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Varsity Letters: Chris Lee and Matt Salem on KKR’s Debt Strategies

Global investment firm Kohlberg Kravis Roberts & Co. was founded in 1976—so the story goes—when Henry Kravis and George Roberts dined together at (the now defunct) Joe and Rose restaurant on Third Avenue between East 46th and East 47th Streets. Today, KKR has $168 billion in assets under management (as of Dec.31, 2017).

The firm has had a private equity real estate strategy in place since 1981, but more recently it is being recognized as an increasingly powerful force in the debt space,  too.

The firm has two debt strategies; KKR Real Estate Finance Trust (KREF)—an externally managed real estate investment trust (REIT) that originates senior commercial mortgage loans—and KKR Real Estate Credit Opportunity Partners (RECOP), which purchases junior tranches of commercial mortgage-backed securities.

“What takes several people years to build, in terms of size and breadth, they’ve accomplished in a couple of years,” said A.J. Sfarra, a managing director at Wells Fargo Securities. “They’ve raised a $1 billion B-piece fund and a mortgage REIT.”

KREF currently has a total market capitalization of $1.1 billion and a total portfolio size of $2.5 billion. It originated $1.5 billion of loans last year alone—$800 million in the tristate area—playing in the large loan, transitional and value-add space and competing with private lenders such as Square Mile Capital Management, Blackstone and TPG.

In November of last year, it raised a $1.1 billion fund for its RECOP strategy and is the most active buyer of CMBS B-pieces in the market, with an impressive 35 percent of market share. In 2017, it bought junior tranches on 12 deals, comprising $10.9 billion in principal balance. For all transactions,  KKR satisfied either a portion or the entire risk retention requirement, retaining $949 million in face value of the bonds.

Chris Lee and Matt Salem, the firm’s co-heads of real estate credit, lead KKR’s debt business from the company’s headquarters at 9 West 57th Street between Fifth Avenue and Avenue of the Americas.

A “frustrated Cowboys fan,” Lee hails from Dallas. After studying economics at Emory University he got his industry start with a summer internship at J.P. Morgan Chase Securities, which then led to him to join Goldman Sachs’ commercial mortgage group as an analyst in 1990. He remained there until 2009 when he moved to Apollo Global Management, then to KKR in 2012.

“I like the competitive nature of it, where you’re out competing every day against very savvy investors to create transactions,” Lee—who turns 40 next month—said of his draw to commercial real estate. “I also like the personalities in real estate. You meet a lot of colorful people, and it’s one of the industries where you continuously interact, whether on the finance side or the development side.”

Jeff Fastov, a senior managing director at Square Mile Capital Management, was co-head of lending at Goldman Sachs when the young Lee joined the bulge-bracket bank, and Lee’s first boss out of college. “His raw intelligence is immediately apparent, and he’s incredibly personable and well-liked,” Fastov said of his protégé. “So when you put these two [attributes] together he’s a formidable competitor because people really like to do business with him.”

Salem, 44, is also a New York City transplant. A Kansas City native (and die-hard Kansas Jayhawks fan), he studied economics at Bates College in Maine and—bucking the traditional route of most Wall Street programs—moved back home after college instead to seek employment.

After “being turned down a bunch of times,” by local banks in his hometown, Salem took a job at Midland Loan Services in 1996. Its platform was growing and it was hiring college kids to assist in its expansion, he recalled. Three years later, he took a position at Travelers Insurance—owned by Citigroup at the time—and moved to New York City. It was there that Salem was tasked with investing in high-yield real estate debt and early mezzanine loans, before segwaying—serendipitously, perhaps—into buying CMBS B-pieces.

When Citi sold Travelers, Salem tried the sell side out for size, working at Morgan Stanley, before joining Goldman Sachs in 2006 as a CMBS trader and ultimately running CMBS trading for the investment bank through the crisis. In 2011, he joined Rialto Capital Management to build out its performing businesses, including high-yield lending platforms—such as preferred equity and mezzanine loans—as well as CMBS B-piece investing.

mattandchris 149 Varsity Letters: Chris Lee and Matt Salem on KKRs Debt Strategies
Matt Salem. Yvonne Albinowski/For Commercial Observer

Meanwhile, over at KKR, Lee and KKR’s head of real estate, Ralph Rosenberg, were planning the next iteration of the firm’s real estate business.

“When I got here in 2012 we were figuring out where we wanted to start the business, so we started it in opportunistic real estate because we thought that would be the area we could differentiate ourselves the most,” Lee said. “The goal was to have an integrated business as a solutions provider where we could provide both equity and debt.”

KKR raised its first equity value-add fund—the $1.5 billion KKR Real Estate Partners Americas, or REPA—at the end of 2013. (“We bought a number of hotels in that fund as the hospitality recovery was starting to take hold,” Lee said. “So a lot of it was a buy-fix-sell strategy where we were buying assets that had broken capital structures or broken operations, fixing them then selling them.”) And it raised its $2 billion successor, REPA II, last year.

But Lee and Rosenberg wanted to further expand the business that KKR had evolved to include a credit business. They already knew that Salem was the man for the job.

“Matt had demonstrated the ability to lead and manage a team,” Lee said. “Rialto had a very active business across multiple products and we had very complementary skills. There was a view that we’d be able to do one plus one equals three if we put our different backgrounds together.”

Salem joined KKR, along with nine members of his Rialto team, in 2014.

“I thought it was an absolutely perfect move for him,” Sfarra said of Salem’s move to KKR, “and in way I couldn’t see him anyplace else. KKR is a world-class organization and he fits that mold perfectly.”

Since then, Lee and Salem have been off to the races, finding opportunity in the heightened regulatory environment and leveraging off KKR’s existing infrastructure.

“We both had a very consistent view of where the market opportunity was, and that was direct, transitional lending,” Salem said. “We didn’t think the banks were in a place to commit that capital anymore, and we thought that we had a different approach in being fully integrated into a global asset manager, and being able to draw not only from an experienced bench of private equity and credit professionals but also from those focused on real estate equity within our own team.

“We think like property owners and we can be flexible,” Salem continued. “So there was a great opportunity to commit capital both from a relative value perspective for our investors as well as differentiating ourselves in the market to our clients who are borrowers and property owners.”

KKR’s lending portfolio is heavily weighted toward office and multifamily assets (the opposite is true for hotels, which comprise less than 5 percent of KKR’s business) and it’s carving out a niche for itself in value-add plays in acquisitions as well as construction loan take-outs where leasing is taking longer than expected.

“We have tremendous range in our business,” Lee said. “This year we’ve quoted loans from $40 million up to $400 million and from Libor plus mid-200s to Libor plus 400. Borrowers are buying different properties and executing different business plans so being able to deliver a range of solutions across what they’re doing in their platform helps us to build that relationship and have more connectivity with them, as well as provide us with a better opportunity to prove our experience.”

Recent transactions include a $180 million loan on PIMCO and Zeller’s Fifth Street Towers—a 1.1-million-square-foot Class-A building in downtown Minneapolis. Like most of KKR’s loans, the deal included an initial funding component, in this case $130 million in upfront funding and $52 million in future funding. PIMCO purchased the building in 2015 and had implemented its business plan with some success but leasing was a little slower than expected and—midway through its business plan—it didn’t have access to additional capital to continue to lease the property. KKR stepped in, refinanced the existing loan and gave PIMCO the capital and runway to lease the building up further, closing the deal within three weeks.

The financing was arranged by Eastdil Secured, which has worked with KKR on multiple transactions.

“Chris can understand risks in a transaction very quickly,” said Grant Frankel, a managing director at Eastdil. “He’s very good at understanding the transactions where it makes sense to stretch, and which ones have the quantitative or qualitative intangibles that—as a lender—you may be willing to push a little harder on. He has a very good sense for that.”

Frankel said that the KKR team is easy to work with, too. “Chris and Matt’s originators are very collegial, very smart and they are all pleasant people,” he said. “They’ve built a really good culture. We [at Eastdil] have a similar culture from a collegiality perspective, so it works well.”

Closer to home, KKR made an inventory loan on the Zaha Hadid-designed apartments at 520 West 28th Street to Related Companies. The $200 million loan was collateralized by the property’s 30 remaining condos that were unsold at the time.

“It’s a very special project,” said Greg Gushee, an executive vice president at Related. “KKR quickly understood the structure, the value and our business plan and were extremely flexible in structuring something that would allow us to pursue that plan.”

Flexibility is one of Salem and Lee’s key selling points in making KKR stand out from the herd, Gushee said.  “Some lenders get very fixated on their loan documents when there’s a twist or turn in a deal,” Gushee said. “Chris just says, ‘Okay. Let’s see what makes sense to do here…’ He’s always flexible and open to doing what makes sense for the asset.”  

And, “they can come up with a structure very quickly, get a term sheet to you within days and they can close within 30 days, easily,” Gushee said. “[KKR is] the place to go if you want great execution. They look at the situation and they can customize the solution.” 

Like everyone else in the debt space today, KKR is having to compete with a variety of capital sources for deals.

“It’s competitive, we wouldn’t argue with that, but it’s still a relationship business and it comes down to how you can help your borrower achieve their goal,” Lee said. “A lot of our borrowers aren’t looking to finance a property that is already stabilized; they’re looking for help to execute a business plan. Because we execute a lot of these business plans ourselves we can be very constructive in helping them to solve a capital issue.”

And while relationships are important, so are the cost of funds—something that definitely works to KKR’s advantage.

“Being part of a global asset management firm is extremely helpful for us and we think we have top-tier cost of capital in terms of what we receive from our lending counterparties,” Lee said. “We also have other ways to enhance returns because we have access to different tools at our disposal in terms of the way we finance ourselves, through our capital markets team and our $45 billion corporate credit business. A lot of those synergies accrue to the benefit of our company, KREF, and its shareholders. But that’s how you compete—on borrower experience and on price.”

Salem sees KKR’s speed of execution as the biggest differentiator in its segment of the market: “We’re a small team and not as rigid as [other lenders] so you don’t have to go through layers and layers of investment committee approvals and bank processes to get things changed if business plans evolve,” he said. “Things change in these buildings and they need flexibility and a lender that’s going to be able to work with them through these changes.”

KKR’s other vertical in its debt business, CMBS B-piece buying, has Salem’s name written all over it as a veteran in the space. Most recently, at Rialto, Salem had led a dominant team in the space.

The opportunity was driven by Dodd-Frank and risk retention regulations in the CMBS fixed-rate conduit market, specifically the carve-out that allows banks to pass some of  their risk retention to a third-party purchaser. 

mattandchris 058 Varsity Letters: Chris Lee and Matt Salem on KKRs Debt Strategies
Chris Lee. Yvonne Albinowski/For Commercial Observer

“We thought it was a great opportunity because the banks weren’t going to want to hold that risk and we have the expertise to do it,” Salem explained. “We can create a retention vehicle with our relationships with like-minded, long-dated investors. Combining the institutional client base of KKR with our broad internal underwriting resources across private equity, corporate credit and real estate works well. We draw from all these resources and do all of the underwriting and diligence, which makes us very credible investors in the space.”

Sfarra has known Salem for 15 years. He first met Salem when he was at Citi and buying B-pieces from Wells Fargo. Sfarra hired Salem at Morgan Stanley and sold him B-pieces at Rialto and KKR. Additionally, Wells Fargo took KREF mortgage REIT public last year, leading the underwriting group. “He’s been a B-piece buyer, he’s been a colleague, he’s been a client and he’s a really good friend as well,” Sfarra said.

Further cementing their relationship, Wells Fargo also sold KKR its very first B-piece. “We’re really thrilled to support their business,” Sfarra said. “What they’ve done is built a really successful B-piece business in a really short period of time and the only way you can really do that is by having the capital to do it and by having great relationships. Their word is their bond so people want to transact with them and they’re very smart guys.”

Fastov met Salem when he was on the mortgage desk at Goldman Sachs. “He’s an incredibly smart guy, and very straightforward,” he said. “The B-piece business is one part real estate and one part capital markets which is why he’s so effective at buying CMBS B-pieces because you need both of these skills.”

And while KREF and RECOP continue to have success, so does KKR’s real estate equity business. The opportunity has evolved since 2011 from investing in broken capital structures coming out of post-crisis distress to more thematic investing, with KKR finding macro themes of interest and applying them through the real estate sector.

It also presents opportunities to lend to some of its competitors in the debt space.

Square Mile and KKR teamed up last June on a California office deal, with Square Mile providing a $92 million loan for KKR’s acquisition of 180 Grand—a 15-story, 279,000-square foot-office building located in the Lake Merritt submarket of Downtown Oakland.

“There was a lot of trust that we could deliver on the terms we offered and that we’d focus on what mattered in the transaction,” Fastov said. “When we agreed to do the deal together, Chris said, ‘Let’s stay in touch if there are any real issues in the documentation,’ and guess what? There were none. It’s an example of KKR doing a lot of different things, just as we are, and there are opportunities to be lenders to each other.”

Maybe it’s that out-of-state charm, but—as well as being highly respected deal counterparties—Lee and Salem are known for being all around good people and family guys.

Frankel describes Lee as “a good guy, smart and pretty cerebral. He’s a straight shooter and just a pleasant person you enjoy doing business with.”

“I get Chris’ holiday card every year and his kids are exceedingly cute. If Matt would send me his holiday cards I could comment there, but he doesn’t. So…that’s an issue,” Fastov said, laughing.

As for the future of KKR’s real estate credit business, “I think there’s a lot of growth ahead of us,” Salem said. “We’re one of the newer businesses at KKR. The firm views real estate and real estate credit as strategically important and a growth initiative, and so we’ll have resources and capital available to us to grow.” O.K., KKR.

Source: commercial

MTA, DOT Release Plan to Ferry Riders Across the River During L Train Shutdown

The Metropolitan Transportation Authority and the New York City Department of Transportation have unveiled their long-awaited plan to convey L train riders between Manhattan and Brooklyn while the MTA shuts down the line’s East River tunnel.

The shutdown will begin in April 2019 and last for 15 months. The MTA has argued that shuttering service between Bedford Avenue in Williamsburg and Eighth Avenue in Manhattan is the most efficient way to repair the L train’s Canarsie Tunnel, which was flooded with millions of gallons of water during Superstorm Sandy in 2012.

Eliminating the L for more than a year will disrupt commutes for 400,000 riders, 225,000 of whom take the train between Manhattan and Brooklyn. In order to get those riders into the city, the plan includes increased subway service on nearby the nearby G and J/M/Z lines, longer G and C trains, free MetroCard transfers between the Broadway G and the Lorimer-Hewes JMZ, and similar free transfers between the 3 train at Junius Street and the L train at Livonia Avenue.

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Busway and bike routes along 14th Street. Image: DOT and MTA

DOT also plans to make major road changes to help move commuters across Manhattan. The agency will convert 14th Street into a bus-only street during rush hour between Third and Ninth Avenues eastbound and between Third and Eighth Avenues westbound. There will also be upgraded 14th Street Select Bus Service with a new pedestrian lane, dedicated bus lanes in each direction and a sidewalk expansion. Overall, the agency expects 38,000 riders will take the bus across 14th Street.

The plan also calls for Manhattan’s first two-way, protected crosstown bikeway along 13th Street, which will include a buffer separating cyclists from traffic.

Traffic patterns on the Williamsburg Bridge will shift dramatically to accommodate a handful of new bus routes. Only cars and trucks will with three or more passengers will be able to cross the bridge, in order to keep traffic flowing and keep the bridge clear for additional bus service. During rush hour, 70 buses would carry 3,800 commuters across the bridge. The MTA aims to run three new bus routes: one running from Grand Street L stop in Williamsburg to First Avenue and 15th Street in Manhattan; another running from Grand Street to Broadway-Lafayette in Soho, and a third from near the Bedford Avenue L stop to Soho.

screen shot 2017 12 13 at 6 12 08 pm MTA, DOT Release Plan to Ferry Riders Across the River During L Train Shutdown
MTA is planning new bus routes for Brooklyn riders once the L train shuts down. Image: MTA and DOT

And finally, the city also plans to roll out a new ferry route, connecting North Williamsburg to East 20th Street along the East River. DOT aims to run eight boats an hour in each direction, carrying up to 1,200 passengers an hour each way. Fares for ferry riders will be “integrated with” the M14 and M23 Select Bus Service routes, the agencies note in a presentation, which means that riders will get free transfers between the ferry and the bus.


Source: commercial

Need for Speed: MTA’s Waking Nightmare Could Be Fixed if the Agency Focused on Tempo

Maybe the reason the Metropolitan Transportation Authority has been so late in handing in recommendations about how to deal with poor service is because they’ve been stuck in their own tunnels.

For months, the MTA has been dithering and avoiding publicly addressing its “summer of hell,” and now, another public agency has beat the MTA to the punch and identified the extent of the problem—though, with a few major oversights.

A report last week by the city’s Independent Budget Office (IBO) found that the number of subway delays has tripled since 2012 and that the annual cost to the city in commuters’ lost time was $307 million. It attributed most of the delays to overcrowding.

The report falls short in diagnosing the extent of the MTA’s problems. For one thing, its estimate of the cost of subway slowdowns is far too low. An internal New York City Transit report from last year, made available to Commercial Observer, says that the average delay per passenger trip is three minutes. This may not seem like a lot, but, according to 2015 data by the National Transit Database, the average subway trip is only 21 minutes, making the three-minute delay about 14 percent of total travel time. Based on this information from the leaked document, the total cost of delays on the subway, not just at rush hour—the IBO’s report looks only at rush-hour delays—is $3 billion per year.

Another miss—and a major one—in the report is blaming overcrowding for most of the delays. An operations planner within NYCT, the agency within the MTA that runs the subways and most buses, who spoke to Commercial Observer on condition of anonymity, explained that internal rules require the agency to log a cause for every delay, and when the cause is unknown, the agency enters “crowding.”

If the problem, then, is not overcrowding, what is it? In one word: speed.

Average train speed has decreased in the last few years, while the scheduled trip times have not changed. CO’s source in operations planning said the schedules did not change because management was afraid of embarrassing itself: Slower official schedules would invite more scrutiny from the MTA board.

Why are trains running slower than they used to? NYCT began deemphasizing speed as a goal. The New York Daily News reported that as soon as Ronnie Hakim (who became head of the MTA earlier this year) became the head of NYCT in 2015, she expressed concern over a poster that read “Safety, Service, Speed and Smiles,” asking “Why is speed on there?”

The worst of the causes for the recent slowdowns came from a decision regarding punctuality. Traditionally, American transit operators, ranging from Amtrak’s multiday trains to local bus agencies, have measured timekeeping by whether the train or bus arrived at the end station on time with a small fudge factor (the MTA adds five minutes). This is known as on-time performance.

Recently, NYCT switched to prioritizing a measure called wait assessment. The MTA’s public data explains that wait assessment measures whether trains or buses arrive at each station at the scheduled intervals. As previously reported by this writer for Vox, wait assessment led dispatchers to hold trains ahead of each delayed train. For example, if one A train were delayed by 10 minutes, they would hold several A trains ahead of it to smooth out the delay for passengers who have not yet boarded. Instead of making some passengers wait 10 more minutes for their A train, they would make many more passengers wait two minutes.

The result was a disaster. Trains became slower, delays propagated between lines, and on-time performance fell from 85.4 percent in 2011 to 63.2 percent this year. An A train delayed by two minutes might enter a shared section of track too close to the D train, delaying either train another two or three minutes; the D might then be delayed entering a section shared with the B, creating cascading delays. Until last summer, senior management swept the problem under the rug, forbidding junior planners from using the word “delays.”

Shams Tarek, a spokesman for the MTA, told CO that the agency is not indifferent to the speed of its service, but is rather prioritizing safety as “absolutely essential.” He added that wait assessment is not the MTA’s main metric for evaluating punctuality, but rather one measure supplemented by other metrics.

One potential solution to the subway system’s problems could be adopting best industry practices from abroad. TransitCenter is a New York-based think tank dedicated to promoting good transit practices. Senior program analyst Zak Accuardi spoke to CO at length about a new measure of punctuality, called “excess journey time.”

Excess journey time is the sum of delays caused by waits longer than the scheduled frequency (“excess wait time”) and delays caused by train travel times longer than the scheduled timetable (“excess travel time”). It’s this measure where, per the leaked NYCT report, the average is three minutes per passenger trip, split evenly between excess wait time and excess travel time.

Accuardi explained that London and Singapore already use excess journey time as their primary punctuality measure on trains and on buses that run every 12 minutes or less. 

“Our general approach to the MTA is to be cautiously optimistic,” Accuardi said. His optimism was rewarded at the end of last month, when the MTA announced that it would begin using excess journey time as a punctuality metric for the subway (but not for buses).

More careful data analysis is required, Accuardi added, tracking each delay backward in time to see what caused it. This is especially important because of the highly branched nature of the subway. For example, a major delay on the Q may turn out to have started on the C, leading to a chain reaction of trains waiting for another train to clear a shared track segment. But doing this analysis requires a culture of accountability for delays within the MTA, and its top management has created the exact opposite culture, to the frustration of both of CO’s inside sources.

Accuardi also added that computing excess journey time requires access to data about where passengers get on and off the train. Analysts within NYCT can estimate this, using MetroCard data. If they notice that a passenger swipes a MetroCard at one station in the morning and then at another station in the afternoon, they can assume the passenger travels between those two stations. With this information, planners can know which delays affect the most passengers and take necessary precautions to avoid them.

But not everyone is satisfied with the adoption of excess journey time as a metric. Adam Rahbee was a planner and manager at multiple transit agencies for many years, including NYCT, Transport for London and the Chicago Transit Authority. He oversaw changes on the London Underground that improved punctuality. And he had harsh words about excess journey time, or any other single reliability metric. Rahbee argued to CO that the managers who try to influence the metric have no power, and instead other departments make decisions about operations planning and scheduling without any interdepartmental coordination. Schedulers blame train operators for driving more slowly than the timetable tells them to, while train operators blame the schedulers for writing unrealistic timetables. As a result, in London, excess journey time has not improved in the almost 20 years it has been the preferred reliability metric.

Accuardi emphasized the importance of accountability in measuring punctuality. Someone needs to be responsible for making sure trains run on time, and it can’t be individual train operators. NYCT’s line manager program makes individual line managers accountable, but it is difficult to assign blame for problems given that most lines share tracks with multiple other lines.

The MTA already has all the tools it needs to improve train trip times and reduce delays, and many employees are aware of the issues they are facing; Accuardi learned of the excess journey time from low-level planners within NYCT. The problem is political and institutional dysfunction. Planners who figure out ways to improve service cannot share them with their bosses for fear of inviting political backlash; while some midlevel planners long pushed for excess journey time as the focus and for more attention to speed, it took last summer’s bad press and the recommendations of TransitCenter for management to adopt the new metric. It still remains to be seen if NYCT follows through on TransitCenter’s recommendations for more accountability and better analysis of which delays affect the most passengers—in other words, if it’s using the full power of excess journey time, or if it just wants to be seen as doing something.


Source: commercial

No One at the Wheel: What Will Driverless Cars Do To Real Estate?

To say that the introduction of driverless vehicles will have both macro and micro effects is a macro understatement.

Automation has and will continue to change the way Americans travel, commute and consume, distribute and own things—everyone from economists to Facebook’s Mark Zuckerberg agrees. And driverless cars are on their way. With Intel’s August acquisition of sensor and navigation software firm Mobileye, another major company formally entered the cutthroat race to develop mass-market driverless cars. Both Ford and GM have already acquired software and artificial intelligence companies; Tesla offers an “autopilot” feature, and Elon Musk contends his Tesla cars ship with adequate hardware to go driverless already. The House of Representatives, in early September, approved legislation that paves the way for driverless cars to, well, get on the road. Comparable legislation has been introduced in the Senate.

What will the inevitable shift toward cars that drive (and park) themselves do to the real estate market? That’s one thing no one agrees on, yet.

“I think the future rarely plays out the way people anticipate that it will,” said Seth Pinsky, an executive vice president at RXR Realty and former president of the New York City Economic Development Corporation. “I think it’s very difficult in the real world to know that what you’re doing will avoid obsolescence many years down the line.”

It’s perhaps a fool’s errand to attempt to anticipate what something as profound as self-driving cars might do to any industry, but Commercial Observer learned that many of the largest real estate companies feel that—at this point—they have no recourse but to try.

The general sense is the industry got caught flat-footed with the housing crisis. It doesn’t want to repeat that with self-driving cars.

Tech experts and real estate pros say the possible effects range from different underwriting to societal upheaval. One industry leader believes that a significant percentage of the American workforce could be rendered moot—and how many office buildings will we need when no one has a job? To say nothing of what that does to the housing market.

At the other end of the spectrum are more immediate, practical changes. For instance, it seems likely real estate developers will build less parking in the future, as the personal vehicle fades from view (not that this is as big an issue in New York City as it is in the rest of the country, but it’s certainly something to consider).

Real estate executives find themselves pondering the smaller, pragmatic choices they face as they brace for the pending larger, more fundamental challenges to their business. Changes in demand and valuation for certain kinds of real estate are already being felt, partly in anticipation of driverless cars’ ubiquity and partly because ridesharing is already a preview of the changes we’re likely to feel.

“For every disruption there is opportunity,” said Spencer Levy, the head of research for the Americas at CBRE. “[But] there are going to be unexpected impacts on certain areas of commercial real estate [no matter what].”

Nico Larco, an architecture professor and co-founder of the Sustainable Cities Initiative at the University of Oregon, was less circumspect. “Land valuation should, in theory, go completely crazy,” he said.

If the cost of transport plummets, it won’t matter nearly so much what’s nearby (unless it’s so nearby it’s walkable).

“The things that will retain value will be based on things that are next to it that create buzz,” Larco argued. “It’s not that distance won’t matter, but it will matter less.”

As a result, real estate is atwitter about driverless cars, with both doomsaying and unbridled optimism—at least on the surface—on show in equal measure.

“It’s like, this weird time where it’s obvious this is going to be a transformative moment in real estate,” said Brandon Huffman of real estate investment manager Rubenstein Co. “There are all types of theoretical social impacts, including job loss across the board.”

The real estate industry might not need to panic yet, because technologists are taking a longer view. Robert Seidl, a managing partner at Motus Ventures, a fund that focuses on transportation and related industries, is surprisingly sanguine about the issue.

“I think we’re a good 10 or 15 years out on a scale where typical pedestrians would see it,” Seidl said. “Just like electric vehicles take up a tiny, tiny part of the electric space, though they have been poised to take off for a long time.”

John Krafcik, the chief executive officer of Waymo, Google’s robocar company, said much the same thing at Bloomberg’s recent “Sooner Than You Think” conference at the Cornell-Technion campus.

“It’s going to be a transformative technology,” Krafcik said, “but it’s going to unfold over quite a long period of time.”

gettyimages 486281999 No One at the Wheel: What Will Driverless Cars Do To Real Estate?
Google’s Lexus RX 450H Self Driving Car. Photo: Mark Wilson/Getty Images

The Death of the Parking Lot

While Huffman believes we’re 10 years away from a full shift away from personal automobiles, he said the way owners value office buildings is already changing.

“For urban office [product], one-third of the value is in the parking,” Huffman said.

As parking becomes less important, the underwriting to buy and finance such buildings will have to change. Already, those revenue streams have been impacted by Uber, Lyft, Via and the like, he added. “That cash flow is dropping off a cliff,” he said. “We are very wary of investing in a property where value is predicated on parking.”

Levy said developers are more often “opting for horizontal parking decks instead of ramped decks,” because they will be easier to convert to another use when parking is no longer needed.

Georgia Tech City and Regional Planning Professor Subhro Guhathakurta recently supervised research modeling self-driving cars’ impact in the Greater Atlanta area. “We found almost 90 percent of parking would not be necessary,” he told Commercial Observer.

Michael Comras, a Miami-based developer and the owner of an eponymous retail brokerage, said civic leaders are ahead of the curve on the parking issue, like the Miami Beach Planning Board director who told Comras he wishes the city would no longer require parking for new developments.

“Over time, I think this will become more prevalent,” Comras said. In San Francisco, the city has relaxed parking requirements for new buildings, where “a half dozen” residential projects have been built without parking included in recent years, according to the San Francisco Examiner.

Still, what will happen to the existing oceans of parking surrounding suburban apartment buildings, malls and big-box stores? Build on it or raze everything? It could go either way.

Those spaces are already seeing less use thanks to ridesharing.

Ridesharing with drivers will probably never be profitable, so Seidl predicts strange days ahead as the ridesharing startups run out of venture capital money before the software can drive cars.

“We might actually see—before we go forward—a few steps back,” Seidl said.

If Lyft and Uber can’t make money with drivers, they could run out of investor cash before the technology that will save their businesses is ready. If that happens, lawmakers might lose the will to write rules for this new industry. That’s where we might see steps backward.

On the other hand, were the ridesharing companies to wither on the vine, the carmakers might be ready to take their place. That means Detroit still has a shot at dominating the future of the automobile.

Of course, driverless cars will still have to be stored somewhere even if there should likely be many fewer cars in aggregate. Huffman imagines that most people won’t own their own cars. Krafcik described a future where each car costs more and a rider has to pay some kind of subscription to the cloud intelligence that drives it.

On multiple levels, every mile in a self-driving car will cost more, but transportation will probably still make up less of the average American’s budget because people will pay per ride. Levy said many businesses and offices will develop a drop-off and pick-up format, like airports have currently.

There is a consolation prize for the consumer to counter the unpleasantness of continually being dropped off at the airport: the concomitant death of traffic. As smarter cars, which communicate with one another, rule the road, hesitation and error will be nearly eliminated. A surprising side effect of this, in Huffman’s view, will be how viable suburban living could become.

“The biggest problem with living in the suburbs, which is dealing with the commute, is eliminated,” Huffman said, because not only will traffic be largely mitigated but also the car becomes another space where many people can get work done (if you don’t get motion sickness, of course). As the millennial generation—already about a quarter of all Americans—forms households and has children, their renewed interest in the suburbs, which is already evident, is likely to grow, he added. Indeed, almost 50 percent of millennial U.S. homeowners lived in a suburban market in 2016, according to Zillow’s Group Report on Consumer Housing Trends. Meanwhile, 33 percent lived in urban markets—figures contrary to the received wisdom that millennials largely reside in cities (the rest live in rural communities).

But foretelling the death of traffic could be premature. Robin Chase, the founder of Zipcar and an investor in self-driving car companies, said last year that traffic could be just as bad or worse with all the deliveries self-driving cars will make. Policymakers need to think now about rationing those trips.

Policymakers also need to think twice about closing down mass transit options. Even in the robot car future, the dedicated lanes of a rail system could remain the fastest route for many commuters.

Public transport dollars are very long-term dollars, Seidl cautioned. “If they shut down, they are not coming back,” he said.

But there are significant hurdles to a suburban renaissance, as author Richard Florida pointed out in his book The New Urban Crisis. “With their enormous physical footprints, shoddy construction, and hastily put-up infrastructure, many of our suburbs are visibly crumbling,” Florida wrote. The cost of reinvigorating them will not be minor.

Seniors are also likely to be more mobile and self-sufficient with driverless cars providing goods seamlessly and easily escorting the elderly to their doctor appointments and bridge games. The result? Senior housing might not be as important, Levy said.

The sectors that attract the most capital now could be uprooted by this technological change, from senior housing (which provided an average 13.64 percent return on investment over the seven full years prior to second-quarter 2017, per CBRE) to urban housing (about $158 billion in trades in the multifamily sector closed in the U.S. last year, according to data from Real Capital Analytics). Suburban housing and office buildings may recoup those sectors’ losses. “Demographically, [senior housing] looks like a great place to go,” Levy said. “But this is the type of disruptive technology that could change demand.”

The return of the suburbs could in turn reinvigorate the suburban office market, which is practically a dirty word in real estate these days.

“The pendulum may swing back” for the maligned asset class, said Daniel Parker, a senior vice president with Hodges Ward Elliott, an investment sales and real estate financing brokerage. “More and more places could be viable office districts.” One day, inking a lease in Midtown South might not be payday for brokers as it has been of late.

Larco agreed that the suburbs could win. “We point toward more and more sprawl,” he said. “The rest of the city should see a drop in value.”

Guhathakurta isn’t so sure. “Our conclusion was that there will be some amount of dispersion, but it’s not going to be so dramatic as other people have been afraid of,” he argued.

This can be explained in part by price. People behave very differently when a cost is fixed versus when a cost is marginal. Because they pay money each time they get in a car, people who rely on ridesharing take fewer trips than people who own cars. Even if the overall cost is lower, consumers will be aware that they are paying something every time they ride.

Suburbanites without cars will also face a new cost of transport: waiting. If the out-of-pocket cost drops with ridesharing, waiting for your car will be a new cost. Denser areas should have shorter waiting times, though.

Both of these factors could constrain the pressure to live farther away.

Or Musk will invent something no one anticipates that makes owning robot cars super cheap, too. Then, all bets are off.

copy of olli at phoenix lm 2 No One at the Wheel: What Will Driverless Cars Do To Real Estate?
Local Motors’ Olli automated trolley car. Photo: Local Motors

Pilot Cities

These days, the U.S. is usually left in other countries’ dust when it comes to rolling out infrastructure—just ask anyone who has used Wi-Fi in South Korea. It’s likely that driverless cars, though developed at least in part by American companies, will be no exception, sources said.

Israel, Singapore and other Asian countries are much more likely to become a lab for driverless cars’ implementation than the U.S. for regulatory and logistical reasons, they said.

In the U.S., metropolises could also easily become “have and have-not” cities, Levy said.

In Ann Arbor, Mich., for instance, you can already navigate the University of Michigan’s engineering campus via driverless shuttle buses developed by a French company, NAVYA, as The New York Times reported in July. NAVYA recently opened its North American headquarters in Saline, Mich. It’s one of several companies betting that small commuter buses will be the West’s gateway drug to life without steering wheels. A similar company, EasyMile, also just opened offices in Colorado.

America also has its homegrown trolley companies, such as Local Motors in Chandler, Ariz., which makes a trolley called Olli that can only be described as adorable (like a shoe box with all its edges rounded off and little wheels on the bottom). Seidl’s partial to one of his portfolio companies, which retrofits existing shuttles and cars, Auro Robotics.

All of these companies agree that university and corporate campuses, resorts and amusement parks will see the driverless renaissance first. “Where you have a private, large-ish area and private roads,” Seidl said, “you can go to implementation much faster.”

Meanwhile, in Pittsburgh, Uber’s attempt to roll out driverless cars for ridesharing with the mayor’s blessing seems to be falling apart after nine months, as the Times also reported. The startup allegedly began charging for rides despite its initial promise that they would be free while part of the pilot program, causing Mayor Bill Peduto to lose political capital. City officials and citizens are frustrated that Uber has not created any of the jobs it promised or even shared the traffic data generated by its cars.

But the experimentation in trucking has begun. Uber-owned Otto has already made one autonomous delivery in Colorado. The vehicle automation firm Peloton Technology is winning new laws across the country that lets diesel trucks talk to each other so they can drive very close together, reducing air resistance and fuel costs for trucks. And Starsky Robotics is testing a platform in Florida where humans are still needed, sometimes, but they can drive via remote control from a cubicle in an office.

Distribution Revolution

Driverless cars and improved drone technology, which economists and futurists are even more sure is on its way, will only further cement Amazon’s role as America’s distributor of choice.

“The highest cost in the supply chain for shipping is labor,” Levy said. Eliminating that cost is an obvious call, and driverless cars are going to help. Amazon, needless to say, is likely to be at the forefront of this effort.

Seidl echoed this sentiment. “For Amazon, the end of the supply chain is the house,” he said.

But there’s good news for brokers. While everyone we spoke to generally agreed that warehousing will largely get bigger and more spread out, Larco added that there will also be a need for lots of small warehouses in the most dense urban areas. In fact, we already see Amazon doing just that in New York City with a 50,000-square-foot facility in Midtown and the forthcoming massive fulfillment center on Staten Island. Maybe that’s what we can do with the parking garages?

Various accommodations to facilitate drop-off in urban areas will be needed. Think of how, when Fresh Direct launched its business, New Yorkers complained bitterly about the trucks pausing in the street for deliveries. A whole infrastructure to handle driverless cars’ arrival will be necessary.

Apartment buildings will likely be redesigned to accommodate new modes of distribution, Parker said. Already, the industrial sector is bracing for the changes. “In talking to investors, they are thinking about ways industrial properties can accommodate Amazon’s model where [goods are] delivered in a few hours,” he said. He imagines shopping taking the form of scanning the items you want, leaving the store and finding the items at your door, delivered via driverless car or drone, a few hours later.

And there is likely to be further consolidation among distributors, Parker said, with the gargantuan and expensive task of erecting an infrastructure being possible only for, well, Amazon.

“I saw a tweet recently,” Parker said. “It said, ‘If Amazon wants to be in your business, sell now. If Amazon doesn’t want to be in your business, sell now because your business sucks.’ ”

gettyimages 659266120 No One at the Wheel: What Will Driverless Cars Do To Real Estate?
An Uber self-driving car drives down 5th Street in San Francisco. Photo: Justin Sullivan/Getty Images

Diseases of Despair

While there’s always the chance that building that whole new infrastructure can help the job market, this budding technology augurs massive shifts in employment, at best, and a huge uptick in unemployment, at worst.

“We cannot think about autonomous vehicles as a transportation issue. We need to think about autonomous vehicles as an everything issue,” Larco said.

Automation has already been eating into the market for lawyers (with computers doing the lion’s share of tasks that consumed hundreds of hours like document review), and law school admissions have plummeted in response. For the first time in decades, an accredited American law school, California’s Whittier Law School, shut down.

What happens to the massive chunk of the American workforce that drives for a living, when driverless cars dominate the highways? A speaker at the CREFC conference earlier this year pegged the number of Americans who drive for at least part of their job as 30 percent of the workforce; the Los Angeles Times recently said 5 million Americans will lose their jobs when driverless cars are fully implemented. Either number would be devastating to the economy and to real estate.

“The most complicated and controversial of questions [centers on] drivers and jobs and the housing market,” Levy said. With a healthy portion of America automated out of professional relevance, prospects for housing—where the majority of Americans have a financial stake of some kind, either through their own equity or a retirement fund that is tied in some way to real estate—darken. With the lessons of the Great Recession still fresh, real estate executives are scrambling to think of ways to ease this potential shock.

The proposition floating in real estate circles may surprise you: universal basic income.

“The solution that has been suggested is basic income,” Levy said. “But it is the wrong answer.”

Universal basic income (UBI), which has been implemented in pilot programs in Canada and the Netherlands recently, is often explained as “paying people for being alive.” Citizens are given a monthly, unconditional stipend that is sufficient to meet their needs, making income from employment all icing on the financial cake (although it would likely be taxed more heavily). The idea has been around in various forms for centuries but has gained more traction recently. Switzerland held a referendum to offer all citizens a 2,000-francs-per-month UBI last year, but 77 percent of voters said no.

Arguments for UBI range from the philosophical—Thomas Paine thought true individual freedom meant freedom from your employer—to the practical: When disruptions to the economy create shocks like 2008, money, talent and resources go to waste. Putting an easily administered universal safety net in place could cushion people from shocks. Think of providing liquidity to an individual’s personal financial system to incentivize longer-term planning.

A study in Ireland in 2012 showed UBI could be funded there by implementing a 45 percent flat tax with no exemptions—they wouldn’t be needed, after all—on all personal income. In their simulation, they improved financial prospects for more than half of the country’s citizens.

Of course, the idea is usually suggested by thinkers on the political left. But even economists and political scientists on the right, like Charles Murray and Milton Friedman, have argued for versions of UBI, partly because it would streamline the welfare-administrative state.

In America, UBI sounds impossible, but it might be the best mechanism to administer benefits to the growing segments of Americans who are no longer looking for work. In September 2015, the total proportion of Americans participating in the workforce hit 62.4 percent—the lowest percentage since 1977—according to FiveThirtyEight. While employment proportional to the total population has been ticking up slowly since early 2016, the larger trend remains profound, given that unemployment is predicted to grow quickly as automation improves.

Levy thinks UBI won’t help. He cites statistics on the growing number of “deaths of despair” in the U.S., usually defined as those from opioid abuse, alcoholism or suicide. Such deaths have risen steadily since the turn of the last century, according to numerous academic studies.

Clusters of deaths of despair are apparent in areas where industries have died and people, especially men, who want to be gainfully employed sit home, possibly collecting a social benefit. White Americans without a college degree between the ages of 45 and 54—a dominant rust belt demographic—have seen a half percentage increase in mortality rates every year from 1999 to 2013, according to Princeton University economists Anne Case and Angus Deaton.

Levy said that vast swaths of the unemployed, subsisting on UBI, will be even more prone to such deaths. And education is not a fix for this demographic quagmire, he said, because it “takes too long.”

But there aren’t any other apparent answers.


Source: commercial

Port Authority Floats Idea of Rebuilding Bus Terminal—Right Where It Is

The Port Authority of New York & New Jersey might rebuild its much-reviled bus terminal on West 42nd Street rather than build a new one elsewhere, officials announced during a board meeting today.

If the bistate agency chooses to keep the bus station in its current spot in Hell’s Kitchen, it would add two floors to the existing four-story structure between West 40th and 42nd Streets and Eighth and Ninth Avenues. The authority could do the construction while maintaining “integral bus operations” and pedestrian access through the huge site, said Steven Plate, the chief of the Port Authority’s capital projects.

He explained that the build-in-place option was structurally viable as long as construction was conducted in phases—meaning that the Port Authority would be able to safely run buses and add extra floors to the building. Similar redevelopment projects have been conducted at the World Trade Center, the Hospital for Special Surgery on the Upper East Side and previously at the bus terminal, Plate said.

Although the terminal was first built in 1950, it was expanded first in 1963 and then again in 1979. The latter renovation added a north wing and a 70-store shopping mall, boosting the station’s size by 50 percent and expanding its footprint to two full blocks, as Commercial Observer noted in a 2015 feature on the terminal.

However, the agency is still considering several development options for the terminal, including seizing property elsewhere to build a new one, or moving it to another state-owned property, like the Javits Center.

A quarter of a million people and 8,000 buses pass through the station every day, and the authority expects that 100,000 people will use it by 2040. The agency has already earmarked $3.5 billion in its budget for redevelopment of the facility, where construction is not expected to begin until a two-year-long environmental review is complete.

This week, the agency issued a request for proposals for a consultant to conduct the environmental review. But many other details, like the expected completion date for the project, remain vague.

The renewed focus on keeping the bus terminal where it is comes after more than a year of controversy among West Side neighbors and elected officials. In October 2015, the agency launched a design competition to solicit plans for a new facility. But some of the proposals involved seizing property through eminent domain, which was a non-starter for local politicians. The eminent domain suggestion also angered nearby residents, who feared that the authority would displace homes and businesses.

Now the Port Authority—which has a new executive director, Rick Cotton, as well as a handful of new board members—claims it’s going to focus on a “robust public outreach program,” Plate said during the meeting. That isn’t surprising, after five elected officials who represent the neighborhood—including Rep. Jerrold Nadler, Manhattan Borough President Gale Brewer and Councilman Corey Johnson—penned a letter to the agency’s chairman last November slamming the design competition and the planning process up to that point.

“This type of large-scale project must be planned with an objective eye towards the communities it serves, both the surrounding residents and the passengers that are coming to New York City,” the politicians wrote.


Source: commercial