increased vehicle prices, and potentially widening bond market credit spreads.
If prolonged, the strike could even influence mortgage rates, particularly in regions of Michigan and Ohio, where closed plants may result in a regional recession. Slower growth in these regions could send rates lower, benefiting homebuyers but potentially stoking inflation further. Income loss among workers may also affect local spending and home-price trends.

8. GOVERNMENT SHUTDOWN

The prospects of a fourth Federal government shutdown in the last ten years were raised this week after Congress failed to agree on either a stopgap or permanent spending bill with an October 1st deadline swiftly approaching.
The immediate impact of a government shutdown is mainly felt by Federal workers, who are often furloughed as a result, while others work with delayed pay, which can seep into local economic fundamentals.
According to an analysis done by Pew Research, since the passing of the 1974 Congressional Budget Act—which outlined the modern structure of the appropriations process— Congress has only passed all its required appropriation measures on time four times. Further, there have been five government shutdowns since 1995.
Typically, Congress relies on continuing resolutions (CR) to buy itself time to address legislative budget gridlocks, which usually extend funding levels from the prior year for existing programs. However, it is unclear if Congress can rely on a CR this time, as the current difficulty preventing an agreement surrounds a push by some House members to enact deep spending cuts to existing programs.

9. CRE OFFICE LOAN MATURITIES

Out of roughly $1.1 billion in office loan balances that had original maturity dates in August, only 7.7% were reportedly paid off, according to a recent analysis by Moody’s Analytics.
The analysis notes that declining payoff rates are explained mainly by the underlying performance of maturing loans rather than a deterioration in the ability of stronger-performing loans to complete payoffs. According to Moody’s Analytics data, 70% of the August loan maturities had “significant lease rollover” and debt yields below 8%.
Looking at the payment status of loans set to mature in 2023 but did not pay off, 40% continue to make monthly payments, while 60% are non-performing.

10. PRODUCER PRICE INDEX: IMPLICATIONS FOR RETAIL

A new analysis by Trepp notes that a significant surge in the Producer Price Index (PPI) in August may add pressure to consumers whose spending has kept retail margins afloat in the face of rising interest rates.
According to the BLS, the PPI for final demand goods rose by a seasonally adjusted 0.7% in August — 30 basis points above its July rise and the largest month-over-month increase since June 2022.
The increase in wholesale prices significantly outpaced advanced forecasts by WSJ economists and signaled a persistence of production cost pressures on manufacturers. According to Trepp’s analysis, this may further increase acquisition and sell costs for sellers, resulting in compressed Retail NOI and revenues.

SUMMARY OF SOURCES

(1) https://www.federalreserve.gov/newsevents/pressreleases/monetary20230920a1.htm#:~:text=The%20Board%20of%20Governors%20of,%2C%20effective%20September%2021%2C%202023
(2) https://www.conference-board.org/topics/consumer-confidence
(3) https://www.census.gov/construction/nrs/current/index.html
(4) https://www.chandan.com/independent-landlord-rental-performance-report
(5) https://www.dallasfed.org/research/surveys/tmos/2023/2309
(6) https://www.federalreserve.gov/monetarypolicy/beigebook202309.htm
(7) https://www.npr.org/2023/09/15/1199673197/uaw-strike-big-3-automakers
(8) https://www.pewresearch.org/short-reads/2023/09/13/congress-has-long-struggled-to-pass-spending-bills-on-time/
(9) https://cre.moodysanalytics.com/insights/cre-news/ma-cre-office-loan-maturity-monitor-remainder-of-2023-looks-no-better/
(10) https://www.globest.com/2023/09/25/new-ppi-concerns-put-the-retail-market-on-notice/

We are ready to assist investors with Santa Ana commercial properties. For questions about Commercial Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.

Branding and property certifications are among the requirements that tenants and investors should consider, according to a top property manager.

Evaluating how well an office building is run may be a crucial but difficult assignment for both prospective tenants and potential investors. How can you tell if a building is being maintained to a level that will make it a pleasant place for your company to conduct business or a wise investment?

Javier Lezamiz, senior managing director and New York lead for Cushman & Wakefield’s asset services unit, was consulted by LoopNet to aid with the solution to that question. Lezamiz has overseen commercial real estate for close to 30 years. In his current position, he is in charge of 650 staff members who provide management services for more than 220 properties totaling around 47 million square feet of commercial space in New York City and on Long Island.

That’s a lot of space, to put it simply. In fact, Crain’s New York Business reports that it makes C&W the largest commercial property management in New York City.

Following are the six factors that LoopNet determined to be indicative of a commercial property that is well-managed based on our discussion with Lezamiz.

Branding.
Employee awareness.
Public Area Maintenance
Property Certifications.
Organizational Framework.
Tenant participation.

Branding
Lezamiz asserts that one of the simplest methods to determine whether a commercial property is well-managed is to look at the signs identifying the property manager, which are often found on the building’s façade or in the lobby.According to Lezamiz, “Right at the front door, you’ll see a plaque that is prominently affixed to the building that says, ‘Cushman and Wakefield, managing agent.'” This is true for every property that his company looks after.

While a company’s reputation doesn’t always matter, learning about the management company—whether it’s a well-known manager like C&W or a small property owner’s in-house team—can help create reasonable expectations for how the property is operated.

A careful investor or renter should conduct some basic background research on the property manager, including finding out how many properties they are in charge of, how long they have been in the industry, and what other customers and tenants have to say about them.

Lezamiz argued that while C&W manages a wide range of properties in terms of class, size, and function, the capacity to manage various assets in the same way implies a high level of management expertise.

“When you’re able to take your brand and replicate it identically across other assets, that is key to most people distinguishing us versus our competitors or distinguishing one owner versus another,” he added.

Additionally, the absence, concealment, or less-than-obtrusive display of that sign conveys the message that no one is really interested in taking ownership of or being linked with the property. Potential renters and investors are also unlikely to want to be associated with it in that case.

Employee Awareness
You should pay attention to how the staff acts and presents themselves in buildings with enough staff stationed in the lobby, whether it’s security, a concierge, or a porter, Lezamiz advised.

Tenants and investors should anticipate attentive, properly attired building employees, according to Lezamiz. Given the rising security worries in many of the nation’s urban centers, you want “a security staff or concierge in your lobby that gives you a sense of wellbeing.”

This calls for the employees to be cordial while still being forthright about their duties and the expected behavior of site visitors. A good staff, in Lezamiz’s opinion, will make both guests and tenants feel “welcome” and “like they are looking out for me.”

Public Area Maintenance
The lobby, hallways, elevators, and amenity spaces are just a few examples of the common areas in a building that prospective tenants and investors will want to thoroughly inspect.

According to Lezamiz, all of these communal areas ought to be “clean and well-lit.” A light bulb that needs to be replaced or stray pieces of trash, such as a piece of paper here or a food wrapper there, could indicate that the property isn’t being properly maintained.

Additionally, it affects other areas of the property negatively if the common areas that are visible to the public look dirty or in poor condition.

In such a case, “I could imagine in the mechanical rooms and so forth, how dirty they must be,” Lezamiz remarked.

Property Certifications
Speaking of the mechanical rooms, Lezamiz said that building certificates may be used as a stand-in for inspecting such systems even though residents and occasionally even potential investors aren’t typically allowed access to those areas.Lezamiz emphasized that tenants and investors in particular had to look for a LEED or Fitwel certification. While Fitwel assesses how well a property supports the health and wellbeing of its residents by assessing characteristics like indoor air quality and access to outdoor space, among many other indicators, LEED certification focuses on how building systems affect the environment. An alternative certification to Fitwell is called WELL.

Because these certifications are extremely difficult to obtain, Lezamiz claimed that their presence indicates “that the standards of the property management team are very high when it comes to indoor air quality and when it comes to providing the most sustainable type of services to any of the occupants of that building.”

Organizational Framework.
According to Lezamiz, a property should ideally have a dedicated property manager, and even better, one who is based on-site. He did admit that many properties are too small to warrant having their own property manager, but he insisted that this shouldn’t exclude them from being well-managed.

More importantly, anyone with an interest should be aware of the property manager’s level of experience. Additionally, the most crucial query would be what type of support system is in place because efficient property management frequently “takes a village,” as Lezamiz put it.

“If a property manager is across three, four, or five properties of a similar size, but they’re properly supported with assistant managers or administrators, that property manager could still be just as effective as a dedicated property manager.”

Tenant Interaction
The ultimate goal of excellent property management is “always about tenant satisfaction,” according to Lezamiz. “Happily occupied tenants are more likely to extend their leases and recommend that property to others.”

Although asking tenants directly about their opinions of the property may not be practicable, asking the property management about their interactions with tenants will give interested parties an idea of how involved the tenant population is. For instance, a smart property manager, according to Lezamiz, will regularly survey tenants and offer events.

Beyond those activities, it’s crucial for a property manager to meet face-to-face with their tenants on a frequent basis. Lezamiz stated that he likes to have weekly meetings with his tenants because their operational difficulties may have a significant impact on how he manages the building. “Having that one-on-one” will lead to “a tenant who’s satisfied and enjoys being at the property.”

We are ready to assist investors with Santa Ana office properties. For questions about Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.

Maintaining control over loans enables lenders, investors, and real estate experts to recognize possible dangers and take quicker action.

What kind of property information can place a building on a watchlist? This issue has been examined by CRED iQ, which has produced some data points and added 4,600 loans this past July, putting 12,000 loans on the year-to-date servicer radar in 2023.

DSCR: Fixed and adjustable rate triggers for the debt payment coverage ratio were responsible for 36.5% of all loans;
ARD. 13.5% of names on the list had a pending maturity or expected repayment date, which was an increase of 4.5 compared to all Watchlist accounts in the CRE database.

Vacancies. Compared to the overall Watchlist factor of 11.7%, the occupancy reduction accounted for 9.5%, a modest decrease.
Tenants are moving out. 2.3% of Watchlist loans were due to major tenant expirations, which represents a little increase of.3% compared to all Watchlist files.

One notable instance is the 195,375-square-foot, $130 million-in-debt, Manhattan office tower at 1166 Avenue of the Americas. According to CRED iQ data, the loan was just moved to the blacklist as a result of its main tenants moving out. One of such renters is D.E. Shaw and Arcesium together accounted for 44% and 20%, respectively, of the gross leasable area. The building’s revenue could drop by $8–$8 million as a result of losing those tenants, which would also affect the debt payment coverage ratio.

Why is a watchlist for commercial real estate so crucial? Lenders, investors, and real estate experts who wish to monitor the performance of their commercial real estate loans will find them to be very helpful. CRED IQ offers the following additional justifications:
They act as early indicators of financial trouble.

They keep an eye on delinquencies, which aids in determining the total risk exposure of a portfolio of commercial real estate and enables prompt risk mitigation measures.

They enable lenders to base possible loan sales, loan restructuring, and asset management choices on delinquency trends.

By examining delinquencies in relation to different property kinds, geographical areas, and asset classes, they provide investors with knowledge to help them make informed decisions about diversifying their portfolios.

Since high delinquency rates may indicate more serious economic difficulties, they provide insights into market movements and economic situations.

They help lenders and investors spot delinquencies so they may take action to reduce potential losses like foreclosure or debt workouts.

They support the management of collections and offer advice to borrowers on compliance with loan servicing.

They aid financial institutions in adhering to legal obligations and accurately reporting delinquency rates.

To help real estate professionals understand new market trends and potential investment opportunities, they assist in tracking delinquencies.

They support the valuation of many sorts of investment products and assets, including commercial mortgage-backed securities.

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1. AI AND COMMERCIAL REAL ESTATE

A recent article by MSCI Real Capital Analytics suggests that despite the growing concern about AI’s potential impact on commercial real estate, a balanced view should be taken that considers both the economic risks of AI and its potential positive impact on productivity.
The authors argue that AI could advance economic productivity, leading to higher incomes and increased CRE demand over the long run. Data from MSCI RCA shows that, generally, as a country’s economic output per worker (a standard measure of productivity) increases, so does the value of a country’s
commercial real estate assets.
Like earlier periods of technological advancement, the dawn of AI may increase structural unemployment in the short term but create demand for new knowledge and skills, which effective federal education and training policies can aid.

2. RETAIL THEFT HITS MARGINS, FOOT TRAFFIC RISES

In its Q2 earnings report, Dick’s Sporting Goods’ cited retail theft as a critical factor compressing profit margins, shaking equities in the sector this week. While not cited as a primary factor, the report highlights a widespread issue facing many retailers as some US cities see a spike in thefts.
It is yet to be determined how this may affect Retail real estate. Still, falling investor confidence in the consumer sector could trickle down to commercial activity if businesses delay expansion plans as a result.
So far, however, retail foot traffic continues to increase and serve as a positive force for valuations, helping offset the impact of rising “shrink” rates.

3. MULTIFAMILY, A BRIGHT SPOT FOR CRE

Multifamily has continued to be a bright spot for commercial real estate even in the face of higher interest rates and falling home affordability, as detailed in a recent Mortgage Professional America (MPA) analysis.
While new supply has hit apartment rents, from a loan perspective, the piece argues, the sector continues to perform well compared to when they were initially financed.
According to data cited in the analysis, the average 10-year increase in value of a multifamily asset stands at roughly 160% and was underwritten in a lower interest rate environment, amplifying returns.
Contrarily, more recently purchased assets haven’t seen the same levels of appreciation as rates climb. While this is a downside risk for the sector, it represents a smaller share of total assets than those last transacted before the Fed’s tightening cycle, tempering the risk.

4. WARNING SIGNALS FOR CONSUMER DEMAND

Demand for manufactured goods and services weakened in August, according to the latest data from S&P Global’s US Composite PMI Index. From July to August, business activity saw its most significant drop since November 2022 despite growing for the seventh consecutive month.
Consumer spending has largely shaken off the effects of inflation and falling sentiment, which has catalyzed the recent quelling of recession fears. However, August’s data registered worse than expected and could be a leading indicator of an upcoming fall in consumption. New business and orders fell across all sectors, while new business in the service sector fell for the first time since February.
Standing out in the survey was a fall in service demand, which has recently propped up consumption and, by extension, economic growth, as goods consumption has fallen from pandemic highs. The fading impact of service-led growth may hamper GDP. Still, it would be a welcomed sign for the Federal Reserve, which has frequently cited services inflation as a persistent barrier to reducing economy-wide price pressures.

5. NEW HOME SALES CLIMB

Sales of new single-family homes in the US increased 4.4% annually to a seasonally adjusted annualized rate of 714,000 in July, according to the US Census Bureau.
July’s increase was the largest year-over-year increase since February of last year and beat consensus market expectations.
Sales in the US Midwest region saw the highest year-over-year growth rate during the month, climbing by 74.4% to 84,000. Meanwhile, the West region saw the largest overall total transactions over the past 12 months, registering 181,000 sales while climbing 21.5% year-over-year.
Sales in the South declined by 6.3% year-over-year, while sales in the Northeast dropped by 2.9%.
The median price of a new single-family home sold was $436,700 in July compared to $478,200 one year ago.

6. CRE’S IMPACT ON BIG CITY BUDGETS

Diverging trends in the commercial real estate industry make it challenging to forecast fiscal consequences for local governments, but a recent analysis by the Tax Policy Center notes that most US cities saw an increase in their property tax base between 2019 and 2022, though this may be a lagging indicator.
A separate analysis by GreenStreet estimates that, on average, CRE values, while down over the past year, are roughly on par with those registered in early 2018. While falling valuations present a risk to city budgets, pandemic-era value increases provide many cities a fiscal floor for impending falls in tax revenues. However, how this translates into fiscal health largely depends on local policies and priorities.
According to analysis, Boston maintains the highest reliance on commercial property tax revenue, which accounts for close to 36% of its total general revenues. Dallas is second, with property taxes accounting for 26% of revenues, and Atlanta is third, with 19%.
Conversely, Phoenix relies the least of any large metro on property tax revenues, accounting for just 3% of total general revenue, with Chicago second at 7% and Charlotte at 3rd with 8%.

7. US ECONOMY LIKELY INSULATED FROM CHINA CRE TROUBLE

The recent bankruptcy filing by China Evergrande, a property giant in China, has raised concerns about potential economic stagnation in America’s third-largest trading partner and how it may affect the economy at home. However, the US economy will likely be insulated from the worst effects of the crisis.
For starters, one consequence of the US/China trade imbalance is that Chinese purchases of US goods and services account for less than 1% of US GDP. If Chinese commercial real estate markets falter and the nation’s growth declines, it will likely have a muted impact on US business activity.
For further context, consider the potential trouble brewing in US CRE markets. The office sector, which has been the focus of increasing concern in recent months, is currently valued at $2.5 trillion, according to the Bureau of Economic Analysis. In comparison, total US investment in China (including Hong Kong) stands at just $515 billion. Therefore, domestic concerns should weigh heavier for US investors than China-based ones.
However, if the Chinese economy tips into an extended period of deflation, a weaker yuan may lower the relative costs of Chinese goods abroad, a potential counterweight to US inflation.

8. JACKSON HOLE SUMMIT

As the world’s top economists and policymakers descend on Jackson Hole, WY, for its annual summit, Federal Reserve officials are expected to express a more dovish tone compared to 2022 when Fed Chair Powell warned that a recession may be needed to calm post-pandemic inflation.
In recent days, some officials have signaled that the central bank may be close to finished with its tightening cycle, with Philadelphia Fed President Patrick Harker referring to current rate levels as “restrictive,” a more pointed term than typically used in recent statements by officials.
Still, as put by Jason Furman, an economist at Harvard, Powell is not expected to boast in a “mission accomplished” tone as he speaks to his peers this week and may suggest that there is more work ahead. However, many expect Powell to refrain from the spookier language compared to 2022, when officials aimed to realign Wall Street expectations on the inflation fight.
A new point of intrigue for Jackson Hole watchers will be economists’ reaction to an unexpected rise in US economic growth and a fall in recession fears. Particularly, onlookers will look to gauge whether the latest data signals that policymakers will keep interest rates higher for longer.

9. RETAIL SALES CLIMB

According to the latest data from the Census Bureau, US retail sales were up 0.7% month-over-month in July.
Retail sales beat the market consensus forecast of a 0.4% increase and followed an upward revision of June’s data. This is the fourth consecutive month where sales have increased.
Amazon Prime Day may have boosted July sales, with nonstore retailers recording the largest monthly increase across all subtypes, up 1.9%. The category of sporting goods, hobbies, musical instruments, and books rose by 1.5% in the month, followed by food services and drinking places (1.4%).
The most significant monthly decreases in sales were seen in furniture stores, falling 0.8%; health and personal care, falling 0.7%; and building materials and garden equipment, falling 0.7%.

10. JOBLESS CLAIMS FALL

Initial unemployment claims fell by 10,000 to a seasonally adjusted 230,000 during the week ending on August 19th, the latest data available from the US Labor Department.
While jobless claims rose to start the year as the Fed’s monetary tightening began to raise costs for businesses, leading to some layoffs, the labor market has so far avoided a major shock.
The number of continuing unemployment claims, which represent those receiving benefits for more than one week and a valuable barometer for hiring levels, also fell by 9,000 during the week, landing at 1.70 million.
The simultaneous forces of a strong labor market, falling inflation, and a recent increase in capital spending have prompted many economists to revise upward their GDP expectations for the year, according to comments by Reuters.

SUMMARY OF SOURCES

(1) https://www.msci.com/www/blog-posts/do-not-fear-the-impact-of-ai-on/04017862827
(2) https://www.marketwatch.com/story/dicks-sporting-goods-said-retail-theft-hit-margins-this-issuehit-them-harder-a6634d50
(3) https://www.mpamag.com/us/specialty/commercial/why-the-commercial-real-estate-landscapeis-both-bright-and-dark/457374
(4) https://www.pmi.spglobal.com/
(5) https://www.census.gov/construction/nrs/current/index.html
(6) https://www.taxpolicycenter.org/taxvox/future-commercial-real-estate-and-big-city-budgets
(7) https://www.nytimes.com/2023/08/21/opinion/columnists/china-financial-crisis-economy.html
(8) https://www.bloomberg.com/news/articles/2023-08-24/bullard-says-reaccelerating-us-economycould-prompt-higher-rates#xj4y7vzkg
(9) https://www.census.gov/retail/sales.html
(10) https://www.dol.gov/ui/data.pdf

The industrial sector is the least impacted.

In order to advise subway users to cross the gap between the train entrance and platform, the phrase “mind the gap” was first used in England.

Today, a bid-ask transaction is the standard in commercial real estate, where bidders and sellers are divided by a chasm between their estimated values of a contract. Unfortunately, as MSCI stated in its Q2 2023 capital trends report, this pricing difference is significantly affecting deal volumes.

The observation is consistent with what many in CRE have reported as anecdotal to GlobeSt.com since September 2022, namely that deal transaction volumes have decreased significantly and that potential buyers and current owners are still too far apart on price expectations for higher levels of deal volume to close across most property sectors.

The industrial sector is the most evenly balanced, maybe because data suggests that rents are high and support buyers’ perceptions of their value. The price expectations gap, according to MSCI, shows that little movement is needed to bring buyers and sellers together, as volume is still elevated relative to history. Industrial is experiencing small price drops.

However, there are large gaps and declining volumes in the office, retail, and multifamily sectors, which creates a vicious cycle. Because it is more difficult to find supporting data for values, price discovery is required more when there are fewer transactions.

The worst of these, according to MSCI, is the office sector, where there is a 7.4% difference between buyer and seller expectations. A liquidity-adjusted version of the RCA CPPI for offices would have required a 17.6% YOY fall, according to the predicted gap, to bring volume to a more typical level for the quarter.

The company agrees that an “outside shock” for offices, such as significant distress sales, might draw customers back in while assisting in the creation of new prices that are acceptable to both parties. MSCI views this as a low-probability, unlikely optimistic take. Less optimistically, they stated that the price expectation difference would widen even further in the upcoming quarters.

The evidence implies that rising cap rates have been absorbed by pricing changes. All main property types, even the industrial one that was least impacted, have higher cap rates, according to the RCA Hedonic Series.

However, they added, Relative to the levels seen before the low-interest rates in 2021 and 2022, some sectors are still priced dearly. In the second quarter, industrial cap rates were 60 basis points lower than the average for 2015–19. In contrast, CBD office cap rates were 40 basis points higher than the pre-pandemic norm.

Over the next two years, there will be 3,600 distressed bargains to pick from.

In order to achieve high returns on money in the real estate sector in 2023 and 2024, one must invest in distressed CRE assets. This distressed cycle differs from previous ones in that most lenders aren’t repossessing the CRE assets. Instead leneders are managing and leasing them for a while, then selling the properties. Rather than foreclosing on the property, they are more likely to sell the note or mortgage.

Lenders prefer to be “asset-light” when it comes to huge and complicated CRE assets, like many other industries like hotel management, technology manufacturing, food delivery, and ride-sharing. For intelligent distressed investors who have acquired mortgage notes secured by commercial property and are familiar with the onerous foreclosure and bankruptcy procedure that may follow, this gives a special and intriguing opportunity to gain a clean title to the property. In order to benefit from the influx of incoming CRE loans that will go into default, distressed investors should start acquiring funds right away.

These problems will lead to CRE distress and defaults in this cycle:

Increased interest rates and the borrower’s inability to refinance at these rates
A decline in occupancy, revenue, and NOI, as well as the borrower’s inability to pay the property’s current debt service
Covenant violations and mortgage loans
Inability to pay the escrows and payments due under the mortgage and note
In some circumstances, it will be more expensive and prohibitive to use an interest rate swap or collar to minimize the interest rate risk associated with floating rate loans.
A substantial drop in the property’s value
A drop in occupancy, the departure or bankruptcy of important tenants, and

There is a fantastic chance for distressed investors to get in touch with the various CRE lenders and try to purchase the note and mortgage on the property at a sizable discount given that all the aforementioned problems presently affect around 2.0%, or $90 billion, of the total CRE loans outstanding, which total $4.5 trillion.

There will be 3,600 distressed deals available over the next two years if the average defaulted loan is $25 million. The discount on the loan paper must be 10%–15% higher than if the property had been sold by the lender as a foreclosed asset because distressed investors today are taking on more risk by purchasing the note/mortgage and then going through the foreclosure process, which is typically handled by the original lender.

For instance, a $100 million office property that had $70 million in debt at 5.0% interest alone and was 95% leased in 2019 is now 70% leased and is only worth $70 million. The NOI at the time of acquisition was at a 4.5% cap rate, or $4.5 million, but it is now just $3.2 million, which is less than the $3.5 million a year in debt payment. In spite of efforts to restructure the loan with a lower interest rate, postponed payments, or a debt paydown, the borrower has defaulted on the loan by failing to make the last three months’ worth of payments.

The lender engages a CRE brokerage company to sell the note and mortgage since it does not want to foreclose on the property. likely distressed investors will require an extra discount on the note of at least 10%-15% or a price of $59.5 million to $63 million for the $70 million loan since they must go through the foreclosure and likely bankruptcy process, which in certain places might take years.

This is a reduction of 37% to 59.5% and 85% to 90% from the original loan amount and property value, respectively. The investor will foreclose or accept a deed in lieu of foreclosure if the borrower does not tie him or her up in bankruptcy. The investor has now acquired the office building at the above significantly reduced price and will benefit from any occupancy and rent increases when the local office market improves and the building’s valuation rises as a result of falling interest rates.