Expiration of Gov. Tax Credits Could Deepen U.S. Affordable Housing Dilemma

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Good morning. Welcome back to CRE Daily—your morning brief where you get the essential news and trends in commercial real estate, all in ~5 minutes.

Here's our agenda for today's briefing:

• The U.S. risks losing nearly 200,000 affordable rentals in the next five years as tax incentives for affordable housing near expiration.

• The biggest gateway markets are shouldering the bulk of maturing CMBS debt in the upcoming 18 months.

• EQT Exeter has surpassed its $4B target, despite industrial market fluctuations post-pandemic.

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Expiration of Government Protections Sparks Concern Over Future of Affordable Housing

With the looming expiration of government protections on many rental properties, the U.S. is on the precipice of losing almost 200,000 affordable housing units in the next half-decade. The curtain is falling on a 30-year tax credit program designed to incentivize developers to construct affordable housing, handing landlords the power to dictate their rents.

Rising rental market: The impending expiry of these agreements comes on the back of a significant surge in rental prices. In the period from early 2021 to summer 2022, asking rents for market-rate units jumped by 25%. Therefore, it is anticipated that many landlords will capitalize on this trend and increase their rents.

Cities facing losses: Moody’s Analytics estimates that about 188,000 government tax credit-funded, low-cost rental apartments could transition to market rate by 2027. Major cities such as Dallas, Chicago, and Houston could experience substantial losses in their affordable housing offerings. During the pandemic, a significant portion of affordable housing disappeared, with the number of affordable units dropping by 400,000 between 2019 and 2021.

Impact on renters and landlords: The expiry of these protections could lead to significant rent increases, leaving long-term renters in a difficult position. For instance, a senior citizen in California saw her rent more than double after the landlord opted out of the federal tax-credit program in 2021. Landlords, who have been significant supporters of the tax-credit program, are expected to raise rents to cover the increasing costs of maintenance, insurance, and property taxes in the absence of new subsidies or incentives.

➥ THE TAKEAWAY

Big picture: The future of affordable housing in the U.S. is at a critical juncture, with a looming deficit of such housing units and increased demand outpacing supply. While there are calls to increase the number of government-issued tax credits and certain buildings are finding ways to maintain lower rents, construction of new affordable units struggles against rising interest rates and inflation. It's crucial for policymakers to strike a balance between maintaining affordability for tenants and ensuring the economic viability of these properties for landlords.

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Over $1 Trillion CRE Debt Set to Mature with Major Metros at High Risk

Amid rising interest rates and slow post-COVID recovery, the commercial real estate sector faces significant stress, with over $1T in debt due by 2025. But which major metropolitan areas have the most exposure?

Heavy load: It's no surprise that the biggest gateway markets are shouldering the bulk of maturing CMBS debt in the upcoming 18 months. Leading the pack is New York, with approximately $39.8B in debt, trailed by Los Angeles ($17.9B), Miami ($12.6B), San Francisco ($11.4 B), and Las Vegas (around $10.6B). The analysis focused on all types of commercial real estate properties financed through CMBS debt and loans, including both current and distressed payments.

A closer look: An analysis of distressed loans, earmarked for watchlists or special servicing, reveals a similar pattern with New York, Chicago, and San Francisco carrying significant distressed CMBS loans. However, these only represent a fraction of the total distress in each metro area, yet they pose challenges to property owners looking to refinance or sell assets.

Delinquency rates: Trepp reports a notable increase in the CMBS office delinquency rate from 1.86% at the year's start to 4.5% in June. Retail and hospitality assets hold the highest delinquency rates. In the next three years, loan maturities are expected on over 9,500 office buildings, equating to 17% of all U.S. office stock.

➥ THE TAKEAWAY

What happens next: The commercial real estate industry faces a tough period with the impending wave of maturing loans. Lenders' likely approach of extending loan terms may not solve cash-flow issues for some properties. Trends of landlords abandoning underperforming properties or selling assets at lower prices suggest the need for new strategies as financial pressures mount.

EQT Exeter Surpasses Target, Closes Industrial Value Fund at $4.9B

EQT AB's real estate division, EQT Exeter, has surpassed its $4 billion target, closing its new Industrial Value Fund VI at $4.9 billion, despite industrial market fluctuations post-pandemic.

Fresh powder: EQT Exeter's new fund saw backing from prominent U.S. public pensions, including the Public School Employees’ Retirement System of Pennsylvania, the Los Angeles City Employees’ Retirement System, and the New York State Common Retirement Fund. EQT Exeter was established in 2021 via EQT AB's $1.87 billion acquisition of Exeter Property Group, aiming to enhance its real estate footprint, especially in the U.S. logistics sector.

Global presence: Operating from Radnor, Pa., EQT Exeter claims to be the fifth-largest owner of industrial real estate globally, boasting tenants like Amazon, UPS, and Google. EQT AB oversees roughly €119 billion across private equity, infrastructure, and real estate asset classes.

Market correction: Industrial real estate, previously booming in the pandemic era, has faced a slowdown. EQT Exeter's CEO, Ward Fitzgerald, reports a 15%-25% decline in industrial property values, attributing it to a "short-term correction." However, Fitzgerald notes that sellers have started to adjust price expectations, fostering better conditions for deal-making. The company anticipates an uptick in its exit pace over the next two to three years, expecting improved market conditions.

➥ THE TAKEAWAY

Investment strategy: EQT Exeter plans to commit to around 200 transactions with its new fund, each averaging $20 million. Fitzgerald underscores EQT Exeter's unique approach—maintaining regional offices and direct leases with tenants—distinguishing it from competitors. Additionally, the firm's predecessor funds have shown robust returns, indicative of the firm's successful investment strategy. EQT Exeter's notable 2021 exit with the sale of 328 buildings for $6.8 billion further highlights its strong performance.

• Bold new bet: New York real estate broker-turned-developer, Michael Shvo, began his transformation of Miami Beach with the acquisition and restoration of the vacant Raleigh Hotel, but he’s only getting started.

• Tax strategy: Michael Hurst provides insights into the IRS' recently introduced alternative method for evaluating the influence of expenses related to common improvements on gains and losses.

• Bad deal: Over the past decade, New York invested close to $1B in Elon Musk's ambitious vision for what was intended to be the largest solar-panel factory in the Western Hemisphere. This investment stands as one of the largest public expenditures of its kind to date.

• Launching a career: Austin tops the list for the best city to start a career, followed by Seattle, Salt Lake City, Indianapolis, and Kansas City in the top 10.

• Sale-Leaseback: In a move to generate cash, discount retailer Big Lots has entered into a sale-leaseback agreement with Blue Owl Capital, selling 26 of its stores and a distribution center in California. The agreement is valued at $318M.

• Handing back the keys: Ashford Hospitality Trust, a real estate investment trust based in Dallas, has announced its intention to surrender ownership of 19 hotels. The decision comes after the company failed to meet debt yield tests on loans that were nearing maturity.

• Miami magic: Eyal Ofer's Global Holdings has purchased the Mondrian Park Avenue hotel in NoMad for $157M from Moin Development. This acquisition follows Ofer's earlier acquisition of the senior mortgage on the property.

• What comes next? Unlike the office sector, the U.S. multifamily market is facing an upcoming surge in debt maturities in the fall. However, borrowers in the multifamily sector are in a significantly different position, without the same existential concerns.

• Deals stall out: Rising costs have led to a decrease in office leasing activity in Dallas, with a decline of almost 28% reported in the second quarter. Companies are opting to delay major space decisions in response to these cost increases.

Houston topped the list of U.S. destinations witnessing the largest influx of people amidst a surge in residents moving to southern states.

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