Good morning. Rents remain flat, but pros are cautiously optimistic. A $28M profit from a wager on rising rates will help pay for a future Nashville development. Meanwhile, Q4 saw a lag in real estate lending, led lower by industrial financing.

Read: There’s no doubt that the rise of e-commerce has impacted the commercial real estate market. This report from JP Morgan details industry trends poised to impact the market further this year.

Listen: On this episode of the Capital Allocators podcast, Ian Charles and Sam Kennedy discuss Fenway Sports Group, which owns legendary organizations like the Red Sox and Liverpool FC.

FLATLINING

Rents Didn’t Rise in January, But There’s Hope for Growth

The last two years have seen demand fly off the charts, with rents rising accordingly. But since all good things must eventually come to an end, that kind of rent growth was unsustainable. Last month’s flat rents called into question how much more demand could decline.

Flatlining fast: In January, average multifamily rents stayed flat at $1,701, according to a report from Yardi Matrix, after a $4 decline in December and a $9 drop in November. However, rents were flatlining in winter, typically a slower season for multifamily leasing. When looking forward to spring and summer, growth should stay steady in the top 30 metro areas, with some outsized markets falling back to medians.

Workers need apartments: The job market’s strong showing could be a tailwind for multifamily. With 517K new jobs created in January, there’s every indication that demand for housing should remain stable. The primary concern of multifamily operators seems to be rising expenses. With property taxes, financing costs, and insurance premiums all going up, landlords will have to find creative solutions to control costs.

Some welcome success stories: Of all major US metros, Indianapolis is in the lead at 10.5% YoY rent growth. Phoenix and Las Vegas grew by 0.6% and 0.3% respectively, despite rents dropping from their peaks last year. All-in-all, while rents have been declining slightly, growth has yet to stagnate, and demand looks good, so the sky isn’t falling down just yet.

➥ THE TAKEAWAY

The outlook: Yardi Matrix forecasts lower national rent growth in 2023 due to certain markets like LA County, Miami, and Manhattan. Only one market saw rent decline in 2022. Economic growth may slow due to the Federal Reserve's interest rate increases to curb inflation, potentially leading to a decline later in the year. New supply in Class A properties may cause volatility in markets like Austin, Salt Lake City, and Miami.

PLACING BETS

This Chicago Developer Made $28M Profit on Rising Rates

You don’t need us to tell you that the Fed’s interest rate hikes have become a huge hurdle for CRE investors. But where most saw a challenge, David Scherer saw an unlikely opportunity—and reaped the rewards.

Peering into the future: A year ago, Scherer anticipated the rise in rates and started buying a type of derivatives contract used by hedge funds to balance investment risk. Typically, smaller developers don’t play the derivatives market like this, but Scherer was an exception. At the time, his investment committee thought buying $18.5M of these contracts was nuts, but they ultimately relented and gave him the green light.

Fruits of their labor: Nearly one month later, the Fed made the first of its aggressive rate hikes. As the 10-year Treasury rose above 1%, Scherer’s bets began to take off. He wanted a way to hedge against rates on loans he hadn’t taken out yet, and the play seemed to have worked. By July 2022, Scherer sold his contracts for over $46M, doubling the firm’s money and turning a $28M profit.

➥ THE TAKEAWAY

Next move: With a cool profit in their pockets, Scherer’s firm plans to reinvest in development efforts. The funds will be used to cover higher construction costs as they expect to borrow $150M for a 720-unit apartment complex in Nashville, TN. All the while, Scherer has kept his eye on rates. When they dropped (albeit briefly) in the summer of 2022, he placed more bets which he still holds to this day.

THE BIG CHILL

Real Estate Lending Lagged in Q4 2022, Dragged Down by Industrial

Real estate lending activity took a big hit in the final quarter of 2022 as higher interest rates continued to wreak havoc on the markets. The decline was led by the industrial sector, which posted the steepest drop-off.

Checking the numbers: Recently released data from the Mortgage Bankers Association revealed that Q4 saw 54% fewer originations than Q3. Typically, the last quarter of the year has the highest volumes, but economic factors influencing the markets (like high interest rates and economic uncertainty) chilled investor sentiment. The CBRE Momentum Index noted a quarterly decline of 15%.

The gears need greasing: Industrial was hit hardest by this freezing effect, suffering a 69% YoY decrease in the dollar volume of loans for properties. The pandemic pivot to e-commerce upped rents across the sector. However, higher inflation began to settle, and consumer spending began to wane, reversing the direction of the market. Similarly, office properties saw 56% less lending.

➥ THE TAKEAWAY

Preparing for the worst: Data from BankRegData shows that the number of loans held by US banks hit a record high in Q4 2022, but lenders are putting more funds aside to cover potential losses in case of a major downturn. Banks seem to expect property values will decline and demand will weaken, so they continue to tighten lending standards.

• Downward slope: The Mortgage Bankers Association expects commercial mortgage borrowing to drop to $684B in 2023, a 15% decline from 2022.

• Circling the drain: Vornado Realty Trust (VNO) continues to be a poster child for the hurting NYC CRE market as they defaulted on a $450M loan for a Fifth Ave property.

• In the black: After weathering the pandemic for three years, AirBnB (ABNB) has pulled it off, posted record Q4 revenues to achieve its first profitable year.

• Left in the dust: Once a paragon of climate-friendly design, the skyscraper at One Vanderbilt in NYC is already outdated when accounting for changes in the city’s green policies.

• Spending spree: US retail sales were sluggish in the last two months of 2022 but came roaring back in January, up 3% thanks to vehicles, clothing, and dining.

• Looking for suitors: Sandwich chain Subway has partnered with JPMorgan Chase (JPM) to seek out an interested buyer. No deals are currently on the table.

• The Art of Debt: The Trump Organization’s most valuable office property, 40 Wall Street, is in trouble. Currently, it has an outstanding balance of $126.5M as vacancies continue to rise.

• A new approach: Developers are turning to C-PACE (Commercial Property-Assessed Clean Energy) financing packaged with traditional construction loans.

• Eyes on Brady: Tom Brady's South Florida real estate portfolio is quite impressive, and includes an under-construction mansion and Gisele’s various surfside homes.

• Tax war: Landlords in San Francisco are suing to challenge the voter-approved ‘Empty-Homes’ tax, which would cost property owners more in taxes for every vacant unit they hold.

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📰 Deals & Dealmakers

• Warehouse empire: EJF Capital and North Signal Capital closed a $75M senior construction loan from Bank OZK to build three warehouses in Hardeeville, SC.

• Changing things up: Brookfield Properties (BPYPO) is changing plans for its 48-acre DC riverfront development. They now want to include incubator spaces for small businesses and a more curated design.

• Serendipitous: Flexible office provider Serendipity Labs has penned a deal with the Durst Organization to operate a 41K property at 205 East 42nd St. for the next 10 years.

• Setting the bar: Real estate tech VC firm Camber Creek closed the largest proptech raise in 2023 so far at $100M. They closed their last fund with $325M to wrap up 2022.

• Rubbing elbows: Developer KDC is ready to construct a $200M Dallas office tower to capitalize on the proposed placement of a Goldman Sachs (GS) hub in the area.

• Taking the exit: MAC Management has sold a retail asset in River North, Chicago to Koss Real Estate for $15M.

• Hunting for housing: HHHunt has acquired Abberly Riverwalk, a 304-unit luxury apartment community in Nashville from its previous owner, Wood Partners, for $106M.

• Feeling the squeeze: Real estate investor RFR Holding is seeking financing for the Seagram Building in Midtown as an impending $1B debt package gets closer to maturity.

• Uphill battle: Erno Bodek, the longtime owner of Chelsea’s 541 West 21st St., has put a conversion project into bankruptcy to stop an attempt at foreclosure by lender SME Capital.

• Picking up the pieces: Hedge fund King Street Capital Management is buying the debt of WeWork (WE) as it trades at a deep discount compared to its face value.

• Moving on: Retailer GAP (GPS) is selling the 171 KSF HQ of its Athleta brand to the Sobrato organization for nearly $80M.

📈 Chart of the Day

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