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Good morning. Welcome back to CRE Daily! Hope your July Fourth weekend was cooler than ours. Here’s what we got for you in today’s issue: Rents for student housing are poised to grow, with strong demand at many colleges. Meanwhile, office market turmoil is causing issues for ground lease negotiations.

Today's edition is brought to you by Redwood Living—an innovative, 100% ground-up construction development and property management company known for its single-story apartment neighborhoods.

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From Dorm Rooms to Dollars: Why CRE Investors are Eyeing Student Housing

In the midst of a struggling commercial real estate industry, where office buildings sit empty, and apartment rent growth slows, a beacon of hope emerges in the form of student housing.

Positive outlook: Despite a slowdown in apartment rent growth, the future looks bright for student housing. CBRE reported that sales of student housing properties hit an unprecedented $22.9B in the previous year, notwithstanding the significant increase in mortgage rates. Multifamily rents saw a deceleration to 2.3% following high two-digit increases in 2021-2022, whereas, in contrast, student housing rents are expanding at around 9%, as per RealPage. Occupancy rates remained steady throughout the pandemic, even at the height of online learning, and have now returned to pre-COVID-19 levels.

Demand drivers: Student housing landlords can continue raising rents since the high-interest rate environment limits the number of new developments and thus limits supply. Many colleges, especially top research universities and schools in the 5 highest-earning athletic conferences for football, are experiencing strong demand for housing. Like other property types, student housing values have fallen due to the higher cost of capital. Still, the decline has been less than other property types since rent growth and occupancy remain strong.

Mixed bag: Nevertheless, the student housing sector isn't entirely flourishing. There has been a surge in student housing properties experiencing hardship, predominantly those that are older or in poor condition. Properties situated near smaller or lesser-known schools are grappling with low demand as a result of a decrease in enrollment. On a broad scale, enrollment fell by 1.1% last year. However, schools participating in the most profitable athletic conferences and those with reputable research programs saw an uptick in enrollment.

➥ THE TAKEAWAY

Zoom out: The resilience of student housing as an investment option remains strong, largely due to its inherent stability during economic fluctuations. The rationale is that individuals pursue education irrespective of good or bad times. According to JLL, investors maintain their confidence as student housing is 70% pre-leased for the upcoming Fall, a figure comparable to May 2019. Notably, institutions renowned for research and top-tier athletic conferences are witnessing preleasing rates surpassing those of 2019. This could be the driving force behind Blackstone's (BX) bold move into student housing last year, exemplified by their hefty $12.8B purchase of American Campus Communities.

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Slowing Office Sales Pose Risk For Ground Lease Resets

For over a hundred years, New York's investors have traded skyscrapers by separating land from the building. In the present office market downturn, however, this method is escalating disputes among various owners.

Intricacies of ground leases: Amid a real estate downturn and office sector upheaval, ground-lease arrangements – where building operators lease land based on its current value – are encountering roadblocks. The primary cause of these difficulties lies in assessing the office market value, which is critical for determining the land value under office buildings, particularly with limited office building sales.

The numbers: As per Trepp, about 11% of New York's securitized office properties operate under these leases, typically spanning 99 years, with recalibrated rents every 20-30 years, usually based on a percentage of the land's fair market value (FMV).

Rent reset predicament: Ground rents, historically appraised on the land's vacant value, also consider surrounding office values, which are currently difficult to ascertain due to sparse sales. In Q1 2023, office sales in Manhattan plunged to $489.5M from $5B in Q1 2022. With office rents declining since the pandemic, building operators are hopeful of avoiding major ground lease rent increases.

A case study: A current example of a dispute related to these arrangements involves Vornado Realty Trust and the Korein family, the landowners under Vornado's office tower, Penn 1. After renewing their ground lease through 2073, Vornado is negotiating the rent for the next 25 years. Given current market conditions, high interest rates, and the state of financing, they believe the rent should be significantly less than previously anticipated. The matter is now under legal scrutiny.

Changing landscape: Land prices in Manhattan have significantly fallen, with the average acre selling for about $67.7M so far this year, down 57% from the same period last year. This drop contrasts with the rise in values in the decade leading up to the pandemic. Ground leases, typically long-term agreements with scheduled rent resets, have seen dramatic rent increases, potentially leading to building operators forfeiting property ownership

➥ THE TAKEAWAY

A look ahead: Current challenges and disputes surrounding traditional ground-lease arrangements are reshaping the commercial real estate sector. Agreements pegged to inflation, offering more predictability and lesser volatility than fluctuating land appraisals, are becoming more common. This shift intends to provide stability for both landowners and tenants, thereby reducing contentious negotiations and potential legal battles.

• On the hunt: Artificial intelligence firms are actively seeking office spaces in San Francisco to establish a physical presence and tap into the city's vibrant tech ecosystem.

• More RE, please: Despite a market-wide downturn in fundraising, Bain Capital is aiming to outdo itself by gathering $3.75B for a third real estate fund, a 25% increase over its previous fund.

• Defying tech trends: Apple is expanding its Bay Area office space, purchasing a $70M building near its Cupertino headquarters for 35% discount.

• Rock bottom: Despite a 71% drop in CRE sales volumes, Colliers reports that transactions may be starting to recover.

• Boom or bust: Despite rezoning efforts to revitalize East New York in Brooklyn, the neighborhood has yet to experience the anticipated transformation and economic boom.

• Sun Belt success: Swiss-based firm Empira Group plans to build a $200M apartment tower in Dallas’s Arts District.

• Trickle-down effect: The challenges faced by the office market due to the widespread adoption of remote work have begun to impact the multibillion-dollar ecosystem, including companies specializing in office design, construction, and services.

• Judgment day: The real estate industry is facing a "judgment day" as the effects of the pandemic continue to reshape the market, leading to increased scrutiny on investment decisions and a shift in focus towards long-term sustainability.

• Exercise prudence: Federal regulatory agencies jointly issued a final policy statement on CRE loan accommodations and workouts, calling for financial institutions to work prudently and constructively with creditworthy borrowers.

• Think green: HUD has allocated $4.8B to support energy-efficient and resilient retrofit projects for multifamily affordable housing properties.

• Breech of contract: Developer Alexico Group is suing Rockrose Development and St. Francis College, alleging breach of contract, after St. Francis sold the property to Rockrose.

• Repricing trends: In a recent NMHC survey, 47% of respondents saw deals reprice up last month, down from the 58% who witnessed upward repricing last December and much fewer than the 83% who found that to be the case a year ago in June.

• South Florida slowdown: The South Florida office market experienced stagnant leasing activity and asking rents during 2Q, reflecting a lack of significant growth in the region's office sector.

• Receding redemptions: Blackstone (BX) saw a decrease in fund withdrawals in June, showing signs of potential stabilization in investor sentiment.

• Inappropriate behavior: Renowned architect Sir David Adjaye is facing misconduct allegations, which have brought scrutiny to his professional reputation and raised concerns about his conduct.

• New REIT alert: Invesco Real Estate has introduced a perpetual life credit REIT, expanding its offerings to provide investors with a long-term vehicle for investing in core-plus credit.

• Rent control: National landlord organizations have joined forces with the CHIP coalition in a Supreme Court battle against rent regulation, aiming to challenge their constitutionality.

• Cost cutting: Walgreens (WBA) plans to close approximately 450 store locations nationwide, as part of its ongoing efforts to cut costs and optimize its retail footprint.

• Pickleball y'all: Invited, the largest owner-operators of private golf and country clubs, opened a pickleball court on the 48th floor of Santander Tower in Dallas.

According to Oxford Economics, Americans are expected to return to major metros over the next five years, driven by factors such as employment opportunities and the desire for urban amenities.

While the pandemic brought a huge influx of people to the Sun Belt, the report predicts a slowdown in migration in Sun Belt cities in the coming years, though the overall net migration remains positive.

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