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.

1. INTEREST RATE OUTLOOK

• Despite the Federal Reserve’s decision to hold rates constant at their June meeting, current market forecasts project an 81.8% chance that the FOMC will move forward with a 25-basis point hike in July, according to the Chicago Mercantile Exchange’s Fed Watch Tool.
• In June, officials placed their year-plus hiking cycle on pause in an effort to evaluate the success of their tightening effort thus far. Earlier in the month, national employment data registered stronger than expected, while annualized inflation continued to trend downwards.
• With recession concerns still pertinent, the Fed opted to pause and digest incoming data. At the same time, some officials have signaled a preference for further rate hikes to anchor longer-term inflation expectations. Notwithstanding recent deceleration, Real PCE, the Fed’s preferred inflation gauge, remains
  well above the central bank’s 2.0% target.
• In recent days, Fed Chair Jerome Powell indicated that “there’s more restriction coming,” acknowledging that despite the committee’s decision to pause last month, he and other members “expect the moderate pace of interest rate decisions to continue.” While not outright saying that they expect rate hikes to continue, the statement signals the Fed won’t hesitate to move forward with a hike if the data warrants it.

2. HOME PRICES

• Home prices fell annually for the first time since April 2012, declining 1.7% year-over-year in April, according to the S&P/Core Logic Case-Shiller Home Price Index.
• Market forecasts for the Case-Shiller projected a 2.6% annual decline during the month. Despite the steepest annual drop in over a decade, monthly data suggest that home value declines may have hit a cyclical nadir in recent months, as home prices were up 1.27% from March. Between June 2022 and January 2023, home prices fell in each month before turning positive again in February.
• Seattle and San Francisco continue to experience deep year-over-year declines, while several other markets, including Miami, Chicago, Atlanta, and Charlotte, are experiencing modest single-digit growth.
• The southeast continues to be the strongest region for home price growth, averaging 3.6% year-overyear. The west remains the weakest, falling -6.9% over the past 12 months.

3. INDEPENDENT LANDLORD RENTAL PERFORMANCE

• The on-time payment rate in independently operated rental units declined for the third consecutive month in June, falling to 82.5%. Despite the recent retreat in on-time rates, compared to one year ago, the on-time payment rate remains up by 118 basis points compared to a year earlier.
• These data underscore how the rental housing sector has fended off widespread distress while headwinds mount elsewhere in the market. According to MSCI Real Capital Analytics, through May 2023, apartment prices are down 13.8% from their 2022 peak. Additionally, borrowing terms remain stringent as banking sector volatility and high-interest rates impact the attainability and feasibility of debt financing.
• Nevertheless, the continued performance of rental units amid a still resilient labor market is allowing independent operating landlords to withstand the economic malaise. As units maintain their monthly rental payments, the cash flow ecosystem between tenants, operators, and lenders stays intact.
• The June 2023 forecast full payment rate is 91.6% — just 44 bps below its post-covid peak.

4. REGULATORS SOUND THE ALARM ON CRE

• In recent weeks, US regulators have asked major lenders to work with credit-worthy borrowers facing stress in the commercial real estate market.
• The statement arrived from the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, and the National Credit Union Administration, who urged them to work “prudently and constructively” with good clients.
• The outreach comes amid rising concerns about the stability of commercial real estate as lending standards tighten and property values absorb a testing demand outlook.

5. SELLOFF IN CRE STOCKS MAY PRESENT OPPORTUNITIES

• Portfolio manager Jeffrey Kolitch of Baron Funds, a publicly traded fund that manages close to $1.5 in real estate assets, recently expressed his belief that recent stock selloffs in the sector present investors a “gift,” proving some an opportunity to acquire high-quality companies at “attractive” prices.
• At a recent talk, Koltich expressed his disagreement that we are on the cusp of a CRE crisis and his belief that setup for real estate in public markets is bullish. He emphasized the flurry of headwinds that the industry has faced in recent years, including the pandemic and generational shifts in consumer preferences, and how the industry has proven to remain innovative and efficient in the face of them.
• Further, he believes the rising fears surrounding the industry have caused stocks in the sector to fall steeper relative to the broader market, presenting attractive pricing to looking for upside in the public markets.

6. MEASURING UP OFFICE DEVALUATIONS

• A recent CRE Moody’s Analytics analysis explored some of the worst-case scenarios for the office sector by setting out to answer the question: what does it take to see a peak-to-trough Office value decline of 40%?
• The analysis notes that a 40% peak-to-trough decline would require current levels of distress to worsen and sustain. Between Q1 2022 and Q1 2023, office property values have declined nationally by an average of 12.7%. Prices would need to fall by another 31.3% from current levels to reach the 40% aggregate devaluation threshold.
• According to the authors’ calculations, to see office valuations drop by another 31.3% nationally, it would require that occupancy rates fall by an average of 3.8% from current levels and an NOI drop-off of 24.5% from current levels.
• The analysis notes that while the above scenario will likely play out in some properties, “the chances we see broad office declines at this level is on the tail end of the distribution of possibilities, as opposed to the expected case.”

7. RENTS DECLINE

• According to Realtor, May rents on 0–2-bedroom apartments fell -0.5% year-over-year through May, marking the first decline since they began tracking the segment in 2020, signaling a potential shift in the market cycle.
• Smaller units saw rents increase over the year, with studio apartments up 2.0% in the past 12 months and one bedroom up by 0.4%. The retreat in rents was driven by two-bedroom units, which have declined by 0.5% year-over-year.
• The median asking rent in the 50 largest US metros rose by $3 from April but is down $38 from its July 2022 peak.
• Rents in the West are falling steeply, down -3.0% year-over-year, while markets in the South have seen an average decline of -0.7%. Rents in the Midwest continue to climb but are slowing, rising 4.5% in the past 12 months.

8. THE FIVE TIGHTEST RENTAL MARKETS IN THE US

• According to recent research from Chandan Economics and Arbor Realty Trust, the five tightest rental housing markets in the US today are Cape Coral, Louisville, Boston, Knoxville, and Worcester. The scoring matrix relied on two factors: rent growth and occupancy.
• Cape Coral, FL, which had the country’s most intense rent growth pressures through April, has seen its profile rise as a retiree destination. Meanwhile, Louisville and Knoxville have gained in recent years as their combinations of urbanized downtowns and housing affordability have attracted new residents.
• In Massachusetts, Boston’s market tightness appears primarily due to supply-side factors, including the market response to the municipal government’s push to implement rent control. At the same time, Worcester is gaining from demand-side factors as its downtown revival attracts residents away from Boston.

9. MIXED USE MALLS

• Some developers are turning to a mixed-use approach to salvage the value of struggling big-box retail space, specifically by combining a variety of smaller retail tenants with residential properties mixed in.
• For instance, many investors owning property at former Sears locations are now converting them into experimental “live, work, and play” environments, reflecting a trend to revitalize malls and adapt to changing consumer preferences.
• Sears, a retailer with a formerly sizeable national footprint, has just 12 department stores remaining nationwide following a Chapter 11 bankruptcy filing and the effects of the pandemic’s “retail apocalypse.” During the proliferation of malls in the 1960s, Sears positioned its auto center adjacent to mall parking lots where their department stores were typically located.
• As a result, properties that formerly housed these connected retail sites are in a unique position to accommodate such a mixed-use approach and may serve as a template for investors looking to implement such a strategy. The new strategy focuses on residential, retail, and other amenities.

10. NET LEASE INVESTING

• For net lease investors, the recent pause in rate-hikes may signal an easing of cap rate expansion, but the likelihood of additional rate increases in the coming months means that investors should brace for further cap rate increases before normalizing in 2024.
• Even if the Fed’s tightening cycle halts and rates remain neutral for the foreseeable future, lending conditions and risk appetites will likely remain restrictive in the near term.
• Those with cash-on-hand, who can secure long-term lease deals with creditworthy tenants—alongside the proper due diligence processes to execute those deals—should be able to proceed with investment plans despite the lending pullback.
• However, smaller deals will have an advantage in this environment, as larger players with more significant targets may be forced to stay in wait-and-see mode until demand unsticks.

SUMMARY OF SOURCES

• (1) https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
• (2) https://bit.ly/44unGBr
• (3) https://www.chandan.com/independent-landlord-rental-performance-report
• (4) https://www.bloomberg.com/news/articles/2023-06-29/us-asks-lenders-to-help-firms-withcommercial-real-estate-stress?srnd=markets-vp#xj4y7vzkg
• (5) https://www.barrons.com/articles/real-estate-stocks-selloff-ac3cb792
• (6) https://cre.moodysanalytics.com/insights/cre-news/capital-market-quick-take-what-does-it-taketo-see-a-peak-to-trough-office-value-decline-of-40/
• (7) https://www.realtor.com/research/may-2023-rent/
• (8) https://arbor.com/blog/the-top-five-tightest-rental-markets-in-the-u-s/
• (9) https://www.globest.com/2023/06/29/vacant-sears-stores-find-new-life-as-housing-in-mixeduse-malls/
• (10) https://www.globest.com/2023/06/29/what-does-the-feds-breather-mean-for-net-leaseinvestors/

SVN | VANGUARD is pleased to announce the addition of Eric Lambiase to our SVN Southern California team. Lambiase brings over 25 years of successful transaction experience representing both regional and national tenants and landlords. As Senior Vice President at SVN, Eric will assist in leading our Retail effort in both landlord and tenant representation, said Managing Director, Cameron Irons.

1. FED MEETING MINUTES

• Minutes from the FOMC’s May 2-3 policy meeting showed that central bank policymakers were split on the decision to continue raising interest rates or pause increases during its most recent vote.
• Ultimately, the decision to raise rates by 25 basis points in May was unanimous. However, the minutes signal that officials are taking an increasingly balanced approach to fighting inflation as their tightening efforts gradually show their impact on the US economy.
• While some officials have signaled openness to a pause, most have also reiterated that the committee is not “done” in its fight against inflation, and their decisions remain data dependent. Other officials remain aggressive in stamping out recent price pressures, believing that rate hikes should continue to anchor
  future inflation expectations.
• According to the Chicago Mercantile Exchange’s Fed Watch Tool, there is a 66% chance that the Fed will pause rate hikes at its June policy meeting.

2. DEBT CEILING NEGOTIATIONS

• President Biden and House Republicans appear to be inching closer to a bipartisan deal to avert a looming debt-ceiling limit, according to senior aides from the White House and Speaker Kevin McCarthy.
• Talks have intensified in recent days as a projected early-June fiscal cliff approaches, and a deal that satisfies both sides of the aisle remains elusive.
• The Treasury Department estimates that the US could run out of money as soon as June 1st, which economists warn could potentially upend the global financial system and send the economy into recession.
• On May 24th, Fitch, a rating agency, placed the US Government’s “AAA” credit rating on negative watch, signaling that partisan disputes have threatened the standing of US creditworthiness.
• House Republicans are seeking significant cuts to discretionary spending before agreeing to raise the debt limit. The White House and Congressional Democrats initially looked to pass a clean increase without cuts but recently agreed to freeze spending at current levels for the following year.
• It is expected that both sides will need to compromise to pass legislation through the Republican-controlled House and Democrat-controlled Senate.

3. HOW A US DEFAULT COULD IMPACT CRE

• If no deal is reached in Washington and the US defaults on its debt, the result will have far-reaching effects on parts of the global economy, with commercial real estate among them.
• US Treasury values would fall, creating upward pressure on mortgage yields and other market interest rates. According to the Mortgage Bankers Association, this process has already begun to play out simply based on the growing possibility of default. In recent days, default fears appear to have pushed mortgage rates up and resulted in a decline in purchase applications.
• The recent banking crisis would also likely intensify, as recent distress was mainly due to an oversaturation of treasuries on the bank’s balance sheet that was not hedged for the risk of rising interest rates. If a default were to cause even further upward pressure on rates, banks that have avoided issues during the Fed’s rate hikes might get thrust into distressed positions. This could significantly dry up financing for CRE projects.
• A debt ceiling crisis would immediately delay deals, and prices would initially fall in the wake of a default. However, opportunistic buyers may swoop in during this time, as seen during the early days of the pandemic, and create some market demand.

4. BANK SHARE OF CRE DEBT

• As small and mid-sized banks face new challenges, there have been increased concerns around their foothold in commercial real estate debt markets. However, a study by Moody’s Analytics suggests that while smaller banks have grown in market-share recently, they are far below the “65-70%” number thrown
  around by some recent doomsday-like analysis.
• According to Moody’s estimates, banks account for 38.6% of CRE lending, while mid-sized regional banks, of which there are 135 nationwide, account for just 13.8% of CRE debt.
• The nation’s top-25 largest banks hold 12.1% of CRE debt, while the 829 community banks hold 9.6% of CRE Debt.
• As noted in the Fed’s most recent Senior Loan Officer Opinion Survey (SLOOS), most lenders tightened credit standards during the first quarter of 2023, which could reduce some financing options for the CRE market. However, Moody’s notes the CRE debt market is large and diverse, and several non-bank lenders such as insurance companies, mortgage REITs, and others could step in to fill the gap.

5. Q1 GDP SECOND ESTIMATE

• The Q1 US GDP estimate was revised from a 1.1% annualized rate to 1.3%, according to the latest data from the Bureau of Economic Analysis.
• The upward revision reflected a smaller decrease in private inventory investment than previously estimated, while consumer spending accelerated more than expected (3.8% compared to the previous estimate of 3.7%). The upward revision in spending is notable given rising financing costs and inflation that, while cooling, remains high by historical standards.
• Non-residential fixed investment was also revised upward to 1.4% annualized versus a previously estimated 0.7%, while government spending was revised up to 5.2% annualized compared to the 4.7% previously estimated. Residential fixed investment shrank more than previously estimated.
• Despite the upward revision, Q1 2023 remains the slowest quarter for growth since Q2 2022, though a US recession appears to have so far been avoided.

6. NEW AND EXISTING HOME SALES

• Sales of new single-family houses rose to a seasonally adjusted annual rate of 683,000 in April, according to the Census Bureau, 4.1% above March’s pace and 11.8% above the April 2022 level. For sale inventory currently has 7.6 months of supply.
• The median sales price for a new home sold in April was $402,800.
• Meanwhile, according to the National Association of Realtors (NAR), existing-home sales declined by 3.4% in April to a seasonally adjusted annual rate of 4.28 million. Sales were down 23.2% from one year ago.
• The median existing-home sales price fell 1.7% in April to $388,800.

7. EMERGING TRENDS IN DINING

• At the recent ICSC conference in Las Vegas, dining experts convened for a session to discuss emerging trends in the food and beverage industry, including the evolution of consumer behavior and its impact on retail real estate.
• Speaking about plans to expand their “Dave’s Hot Chicken” brand, SVP of Real Estate Dannon Shiff explained that the ideal space for his brand includes daily necessities, possesses high visibility, has ample parking facilities, and presents a significant signage opportunity.
• Patrick Chamberlain of Hart House spoke about the need for location relative to local trade areas, where travel guests or employees seek lunch and dinner options. Their brand is eyeing both urban and suburban locations for expansion, noting that the remote work shift has led to reevaluations of local trade hot spots.

8. CONSUMER SENTIMENT

• US consumer sentiment fell to a six-month low of 57.7 in May 2023, down from a reading of 63.5 in April, according to data from the University of Michigan.
• Survey forecasters had projected a reading of 63 in May, but a recent deterioration in expectations about the economy’s future trajectory led to steeper declines.
• The expectations sub-index fell to 53.4 in May from 60.5 during the month prior. The current economic conditions index fell from 68.2 to 64.5.
• Year-ahead inflation expectations fell slightly to 4.5% from 4.6% in April.
• According to survey director Joanne Hsu, recent negative news stories, including the debt ceiling standoff and banking crisis, may have led to the fall in sentiment in recent weeks.

9. PENDING HOME SALES

• Pending home sales, meanwhile, remain steady. According to the NAR, pending home sales remained unchanged from March at an index reading of 78.9 in April.
• Pending transactions remain down by 20.3% year-over-year. According to NAR Chief Economist Lawrence Yun, limited inventory has prevented some buying interests from being met, while affordability challenges “continue to hold back singings.”
• The highest activity level occurred in the South and Midwest regions, respectively. The northeast region saw the lowest activity levels, followed by the West region.

10. HOUSING PERMITS AND STARTS

• Building permits fell 1.5% from March to April, registering a seasonally adjusted annual rate of 1.41 million homes in April, down from 1.43 in March, according to the Census Bureau. Permits are down 21.1% year over- year.
• Housing starts rose 2.2% month-over-month in April to 1.40 million— up from 1.37 million. However, starts remain 22.3% below their April 2022 level of 1.80 million.
• Housing completions fell 10.4% in April to 1.37 million, down from 1.53 million. However, completions are 1.1% above their April 2022 level of 1.36 million.

SUMMARY OF SOURCES

• (1) https://www.federalreserve.gov/monetarypolicy/fomcminutes20230503.htm
• (3) https://www.realtrends.com/articles/how-the-debt-ceiling-crisis-could-derail-the-real-estatemarket/
• (4) https://cre.moodysanalytics.com/insights/cre-news/whats-the-real-situation-with-cre-and-banksdoom-loop-or-headline-hype/
• (5) https://www.bea.gov/
• (6) https://www.census.gov/construction/nrs/pdf/newressales.pdf
• https://www.nar.realtor/newsroom/existing-home-sales-faded-3-4-in-april
• (7) https://www.globest.com/2023/05/23/industry-experts-talk-dining-trends-and-real-estate-aticsc/
• (8) http://www.sca.isr.umich.edu/
• (9) https://www.nar.realtor/newsroom/pending-home-sales-recorded-no-change-in-april
• (10) https://www.census.gov/construction/nrc/pdf/newresconst.pdf

NATIONAL OVERVIEW

The US industrial sector has been the forerunner of commercial real estate over the past decade. And so far, prevailing winds appear to be carrying the sector’s growth forward. In the early 2010s, the industrial sector’s growth was defined by the e-commerce boom, as Amazon carts replaced shopping carts and Cyber Monday became Black Friday for millennials. As a result, retailer demand for warehousing and flex spaces skyrocketed. According to MSCI Real Capital Analytics, industrial property prices grew by an industry-leading 154% over the past ten years and more than 45% since the start of the COVID-19 pandemic.

During the pandemic years, a structural shift in consumer activity amid lagging supply chains brought forward the worst congestion ever since the dawn of widespread containerization. Clogged ports and rising inventories allowed many inland industrial properties to capitalize on new demand. While most supply chain bottlenecks have gradually subsided, the new post-pandemic normal for online consumption keeps industrial in CRE’s driver’s seat.

Like all sectors, recent increases in borrowing costs have dampened transaction activity in the industrial sector. According to the industry group NAIOP, net absorption slowed during the final half of 2022, dropping to 176 million square feet from the 236 million square feet absorbed during the first half of the year. Still, industrial properties have begun 2023 performing better than some expected as demand continues to outpace supply in several key markets.

Data from the February Logistics Managers’ Index (LMI) show a rise in forward-looking sentiment for the warehouse sector. After hitting a nadir in November, the LMI future metric has climbed for three consecutive months and, in February, reached its highest mark since last Summer. Moreover, the LMI future has continued to signal expansion in the sector despite falling throughout Fall 2022 (an index reading above 50 indicates expansion, while below 50 indicates contraction).

Simultaneously, warehouse capacity experienced its first uptick in over two years, with additional supply expected to come online later this year. Still, analysts don’t expect this new supply to roil industrial markets. As Zac Rogers, lead analyst for the LMI, puts it, a modest short-term jump in warehouse capacity “will make it more sustainable over the long run.” Other industry observers appear to agree. In early March, NAIOP raised its projections for net absorption over the next two years, projecting 310 million square feet of absorption in 2023, followed by 323 million in 2024.

Financials

TRANSACTION VOLUME

According to MSCI Real Capital analytics, industrial transaction volume totaled $154.0 billion in 2022 — decreasing 13.3% from the previous year. Despite the year-over-year pull-back, 2022 remains the second-most active year for industrial transaction volume on record.

Compared to the pre-pandemic peak (2019) of $117.6 billion, 2022’s total rose 31.0% higher. Overall, the long-term drivers of the sector’s momentum remain intact. A return to in-store shopping eased the acute demand surge for warehouse and fulfillment space. However, the secular convergence of retail and industrial should be a tailwind for industrial sector demand for the foreseeable future.

According to the 2023 ULI-PwC Emerging Trends in Real Estate Survey, real estate investors gave a net buy rating for all tracked sub-types of industrial, including flex, fulfillment, manufacturing, R&D, and warehouse.

CAP RATES AND PRICES

Despite the long-term optimism surrounding the industrial, the sector’s cap rate profile was subject to the same market forces that saw yields rise for all other commercial property types.

After industrial cap rates sank to a new all-time low of 5.2% in Q1 2022, the effects of rising benchmark interest rates were felt throughout the year. Cap rates rose each of the next three quarters, settling at 5.3% at the end of the year. In total, cap rates rose by 19 bps between Q1 and Q4.

As cap rates have risen, pricing momentum has ebbed in the industrial sector. Still, prices kept rising through the first three quarters of the year, reaching a new all-time high of $164/sqft in Q3.

However, in Q4, slowing growth eventually turned to contraction, and average prices in the industrial sector fell marginally to $158/sqft — sliding 3.7% quarter-over-quarter. Nevertheless, industrial prices remain up by 3.0% from a year earlier despite the single-quarter drop.

Regional Performance2023Regional

In developing the regional industrial rankings, the SVN Research Team utilized a scoring matrix. The matrix offers a comprehensive view of how regional markets are performing within the context of growth from a year earlier, as well as compared to before the pandemic. The eight following criteria were included in the matrix:

1. Transaction Volume: 1-Year % Change
2. Transaction Volume: % Change Over Pre-Pandemic (2019)
3. Share of US Transaction Activity: 1-Year Change
4. Share of US Transaction Activity: Change Since Pre-Pandemic
5. Cap Rates: 1-Year Change
6. Cap Rates: Change Since Pre-Pandemic
7. Pricing: 1-Year % Change
8. Pricing: % Change Over Pre-Pandemic

TOP PERFORMERS: SOUTHEAST

Echoing a common theme across all commercial real estate verticals, the Southeast again stands out as a top-performing region. The last several years have been a renaissance for commercial real estate in the Southeast, as migration trends have favored the region, causing product demand to surge across property types.

As a result, no region has seen a larger market share increase over the past three years than the Southeast. In 2019, the year before the pandemic, $19.8 billion of industrial assets changed hands in the Southeast, accounting for 17.4% of the nation’s total. In 2022, this total surged to $31.1 billion, accounting for 20.2% of all US activity — a 2.8 percentage point gain in total market share. Southeast industrial assets have also seen some of the most intense pricing pressures in recent years, with valuations rising by 46.0% between 2019 and 2022.

TOP PERFORMERS: SOUTHEAST

The Mid-Atlantic’s 2022 strong showing crossed over to the industrial sector as well. While transaction volume decreased in the region compared to the year before, it did so by less than any other region. Still accounting for $15.3 billion of traded industrial assets last year, transaction volume only dipped by 4.5% in 2022.

Meanwhile, every other region saw a year-over-year decline in volume between 11.3% and 20.8%. The Mid-Atlantic also managed to buck the 2022 trend of rising cap rates. On average, cap rates for industrial assets dipped by 7 bps in 2022 compared to the year prior — the second-best mark of any region.

Our Orange County commercial real estate brokers will help you every step of the way in finding the right industrial real estate investment property, contact us for details.

SVN Research | State of the Market Report | Retail 2023

NATIONAL OVERVIEW

After benefiting from a pandemic-era boost in spending and consumption, retail sector fundamentals began to waiver during the second half of 2022. Investors inched into 2023 cautiously, but several critical retail growth metrics have continued to trend positively early this year.

Above all, consumer spending continues to defy the damnation of inflation. According to the Bureau of Economic Analysis, personal outlays increased by $312.5 billion in January, growing by 1.8% from December and 8.4% over the last 12 months. As consumption normalizes from sky-high 2021 growth levels, it’s been tempting to view the reversion as an impending headwind for retail. Yet, if inflation’s downtrend continues without significant pain to labor markets, today’s expenditure levels may represent a new equilibrium for consumer spending.

Since monetary policy tightening began in March 2022, consumer spending has grown at an average of 8.4% year-over-year, well above the 4.2% average rate reached during the Fed’s last tightening cycle before the pandemic. Further, during the previous cycle, consumption growth did not substantially slow until COVID-19 hit US shores, and subsequent shutdowns, layoffs, and reduced spending ensued.

Overall, the retail sector continues to go through a reorganization process. At its core, retail real estate is valued by its ability to put goods and services in the hands of consumers. That requires not only a willingness to spend from consumers — but also a preference for how they interact with goods, brands, and services across a digital-physical divide. Increasingly, online retailing has become an incubator of sorts, where successful brands will mature into brick-and-mortar as part of a second-stage expansion. While the US remains over-retailed and the market correction is ongoing, new models of success are emerging. It is not to say that momentum has (or will) suddenly rush in for retail. Still, more and more, it looks like the retail sector’s worst days are in the rearview.

Financials

TRANSACTION VOLUME

According to MSCI Real Capital analytics, retail transaction volume totaled $86.8 billion in 2022 — increasing 5.6% from the previous year. Retail was the only one of the “core four” commercial property types to see an increase last year.

Often, structural forces are more impactful than cyclical ones. The retail sector was already experiencing a secular reorganization when the pandemic hit. Then, the exogenous shock of the shutdown and protracted period of social distancing hyper-accelerated the retail sector’s shakeout. While the process was painful, the sector is starting to see the light on the other side. A combination of the sector having less rightsizing left to do, and retailers experimenting with new hybrid models that blend e-commerce with brick-and-mortar, is fueling optimism for the sector ahead — leading to more investment. Last year marked the first time that retail investment volumes increased in consecutive years since 2015.

CAP RATES AND PRICES

Cap rates in the retail sector followed the trend observed throughout the rest of the commercial real estate ecosystem. As capital sought deals ahead of the Fed’s widely anticipated monetary tightening, cap rates sank to new all-time lows. For retail properties, cap rates reached their low point in Q2, touching down to 6.0%. While cap rates then started picking up in Q3 and Q4, the movements were mild compared to other property types. By the end of the year, cap rates had risen to 6.2%, though they only moved by a total of 13 basis points off their Q2 nadir.

With retail cap rates starting to inch higher, the wind in the sails of pricing has died down. Prices kept on rising through the first three quarters of the year, reaching a new all-time high of $300/sq ft in Q3.

However, reflecting the impact of higher interest rates, pricing started to soften, with retail asset valuations declining to $287/sqft. While prices remain up by 1.6% year-over-year, the drop from the previous quarter was a more substantial — 4.3% — the most significant quarter-over-quarter decrease since 2009.

Regional Performance

In developing the regional retail rankings, the SVN Research Team utilized a scoring matrix. The matrix offers a comprehensive view of how regional markets are performing within the context of growth from a year earlier, as well as compared to before the pandemic. The eight following criteria were included in the matrix:

1. Transaction Volume: 1-Year % Change
2. Transaction Volume: % Change Over Pre-Pandemic (2019)
3. Share of US Transaction Activity: 1-Year Change
4. Share of US Transaction Activity: Change Since Pre-Pandemic
5. Cap Rates: 1-Year Change
6. Cap Rates: Change Since Pre-Pandemic
7. Pricing: 1-Year % Change
8. Pricing: % Change Over Pre-Pandemic

TOP PERFORMERS: SOUTHEAST

Shockingly, it turns out that attracting many new residents (who also happen to be consumers) into your region is a good thing for retail, too. The Southeast, a hotspot destination for young, starting-out families priced out of affordable housing options in high-cost markets, has seen broad commercial real estate success.
Over the past three years, retail asset prices have soared in the Southeast by 27.9% — blowing past every other corner of the country. The pricing increase comes with more investment dollars targeting retail assets.

All regions saw a rise in retail investment volume between 2019 and 2022. However, these growth rates sat between 6% and 33% for all areas other than the Southeast. Meanwhile, growth in the Southeast lapped the rest of the playing field, jumping by an incredible 75.8% in that time.

TOP PERFORMERS: WEST

How could the region that boasts Rodeo Drive not pop up here? Anchored by metros such as Los Angeles, San Francisco, Las Vegas, and Salt Lake City, the West has a unique balance of legacy gateway markets and high-growth markets that are starting to show their economic might. No region saw a bigger relative or absolute increase in investment volume than the West.

A total of $22.8 worth of retail assets changed hands in the West last year — $3.9 billion more than in 2021, representing a 20.6% increase. Moreover, after briefly losing its crown as the most active retail investment region in 2021 to the Southeast, the West narrowly recaptured its title in 2022 — securing 26.1% of all retail sales compared to the Southeast’s 26.0%.

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

1. Q1 2023 GDP

• The US economy grew at an annualized rate of 1.1% during the first quarter of this year, slowing significantly from the Q4 2022 annualized rate of 2.6% and registering well below the Dow Jones consensus forecast of 2.0%.
• Growth in Q1 primarily reflected an increase in consumer spending partially offset by a decrease in private inventory investment.
• The increase in consumer spending was aided by increases in both goods and services spending. Spending on motor vehicles and parts led to goods consumption, while an increase in health care and food services spending carried much of the rise in services.
• Government spending increased during Q1. On the federal level, the increase primarily reflected nondefense expenditures, while on the state and local level reflected a rise in compensation for government employees.
• A pullback in Wholesale Trade growth led to a decrease in private inventory investment, specifically within machinery, equipment, and supplies. Manufacturing also saw a retreat.
• A decline in residential fixed investment was led by a decrease in new single-family home construction.

2. NMHC QUARTERLY SURVEY OF APARTMENT CONDITIONS

• As of the NMHC’s April 2023 survey, apartment investors across the US continue to report a challenging financing environment, with the availability of both debt and equity continuing to shrink.
• A majority (51%) of apartment operators report that conditions in their local markets are looser (higher vacancies, less rent growth) today than three months earlier. 34% of operators said conditions were unchanged compared to three months again, while just 14% reported a tightening.
• While the majority of investors (53%) report that now is a worse time for borrowers than three months ago, this share has started to drop off over the past two quarters. When asked in October 2022, a supermajority (90%) felt that borrowing conditions had worsened, and 0% reported an improvement. Fast forward to the April 2023 survey, this declining share has dropped by 37%, while 12% now say financing conditions are improving.
• Notably, while a majority of investors (64%) anticipate a continued bumpy landing thanks to the Federal Reserve’s monetary tightening cycle, they do not anticipate a recession. Just 21% of respondents expect a hard landing with a recession.

3. CONSUMER CONFIDENCE

• According to data from the Conference Board, consumer confidence fell in April to 101.3, declining from a reading of 104.0 the month before.
• The present situation index, a snapshot of current business and labor market conditions, rose from 148.9 to 151.1.
• The expectations index, based on the shorter-term sentiment of income, business, and labor market conditions, fell from 74.0 to 68.1 in April. Moreover, outside of a brief uptick in December, the expectations index has been below 80 since February 2022.

4. MORTGAGE APPLICATIONS

• Mortgage applications climbed by 3.7% during the week ending on April 21st, 2023, an 8.8% fall in the previous week, according to the Mortgage Bankers Association.
• Mortgage application demand fell significantly during the second half of 2022 as mortgage rates rose steeply. After falling for much of December, mortgage applications increased to begin in 2023.
• Applications to purchase a home increased by 4.6%, while refinance applications rose by 1.7% during the week ending April 21st.
• Despite recession concerns, markets largely expect a 25 basis points hike by the Fed at their next meeting, which has placed upward pressure on treasury and mortgage rates.

5. OFFICE DEMAND

• Office demand is on the rise again, according to the latest data from VTS. The VTS Office Demand Index (VODI) rose by 31.3% between March and April.
• Historically, the month of March tends to experience a seasonal surge in office demand and occupancy. However, this year’s surge is higher than in the previous five years. Still, since office occupancy remains below pre-COVID levels, similar increases in demand today will have an outsized impact on month-tomonth growth than in previous years.
• That said, the VODI remains 4.5% below its March 2022 level, signaling a continuing long-term recession in office demand. However, the gap is narrowing. In February, the VODI was down by 12.5% from a year earlier.

6. MSCI RCA: APARTMENT

• Apartment cap rates ticked up again in Q1 2023, rising 19 bps from the previous quarter and settling at 5.0%. Compared to one year ago, apartment cap rates are up by 57 bps.
• Trends are similar across sub-asset types within the apartment sector. Both garden-style and mid/ highrise apartments finished Q1 2023 with a 5.0% average cap rate. Moreover, both sub-asset types saw similar quarter-over-quarter changes, with garden and mid/highrise units rising by 17 bps and 18 bps, respectively.
• Apartment transaction volume totaled just $25.4 billion in Q1 2023 — the least active quarter on record since Q2 2020. Volumes declined 52% quarter-over-quarter and 64% year-over-year. Valuations have also fallen for their third consecutive quarter, dropping by 9.4% since reaching a peak in Q2 2022.

7. MSCI RCA: RETAIL

• For a third consecutive quarter, retail cap rates continued rising in Q1 2023. Retail cap rates sat at an average of 6.4% during Q1, rising 17 bps quarter-over-quarter and 34 bps year-over-year.
• Urban storefronts were the only retail sub-type not to see an average quarter-over-quarter cap rate increase, holding at 5.4%. Lifestyle/power centers and single-tenant retail assets also see favorable cap rate trends, posting mild quarter-over-quarter gains while maintaining year-over-year decreases.
• Retail transaction volume increased mildly (+0.1%) in Q1 2023, totaling $16.9 billion in sales. Still, the positive gain is noteworthy as other sectors saw a significant pullback last quarter. Measured, year-over year, retail asset sales are down by 27.4%. Moreover, asset valuations have softened by a cumulative 7.6% over the past two quarters.

8. MSCI RCA: OFFICE

• The office sector has now seen cap rate increases in the past four quarters. Average office cap rates jumped again in Q1 2023, this time by 17 bps to land at 6.7%. Over the past year, office cap rates have risen, on average, by 54 bps.
• Suburban office cap rates have jumped 54 bps in the past year, rising to 6.8% through Q1 2023. Meanwhile, central business district (CBD) office cap rates have risen by a more gradual 32 bps, reaching 5.8%. Notably, CBD office cap rates did not meaningfully compress during 2021 as functional concerns were already impacting pricing.
• Office transaction volume cratered in Q1 2023, with just $10.7 billion worth of assets trading hands. Compared to the prior quarter, trading volumes sank 48.1%. Year-over-year, deal volumes fell 68.4%. Similarly, asset valuations continue to feel the heat of higher interest rates, dropping 2.8% quarter-over-quarter and 9.1% year-over-year.

9. MSCI RCA: INDUSTRIAL

• Despite strong fundamentals, the industrial sector has proven it is not immune to the effects of higher interest rates. Like the office sector, industrial assets have now seen cap rates rise in the past four quarters. Industrial cap rates have risen 12 bps quarter-over-quarter and 35 bps year-over-year through Q1 2023, landing at 5.5%.
• Single-tenant industrial space has seen the most dramatic increase in average cap rates over the past year, rising by 63 bps to 5.7%.
• Transaction volume sank to its lowest quarterly amount in Q1 2023 since 2020, falling to $15.5 billion. The Q1 totals stand a decrease of 47.2% quarter-over-quarter and 54.4% year-over-year.

10. CASE-SHILLER HOME PRICE INDEX

• According to the S&P Case-Shiller National Home Price Index, negative pricing pressures may be starting to ease in the housing sector.
• As of February 2023, for the first time in eight months, home prices did not fall on a month-over-month basis. While the monthly gain was marginal (+0.2%), the directionality is meaningful.
• Through the February 2023 data point, average home prices are down from their June 2023 peak by just 2.7%. While higher interest rates have sapped new homebuyer demand, existing homeowners being locked into low mortgage rates has meant a lack of default distress. As a result, while buying activity has fallen off, the impact on pricing has been marginal.

SUMMARY OF SOURCES

• (1) https://www.bea.gov/data/gdp/gross-domestic-product
• (2) https://www.nmhc.org/research-insight/quarterly-survey/2023/nmhc-quarterly-survey-ofapartment-conditions-april-2023/
• (3) https://www.conference-board.org/topics/consumer-confidence
• (4) https://www.mba.org/news-and-research/newsroom/news/2023/04/26/mortgage-applicationsincrease-in-latest-mba-weekly-survey
• (5) https://view.ceros.com/vts/vts-office-demand-index-april-2023/p/1?utm_medium=email&utm_source=content&utm_campaign=2023-04-26-dta-vodiapril2023report&utm_content=national&mkt_
• (6) https://storage.pardot.com/36252/1681929980GgvZJteN/2304_RCACPPI_US.pdf
• (7) https://storage.pardot.com/36252/1681929980GgvZJteN/2304_RCACPPI_US.pdf
• (8) https://storage.pardot.com/36252/1681929980GgvZJteN/2304_RCACPPI_US.pdf
• (9) https://storage.pardot.com/36252/1681929980GgvZJteN/2304_RCACPPI_US.pdf
• (10) https://www.spglobal.com/spdji/en/index-family/indicators/sp-corelogic-case-shiller/?utm_content=Intl_Indicators&utm_source=google&utm_medium=next_gen&utm_term=home%20price%20indices&utm_campaign=paid_

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