Tag Archives: CommercialRealEstate

What Rising Interest Rates mean for Commercial Real Estate

By: Daniel Li

2022 will be a transformative era for capital markets in all sectors of the U.S. economy. In order to combat inflation caused by the stimulus measures implemented by the Federal Reserve during the COVID-19 pandemic, the Federal Reserve has recently decided to accelerate plans to increase interest rates. On December 15th, 2021, the Federal Reserve announced that it would end its pandemic-era bond purchases in March of 2022 and plan for three 25 basis point interest rate hikes by the end of 2022. 

Due to the leveraged nature of commercial real estate, the rate hike by the Federal Reserve will have significant impacts on both debt and equity markets. As properties are often financed with commercial mortgages, commercial real estate markets are most exposed to interest rate alterations. With the rise in interest rates, we see the cost of debt rising accordingly. There are many debates regarding whether there will be increases or decreases in cap rates as a result of the interest rate increase and current macroeconomic factors. 

Fundamentally speaking, increased interest rates lead to more expensive financing. From an equity perspective, acquiring new properties will have narrower margins, and in turn, may create a more conservative market. From a debt perspective, the increased rates may cause a decline in deal flow, however that loss in volume may be balanced by increased margins on invested capital. 

The record low federal fund rate at the beginning of the pandemic (0% to 0.25%) reduced the cost of financing, and as a result, instigated a surge in buy-side activity, development, and increased prices. As with any artificial injection of capital to stimulate the economy, there are repercussions; one of which being the rapid increase in inflation. Thus the Federal Reserve’s upcoming move to not only increase interest rates but to raise them ahead of schedule has been a long time coming.  

To look at lasting effects on commercial real estate markets, lenders and investors are looking towards two factors regarding interest rates. One, the effect of the interest rate hikes on cap rates, and two, the adaptability of commercial debt markets in regards to a rate hike. Concerning cap rates, there are generally two ways they can move. One, many believe that a rise in interest rates correlates with a rise in cap rates as property values decrease. Two, others believe that with increased interest rates, investors pay more to borrow capital, cutting into profits, and thus decreasing cap rates. However, when considering cap rate movement in relation to interest rates, we must consider a longer timeframe. As a result, it becomes hard to predict changes in cap rates as a result of increased interest rates, as other factors come into play such as capital flows, investor sentiment, and real estate fundamentals. Historically, changes in federal interest rates have not resulted in immediate changes in cap rates. The ultimate question is whether the market is well prepared to adapt to such a change. 

Broadly speaking, the effects of rising interest rates are unpredictable. In addition, recent geopolitical developments such as the Russia-Ukraine War make it uncertain where the Fed will go with interest rates. However, we are certain that they will go up, and as such, create an environment for the movement of cap rates and the exacerbation of current squeezes on markets.

Graph 1.1

Graph 1.2

Secondly, we will see some asset classes take the hit worse than others. From the graphs above, we can see how historically speaking, with previous interest rate increases in 2015-2018 and 2004-2005, cap rates have generally compressed. However, stable cash-flowing asset classes with high occupancy rates such as multifamily will fare better than higher risk higher reward asset classes such as industrial, office, and retail. Since the margins on rent from these asset classes become tighter through the increase in interest rates, the risk of industrial, office and retail in regards to defaults will increase. We can see this through Graph 1.2, where apartment cap rates saw less compression than industrial, office, and retail asset classes. While the previous two interest rate hikes have led to cap rate compression, this is not indicative of what will occur in the present day. However, we do see that multifamily generally can withstand these macroeconomic trends better than office, industrial, and retail asset classes.

With the increase in the cost of financing, we will see spreads tighten as value add opportunities diminish. Since the market for many stable cash-flowing asset classes such as multifamily are already facing extreme demand and competition, the increasing cost of debt due to interest rate hikes will continue to chip away at the returns of value-add opportunities. According to Forbes, many investors in 2020 faced a difficult decision of either accepting lower returns with the appropriate amount of risk or finding ways to add more value to hit more opportunistic returns. The interest rate hikes of 2022 will exacerbate this trend as financing becomes more expensive. Ultimately, the interest rate hike will make competitive markets less viable, pushing investors to do two things. One, more conservative strategies such as core and core-plus will be adopted in order to accommodate for the increasing competitiveness of value-add opportunities, and two, we will see expansion towards suburban areas. Regions such as many of the Sun Belt states (i.e. Texas, North and South Carolina, and Florida) have high suburban demand for multifamily. According to Matthews Real Estate Investment Services, the demand in this region is driven by rapid population growth and increasing employment opportunities. With these growth and demand drivers, investors are looking to those areas to find more lucrative value-add opportunities.

According to Cushman and Wakefield, in the long term, this rate increase will benefit the health of property markets. The purpose is ultimately to reduce the potential for inflation to become entrenched, giving way to a more aggressive hike in the future, and potentially causing a recession. In the short term, interest rates are not necessarily a shift away from the current norm, but a force that can exaggerate many of the effects we saw in recent years. Multifamily will continue to offer stable returns, despite its slow yet steady cap rate compression, and investors will become more risk-averse and/or find opportunities in emerging markets. 

In a constantly changing market, one slow step could be a missed opportunity. At Lever Capital Partners, our steadfast team of industry experts track the latest trends and understand how to source and utilize the best available capital. Whether you are looking for an equity partner, a lender, or a combination to fund your next project, Lever can advise you on obtaining the most attractive financing the market has to offer. Here at Lever Capital Partners, we pride ourselves on our wide range of experience in refinancing, recapitalizing, converting assets, ground-up construction, acquisitions, and our overall creativity in getting our clients the capital they need for any commercial real estate related transaction. Our industry professionals look forward to speaking with you about your next project.

References:

https://www.forbes.com/sites/calvinschnure/2021/04/29/the-fed-interest-rates-and-the-good-news-for-commercial-real-estate/?sh=4ec0a93d57e4

https://www.forbes.com/sites/forbesrealestatecouncil/2020/04/07/are-there-any-value-add-deals-left/?sh=7dc98df12269

https://www.millionacres.com/research/millionacres-research-report-cap-rates-and-interest-rates-whats-the-correlation/

https://www.federalreserve.gov/monetarypolicy/openmarket.htm

Multifamily, The Post-Pandemic Investment Poster Child: An Inside Look at Post-Pandemic Multifamily Investment Trends

By Will Crystal

The effects of COVID-19 have been felt throughout the entire commercial real estate sphere and continue to impact investment decisions across all property types. The pandemic has revealed a plethora of new opportunities in the marketplace, creating trends that are expected to continue into the foreseeable future. One of the most notable trends we are seeing is an uptick in multifamily investment and financing. The combination of record-high rental rates, surging demand, and skyrocketing market values is creating financing and capital event opportunities for property owners while forcing developers and investors to get creative.

Demand for multifamily housing has spiked dramatically in the first three quarters of the year and according to data from property management and analytics platform RealPage, “absorption of multifamily units jumped by more than 255,000 in the third quarter.” This extreme increase in demand can partially be attributed to the post-pandemic job market recovery we’ve been seeing, specifically regarding middle and higher-income jobs. Peter Linneman, of Linneman Associates, “believes that 3.5 million people will return to the workforce in the next six to nine months, and there will be an additional 2 million or more jobs added as the economy continues to grow” (Linneman, BisNow). Subsequently, more people than ever before can afford apartments due to stabilizing incomes related to job market recovery. This can be attributed to “the most recent ADP data from September [2021], indicating a [growth in] jobs [from] the previous two months”, due to the “elimination of the additional unemployment benefits issued in response to the pandemic” (Linneman, BisNow). Significantly more people are seeking employment as covid subsides and there is no shortage of available jobs, from the restaurant business to middle-income level jobs.

Additionally, the average price for multifamily assets has increased over the last 2 years, along with demand. Pricing and demand are projected to continue this upward trend in both the short and long term. In August of last year alone, there were “new construction permits totaling over 57,000 units issued across the U.S.” for multifamily development. This is the highest demand for permits in a single month since June of 2015. The trend is not expected to slow anytime soon, as 450,000 multifamily units are projected to be developed in 2023-2024.

While the demand for multifamily continues to surge as the market recovers from the pandemic, increasing uncertainty around office and retail assets has prompted many to convert those existing buildings. Both office and retail assets have seen record low occupancy rates during the pandemic. As a result, we are seeing many of the distressed properties getting converted to multifamily. This conversion strategy allows investors to capitalize on rising rents and demand in the multifamily sector, without having to buy in at the price levels we are seeing in the residential market. This trend has created a significant opportunity for developers and investors, as “renovations could cost about 30% to 40% less than new construction for the same number of units.” Not only are investors saving on construction costs, but they are also able to buy these distressed buildings at significantly lower prices than comparable existing multifamily properties in the same markets. Multifamily developers have experienced many challenges throughout the pandemic, especially regarding construction costs. These challenges and specifically the increased costs have made it difficult for individuals to start investing in the multifamily space, making the conversion strategy that much more attractive. 

While multifamily investors key in on the conversion of commercial assets to multifamily given current market conditions and compressing cap rates, current property owners are able to take advantage by capitalizing on the current borrower/sponsor-friendly state of the capital markets. As cap rates compress, property owners/sponsors can get significantly more attractive debt, whether it be construction, bridge, Mezz, or permanent financing. “Multifamily cap-rate compression averaged 31 basis points in infill markets and 41 basis points in suburban markets” (ADG Multifamily). With market prices at all-time highs and the gradual increase we’ve seen in rental revenue due to record demand, it is the optimal time to get financing for a new project, refinance your existing debt, or recapitalize your equity. Investors have significant dry powder ready to be deployed in the multifamily space, whether it be a conversion or ground-up development. Meanwhile, banks, debt funds, and insurance companies aggressively look to deploy capital in both areas at rates lower than any other asset class.

Lever Capital Partners has significant experience in the multifamily space and can assist you in securing any financing needs for your next project. Whether you own an existing multifamily property and are looking to refinance or recapitalize, or you are a developer looking for construction financing for asset conversion or ground-up development, we have the resources and experience to get you what you need. We pride ourselves in our ability to bring clients a range of financing options that reflect only the best that the market has to offer.

Sources:

https://www.bisnow.com/national/news/commercial-real-estate/peter-linneman-walkerdunlop-walker-webcast-110461

https://www.bisnow.com/national/news/multifamily/apartment-demand-all-time-high-construction-tries-catching-up-110465

https://www.bisnow.com/national/news/multifamily/record-number-of-commercial-spaces-converted-into-apartments-this-year-110453

The Evolving World of Commercial Real Estate and Movements to Keep an Eye on in a Post-Covid World

By: Andy Evans

As vaccines roll out across America, and day-to-day life begins to resume as usual, it is crucial to understand how Covid-19 has affected the commercial real estate industry. As we know, the pandemic shifted people’s perceptions on the necessity to work in an office every day or go to a physical store to purchase the goods they need. We saw a significant rise in work-from-home structures as well as a staggering 44% growth in e-commerce volume compared to the previous year (Forbes).

With that being said, the commercial real estate industry remained remarkably stable. The number of foreclosures barely increased, while prices fell far less than after the 2008 financial crisis and are already rebounding much quicker than anticipated. Stability can partially be attributed to supportive federal monetary policy and low interest rates that allowed struggling assets to hold out. As we near the end of the pandemic, US private real estate companies are sitting on record levels of dry powder nearing 400 billion (PGIM) and are looking to capitalize on the increased momentum in the economy. While asset classes such as industrial and multifamily will continue to show their strength in the market, we have identified several emerging sectors where investors can expect to see significant growth and potential.  Out of crisis comes opportunity and the trends that we have outlined below are creative ways to tap into newly emerging markets, asset classes, and strategies. 

  1. Logistics/Cold Storage

A surge in online shopping and grocery sales has led to a steep increase in demand for cold storage space. Developers across the country are eager to get into the space due to the consistency of cash flows and the overall stability of the business. In 2020, online grocery shopping grew 81% in comparison to 2019 (Coresight Research) and factors such as subscription meal services and specialized pharmaceutical products are driving this emerging asset class. Growth is projected at 11.71% from 2019 to 2026 (Foodinstitute).

  1. Multifamily Conversions 

Converting other types of buildings into multifamily apartment complexes for rent has grown increasingly popular as construction costs have skyrocketed in the last year. Malls, factories, office buildings, and hotels are considered ideal candidates for traditional, micro, affordable, and senior living concepts due to the fact that they are generally located in already desirable areas. These conversions often have unique characteristics considering their history and are attractive because they are generally less expensive on a cost-per-door basis than newly constructed units. 

  1. Retails Creative Repositioning Opportunities 

With malls and retail centers struggling to garner shoppers and foot traffic falling 22% in the country’s top 10 malls (FNRP), many redevelopment opportunities are presenting themselves across the country. 78% of consumers expect online shopping to become more popular post-COVID 19 (Deloitte) and as a result, landlords must find new and innovative ways to stay relevant.  Popular redevelopment projects include apartment complexes, school campuses, medical facilities, and even churches. Another study conducted by Deloitte explores how malls could stay relevant by repositioning the assets based on the goal of creating a place where people can socialize, eat, live, and work all in one location. These physical spaces are not going anywhere anytime soon, so finding innovative ways to capitalize on the significantly discounted assets presents ample opportunity for massive upside.

  1. Last-mile Distribution

Industrial assets located within the urban core or strategically placed in high-density areas to reach the maximum population (known as “last-mile distribution”) are seeing record growth with the increase in e-commerce. The increase in e-commerce that we are witnessing places massive pressure on logistics operations, and these assets are proving to be the solution. America’s appetite for one and two-day deliveries depends on access to local inventory. With the high demand for these spaces, we can expect to see buildings repurposed for this use or new built-to-suit development projects. Regardless, these assets will provide stable returns for investors and provide diversity to a portfolio.

  1. Office – Coworking Space 

Coworking spaces and micro-office units will continue to grow in popularity as more and more entrepreneurs start online businesses and seek a workplace where they can work distraction-free. E-commerce start-ups continue to grow and having a physical office space is critical for their continued success. These businesses do not seek large class A office spaces but instead like the new and trendy coworking locations that also offer amenities within the building. This repurpose strategy can be implemented by any office owner/operator and will prove attractive to a wider variety of tenants. Reaching high occupancy levels is becoming harder and harder for landlords and this innovative strategy may be the gateway to success. 

  1. Affordable Housing 

As housing becomes more expensive and landlords are once again able to enact eviction memorandums, we can expect to see shifts towards affordable housing. The majority of the US population continues to find renting an apartment or home a more affordable option compared to homeownership and this sector is expected to yield high growth. Affordable housing brings a more certain guarantee of payment and allows landlords to feel safe in their projections and yields during uncertain times. Despite below-market rents, this sector has better occupancy and less volatility than market-rate units. Throughout the pandemic, affordable housing rent growth was 1.2% in 2020 and outperformed traditional multifamily (GlobeSt.).

  1. Non-traditional Sectors (Data centers, senior housing, and self-storage) 

Non-traditional sectors continue to provide evidence of resilience through economic downturns.  Data centers are in high demand across the country as we see a massive increase in access to internet-related services and the rise of 5G. These centers need physical space which provides a great investment opportunity. Further, in the next 10 years, the senior population cohort will grow at twice the pace of the past decade and will need to meet a demand of more than 23,000 units per year (HavenSI). This demand spike will provide investors and developers stable and safe investment opportunities. Lastly, the self-storage sector is projected to see annual compounded growth from 2020-2025 of 134.79% (Forbes). Population growth and rental vacancy are the driving factors for this notable increase that will bring bountiful investment opportunities with it.

The trends outlined above illustrate the new high growth and innovative movements of the commercial real estate industry in a post-COVID world. Lever Capital Partners understands the changing landscape of this industry and knows how to adapt to it. Reflecting on conversations with many capital providers at the 2021 Annual MBA Conference, as well as several current clients, we can firsthand see the unspent capital out there in the market right now. Investors are hungry to get back to investing in projects that they believe in and most importantly in ones that are backed by a compelling story. Lever understands the opportunities out there and can provide you with the capital to lead the initiative. Whether your needs include debt, joint venture equity, or secondary financing, we can discuss the capital currently available for your project and work together to guide you to an efficient closing. 

References:

https://www.tylercauble.com/blog/commercial-real-estate-investing-in-2021-trends-markets

https://www.naiop.org/en/Research-and-Publications/Magazine/2020/Summer-2020/Business-Trends/Experts-Speak-on-COVID19s-Impact-on-Commercial-Real-Estate

https://www2.deloitte.com/us/en/insights/industry/financial-services/commercial-real-estate-outlook.html

https://www.multihousingnews.com/post/how-the-pandemic-could-spark-more-conversion-projects/

https://www.forbes.com/sites/stevebanker/2020/07/24/what-will-last-mile-delivery-look-like-post-coronavirus/?sh=29feef683b22

https://www.forbes.com/sites/forbesrealestatecouncil/2020/12/01/a-look-at-self-storage-growth-trends-now-and-post-pandemic/?sh=2468ed472165

How Lenders and Investors are Changing Their Underwriting Assumptions

By: Adam Horowitz

Lever Capital Partners is speaking with lenders and investors on a daily basis and have been hearing that changes in underwriting are at the forefront of their minds. The number one question capital providers are asking is, “In the current post-Covid world, what changes have you made in your underwriting assumptions?”. The conversation is a non-starter if the sponsor has not thoroughly thought through these changes and can’t clearly point to adjustments made in the proforma with a compelling story to back it up. Here are a few of the major underwriting changes we’re requesting from our sponsors (for now) and our recommendations about how to present them to the market: 

  1. Cap Rates – Needless to say there is pricing uncertainty in the market (investment sales volume has dropped roughly 70% in Q2 2020 from the same period in 2019, according to CoStar and RCA Data). Pre-Covid comps are being ignored so it’s important to factor in a conservative premium to appease investors. Recently, we’ve seen value adjustments of 10%+ for multifamily properties up to 30%+ for hospitality, depending on the specific asset. Don’t be shocked when looking at your updated IRRs.
  2. Rent Growth – Underwriting future income streams poses a considerable challenge for most properties without long term leases or credit tenants in-place. Across the board, investors are underwriting untrended rents and factoring in zero rent growth for the next 2-3 years. In rare instances, some markets are projected to have a negative rent growth rate over the next 1-2 years. Where you build / purchase will be heavily scrutinized now.
  3. Exit Cap to Yield on Cost – In regular times we’d typically look for untrended yield on cost spreads of 150 basis points compared to the exit cap rate. The industrial and core multifamily spreads are holding close to those numbers but we’re seeing a much wider spread for all other asset classes. Be prepared to show numbers in the 175-200+ range.
  4. Spec Development – Building spec has always been a challenge, even in the most bullish of times. Office and retail have required a fair amount of pre-leasing even in the early part of this year. But now, given the circumstances, nothing is going to happen unless you are heavily pre-leased with credit tenants in tow. Walking into the lender’s office with a mask and a dream won’t cut it, so start lining up those credit tenants.
  5. Debt Assumptions – The lending world has dried up considerably with some participants leaving the market (debt funds) and others on the sidelines only willing to lend to existing relationships (banks). Overall, leverage has decreased with developments maxing out at 65% and more commonly in the 50-60% range while interest rates spreads have widened, increasing all-in rates. You’re likely going to need more cash, and investors are much more focused on the debt status than ever before.

Without these adjustments, most lenders / investors will take a quick pass. Your ability to identify and edit your original underwriting shows you’re adapting to the new normal, have an understanding of what metrics had to change and are able to craft a workable solution around the modified numbers. To come off as a sharp sponsor and on top of the market, we recommend having your changes ready to present by (1) preparing a doc that outlines your changes that you can share with investors and lenders and (2) crafting a compelling story for the asset and market that you can talk through.

These are the first things we ask for when looking at new deal packages. If you follow the above rules you might be one of the fortunate few to get a new loan or investor equity. We can help when you’re ready to “turn and face the strange” as Bowie said. We’re home working in our PJs waiting for you to call.

2019: The Market Ahead

By Max Bleiler, Lever Capital Partners

Investor appetite is lessening in 2019, according to firms surveyed for the 2019 Annual Investor Intentions Survey by CBRE. Of those surveyed, 98% intend to continue making acquisitions in 2019, but anticipate that they will do so at a slower pace. Furthermore, they are increasingly looking to secondary markets as well as alternative asset classes for yield. Amongst investors, the majority of investments are being made in pursuit of a stable income stream, followed by expectations of capital appreciation. This makes sense as prices across asset classes and markets are at or near all time highs.

Amongst investors, there is continued fear that 2019 may be the year of a global economic downturn. As we are all aware, this fear has been a growing concern over the past few years, but there has yet to be any strong indication that the apocalypse is now. Secondary to this concern is fear over what rising interest rates will do to the economy. At this time, the Fed seems to have indicated that they are taking a break from raising rates, so this fear, at least for 2019, can be put to bed.

Atlanta, Denver and Central Texas markets have emerged as leading metropolitan areas for real estate investment in 2019. Amongst Tier I cities, Boston and Chicago remain in favor while New York, Seattle and D.C. fall behind other Tier II and Tier III locations, including Las Vegas. These trends are continuations of what Lever Capital Partners has seen over the past few years and expects to continue to see moving forward.

Across asset types, industrial reigns top amongst investors. This continues a duel between industrial and multifamily spanning several years now. As tech giants continue to develop distribution plans for our increasingly e-economy, large investors have indicated they believe this sector is ripe with opportunity. Across asset types, value-add strategies remain most popular amongst investors, a trend that has now been increasing for nearly half a decade which Lever Capital Partners expects to continue in the short term. To the surprise of many, retail continues to hold its ground as an investment class, despite much buzz about the so-called “death of retail”.

Looking to the year ahead, the study indicates that 2019 is forecasted to be a slower version of 2018. Many of the concerns of the market have been sustained for several years now and trends in favorable real estate classes, investment strategies, and geographies are continuations from what Lever Capital Partners has seen in the past. In our experience over 2018, we saw increased activity in the senior housing, student housing, and industrial sectors. We anticipate these trends to continue as we move further into 2019.

At Lever Capital Partners we work closely with developers and owners to connect their projects with capital appropriate to their needs. We appreciate and anticipate the challenges the market cycle can bring to real estate transactions. We pride ourselves on our ability to have open conversations with clients and provide quick feedback, as to the market appetite, for their bespoke products. When partnering with developer clients in early stages, we are able to provide our market forecasts and help guide clients toward more financially feasible transactions.

Reference:
CBRE Americas Investor Intentions Survey 2019

Smaller Metros in the West are Emerging

Our team at Lever Capital Partners has noticed similar trends as we started seeing more smaller metro deals come across our desk the last few years. It’s still hard convincing non bank commercial real estate lenders to do business in many of these markets, despite showing the data that supports commercial real estate financing in those areas. The more cre news similar to this article the better support we’ll have in the future when working on deals in this sector.

– Adam Horowitz, Principal of Lever Capital Partners and President of the Real Estate Capital Alliance

Click here to read more about the emergence of smaller and Western metros.