Good morning. In today’s email: It’s the end of an era for apartment sales, which are slated to underperform in Q4 after a record-breaking run this past year. Big players in the CRE sector are hedging their debt with interest-rate swaps, but they might be taking on more risk than they bargained for in the process. Prologis believes the next couple of years will see a serious shortage of warehouse space. Meanwhile, a series of deals between hedge funds pave the way for a new 1.7MSF office tower in NYC. 

READ, WATCH, LISTEN

• 📖 Read: CREXi recently identified six cities in the United States that could be designated as the cheapest for CRE in 2023

• 💻 Watch: Real estate experts discuss their predictions for the housing market in 2023

• 🎧 Listen: Chris Pompliano discusses his experiences in the army and at Facebook and offers advice for tech investing on The FORT

OUT WITH A FIZZLE

Q4 Apartment Sales Are Headed For Record Lows This Year

It looks like 2021’s golden age of apartment sales is over. High lending costs, slowing rent growth, inflation, and an oversupplied market have given apartment sales a serious gut check. Things could turn around next year, but in the meantime anyone praying for a Christmas multifamily miracle better prepare for a lump of coal in their stocking.

It’s going down: Q4 typically outshines Q3 in apartment sales, but that’s not likely to happen this year. To date, Q4 2022 has logged a measly $32B in apartment sales—the lowest volume since Q4 2014’s $35.5B. That doesn’t sound too bad until you remember that last year’s Q4 apartment sales volume hit a record $130B.

Blame it on the rate: In the first half of the year, sales were brisk. That changed with the Fed’s decision to raise interest rates in April, which drove lending costs up and apartment sales down. Then bad became worse when construction finished on many long-delayed projects and the double-digit annual rent increases seen during 2022’s first three quarters disappeared by the fourth.

➥ THE TAKEAWAY 

Known unknowns: With persistent inflation and expert sentiment down in the dumps, it could be a while before apartment sales recover. Many analysts believe the market is likely to stay in a slump as long as overall economic conditions remain uncertain. But that’s uncertainty for you—nobody knows how long this will last.

FLOAT YOUR BOAT

CRE Borrowers Hedge Their Bets to Avoid Getting Burned by Rising Interest Rates

Big CRE borrowers are hedging their debts with interest rate swaps and caps to protect themselves from rising rates. Problem is, fickle market conditions and a history of financial crises make it hard to tell whether that bet is a safe one.

The tradeoff: Firms that began 2022 with variable-rate debt have suffered thanks to the Fed’s rate hikes. They’ve been trading variable-rate debt for fixed-rate debt to reduce exposure. But the cost of interest-rate caps has grown more than 10x since the start of the 2022, making swaps way pricier. And if rates do fall, interest-rate swaps would actually become a liability for lenders rather than an asset.

Indecent exposure: There’s huge variability in rate exposure among CRE’s fat cats. Some corporate landlords only have 10% exposure, while Vornado Realty Trust (VNO) and Blackstone (BREIT) both had  around 50% exposure at the start of the year. Since then, Vornado and SL Green Realty (SLG) have both whittled that number down to 25%. BREIT actually has more exposure now, with nearly all of the company’s debt tied up in complicated hedges.

➥ THE TAKEAWAY 

Over the hedge: Eventually, the Fed will likely lower rates as part of an aggressive attempt to bail the economy out of a recession. By then, variable-rate debt will be more attractive. But realtors would do well not to put money on such predictions because similar hedging in the name of profit (e.g., credit-default swaps on mortgage bonds) was a central catalyst of the 2008 financial crisis. So long as realtors hedge to reduce their exposure rather than make a windfall, however, this behavior is unlikely to lead to a crash.

THE “WHERE” IN WAREHOUSES

Prologis Predicts a Nationwide Warehouse Shortage Into 2024

According to Prologis (PLD), U.S. warehouse development will fall to a 7-year-low in 2023 even as rent growth surpasses 10%. Prologis believes the main reasons for the slump will be surging capital and construction costs that have also waylaid the residential housing market. 

By the numbers: According to the Prologis report, the warehouse construction pipeline “will drop from over 500 million square feet in Q3 2022 to 275 by year-end 2023.” Additionally, starts are expected to fall by 60% to less than 175 MSF during the same period. It’s about to get real quiet out there.

The Prologis prognosis: Prologis believes that sustainable warehouse development may buck this trend since sustainable building costs are steadily falling. The construction of sustainable developments is also encouraged by government incentives and the European energy crisis. Other analysts believe these gains will take longer to materialize than Prologis thinks, creating a widespread warehouse shortage by 2024.

➥ THE TAKEAWAY 

The long view: Warehouse demand is already high (e.g. double-digit rent growth), and is likely to only go higher as supply falls further behind demand next year. As a result, there will likely be little-to-no warehouse vacancies over the next few years, producing or sustaining double-digit rent growth for the foreseeable future. Salud.

Citadel Doubles Down on Expanding Along Manhattan’s Park Avenue

Vornado Realty Trust and Rudin Management Co. have reached a series of deals with Ken Griffin's Citadel that will allow them to proceed with the $1.2B development of a 1.7 MSF office tower in Midtown East, New York.

The master plan: Citadel will master-lease Vornado's 585 KSF 350 Park Avenue for 10 years, with an initial annual rent of $36M. Citadel will also master-lease Rudin's adjacent 390 KSF property at 40 East 52nd Street. Vornado will form a JV with Rudin to buy 39 East 51st Street for $40M and combine that site with 350 Park Avenue and 40 East 52nd Street.

Picking and choosing: As part of the deal, the companies will combine the properties to create a "premier development site." Starting in 2024, Griffin will have options to invest in the site and either acquire a 60% interest in the Vornado/Rudin JV, execute a 15-year anchor lease for Citadel, or exercise an option to purchase the site. Vornado originally planned to build a new tower at 350 Park Ave.

➥ THE TAKEAWAY 

The bottom line: The deal reached between Citadel, Vornado, and Rudin is significant because it a) paves the way for a 1.7 MSF office tower in NYC and b) shows investor interest in developing new office space in Midtown Manhattan. People still care about the Big Apple, and there might be some lucrative opportunities for real estate professionals in terms of leasing, development, and construction in the area.

📰 Editors' Picks

• Backlog bounty: Homebuilders survive the brutal housing market thanks to the huge glut of ordered (but unbuilt) houses they’ve been sitting on ever since the pandemic began.

• Bye Bye Bonus: With the clock running down on the property tax incentive known as the Bonus Depreciation Deduction, real estate professionals have to decide whether or not to claim it before it’s gone.

• Rezoning plans: Mayor Eric Adams has announced plans to rezone a 46-block stretch of The Bronx to promote the construction of more housing.

• NM No. 1: Thanks to promising tech and construction activity and projected population growth, Albuquerque, NM now ranks as the cheapest city in the country for CRE development. 

• The BREIT idea: As more investors try in vain to pull their assets out of illiquid investment vehicles like Blackstone’s, some are wondering whether private funds are a better idea.

• “Whatcha gonna do?” With the Trump Organization convicted of tax fraud, lenders may have the right to demand immediate payment due to “bad boy” clauses that punish unsavory activity.

• Hucking homes: U.S. homebuilding giant Lennar Corp. (LEN) is offering to sell 5,000 discounted homes to investors as buyer demand plummets.

• Payout on pause: A judge in Washington state extended a temporary restraining order blocking Albertson’s (ACI) $4B dividend payout to shareholders in anticipation of the company’s proposed merger with Kroger (KR).

🤝 Deals & Dealmakers

• All scream for ice cream: The city of Virginia Beach shelled out $12.8M to buy an Oceanfront Dairy Queen for the sake of preservation of parks.

• Rosslyn revamp: The Jefferson Apartment Group just acquired the RCA building in Rosslyn, with plans to build a new 27-story apartment tower on the property.

• Absorbing Pangea: Emerald Empire just bought all of Pangea’s Chicago properties in a $600M deal where 7,500 units changed hands.

• Foggy Bottom for bottom dollar: Thanks to a 42-year-old deal, George Washington University just bought a Foggy Bottom office property for 5% of its assessed value. 

• Wynwood win: Moishe Mana just secured a $275M credit line from Centennial Bank to develop his Wynwood properties in Miami, FL.

• Yard sale: Chinese property tycoon Yang Huiyan is looking to raise some quick cash by offering up her $650M stake in Country Garden Services Holdings Co.

• You’re alright, Bezos: Amazon just pledged to commit $24M to the construction of affordable housing units in Bethesda, MD.

 📈 Chart of the Day

Single-Family Construction Draws Households to New Neighborhoods

The pandemic has been a real bummer for apartment dwellers, according to a new report. Apparently, people looking to move during the crisis have been flocking to cities with lots of single-family homes and leaving those with lots of apartments. New York and LA were the big losers, while Boise, Idaho came out on top. Looks like it might be time to ditch that cramped city apartment and head to the suburbs.

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DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.