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The Middle Dominates in Down Markets

From almost every perspective, the 2017 investment sales market left a lot to be desired. While the final numbers for the year are still a couple of weeks away, the year-to-date numbers through the middle of the fourth quarter remained consistent with the trends we saw unfolding over the past two to three years.

The cyclical peak of the investment sales market in New York City was clearly in 2014 and 2015. In 2014 there were 5,534 properties sold in the city, an all-time record by more than 10 percent. This banner year was followed up by a dollar volume of sales in 2015, which hit $80.4 billion, another all-time record. Since these record years, activity in both of these key volume metrics has been sliding backward. The year-end numbers for the number of properties sold will likely show a third year of reduced activity and the dollar volume will likely show a second year of retreat. Values have also been sliding, particularly in the Manhattan submarket where all product types are down slightly. In the outer boroughs, values were mixed with some property types up slightly while others followed Manhattan’s lead.

While the metrics of volume and value are the most talked about in the market—and they should be because they are so indicative of how the market is performing—other metrics that are indicative of the health of the investment sales market are the average price of a property sold and the percentage of transactions occurring above $100 million. Both of these metrics are highly correlated with the health of the sales market.

On a citywide basis, midway through the fourth quarter of last year, the dollar volume of sales was on pace for about 41 percent of it attributed to transactions at $100 million or above. This will be the lowest percentage the market has seen since 2009 when the percentage was 33 percent. Over the last nine years, the average percentage has been 54 percent and was at a high of 67 percent in the market’s peak year of 2015. If we look at just Manhattan, the percentages are, not surprisingly, much higher. In 2017, the percentage of the dollar volume of sales occurring in the over-$100 million market is likely to end up around 60 percent. If this is the final number, it will also be the lowest percentage since 2009. The average percentage over the last nine years has been about 67 percent and hit a cyclical peak in 2015 at 81 percent. These numbers substantiate the fact that the “middle market” becomes much more dominant in tougher times.

Given the impact of extraordinarily large transactions at these dollar volume metrics, it is important, and in many ways more telling, to look at the number of properties sold.

On a citywide basis, midway through the fourth quarter of 2017, just 6 percent of all sales exceeded $100 million. Therefore, 94 percent of all sales in the city were below $100 million and 83 percent were below $25 million. In Manhattan, again 6 percent of the sale transactions were above $100 million. The biggest difference between the entire marketplace and Manhattan is the activity in the $25 million to $100 million bracket. Looking at the broader market, 11 percent of sales transactions occurred in this range while the percentage grew to 19 percent in Manhattan. Comparing these metrics over time would have to be inflation (appreciation) adjusted to have credibility, and we are working on that analysis.

These additional metrics support the position I put forth back in the fourth quarter of 2015 that the investment sales market in New York City was entering correction mode. We are now in the 28th month of this correction, which has been slow and drawn out. The reason for this is because there hasn’t been any particular event to catalyze this correction. It has simply been the natural cyclicality of the market taking hold. So the more important question is, How long will this correction last and what will the impact on value be when things start to improve? During the recent Great Recession in 2008 through 2010, values in New York City dropped on average by 38 percent on a price-per-square-foot basis. Even worse, during the Savings and Loan Crisis in the early 1990s, values dropped on a price-per-square-foot basis by a whopping 58 percent on average. If the worst we see in this correction is a single-digit drop, we should consider this a win, at least on a relative basis. I should also note that during, and subsequent to, the recession in the early 2000s, volumes dropped for four consecutive years but average values never fell.
When we have the 2017 year-end numbers in hand, we will provide insight into the market’s direction. Meanwhile, there are many externalities that could affect the market this year.

Robert Knakal is the chairman of New York investment sales for Cushman & Wakefield.

Source: commercial

In 2018, More Money, One Problem: More Money

It seems that for the past few Januarys, the capital markets had a doomsday prediction for the year ahead. Not long ago, risk retention signaled the death of the conduit loan market. More recently, the wall of maturity was set to topple the commercial real estate industry. In the end, the market’s appetite for CMBS bonds and real estate investments—along with the capital to back it—overcame the apocalyptic forecasts. I could say, “I told you so,” but you’re reading this because you care less about the past and more about what’s in store for 2018. Here’s what you need to know.

First and foremost, there are no market specific doomsday predictions on the horizon. The fact is the debt and equity markets are as robust as ever. As it relates to debt, CMBS issuances have climbed last year from $68 billion in 2016 to $77 billion. Turns out, bond buyers like risk retention and when an originator puts their money where their mouth is. Further, more debt funds have raised capital for loan originations and broadened their menu of lending programs. Most notably, regulated banks are set to see the legislative reigns loosen on their CRE loan originations, specifically, those associated with HVCRE, or High Volatility Commercial Real Estate, loans.

HVCRE loans require regulated banks to keep 150 percent risk weight—an increase from the previous 100 percent requirement. In dollar terms, for a $100 million loan, a bank needs to keep $12 million in capital reserves for a HVCRE loan versus $8 million for a 100 percent risk-weight loan. To be exempt from HVCRE designation, the current regulation mandates that borrowers of acquisition and development loans must contribute at least 15 percent cash into a project’s total cost. So, if a developer acquires a site say 10, 20, or 30 years ago and it appreciates in value to a point that the land contribution would more than suffice as all or some of a developer’s equity contribution into a project, it still doesn’t satisfy the HVCRE regulation for the developer’s 15 percent cash contribution relative to total project cost.

But back to the debt market impact. While I’m not predicting that the correction, amendment or repeal of this rule will significantly increase construction loan origination volume in the short run—banks have long memories and the last recession acutely resonates—it does make banks’ decisions to originate such loans a function of credit again, more so than the regulation associated with last decade’s financial crisis. It also means that there is inherently more debt capital available.

As it relates to equity capital, billions in real estate funds have been raised for all types of assets, regions, hold terms and investment strategies that have still yet to be deployed. Additionally, the alternative investment vehicles that specifically target individual investors directly and through the registered investment adviser and broker-dealer channels continue to grow and proliferate.

Now that we understand capital up and down the stack abounds, we need to also consider that economic indicators such as job and wage growth continue to signal near-term growth and stability, even as the Fed has, and will, continue raising rates into 2018. Think of that as the government taking the training wheels off because we’re cycling of our own volition and not showing signs of wobbliness. Add to this the gift of tax reform that the CRE industry received in 2017. Surprisingly, no one strongly predicted that a real estate-oriented president like Donald Trump would preserve and likely enhance the tax benefits of owning investment real estate. With that uncertainty gone, we can expect to see more capital pouring into the asset class from institutions, and individuals seeking to increase their portfolio allocations to public REITs, alternative investment vehicles and direct investment in real estate.

The comforting aspect of all this capital flow is the general caution and consideration debt and equity investors have been applying without overreaching to secure deals. I hear the common complaint about finding a deal that makes sense, and there is indeed a large and growing disparity between deals being reviewed and deals actually getting done than in the past. The groan is primarily one of intense and growing competition because of the higher volume of available capital and lower volume of available deals. However, when a deal does make sense for a lender or investor, they pounce quickly and with purpose. That is a sign of a healthy and responsible market, not a reckless or overheated one. So for 2018, all signals point to a steady market with no sensational dire predictions to kick off this year, or at least not any with the force to turn the capital spigot off in the near term. This leaves the only remaining problem, where and how all this capital gets allocated.

David Blatt is the chief executive officer of CapStack Partners. Connect with him on LinkedIn or on Twitter @capstackceo.


Source: commercial

Signs of Disrespect

Growing up in the Bronx, my father instilled in me a passion for building that I never grew out of. He encouraged me to hold a hammer instead of a Barbie doll. He gave me Lego sets instead of teddy bears. No tea parties, but he taught me to nail two-by-fours together to build a bunk bed. So it was only natural that I would end up in this business: producing and directing major construction projects and orchestrating project managers, field supers and scores of subcontractors to transform new offices that provide infrastructure for financial, technology, fashion, media and various sectors alike.

I may have climbed the ladder of success, but to this day, I still feel like a fish out of water. If you think Hollywood or politics are upside down you should try being a woman in the New York City construction industry. Let’s be real, I’m not exactly Salma Hayek, so if a man squeezes my ass on a jobsite, who am I going to tell? I could get mad, kick and scream; but oh, wait, I better be careful not to be considered “emotional” or too aggressive. If someone cancels lunch on me for the sixth time, I have to take it nicely or I’ll be tarred as “difficult.” I have to be better, faster and smarter at what I do and still play by rules that no man in the industry even knows exist. Making my way to the top in this business was like taking a toothpick and breaking through a block wall—almost impossible—but somehow I got it done.

Some people would simply prefer for me to go away. On one, memorable occasion, I presented my company to be considered as a construction manager for one of the largest projects of my career—a large commercial project on multiple floors. It was a long shot and I had my doubts we would get it. But then, the phone rang. It was the owner representative, letting me know that my company had been awarded the project. I was thrilled! But in his next breath, instead of congratulating me and letting me enjoy my hard won success, the rep went on to say that he had to be honest, he really hadn’t wanted to make the call because, frankly, he didn’t want me to get the job nor did he think I was qualified to build this project—never mind everyone else who did. I felt like I was at the Oscars when they gave the award to La La Land then took it away and gave it to Moonlight, instead.

On another occasion, I was giving a reporter a tour of one of my jobsites for an article she was writing about me. I introduced her to my field supervisor—a man I had interviewed and hired myself—and asked him to review the details on the drawings of the site. I still don’t know what he was thinking; maybe he just wanted to make himself look big by making me look small, but he spread out those drawings on the table and then, right in front of that reporter, and everyone else present, looked me in the eye and asked me—a seasoned professional and the owner of her own construction company—if I understood what I was looking at. It was like asking a farmer if he knew what dirt was. I fired him the next day. I can smell it when a man can’t accept a woman as his boss, and I work too damned hard to put up with that kind of disrespect.

The truth is, the construction industry will probably never be easy for a woman. It’s a good old boys’ network, and there will always be egotistical men who make it almost impossible for women to enter, exist and thrive in this world. There will always be men who think that women don’t have the brains to build and ought to just stay home and set the table. There will always be men who are threatened by a woman when they feel them stepping into their territory. Well, I got news for them: I can build, I have an incredible eye for detail, I know how to push a project, and I care greatly for my client’s schedule, budget and recommendation letter that said, “Job well done!” I do it better, faster and with more heart. Because honestly? I want it more.

Sorry, fellas, but I’m here to stay, and I’ve got an endless supply of toothpicks.

Barbara Kavovit is the CEO of the New York City-run Evergreen Construction and the author of a soon-to-be-published novel by HarpersCollins due out in late 2018.


Source: commercial

Don’t Believe the Sales Market’s Dipped? Here Are the Numbers

In the last Concrete Thoughts column that I wrote about market conditions, I mentioned that for the first time in this cycle we are seeing values in the Manhattan submarket dropping across all product types. This fact was questioned and discussed by many of my readers through texts and emails to me. Today, we will take a closer look this recent troubling trend.

The volume of sales in Manhattan has been falling for years. The dollar volume of sales has been dropping steadily since the end of 2015 and is now on pace in 2017 to be about 70 percent lower than the 2015 sales volume. This year we are running at a $19.2 billion pace versus the $63.2 billion achieved in 2015. The volume in terms of number of properties sold has been falling steadily since 2014 and is presently on pace to be about 45 percent lower than the 2014 total. Throughout this period of dropping volumes, values had continued to rise, albeit at a decreasing rate of increase, indicating that they were in the process of hitting a plateau. That trend has finally reversed, and the plateau appears to be behind us.

The end of the third quarter of the year was the first time we have seen falling values across the board in all major product type sectors in Manhattan since 2010. This condition exists because of value drops in the multifamily and office sectors, both of which were still appreciating at the end of the second quarter, finally succumbed to downward pressure on underlying fundamentals.

Land values in Manhattan have been hardest hit and are presently down 17 percent from peak pricing levels last year. This year‘s average price is currently averaging $567 dollars per buildable square foot. The volume of development site sold is also down significantly, on pace to be down 35 percent from last year‘s total and down a whopping 83 percent from the cyclical peak in 2015.

Retail properties in Manhattan are currently averaging $3,207 per square foot, an 8 percent decline from the $3,485 per square foot average in 2016. Average capitalization rates here are down 22 basis points this year to 4.24 percent. A compression in cap rates sounds good. However, this statistic is deceiving because last year cap rates in the retail sector increased significantly from 3.51 percent in 2015 to 4.46 percent in 2016.

Office building values in Manhattan have dropped 4 percent this year, to an average of $1,022 per square foot from last year’s average of $1,065 per square foot. Cap rates in this sector have remained relatively flat over the past three years at just under 4 percent on average.

Mixed-use buildings in Manhattan, those with at least 25 percent of the square footage used for retail use with residential above, have seen their values drop 4 percent to an average of $1,324 per square foot this year. Last year the average price per square foot was $1,376. Cap rates in the mixed-use sector are up 37 basis points to an average of 4.01 percent.

Lastly, in the Manhattan multifamily sector, values have dropped also. In the elevator sector, average prices per square foot have dropped 3 percent to $931 per square foot from last year’s $964 average. Average cap rates are up 20 basis points to 3.53 percent. While still relatively low by historic standards, recent activity should see this average increase tangibly over the next quarter or two. In the walk-up sector, values are performing better than in any other sector. They are down just 1 percent to an average of $1,016 per square foot. Cap rates are up marginally by 8 basis points to an average of 3.75 percent. The counterintuitive dynamic of walk-up properties selling for more per square foot than elevator buildings continues to hold.

These reductions in value are modest. How low they will go is still anyone’s guess. But because nothing other than the normal cyclicality of the market catalyzed this shift, it is not likely to be significant. And the silver lining in this is that sale volumes should increase. We are seeing a meaningful pick-up in contract execution activity over the past two months or so, and we hope that trend continues.


Source: commercial

Chicago Office—Suburbs’ Losses Are Downtown’s Gains

Chicago, America’s third-largest office market with over 470 million square feet, exemplifies the nationwide trend of companies relocating to urban areas from the suburbs as young people and knowledge workers congregate in city centers. The Windy City is the largest in the Midwest and differs from its smaller neighbors with its vibrant central core, strong public transportation network and amenities that are attractive to younger residents. Despite population losses in the metro area, downtown Chicago gained over 42,000 residents between 2010 and 2015, according to the U.S. Census Bureau. Some of these gains, however, have come at the expense of its suburban neighbors. In fact, the city reports stable office vacancy of around 13 percent since 2015, but vacancy in the suburbs is much higher.

Beam Suntory, one of the world’s largest spirits producers, and Sara Lee Corp. have traded in their suburban offices for downtown Chicago, and McDonald’s and Motorola Solutions are following suit with planned moves in the next year. The biggest blow outside of the city was dealt to the Schaumburg area, which saw AT&T surrender 1.3 million square feet. The former AT&T campus in Hoffman Estates is a real estate-owned asset of two CMBS trusts, MSC 2006-T21 and BSC 2006-PW11, with a forecast loss of over $70 million. Average vacancy in the Schaumburg area was 21.1 percent as of November, according to CoStar Group. The only major gain for the suburbs in this time was when Caterpillar, which spent over 100 years in downstate Peoria, Ill., moved its operations north to suburban Deerfield in early 2017.

In the other large suburban office markets, Central North and Western East/West Corridor, the average vacancy rate is nearly 16 percent, up from a pre-crisis low of 9.2 percent, with high four- and five-star sublease availability of more than 25 percent between the two. In addition to ConAgra, a number of companies either moved their headquarters or relocated a significant portion of their work force from the Central North submarket to Chicago, including Walgreens, Allstate and Sterling Partners.

In addition, since 2009, many companies have relocated to Chicago from out of state, bringing thousands of jobs and increasing the demand for office space. These include ConAgra Brands, a packaged-food giant that moved its headquarters from Omaha, Neb., in 2016, and the Kraft Heinz Co., which shuttered the Madison, Wis., headquarters of its Oscar Mayer division and established a co-headquarters arrangement between Pittsburgh and Chicago.

Rising demand has led to an increase in office construction in the city. Developers delivered two office towers of over 1 million square feet each in early 2017, River Point and 150 N. Riverside Plaza, and the John Buck Co. is building an 820,000-square-foot office tower for CNA Financial. With its size, Chicago is unique for the region in that the addition of two 1-million-square-foot office towers will have a relatively modest effect on vacancy and rent. In fact, CoStar forecasts a vacancy rate of 13 percent for 2019 for the metro area, 100 basis points lower than at the start of 2017. .

The West Loop could be the greatest beneficiary of growth in downtown Chicago. With technology employers including Google, Gogo and Glassdoor taking space in the area and the nearby Fulton Market’s transformation from a meatpacking district to a restaurant mecca, millennials have made the West Loop one of Chicago’s trendiest neighborhoods.

Morningstar believes that Chicago’s ongoing migration of younger residents to the central core will continue to attract employers to the area. While there will still be a need for suburban office space, the lack of construction in those areas and weaker access to public transit may dampen growth. Consequently, we expect growth in these areas to be more modest.

Steve Jellinek is a vice president of CMBS research and Edward Dittmer is a senior vice president of CMBS credit risk services at Morningstar Credit Ratings. They can be reached at steve.jellinek@morningstar.com and edward.dittmer@morningstar.com.


Source: commercial

One Year Later, Risk Retention Is a ‘Nice to Have’ Feature for CMBS

Risk retention in U.S. CMBS will be one year old later this month. In 2017 (through Oct. 31), Fitch has rated 40 multiborrower CMBS transactions with risk retention. What has changed compared to previous years?

Structurally, average credit metrics like debt service coverage ratio (DSCR) and loan-to-value (LTV) have improved since 2015. Reflecting the improvement in credit, Fitch’s
BBB- credit enhancement has decreased during the same timeframe.

A big factor in the improvement in credit is the influx of investment-grade loans in 2017 transactions. Investment-grade loans receive a credit opinion from Fitch. Typically, they are large loans on high-quality properties with conservative debt levels. Fitch provides a credit opinion at BBB- or higher, analyzing it as if it were a standalone deal. In 2015, 4 percent of the loans in CMBS conduits were investment grade, whereas so far in 2017 that proportion is over 11 percent. In other words, an additional 7 percent of today’s transactions, on average, do not need credit support at BBB-. This means the decline in credit enhancement is exaggerated by the number of investment grade loans in 2017 deals. The improvement in credit remains even if you strip out investment grade and low-levered co-op loans.

This improvement may be a result of risk retention. However, Fitch would posit that a more important reason goes back two years to the introduction of Regulation AB. What this regulation effectively accomplished was to reduce by half the number of originators supplying loans to CMBS. This has allowed the remaining originators to hold their credit line because the borrower is unable to go around the corner to another originator and get better loan terms.

Not all credit metrics have improved in the last three years. Fitch’s cash flow haircut, for instance, has continued to increase. Cash flow haircut is the difference between what the originator determines is available to pay debt service and what Fitch determines, incorporating, among other things, adjustments for above-market occupancies and rents, as well as allowances for tenant improvements and leasing commissions. The haircut went from 9.6 percent in 2015 to 11.3 percent this year. Interest-only loans have also continued to increase. Full-term interest-only loans have almost doubled in the past two years and currently stand at 44.3 percent. In contrast, partial term interest-only loans have declined to just under 30 percent. Interest-only loans in any form now make up 73.6 percent of a deal, up from 66.4 percent in 2015. These trends are also repeated when the investment grade, and co-op loans are stripped out.

Of the 40 loans reviewed with risk retention, there is an equal split between vertical, horizontal and L-shaped structures; L-shaped has 12 deals, horizontal 13 and vertical 15. There are some differences in the credit metrics among the three structures though. Typically, L-shaped structures have better credit characteristics. Both Fitch DSCR and LTV on the L-shaped structure are slightly better compared to the vertical and horizontal structures. Fitch cash flow haircuts on the three structures are all between 11 percent and 11.5 percent. Additionally, there tend to be more interest-only loans in CMBS with the L-shaped risk retention structure compared to horizontal and vertical.

Why do L-shaped structures have the best, or close to best, credit metrics? It all comes back to investment-grade loans. L-shaped transactions have 15.4 percent of loans classified as investment grade. Vertical has just 8.4 percent and horizontal 12 percent.

So one year after the rules became official, has risk retention improved CMBS credit? Certainly, the risk retention deals of this year have better credit than the 2016 and 2015 deals that didn’t. That said, risk retention is more of a “nice to have.” If competition to make CMBS loans increases to the point that credit metrics worsen, then risk retention, and higher credit enhancement from Fitch, may provide the brake on what might otherwise be further declines in credit.

Huxley Somerville is the head of U.S. CMBS for Fitch Ratings. He can be reached at huxley.somerville@fitchratings.com.


Source: commercial

Time for a Plan B for Taxes? 

Recently, Congress is been discussing a tax reform plan that could have profound implications for the commercial real estate market, New York and the entire tri-state area.

There are many aspects of the reform that sound good, but what are the costs to get these benefits?

One of the benefits would be a reduction in corporate tax rates. If corporate taxes are reduced to the extent they have been proposed, profits should rise substantially allowing companies to invest and grow. This would lead to more jobs and the need for more office, retail and industrial space to be occupied by these companies, a good thing for commercial real estate.

Personal tax rates, for all but the highest earners, would go down as well. This would leave the average American with more disposable income, which could be invested or spent on goods and services.

These reductions in corporate and personal tax rates would necessitate tradeoffs. This means that several types of deductions would no longer be permitted. The deduction for state and local taxes (SALT) is a key deduction that appears to be on the chopping block. Importantly, for high-tax states, especially New York, this could be devastating.

With tax rate for the highest earners remaining essentially flat, eliminating the deduction for state and local taxes would effectively raise this group’s tax burden by 6 to 8 percent. New York has the highest tax burden of any state in America. Here, we pay about 12.7 percent in state taxes (that’s before the additional 4 percent tax paid by residents of New York City). If New York City residents moved to a zero-state-tax state like Florida, their tax burden would be reduced by 16.7 percent, a meaningful margin.

This tax increase could be enough to incentivize the highest earners among us to leave the state. I have already heard some high-income earners discussing this. And this is something I think could actually happen. It’s not like the snowflakes in Hollywood who threatened to leave the United States if Donald Trump was elected president. To my knowledge, none have actually moved out of the country yet. However, many New Yorkers in the top tax bracket already have homes in Florida, or other lower tax states, who could decide it’s time to move on. And New Jersey and Connecticut are not options as they have relatively high state taxes as well.

The tax burden in the United States is disproportionately skewed toward high-income earners. For instance, the top 20 percent of taxpayers pay 88 percent of federal taxes. Last year, this group paid approximately $1.2 trillion. The next 20 percent of taxpayers paid about $175 billion in total while the bottom 60 percent of taxpayers paid nothing. In fact, due to refundable tax credits, the bottom 60 percent received $17 billion back.

Additionally, the top 1 percent of taxpayers pays 38 percent of all federal taxes while earning 15 percent of all income.

While these are numbers for the nation, the disproportionality of the tax burden hits New York State even harder.

So what do elected officials do if SALT are no longer deductible? If they want to keep those in the state who earn the most, and consequently add the most to our state’s revenue, action must be taken. There would likely be a significantly negative impact on tax revenue received. Many state politicians have indicated that there is no Plan B if this revenue goes away. Well, it’s time for them to wake up.

Just as happens with any business, if you suspect you are going to have a hit to your revenues, you must cut expenses. But will state officials have the guts to slash spending? That is never easy, or pain free, but is often necessary. I read something last week that came from one of our top politicians in Albany stating all the “progress” that the state has made with regard to reducing the tax burden that New Yorkers face. That’s like saying, if a student studies extra hard and gets a 46 percent on their test rather than the 42 she would have gotten without the extra work, she is making progress. Progress, yes, but the grade is still an F. We still have the highest tax burden in the nation. That’s also an F.

Plan B will require some hard choices. Choices no one seems to want to think about for the moment. Let’s hope they don’t have to.


Source: commercial

Next for Investment Sales: Up, Down or Sideways?

The cyclical peak in the New York City investment sales market is now clearly in the rear-view mirror. Volumes peaked in 2014 and 2015, and values peaked earlier this year. Volumes have been dropping for years, and now, property values are moderating on a market wide basis and are down in all major property types in the Manhattan submarket. Simultaneously, for the past two months, contract execution activity is up sharply, and it is becoming fun to be a sales broker again. But where does the market go from here?

I believe that we are about 26 months into an investment sales market correction. There was no event to catalyze this correction. No stock market crash, no Savings & Loan crisis, no housing market imploding, nothing—just the natural cyclicality of the market.

As a backdrop, since 2014’s 5,534 properties trading hands, the number of properties sold dropped for three years running. We are presently on pace to end the year about 33 percent below 2014’s peak. The drop in Manhattan is even sharper as we are currently on pace for a total that is 45 percent below the cyclical peak.

Also, prices have come down dramatically: There was an all-time record of $80.4 billion of sales in 2015, dwarfing the prior record of $62.2 billion achieved in 2007. This year, we are on pace for $32.7 billion, 59 percent below the 2015 peak. In Manhattan, the present pace should get us to $19.2 billion, 70 percent below 2015’s $63.2 billion record.

While these volume trends have been evident for quite a while, values trends are now becoming clearer. The first sign that values would fall occurred at the end of 3Q15 and beginning of 4Q15 when we saw the Manhattan land market essentially shut down within a three-week period. Bids started coming in 20 percent below expectations on most of sites that we were marketing at that time. In 2016, land value in Manhattan counterintuitively rose by 5 percent. However, because the “real value” of land had fallen by about 20 percent, most sellers simply did not sell, sending land sales volume down by a whopping 79 percent. This condition, where volume drops and value appears to be rising, is quintessentially what the market experiences when a correction sets in. The value of land in Manhattan in 2017 is down 19 percent as closings are finally reflecting what bidding activity told us was going to happen back in 2015.

This leads to an important point that must be made. It is bidding and contract execution activity that is much more indicative of market conditions than comparable sales that have closed. The reason for this is twofold. First, a transaction that closes today is a look in the rear-view mirror. Properties are normally under contract for 30 to 120 days prior to closing and a contract typically takes a month or two to negotiate. Second, because of the historically, consistently and relatively low rate of turnover in any neighborhood, most comparable sales studies look at sales over the past year or so. Think about how “old” the market feedback is on a sale that closed 11 months ago. Therefore, today’s bidding activity on properties for sale provides the best indication of true market conditions.

While land was (and is almost always) the first sector to drop, we are now seeing values dropping in Manhattan in all of the major product types. These include elevator and walk-up apartment buildings, mixed-use properties, retail and office buildings. Fortunately, the percentage drops have all been in the single digits. In the outer boroughs, values are also beginning to adjust with some property types seeing reductions in value while others are still appreciating, albeit at a slowing rate of increase.

Much has been made of the wide bid-ask spread that has existed for quite a while now. This began to widen significantly when underlying fundamentals were beginning to experience downward pressure. First, about two years ago, residential rents began to drop—a condition exacerbated by significant new supply being delivered to the market. Second, we saw softness begin in the retail sector about a year ago as technology changed the way brick-and-mortar retail space was being used. And, third, as office space concession packages swelled, downward pressure was being exerted on office rents, and today, we are seeing some face rents below where they were a year ago. The realization of these market conditions is setting in and impacting the sales market. The contract execution activity I referenced has been caused by a narrowing of the bid-ask spread and that narrowing has been caused more so by sellers coming down to meet the market, rather than buyers becoming more aggressive.

So here is each outcome of where we might head from here and the probability associated with each:

A rising market: Based on contract execution activity, we expect to see volume metrics pick up in early 2018 when the contracts that have been executed over the past two months begin to close. Unfortunately, most of this contract activity will not close soon enough to impact 2017 statistics, which we expect to continue to slide through year-end. However, if sellers continue to adjust to market realities, they will continue to come to the market, and volumes will continue to rise. We are beginning to hear that residential rents are stabilizing and concession packages are being reduced. If rents in the major property types solidify and begin to rise, values will also begin to rise again. Interest rates remaining low would bolster the argument for an upswing in the market. (Probability 20 percent).

A falling market: The trends we are seeing are simply early stage correction dynamics. The Manhattan submarket is suffering more than the rest of the market, but changes up or down generally happen in Manhattan before they hit the rest of this city. It would appear that values would continue to experience downward pressure until values drop on a broad basis in the outer boroughs. With regard to the number of properties sold, while market activity is down significantly below peak levels, absolute levels market wide are only at the long-term average of 2.2 percent of the total stock. Given we are at the average, there is plenty of room for the number of sales to slow even further. In Manhattan, the turnover ratio is also 2.2 percent, below the 2.6 percent long-term average. While below the average here, in past cyclical low points, turnover has fallen as low as 1.2 percent to 1.6 percent. Clearly, there is room for this metric to fall as well. Simultaneously, the Fed has projected three rate increases for next year, which would exert downward pressure on value unless we have tangible growth in GDP. (Probability 30 percent).

A relatively stable market: Because there was not a catalytic event that brought about this correction, it should be relatively mild. Corrections in the past have varied in terms of how they impacted the market. During the S&L crisis in the early 1990s, the volume of sales dropped for four years before gaining traction. At the same time, property values dropped by 53 percent. During the recession in the early 2000s, volume also dropped for four years before turning. However, during that recession, there was not one year during which average sales values dropped. During the recent Great Recession, volume dropped for three years, and values dropped by 38 percent on average. Today, we are in the third year of falling sales volume, and while values in Manhattan are down, market-wide values are still increasing, albeit at a very low rate. This correction could mirror the one in the early 2000s when volume dipped but average values never did. Capital is continuing to flow into the market, and with availability growing, this activity should buoy downward pressures. (Probability 50 percent).

Clearly, time will tell, and tax reform could profoundly change the market. We will continue to watch the market and keep you posted on how things play out.

 


Source: commercial

Pop to Perm

Traditionally, short-term leases (a.k.a., pop-ups) have been seasonal: Halloween costume shops, Christmas stores and sample sales have been a staple of this retail segment for years. But the advent of experimental fashion pop-ups and influencer events have paved the way for a broader pop-up retail strategy, which is looking better to both landlords and tenants.

These “pop-to-perm” strategies allow for new concepts, online brands to try out bricks and mortar and even established companies looking to expand into a new market.

For new brands, small businesses and emerging concepts pop-ups are an exciting opportunity to test the waters without committing to a long-term lease. There are no high buildout costs, co-tenancy clauses or penalties. Landlords, for their part, reap financial benefits of collecting rent and eliminating vacant storefront space at the base of a building.

Popping-up everywhere

According to a recent national study from Chicago-based marketing firm PopUp Republic, the pop-up industry has grown impressively over the past decade to the point today where total annual sales have reached $50 billion. It wasn’t so long ago that Target dropped a concept pop-up at West 42nd Street and Avenue of the Americas. At the time, some questioned the strategy for such a large retailer. They were just testing the waters back then, and apparently, they liked the temperature because now you can find Target stores throughout Manhattan.

Interestingly, there is a psychological component to the pop-up. There have been several consumer-psychology studies in recent years suggesting that pop-ups stimulate part of a consumer’s brain that enjoys new experiences. Aside from the immediate practical implications (more foot traffic and increased sales), the findings also support the effectiveness of pop-up retail as a lasting experiential marketing strategy.

A perfect example is trendy eyewear purveyor Privé Revaux. The inexpensive celebrity favorite sunglass brand—whose business partners include Hollywood luminaries Jamie Foxx, Hailee Steinfeld, Ashley Benson and Jeremy Piven—recently opted for a short-term lease at 120 West 42 Street for its first brick-and-mortar presence. The new store blends all the best elements of an experiential pop-up, including a graffiti-covered New York City subway car that was left by a previous tenant and cloud installation. Expectations, the company said, are to extend their stay after evaluating the amount of traffic the store generates. Because a pop-up tenancy can last from one day to one year or more, the idea of planting a flag with only a short-term commitment can be extremely attractive.

Made to stay: Brands extending their stay after successful debuts

Since 2015, we’ve seen an increase in commercial leases of three years or fewer, as landlords have recognized the value in negotiating for the shorter term as the market stabilizes. One particularly interesting development contributing to the shortening of leases is the steady stream of online brands seeking a brick-and-mortar presence.

To me, pop-up doesn’t always have to be experimental and edgy and on a shoestring budget. And nobody exemplifies that spirit more than The RealReal. Following in the footsteps of other online only businesses like Bonobos, Warby Parker, Birchbox and even Amazon, The RealReal is expanding from e-commerce into brick-and-mortar retail in a mature way.

While the San Francisco-based company—which offers authenticated, high-end resale items online for women, men and the home—has been busy in recent years rounding up more than $150 million in funding for its online business, it has also launched a brick-and- mortar strategy.

Almost one year after opening its first pop-up in Manhattan during last holiday shopping season—which recorded a reported $2 million in revenue in just two weeks—the luxury consignment website earlier this month opened its first permanent retail space on Wooster Street.

Although it didn’t migrate from the online world to the physical, multibrand boutique Northern Grade also recently made the jump from pop-to-perm. After several years as a roving pop-up shop offering indie fashion and décor, the brand initially took a short-term option at 203 Front Street and signed a six-month lease in the Seaport District. Today, it remains a fixture in the Seaport’s rejuvenated retail scene.

In fact, there are so many successful examples of pop-to-perm in recent years we could fill the pages of this issue. Once brands have found their footing, they seek their own long-term spaces, where they can create opportunities that will bond them with shoppers. Smart brands know the value of providing excellent customer service in a memorable, enjoyable and stimulating setting, one that will prompt shoppers to make a habit of returning. But until then, putting products directly into shoppers’ hands at a pop-up or in a store with a short-term lease is an important way for brands to launch an omnichannel approach to retail.

Retail real estate pioneer and investor Robert K. Futterman is Chairman and chief executive officer of RKF, a leading retail real estate brokerage firm in the U.S.

 


Source: commercial

Are Owners in Denial About the State of the Market?

“Better three hours too soon than one minute too late.”–William Shakespeare

The softness in the real estate market started in 2015 when prices of prime property declined from their highs in major cities like New York, Paris, London, Singapore and Dubai. In Manhattan, the decline was most apparent in the luxury residential market as foreign buyers that were paying upward of $100 million for the best buildings in the city, such as 432 Park Avenue, suddenly stopped showing up. Top-floor penthouses at 432 that were initially offered for $80 million were suddenly slashed to $40 million. Initially, the decline was explained as a healthy pullback for a market that had gotten ahead of itself. The Chinese and Russian buyers had bid up the prices and now were absent. In 2016, the market seemed to flatten out and bifurcate as certain growth areas actually appreciated while others, like those high-end condo units, continued to see softness. This time, the market malaise was written off as pre-election jitters. However, here we are almost a year after the election in an economic environment where the stock market has soared to all-time highs while interest rates and unemployment remain low. Logic follows that the real estate market should also be at or near all-time highs, right? Well, that’s not quite the case at all.

Avison Young’s third-quarter market report points out some stark realities:

The New York City investment sales market is shaping up to have one of the lowest annual totals of the past 15 years.

The New York City total transaction volume of $2.8 billion in the third quarter is the lowest of any quarter in eight years.

HNA’s purchase of 245 Park Avenue for $2.2 billion remains the only billion-dollar transaction of 2017.

An optimist might say that, while transaction volume is at a low ebb, pricing hasn’t declined much at all. The bid-ask spread for properties for sale is very difficult to measure, but I’d contend that it is at its widest since the 2009 crisis. Sellers want the all-time highs of a couple of years ago. Buyers only want to buy at much lower prices. In my view, one thing is almost certain: Clearing prices would be lower than the perceived market price, probably much lower, if there were more transactions and sellers had to sell. Paying capital gains taxes, not knowing what to do with sales proceeds, and seller remorse if the market ticked back up are the most logical reasons why sellers are sitting tight. If anything, sellers are pivoting and taking advantage of the continued low interest rates and refinancing their properties to pull out cash.

Meanwhile, the expiration of the 421a tax break in 2016 has caused new development to stall. HVCRE rules have caused banks to retrench on construction lending. As for hospitality, hotels have also declined with the average price per room falling almost 56 percent in the last two years, according to HVS.

For retail, it’s more accurate to look through a national lens. Anecdotally, I have dozens of offering memoranda on my desk where the whisper price on core retail is in the 8 to 8.5 percent capitalization rate range. Two years ago, it was in the 6 to 6.5 percent range. One example of a current offering is a Whole Foods and Barnes & Noble -anchored center in Michigan where the market talk is that it can be had at an 8.5 percent cap range, which would previously have been considered absurd.

So where do we go from here? Barring exogenous events or black swans, the market should bounce along here and eventually resume its rise. The problem is that there are many potential black swans looming around the corner in today’s environment. An escalation of the tensions in North Korea, a domestic political scandal that further spirals, an interest rate spike or another surprise bankruptcy (like Toys “R” Us) are all powder kegs that could cause a domino effect that could torpedo this market. Because the majority of market participants can’t put their finger on what that black swan is, they simply look at the stock market’s rise and assume that they will be bulletproof. That line of thinking is folly, though, and shrewd investors and owners are preparing for the inevitable decline and keeping their powder dry. Many brokers who write columns won’t tell you that the market could decline because it’s bad for business. However, I believe that the client comes first.

Dan Gorczycki is a senior director at Avison Young New York LLC where he advises on debt financing, sales and joint venture equity raises nationally.


Source: commercial