It’s safe to claim we can respond to the question, “Does history repeat itself? after experiencing a number of recessions and identifying important trends. The answer is a loud “yes,” but we can use what we have learned from the past to lessen the risk by planning ahead more effectively.
The news stories of today make it clear that a recession is either coming or has already begun. In any case, the commercial real estate industry has historically been affected by market downturns, and this situation is no exception.
Although past recessions have had both beneficial and negative effects on companies, from credit restrictions to changes in sales volume, the legal issues that arise are probably the most expensive and long-lasting. Understanding the risks that arose during previous recessions and how they were handled may help lenders and developers stay safe during these trying times.Additionally, being aware of the past might help both parties take the appropriate safety measures to prevent a repeat of the same events.
According to statistics, there are statistically more construction-related litigation cases than any other loan litigation claims in any given year, and these numbers are even higher during a recession. Recessions have caused and are expected to continue to cause a variety of legal problems with building financing. Without market changes, these loans are already risky, but during a recession, cash-strapped contractors or those who underbid a project may end up doing shoddy repairs. As a result, there may be more faults as a result of hurried work, supply chain delays, labor shortages, cost-cutting measures, and/or manufacturing issues.
Construction-related issues can become more common and more expensive to handle during a recession, in addition to a rise in construction-related issues. Government shutdowns can affect the timing of permits and even necessitate the suspension of project work amid a recession and pandemic, in addition to the more usual weather delays, workmanship concerns, and supply chain delays. Events of default under the terms of the loan, fines, or extension costs may be triggered by delays. They may also have an effect on long-term funding sources and result in higher carrying costs. Delays may also result in guarantor responsibility for some loans, making it harder for the project to sustain in the long run.
Of course, variable interest rates are sometimes a sign of a volatile market. Early interest rate locking, however, can have benefits and drawbacks. Variations in interest rates can have a significant impact on the expenses of completion for those uncommon construction-to-permanent loans. Numerous lenders had to make difficult decisions regarding the feasibility of loan commitments during previous recessions in the face of claims from borrowers, which led to many borrowers with forward commitments having loan approvals revoked as a result of shifting interest rates.
Broken promises may lead to protracted legal proceedings and, in rare cases, punitive damages. Additionally, the impact and delays that follow might virtually ruin a project’s feasibility. There may also be personal liability if there are guarantors on the loan and the borrower defaults. Numerous lawsuits involving loan commitment termination were filed during previous recessions, and many courts carefully considered whether the reasons for the termination were valid.
Finally, a less reliable renter pool can result from recessions. Borrowers are more likely to default on their mortgage payments when tenants are unable to uphold their rental responsibilities. It should come as no surprise that during a recession, there are more foreclosures, deeds in lieu of foreclosure, and collection attempts. Due to the financial uncertainty, there are more bankruptcies.
Contrary to what many commercial lenders and developers may believe, a recession can really present opportunities. With appropriate planning, some risks may even be reduced. I genuinely believe it comes down to these ten suggestions after decades of risk management and litigation in the aftermath and with the benefit of hindsight:
To completely comprehend all of your contract provisions, have a new set of eyes look over your loan documentation, building contracts, and land purchase agreements. Make sure to carefully review your notice requirements and force majeure clauses and to adhere to them. Throughout the course of the project, review your documentation frequently, especially if construction loans are involved.
Ensure that your deadlines are consistent across all of your documents. Give yourself plenty of time to account for conceivable delays that might be unavoidable.
Make sure you start off by keeping precise, thorough records and notes. Follow up on the performance of the contract, noting any deviations or delays.
Inspect the area on a regular basis. Lenders should personally verify that deadlines are being followed while owners and developers should be monitoring their contractors and the project’s progress.
The key is communication. Although it sounds cliche, effective communication can save a relationship and raise the likelihood that a loan or contract can be modified when necessary.
Examine and keep your insurance.
Limit your promises. Although managing expectations may seem easy, it can sometimes make a difference in a project’s success.
Maintain your lane. In a recent ruling, a judge stated that “[i]f a lender exercises excessive control over a borrower, Although there is no fiduciary responsibility, “if a lender takes a particularly active role in the business decisions of the borrower,” it “may become liable for tortious interference,” even in the absence of one., a lender can take on the role of fiduciary rather than creditor.
Make use of specialists who have the expertise and knowledge to handle any issue that may arise, such as construction managers, inspectors, supervising architects, lawyers, and/or accountants.
Request document revisions as needed, secure the relevant approvals, and record any alterations to agreements.
Following these ten procedures will reduce legal risk, if not completely eliminate it, even during a recession.
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.
The good news is that REITs as a group have recently performed well. They were up 4.2% as of last Friday, per BTIG Research. Comparatively, the S&P 500 and Russell 2000 stock indexes saw returns of 3.6% and 4.0%, respectively.
But then there was this line: “Rates are expected to be in focus again for REIT with strong inflation measures on tap for this week’s economic calendar (CPI prints on Tuesday, PPI prints on Wednesday).”
Additionally, Tuesday’s CPI prints, sometimes known as inflation data, fell far short of forecasts. Almost everything else was up, even if oil was down. Core inflation, which excludes food and energy, reached 6.3%, exceeding experts’ expectations by a factor of 2. Consumers suffered from the basics. Monthly growth in food was 0.8%. Shelter increased by 0.7% from month to month. August to July had a 0.5% increase in transportation.
When the Fed meets next week, the benchmark interest rate will likely rise by 75 basis points, with a potential increase of 1 percentage point.
According to a Nareit piece from early 2022, inflation is often advantageous for REITs. The company stated that “REITs have traditionally offered protection against inflation and outperformed the broader stock market during periods of moderate and high inflation,” where it defined moderate inflation as occurring between 2.5% and 7.0% and high inflation as occurring beyond 7.0%.
But there are also interest rates, which the Fed has aggressively raised in an effort to restrict economic growth and bring inflation back to about 2%.
According to BTIG’s analysis, “REITs as a sector have significantly cleaned up their balance sheets since the GFC.” However, in 2022, both the weighted average rate on REIT debt and the ratio of interest expense to NOI will be at historic lows. If rates continue to rise, which they will, this creates a danger to projections and results.
As a result of rates being so low for so long and seeing so many false starts, the company added, “We think there is a danger that interest expense has been rooted in consensus projections.” To put things in perspective, the current SOFR forward curve indicates an average rate of 3.84% in 2023, before taking into consideration any credit spreads. As a result, the weighted average rate for total REIT debt throughout the industry in 2023 will be higher than the average 1-month rate at present. Unhedged variable-rate balances will be impacted by this, and there may be volatility for external growth if buyers are compelled to reevaluate their financing assumptions.
Experts predicted that inflation would decline as a result of the decline in oil prices, which moderated the strong impact energy has had on the economy. Not at all. It became worse.
In one sense, it wasn’t by much—the rise was 0.1 percentage points. But given the expectations, it came as enough of a shock for the markets to tremble. As of 10:15 a.m., the S&P 500 was down around 2.6%, the Dow was down 2.3%, and the Nasdaq was down 3.2%, according to S&P Global Market Intelligence.
As this episode of inflation shows to be anything but “transitory,” Cliff Hodge, chief investment officer at Cornerstone Wealth, said in a statement sent by email, “Misses on both the headline and core are disappointing.”
There are two things it means for CRE. First, it is unlikely that the Federal Reserve will stop raising interest rates. Consider that in its scheduled meeting next week, a minimum 75-basis point increase is a given. It’s possible that it would increase by a full percentage point in response to the shift, which would result in significantly higher financing costs for all real estate projects. If you previously borrowed at significantly lower rates and are getting ready to refinance, this is bad news for you.
According to Charlie Ripley, senior investment strategist at Allianz Investment Management, core inflation, which excludes food and energy, increased “twice as quickly” as predicted by experts, reaching 6.3%. Market investors are starting to realize that the Fed’s current level of tightening is insufficient to slow the economy and lower inflation, according to Ripley. The Bureau of Labor Statistics emphasizes the second aspect of the impact, which is more indirect and has to do with the specifics of inflation.Since the beginning of the year, the main causes of inflation have been energy and related commodities. The biggest declines are now visible, but inflation is still rising. Even still, the annual increase in energy is still 23.8%. Hodge stated that “price hikes were prevalent,” with more than 70% of the CPI basket increasing by at least 4% annually.
Monthly growth in food was 0.8%. Even though it’s the slowest expansion since February, the unadjusted 12-month growth rate of 11.4 percent is still impressive.
Rent and similar housing costs for homeowners increased by 6.2% annually and 0.7% month-over-month. The core services sector continues to see housing prices lead the way, rising 0.7%, the fastest monthly gain since January 1991, according to Oxford Economics.
Transportation increased by 0.5% from July to August and has increased by 11.3% annually.
Consumer confidence will undoubtedly decline as they experience a tighter strain on necessities, which will also affect their capacity to spend money on other things. The pressure on retail and hospitality might possibly increase, posing a bigger risk to owners and operators from tenants. Casual travel and hospitality could suffer as a result. Because forcing people back into the office would increase costs for the employees, the office, which is already under pressure, might discover that tenants don’t feel they can do it as easily.
Overall, there is no positive news.
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.
According to a recent study from Trepp, CMBS delinquency rates in August 2022 were 2.98%, finally dropping under 3% for the first time since the pandemic. They had hardly decreased below 6% the previous year. Six months have passed since they fell below 4%.
Delinquency for CMBS peaked at 10.34% in July 2012, marking its all-time high. 10.32% was the pandemic’s peak in June 2020.
The percentage of loans that were at least 60 days past due, in foreclosure, REO, or non-performing balloons was 2.89%, which does indicate that the majority of delinquent loans face significant issues. Following that, foreclosure properties accounted for 100 basis points of the total. According to Trepp, “If defeased loans were taken out of the equation, the overall 30-day delinquency rate would be 3.14%.”
Commercial mortgage-backed securities are a significant component of CRE. The CMBS structure enabled lenders to free up capital for additional investments by bundling commercial mortgages into financial instruments that resembled bonds and offering fixed-income to investors in exchange for upfront payments.
According to the Trepp analysis, the decline in delinquency rates is not unexpected. As loans in those categories “continue to see steady improvement each month as loans in those categories cure and/or pay off.”
Lodging delinquency was 5.18%, down from 12.05% a year before. Retail is down from 10.43% last year to 6.45% this year.
Due to continuous pressures around work-from-home, including many employees’ want to continue working from home, office still confronts difficulties. The firm warned that because most businesses are bound by five- and 10-year leases, the effect “will take years to play out.” The office delinquency rate is 1.50% currently, compared to 2.12% last year.
Gerard Sansofti, an executive managing director and the head of JLL’s debt and loan sales platform, claimed in an interview with GlobeSt.com in February 2022 that the general financial meltdown in 2008 resulted in major improvements to the structures of CMBS issuances.
The structures are likewise less important to the projects. Over 50% of the market used to be CMBS. “Today, 10% to 15% of the market is affected. There is substantially more capacity at banks. Additionally, insurance firms have a lot more money. I don’t see the liquidity problem we experienced previously.
Our Orange County commercial real estate brokers will help you every step of the way in finding the right commercial investment property, contact us for details.
As output boosted the US economy in July, volume at The Port of Los Angeles reached its sixth all-time high in seven months, raising concerns about the area’s infrastructure, warehousing demand, and rate structures.
A total of 935,345 Twenty-Foot Equivalent Units (TEUs) were processed in July, breaking the previous record from 2019 by 2.5%.
At a news conference on Wednesday, Port of Los Angeles Executive Director Gene Seroka stated, “Remarkably, we continue to move record amounts of cargo while working down the backlog of ships by almost 90%, a remarkable accomplishment by all of our partners.
Observing that ships are now waiting for space at numerous other ports across the US, Seroka claimed that the supply chain environment in Southern California has improved.
Regarding the biggest port in the world, Seroka remarked, “Our terminals have capacity. For cargo owners looking to re-chart their course, come to Los Angeles. We’re ready to help.”
“We are also seeing many third-party logistics (3PLs) and warehouse users over-order their supply, as it has been hard to get goods from overseas since the pandemic started.
“The record volume has caused rental rates for industrial to rise dramatically. There is not enough warehousing supply to meet the influx of containers and product flooding the Southern California industrial market. With a sub 1% vacancy rate and a scarcity of industrial land, tenants are having a difficult time securing the space needed to store these goods.”
“We predict that tenants will be forced to be searching for warehousing in more peripheral markets where there is more supply of industrial land.”
Highest Rent Gains in Boston, New Jersey, and the Inland Empire
Supply-chain issues, according to Doug Ressler of Yardi CommercialEdge and GlobeSt.com, are making it more important than ever to be strategically situated and pay a premium for space in port areas, which have had the biggest increases in in-place rents in the past year.
According to Ressler, the areas with the highest rent increases are the Inland Empire (8.7%), Boston (8%), New Jersey (7.8%), Los Angeles (7%) and Orange County (6.8%). Additionally, port markets have the lowest vacancy rates. The Inland Empire is at 0.8%, Los Angeles is at 1.9%, and Orange County is at 3.1% in Southern California, which has the narrowest region.
According to Ressler, “The United States is a consumption-driven economy, and most goods come into the country from elsewhere, Estimates peg transportation as accounting for at least half of companies’ supply-chain costs. Although energy prices have fallen of late, those costs are still elevated compared to historical averages.
“Recent supply-chain stresses have illuminated exactly how dependent the U.S. is on other countries for both raw materials and finished products. As a result, firms are now exploring reshoring and nearshoring of manufacturing, which would reshape supply chains but also lead to new challenges.”
Many states around the US, including Florida, California, Minnesota, New York, and Nevada, continue to discuss and implement rent control.
According to a study released this week by the National Multifamily Housing Council, a number of proposals have either been passed, rejected, or put on the ballot in November (NMHC).
According to Ric Campo, the company’s chief executive, apartment operators like Camden recently said in The Wall Street Journal that “it will not build in a rent-control market.”
According to Sean Rawson, co-founder of the California-based Waterford Property Company,“From a public policy perspective, rent control is an extremely short-sighted way to provide housing affordability.” As a developer and investor in affordable housing, Waterford is a strong supporter of income-restricted housing; yet, imposing rent control unfairly burdens private investors, deters new investment in communities, and costs the long-term rental advantages.
“In my opinion, the long-term negative effects far outweigh any short-term political benefits for elected leaders.”
Building permits in Florida often take two years to obtain
These administrations keep citing a lack of homes and rising demand. The recent declaration of a housing state of emergency in Lake Worth, Florida, was considered as the first step toward attempting to enact rent control.
Governments continue to use regulation to stall the building of new homes. According to a recent survey by NMHC and the National Association of Home Builders, the average cost of developing a multifamily property is 40% accounted for by regulations at all levels of government.
According to the Florida Apartment Association, some Florida developers have to wait up to two years to get their building permits.
A review of the status in each state
A resolution to put rent control on the ballot was approved by Orange County’s County Commissioners in Florida. If adopted by voters, the resolution would set a one-year limit of 9.8 percent on rent increases in Orange County.
The city councils of Tampa and Saint Petersburg both voted down initiatives to place rent regulation on their November ballots.
The influential Culinary Workers Union Local 226 in Nevada committed to keep working for passage, and according to NMHC, “we expect a fight at the state level in 2023.”
Kingston, New York, became the first upstate city to establish rent control in the state of New York. 90 miles north of New York City is Kingston.
According to local reporting, the legislation applies to structures with six or more units constructed before 1974, which corresponds to around 1,200 units.
In California, Richmond’s city council decided to put a rent control issue on the November ballot. Richmond is located immediately north of Oakland.
According to NMHC, “if passed, rent increases would be capped at 3 percent of a tenant’s existing rent or at 60 percent of the Consumer Price Index, whichever is lower.”
In November, a rent control referendum will also be held in Pasadena.
A recent webinar entitled “Financing Amid Rising Rates: Best Approaches for $1M-$15M Multifamily Loans” featured market professionals from Walker & Dunlop who discussed how to successfully navigate the current financing environment. Tim Cotter, director of capital markets, Allison Herrera, senior director of SBL, and Allison Williams, senior vice president and chief production officer, made up the expert panel.
In a range of finance contexts, these seasoned experts have discovered strategies to close agreements and have shared their insights and advice. The following advice will assist you in navigating the current financial landscape and gaining momentum if you are an owner of five to 150 unit properties in need of loans ranging from $1 million to $15 million.
Due to these factors, buyers in the multifamily market’s $1 million–$15 million segment should look outside of banks and credit unions for their financing options. The Department of Housing and Urban Development (HUD), life insurance companies, Freddie Mac and Fannie Mae, as well as commercial mortgage-backed securities, make up the whole spectrum of funding sources (CMBS).
Here is a quick summary:
Agency finance: The US government founded Fannie Mae and Freddie Mac with the goal of financing affordable homes in both good and bad economic times. Their programs are less susceptible to market volatility as a result.
If you are aware with the nuances and requirements of the program, agency financing can be executed more quickly because it is non-recourse, which gives it an advantage over many bank options.
Additional benefits for multifamily SBL borrowers include:
HUD offers programs available for development as well as financing market-rate homes as well as affordable and rent-restricted housing.
Don’t let your thoughts be constrained by the idea that life insurance firms only invest in low-leverage, institutional-quality deals involving fully leased properties in significant metropolitan centers. There are options for loans of different sizes, ranging from $1 million to $15 million, and some life companies are willing to finance older assets that require renovations. Additionally, life insurance firms provide many of the benefits of agency financing, including non-recourse terms and relatively quicker and more efficient execution.
CMBS: Despite being frequently seen as “financing of last resort” and with spreads now expanding, CMBS can be an excellent choice for:
You should start with your current portfolio. Have you got a loan with a pre-payment penalty or one that you weren’t quite ready to restructure a few years ago? It could be wise to go over these scenarios once more and look into refinancing possibilities.
Look at your net operating income to acquire the best leverage and highest LTV:
Are your operating costs as minimal as possible?
Can you cut any fees that aren’t necessary?
Are you performing maintenance in the most efficient manner possible?
Finally, organize your paperwork. Having the required documentation on hand expedites the process because you want to lock in an interest rate as soon as feasible.
Many people had begun to think that the Federal Reserve might start to scale down the interest rate rises as a result of some easing in the producer price index and inflation. That news would be welcomed by the CRE sector. However, it’s unlikely to arrive. Certainly not this year.
The minutes from the Fed’s July meeting were made public. Although it is a two-week in the past mirror, it is close enough to show how the Central Bank is viewing the economy and its goals. It appears that a small improvement in some areas of the economy is insufficient for a significant shift.
According to a recent research from Moody’s Analytics, rent growth in the office and multifamily sectors is no longer trending together. This new development shatters a long time trend in which the two sectors frequently followed the same path.
Analysts describe the anomaly as a “great divergence,” noting that last year was the only time that rentals for offices and multifamily buildings really moved in the opposing ways.
According to a recent RentCafe poll, San Francisco, Jersey City, Manhattan, Philadelphia, and Boston witnessed the most increases in Gen Z renters’ lease applications over the past year, with rises of up to 101%. Moreover, a quarter of recent renters in San Diego, Los Angeles, Manhattan, and Philadelphia are also Zoomers.
However, Moody’s also noted that asserting that remote labor has no adverse effects on urban apartment markets would be “premature.”
In an era of hybrid and totally remote office employment, they claim, “it is likely that as households age into child rearing, the typical pull of suburban/exurban life could become stronger.” But it’s also true that a particular lifestyle only exists in urban areas.
