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Southwest Region: 2023 Q3 Perspective

 

 

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In particular, the bank consumer and CRE lending divisions are under close observation by the Fed for possible signs of credit deterioration.

The November 2023 Supervision and Regulation Report states that the Federal Reserve Board of Governors has stated that there are issues even if they believe the “banking sector remains sound overall.” The lending of banks to commercial real estate was one of the problematic areas they identified. Overall, the banking sector is still solid. According to their writing, banking institutions “continue to report capital and liquidity levels above regulatory minimums.” Despite recent pressure on net interest margins, earnings performance has remained strong and consistent with pre-pandemic levels. The decrease in deposits caused by the financial strains in March has abated. Overall, loan delinquency rates continue to be low.

Yet, banks have raised credit loss provisions, and delinquencies for CRE and certain consumer sectors have risen from their low levels. Some banks continue to face elevated liquidity and interest rate concerns, which can be partly related to rising funding costs and large fair-value losses on investment securities. While not the primary problem, CRE is significant enough to be mentioned separately. Delinquency rates for consumer and real estate loans, which “increased slightly during the first half of 2023,” were one culprit, according to the report. It’s hardly shocking that “the CRE office loan segment showed the largest increase in delinquency rates for the largest firms.”

According to the report, S&P and Moody’s have downgraded the bank sector’s credit rating. They both mentioned CRE exposure and rising interest rates, which have caused some banks’ long-term bond holdings to significantly lose value. The Federal Reserve noted that although loan delinquencies are low, larger banks are building up their reserves to protect themselves from lending losses. But that’s not all that’s happening. While larger banks become more cautious and hoard more cash, they are decreasing lending, while smaller banks are increasing their CRE credit activity. Despite the fact that the Fed’s research focuses mostly on large banks, those are the organizations with the resources to more readily endure an issue with CRE loans.

According to estimates, the $33 billion CRE loan portfolio held by Signature Bank would see a fire sale, driving values 15%–40% below face value. In an era of constrained price discovery, this kind of outcome would probably impact loans and property assessments in general. Between 2024 and 2026, waves of maturing office loans are also expected in significant markets. Delinquency rates for CRE bank loans have already reached a 10-year high.
“They wrote that some firms, particularly in the office segment of CRE, have indicated in public earnings releases that they expect increased loan losses.” Supervisors thus keep a careful eye on loan quality and underwriting. A horizontal review has been conducted recently to mitigate exposures to possible declines in CRE markets.

In the end, tighter banking regulations affect all banks, larger ones more so since they attract more attention, but smaller ones eventually close out of prudence or in the event that things go wrong. Recall that following the Global Financial Crisis in 2010, 155 banks closed. 530 closed in 1989 following the savings and loan crisis of the 1980s. There is a chance that banks may become less willing to take on CRE loans, and there isn’t likely to be enough nonbank lending to make up for it, especially because federal regulators are currently preparing to increase their level of oversight of them as well.

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

1. GROSS DOMESTIC PRODUCT

2. CPI INFLATION

3. 2024 COMMERCIAL REAL ESTATE OUTLOOK

4. INDEPENDENT LANDLORD RENTAL PERFORMANCE

5. MORTGAGE APPLICATIONS

6. UNDERGRADUATE ENROLLMENT RISES FOLLOWING YEARS OF
DECLINE

7. NEW HOME SALES

8. CONSUMER SENTIMENT

9. INDUSTRIAL PRODUCTION

10. US RETAIL SALES

 

SUMMARY OF SOURCES

Time and time, the same crucial errors are committed.
The CRE sector differs from every other sector in that it uses a transaction-based paradigm. Transactions involving the sale, financing, and leasing of goods and services are the industry’s lifeblood. The industry as a whole, its participants, and the firm all profit more as there are more interactions. The year 2021 saw unprecedented transaction volumes and a tremendous CRE boom.

The most prosperous organizations and people in the sector are typically skilled in marketing, financing, and/or leasing CRE property. However, the same crucial errors are consistently made when pursuing these transactions, which typically leads to subpar performance, the loss of equity in a property, or the loss of the property in foreclosure. The following are the top 15 commercial investing blunders that we’ve identified:

    1. Purchasing real estate at a low cap rate. Even if the investor thinks that potential rent increases in the future, which may not materialize, will offset the low initial return, cap rates below 5.0% are not warranted. Purchasing CRE at cap rates under 5.0% is comparable to purchasing a tech stock at a 100 price-to-earnings ratio.
    2. Not varying a nationwide portfolio by region, sector, and type of property. Numerous major funds are diversified by kind and region by national firms, but industry diversity is often overlooked. In Silicon Valley, 70% of apartment tenants and 70% of office tenants, if an investor purchases only flats and offices, are employed by the technology sector. Many apartment residents could lose their jobs and be unable to pay their rent if the IT sector experiences a slump. They could even go back home or share rooms with roommates. The apartment market will suffer as a result of this. The office market will suffer if many of the internet companies fail on their leases or reduce the amount of space they need.
    3. Not carrying out all of the necessary financial and property due diligence before buying a portfolio of properties. Many institutional investors that purchase huge portfolios made up of dozens or hundreds of properties don’t perform enough due diligence at the individual property level. They either employ unskilled third-party organizations to perform the property-level due diligence or they just examine the larger and more expensive homes in the pool.
    4. Purchasing real estate using negative leverage. Negative leverage is a “no-no” in commercial real estate because it happens when the cap rate is lower than the mortgage constant, which means the cash-on-cash return will be lower than the cap rate. Many businesses buy real estate using negative leverage in the hope that rising rents will more than offset the low initial return.
    5. Fund a long-term real estate asset or portfolio with short-term floating-rate financing without the added security of a swap or collar. In the past two years, when the Fed abruptly increased the federal funds rate from 0% to 5.25%, this is what has happened. Due to the sudden surge in interest rates brought on by floating-rate debt and the lack of interest rate protection, many CRE investors are now frantically trying to cut their financing costs and risk.
    6. Using a terminal cap rate that is lower than the going-in cap rate when underwriting an acquisition. To “juice up” the internal rate of return on the equity in a transaction underwriting, this is frequently done by the acquisition team or another internal division within a large CRE business.
    7. Institutional investors who provide funding to sponsors with junior management teams with little expertise. The senior management group should be older, with members having seen at least the two most recent secular CRE downturns, from 1987 to 1992 and 2007 to 2012. Having team members with extensive and long-term expertise and understanding of various property kinds, markets, and economic recessions is one of the most crucial factors in CRE investing success.
    8. Utilizing excessively upbeat rent predictions while underwriting a deal. This frequently happens when an inside group trying to grow or acquire a deal wants to improve the transaction’s appearance.
    9. Not looking into the retail tenants’ sales per square foot, a crucial indicator when purchasing shopping centers. The sales per square foot of the anchor tenants, after the cap rate, is one of the most crucial indicators when purchasing retail complexes. A center with high sales per square foot is in a prime location, will remain fully leased, and is in high demand among tenants and customers.
    10. Utilizing a high leverage of above 75%. High leverage is one of the dangers associated with CRE investing and was one of the factors contributing to the Great Recession from 2007 to 2012.
    11. Not granting top staff members an equity stake in the business, holdings, or fund. The “golden handcuffs” are what are referred to as CRE. Your top personnel will depart if you don’t look after them, joining your competition.
    12. Not including in a real estate firm the 15 CRE hazards. Risks in the firm’s investment strategy include those related to cash flow, value, tenants, the market, the economy, interest rates, inflation, leasing, management, ownership, legal and title issues, construction, entitlement, liquidity, and refinancing.
    13. Investing in real estate segments where the investment firm has no prior experience, such as hotels and senior housing, which are more operational businesses than real estate deals. Senior housing is often 80% to 100% operating business and 0% to 20% real estate deal, while hotels are normally 70% operating business and 30% real estate deal.
    14. When buying a sizable portfolio of CRE assets, not getting the Kmart discount. When a sizable CRE portfolio changes hands, it usually consists of Class A queens, Class B pigs, and average Class B transactions. The buyer needs to receive a discount of at least a 1.0% higher cap rate to account for the risk of the Class C properties.
    15. Not double-checking the formulas in an XL underwriting spreadsheet because every CRE underwriting worksheet contains at least one mathematical inaccuracy. When creating a challenging Excel underwriting workbook, this is a regular occurrence, thus businesses should ensure that all calculations are double-checked by an impartial third party.

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

Debt financing is not available to all borrowers or even all industries, but it is not inaccessible either.

According to MSCI’s research on global capital trends for August 2023, CRE investment sales have been declining and disappointing. It has been demonstrating this for months.

The credit ones are linked to the sales ones. There is a widespread belief that obtaining funding is virtually impossible because many banks are exposed to risk from CRE loans, lending requirements are becoming more stringent, and there are concerns that government-sponsored companies may not reach their lending caps.

But MSCI essentially advised holding on. According to the company, “off-the-cuff statements from industry participants might lead one to believe that the commercial real estate markets are in free fall with no debt available.” The reality, however, is more complicated, with certain industries dealing with illiquidity in the debt portion of the capital stack while others are merely dealing with more expensive debt. Each circumstance has unique effects on future investment performance and activity.

When compared to the pace of the first quarter, loan originations tracked by the company increased by 31% in the second quarter. In the second quarter, variables often raise originations, but from 2013 to 2022, the average rise was only 17%. “If the market were viewed through the prism of a typical second quarter, one might conclude that the slide from a time of excessive liquidity in 2021 and 2022 is complete.”

The numbers weren’t consistent; they were drastically dispersed according to category. $51.2 billion in multifamily originations were made in Q2. From 2015 to 2019, the pre-pandemic five-year average was 4% higher. The highest rise was in industrials, which witnessed originations of $17.2 billion, or 45% more than the average for that property type. The total for retail was $14.2 billion, 15% below the five-year average. $10.7 billion was spent on hotels, which was a 17% decrease from the average from 2015 to 2019. Office saw the highest decline, as might be expected: -52% and $15.1 billion.

Taking a look at both industrials and multifamily, it is obvious that funding is available. However, MSCI noted that using debt no longer offers the same advantages as in the past. “LTVs at origination have decreased for both sectors as lenders take precautions against the risks posed by declining real estate values. Apartment LTVs peaked in 2021 at 64.5%, while industrial LTVs reached a maximum of 59.1%. In Q2 2023, these LTVs decreased to 59.4% and 56.1%, respectively. For these areas, it might be preferable to claim that there is no loan available rather than that there is no cheap debt with lenient conditions like there formerly was.

But it is easy to understand how the sales of the category and the availability of credit for it might move together given the decline in the number of offices.

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.

1. INTEREST RATE DECISION/ECONOMIC PROJECTIONS

2. CONSUMER CONFIDENCE

3. HOME SALES & PRICES

4. INDEPENDENT LANDLORD RENTAL PERFORMANCE

5. DALLAS FED MANUFACTURING INDEX

6. BEIGE BOOK SUMMARY

7. POTENTIAL ECONOMIC IMPACT OF UAW STRIKE

8. GOVERNMENT SHUTDOWN

9. CRE OFFICE LOAN MATURITIES

10. PRODUCER PRICE INDEX: IMPLICATIONS FOR RETAIL

SUMMARY OF SOURCES

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.

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.


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