The Bigger Commercial Real Estate Picture

While the office market’s high defaults and sinking occupancy rates steal the spotlight, the multifamily sector is showing signs of possible issues for the latter part of the year.

The Bigger Commercial Real Estate Picture

While the office market's high defaults and sinking occupancy rates steal the spotlight, the multifamily sector is showing signs of possible issues for the latter part of the year.

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Good morning. The pandemic has raised concerns about downtown offices' decline and market instability, while a major shift in another real estate sector is overlooked. Prices are plunging at self-storage facilities as demand falls. Meanwhile, despite their imperfections, two research papers show Opportunity Zones have made a noteworthy impact.

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Market Snapshot

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*Data as of 7/25/2023 market close.

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Why Multifamily Real Estate Could Outweigh Office Issues in the Second Half of 2023

Despite the office market grabbing attention due to high defaults and plummeting occupancy, the multifamily sector is signaling potential concerns for the latter half of the year.

The office market: The pandemic has spurred a remote work trend, casting a shadow over downtown office real estate. While office spaces account for 80% of new commercial real estate loan delinquencies and have about 50% occupancy, they represent only 15% of the $20T market. Much of this is suburban, with urban core, Class A properties making up less than half of the US office space.

CRE by sector

Multifamily mayhem: Meanwhile, the evolving office real estate sector overshadows another unfolding commercial real estate story. The largest category, exceeding office by several billion dollars, is multifamily residential properties, typically apartment complexes. Real estate loans in this area appear particularly shaky due to three main reasons.

  1. Lots of loans were originated in 2021 when rates were cheap.

  2. Interest rates for multifamily loans usually reset after 2–3 years, meaning these developers now face higher rates.

  3. Small and midsize regional banks originated over half of these loans.

What does all that mean? An $8B surge of multifamily commercial mortgage-backed securities (CMBS), dubbed the "Red October," is set to hit starting from the latter half of this year. To provide some context, that's the same amount of office CMBS expected to mature throughout the entire year of 2023. The combination of tighter lending standards and more expensive debt leaves borrowers with limited options. Some may be able to extend, but others will either have to pay more or find new loans.

Upcoming apartment CMBS loan maturities

Rents on the rise: With capital costs increasing, real estate firms are attempting to balance expenses by hiking rents. Average rents have soared to an unprecedented $1,850 per month. Conversely, the national median rent, accounting for luxury and rent control, has steadily decreased since its apex of $1,400 in August 2022. The influx of the largest number of new apartments in four decades this year should help temper rising rents.


Time to panic? For multifamily real estate borrowers, perhaps. Investors, however, should remain calm. Most U.S. CMBS are backed by agencies like Fannie Mae, Freddie Mac, and Ginnie Mae, protecting investors even in default scenarios. Despite the complexity of the market, key takeaways for investors are: Commercial real estate is diverse, high-stress areas may not be the highest risk, and investment strategies should be adjusted accordingly. Performance differences exist between REITs and CMBS, and opportunities might be found where least expected.

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Pandemic-induced Boom in Self-Storage Wanes as Rental Prices Drop

Self-Storage Rents Fall Record Amount as Pandemic Boom Cools

Self-storage facilities, which boomed during the height of the pandemic, are finally showing signs of stabilizing.

Declining demand: Pandemic-era demand for self-storage spaces is waning as people go back to offices and gyms. The decline in home sales due to higher interest rates has also weakened demand since people tend to use self-storage during moves. And while summer typically sees the highest demand for self-storage, summer 2023 has seen the lowest level of demand in 3 years.

Record rent reductions: Lower demand means self-storage facilities are cutting rents by record levels. In some places, rents for new customers are 28% below summer 2021 levels. Public Storage (PSA), the largest global self-storage operator, is charging just $1 for first month's rent. New self-storage customers paid 10% less in 1Q23 from a year ago at $15.45 PSF, the biggest decline since Green Street started tracking rates in 2013.

US self-storage rent per square foot, daily average

Normalizing behavior: Self-storage operators have been known to raise rents far above inflation since most people would rather pay extra than move their stuff to another facility. However, many customers are responding to rent hikes by moving out for the first time since before the pandemic. National occupancy for self-storage REITs has fallen to 92% after record 96% occupancy during the pandemic.


The future may be bright: The pandemic-fueled boom in the self-storage sector is waning, with rents dropping 10% YoY and new leases at a three-year low. Despite these challenges, the sector maintains strong fundamentals, with continued demand from consumers needing additional space, and notable deal activity such as the sale of Simply Self Storage for $2.2 billion.

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Around the Web

📖 Read: As the fastest-growing sport in the US, pickleball is taking over spaces once filled by department and big-box stores. Bisnow spoke with three pickleball operators on why their courts are dreams come true.

🖥️ Watch: David Rubenstein, co-founder of The Carlyle Group and host of Bloomberg Wealth, talk about the CRE crisis as millions of people stay home and employers try to figure out what to do with empty offices.

🎧 Listen: In this episode of The Weekly Take, PIMCO’s John Lee and CBRE’s Chris Ludeman discuss the current state of capital markets, the impact of the Fed’s continued rate hikes, and potential opportunities.


Opportunity Zones Demonstrating Progress Towards Original Goals

The Economic Innovation Group (EIG) has assessed two research papers analyzing Opportunity Zones (OZs). While the policy has imperfections, it represents a bold approach with potential lessons for future government initiatives.

Paper one: Economist Harrison Wheeler's study, "Locally Optimal Place-Based Policies: Evidence from Opportunity Zones," showed that the tax credit associated with OZs boosted new development in large U.S. cities by around 20.5%. However, the study indicated that with better selection of OZs, the impact of this investment could be significantly improved.

Paper Two: In the paper "Use of the Opportunity Zone Tax Incentive: What the Tax Data Tell Us" by David Coyne and Craig Johnson, tax records from 2019 and 2020 reveal a broad geographical investment in OZs. However, the study found some location bias, with areas showing higher socioeconomic indicators more likely to receive investment, leaving room for improvement in serving social interests.


The bigger picture: Despite shortcomings, the OZs have resulted in large-scale private investment and significant economic impacts across 3,800 communities by the end of 2020. They've led to increased commercial and residential development and lifted home values without increasing rents. Future programs could learn from the successes and shortcomings of OZs, particularly in optimizing zone selection to maximize societal benefits.

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✍️ Daily Picks
  • Mixed signals: Baltimore remains a national leader in turning unwanted office space into apartments while the multifamily market keeps sending mixed signals about its long-term health.

  • Wall of worry: CRE is facing a $1T "wall of worry," as property owners face higher vacancy, reduced NOI, falling prices, and rising cap rates, anticipated to persist until 2027.

  • Vornado victory: Financial services firm Canaccord Genuity Group signed a lease for 75 KSF at the Penn 1 building, a major win for owner Vornado (VNO).

  • Growth opportunity: Lazard (LAZ) is launching a new division specifically focused on raising capital as banks look for new channels of growth.

  • No more joy: The $13M West Loop development site deal involving former Sterling Bay broker Joy Jordan is dead, causing the seller to file a lawsuit for breach of contract.

  • Proptech slowdown: A combination of macro factors has slowed proptech investment considerably, while M&A and industry adoption have been fitful at best.

  • Jail time: LA developer Dae Yong Lee was sentenced to 6 years in prison and ordered to pay a $750K fine for his 2017 attempt to bribe a former City Council member.

  • Data center denial: A startup’s plan to build a $100M data center in the Columbia River Gorge of Portland has collapsed after public sentiment united against it.

  • New legislation: A bill moving through the California State Legislature seeks to cap renters’ security deposits as part of a broader effort to make housing more affordable in the state.

  • Hotel gains: Steve Hermann Hotels sold The Inn at Rancho Santa Fe in north San Diego for $100M after acquiring it in May 2022 for $42.7M. Nicely done.

  • Call first: The IRS on Monday halted a decades-long practice of unannounced visits to homes or businesses to collect unpaid balances for most taxpayers.

  • Financing success: Balaciano Group has secured $238M in financing from Morgan Stanley, U.S. Bank, and California Bank & Trust for their 723-unit mixed-use project in LA’s Warner Center.

  • Back to work: Amazon (AMZN) told their remote employees that they may have to relocate to its "main hubs" to keep their jobs.

  • Acquisition of the day: Rexford Industrial Realty (REXR) has acquired a 595,304 SF industrial property in LA County for $210M.

  • Feeling the pain: Since US public pension funds poured money into CRE at record rates during 1H22, they may feel pain as values drop 30–50% in the hardest-hit cities.

  • Celebrity status: Celebrity retail brands have accounted for over 300 KSF of new space in the last decade while captivating young and affluent consumers.

  • Location liquidation: Alan Fine, the new CEO of Location Ventures, is looking for buyers willing to pay top dollar for firm’s projects to avoid a fire sale through bankruptcy.

  • Extreme heat: Construction firms are adapting to the implications of extreme heat on their workforce. However, it's not just the workers who require mitigation – the buildings themselves do, too.

📈 Chart of the Day
Phoenix & DFW Dominate BTR Construction Since 2016

According to CoStar, the Sun Belt dominates the top spots for build-to-rent construction, with Phoenix and DFW ranking #1 and #2.

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