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Multifamily Faces $21.7B Funding Gap, Echoing Office Market Woes

The funding gap that was previously observed in the office sector has now extended to multifamily, according to new estimates by CBRE.

The funding gap: Now at $21.7 billion in the multifamily sector, mirrors the financial troubles first seen in office real estate, pointing to widespread challenges in commercial property finance. Such a gap, which arises from a need to refinance due to decreased property values and LTV ratios, signals growing economic uncertainty and poses significant risks for both investors and lenders.

A rising tide of debt: Initial reports focused on the office sector where CBRE discovered a $72.7 billion gap. Within months, this figure escalated to $82.9 billion. The multifamily sector, previously thought to be insulated, revealed a gap of $21.7 billion. When including the active year of 2021 for multifamily debt issuance, the projection exceeds $44.54 billion for loans maturing by 2026, indicating a deepening of the fiscal challenge ahead.

Between the lines: While the decline in property values leading to these gaps is not uniform across all regions, the impacts are widespread. Borrowers are cornered into considering various strategies to manage their debt, from infusing additional capital to negotiating loan modifications. Similarly, lenders are assessing their options, potentially offloading non-performing loans at a discount or crafting workout agreements to mitigate losses.

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Opportunities amidst the crisis: The situation is not entirely bleak. For investors with significant capital reserves, like the $270.6 billion reported by Colliers, the distressed sales market could be a fertile ground for acquisitions. These transactions might not only offer valuable investment opportunities but also help to establish a pricing baseline for properties affected by the funding gaps.

• Redemption rush: Nontraded REITs are expected to fulfill $20B in redemption requests by the end of 2023, the largest annual total in their history.

• Unsustainable city: A Silicon Valley-backed company was accused of using unfair tactics to force farmers to sell land in Sacramento for a ‘sustainable city.’

• Shutdown showdown: Goldman Sachs (GS) economists report that a government shutdown is now "much less likely" due to geopolitical strife and domestic political turmoil.

• Building diversity: Blackstone (BX) launches the Blackstone Real Estate Leaders Program for college sophomores to promote diversity and provide exposure to careers in real estate.

• Commission conundrum: A class action lawsuit targets NAR, Compass (COMP), Elliman (DOUG), Redfin (RDFN), and others for alleged conspiracy to inflate buyer agent commissions.

• A new record: Fibra Next plans to raise up to $1.5B in Mexico's largest IPO since 2018, backed by industrial properties from Fibra Uno, as nearshoring listings boost the Mexican market.

• McMansion tax: The Chicago City Council committee advances a proposal to increase real estate transfer tax on properties over $1M to address homelessness.

• Kid Icarus: WeWork (WE) is yet again expected to file for Chapter 11 bankruptcy protection very soon, following a $397M loss in Q2. Share prices plummeted on the rumor.

• Abandoned space: The Luzzatto Company has defaulted on a $48M loan for a struggling office building in LA's West Adams neighborhood.

• Fire sale: CA Ventures CEO Tom Scott sells a privately owned jet amid nationwide lawsuits, potentially valued at $25M.

Fed Lets Rates Sit, but Leaves Door Open for More

As the year draws to a close, the Federal Reserve has made a pivotal decision to maintain current interest rates, signaling cautious optimism about the economy’s trajectory. However, more rate hikes might still be on the horizon.

Central bank's stance: During its latest meeting, the Federal Reserve opted to hold interest rates steady, ranging from 5.25 to 5.5 percent—the highest in over two decades. This pause aims to curb inflation while safeguarding the purchasing power of Americans, amid signs of a robust economy with growing GDP, solid job growth, and moderate wage increases.

Potential for increases: Chair Powell has cautioned that despite positive economic signals, the Federal Reserve is not averse to future rate hikes. They are dedicated to ensuring that inflation decreases sustainably, implying that current interest rates could rise if economic indicators demand it.

Looking ahead: Experts had predicted this pause, believing it aligns with the economic expansion and slowing inflation. Economists advocate a patient approach, suggesting that another rate increase would not necessarily accelerate inflation reduction. The commercial real estate sector, in particular, anticipates stable lending terms ahead, which is critical for transaction activities and market confidence.

Implications for investors: Investors and lenders alike seek stability in interest rates. The current hold on rate hikes has been well-received, as it promises a stable cost of debt, potentially marking a peak that could spur new investment activities. The market looks forward to the last quarter for signs of certainty, which would likely encourage deal-making.

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Zoom out: While interest rates are stable for now, their future trajectory hinges on the economy’s natural deceleration. Economists anticipate no cuts before mid-2024, closely monitoring for signs of economic slowdown. Amidst domestic and global uncertainties, the industry is reminded of the unpredictable nature of interest rates and the factors that influence Federal Reserve decisions.

Return-to-Office Plans Provide Hope for Atlanta's Office Landlords

Amidst challenges in the office sector, Atlanta's biggest office landlords are finding room for optimism with successful return-to-work strategies.

Living the lifestyle: Colin Connolly, president and CEO of Cousins Properties (CUZ), has seen lifestyle offices in the Sun Belt enjoying higher occupancy. He emphasizes that the office is not dead, but rather obsolete offices are no longer viable. Fortune 500 companies, including one in Atlanta, are returning to the office for several days a week, indicating a positive shift and demand for high-quality office spaces.

Sector-specific success: Brian Leary, COO of Highwoods Properties (HIW), highlights the increasing return-to-office initiatives in the insurance, financial services, and telecom sectors since Labor Day. While the sublease space in the office market remains high, the addition of more subleases seems to be leveling off. This indicates a stabilizing market and a potential recovery in the coming months.

Go with what works: Brent Smith, CEO of Piedmont Office Realty Trust (PDM), observes that high-value office buildings continue to perform well thanks to the flight-to-quality trend, while lower-tier office properties face challenges in leasing. A JLL report indicates that half of all office vacancies in the top 25 U.S. metro areas are concentrated in the bottom 10% of buildings.

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Tale of two office types: While the overall property sector may face challenges, there is a clear bifurcation in the office market. High-quality office buildings in the Sun Belt continue to perform well and attract tenants looking for a specific work lifestyle, indicating there’s still demand for premium office spaces. This trend presents an opportunity for investors to focus on these high-quality buildings and drive better performance.

When will the party end for the hospitality sector?

The post-pandemic surge in travel demand has led to a significant rise in hotel revenue (RevPAR), which doubled in 2021. However, with hotel prices increasing and broader economic pressures like ongoing inflation and rising gasoline prices, consumer budgets are strained.

Moody’s Analytics predicts a slowdown in the hotel sector's growth in the latter half of 2023, with a 27% annual increase from 2022. While 2024 may see a further 6% rise in RevPAR, growth is expected to decelerate, possibly reversing within the next 18 months. Current projections show RevPAR ending the year 11.3% above pre-pandemic levels.