Office Space in the Sunbelt: Is the Heat Fading?

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Good morning. Sunbelt office markets display weakness, with increased sublease inventory and slower rent growth. Atlanta Hawks owner intends to convert 50 acres in Atlanta into a hotel. Meanwhile, Blackstone's $270M loan backed by 11 NY apartments may result in a default.

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Sunbelt Office Markets Begin to Cool as Demand Shifts

Sunbelt office markets are being affected by remote work and economic uncertainty. Although attractive business factors still exist, data shows a potential slowdown in growth. We'll explore the changing landscape and its implications for the office market.

Slowing growth: Unlike its coastal market counterparts, the Sunbelt has seen higher rents and more job growth in the past few years. But that may be changing as vacancy rates are still higher than pre-pandemic levels and the pace of growth starts to slow down. For example, office rents in Atlanta rose by just 8 cents/SF from Q3 2022 to Q1 2023, compared to average gains of 21 cents in the prior six quarters, according to CoStar.

Sublease inventory is rising: The amount of office space up for sublease is rising in Sunbelt hubs such as Austin and Nashville, which could signal demand is softening. Austin and Nashville have experienced record-high subleases coming to market as many companies, such as Bridgestone Corp., are committed to keeping a hybrid work model.

Continued setbacks: The slower growth in the Sunbelt is another setback for a multitrillion-dollar office industry already struggling to keep its head above water. Remote work is now hurting cities where job growth has remained strong, with many companies looking to cut costs ahead of an impending recession.

➥ THE TAKEAWAY

Increasing imbalances: The Sunbelt office market has a supply/demand imbalance, as many developers were overly optimistic during the pandemic when migration was at an all-time high. But not all Sunbelt markets are created equal. Miami is still showing resilience in the face of adversity but may soon be feeling the heat as a bumpy economy makes its way to South Beach.

It's Time for Operational Spring Cleaning

CRE transaction volumes are at an all-time low—44% since 2020, by our estimate (see the data). Meanwhile, CBRE is forecasting a further 15% YoY drop in investment volume, and debt is becoming increasingly difficult (and expensive) to obtain. Industry experts expect underwriting standards to get more rigorous from here, likely further dampening deal-making.

As Jason Kern, President of Investment Management at Cortland, said, “Buyers smell blood in the water, looking to get some distressed deals at discounted prices. But at the same time, well-capitalized owners and sellers don't want to take a mark down where they're holding their assets on the balance sheet. And if they're not pressured into selling, you're going to have fewer sellers willing to sell into a distorted market.”

This period of “wait and see” can be seen as a challenge for groups that think of their secret sauce as doing deals, this lull creates an opportunity for operational spring cleaning, providing the time and space for managers to focus on ensuring they have the right internal infrastructure and third-party partners to take advantage of whatever comes next.

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NBA Owner Bets $5B on Downtown Atlanta Despite Commercial Real Estate Fears

Tony Ressler, the billionaire co-founder of Ares Management and owner of the NBA’s Atlanta Hawks, is looking to transform downtown Atlanta by turning a vacant railyard into a $5B mix of hotels, restaurants, and offices.

Developing downtown: Atlanta is struggling to attract people to its downtown, but Ressler’s project, The Centennial Yards, aims to fix that. Construction on the 50-acre mixed-use development encompasses various components such as residential units (with 20% reserved for affordable housing), office buildings, retail spaces, and recreational areas. Despite inflation and interest rate concerns, Ressler appeared unfazed by the potential impact on the project.

Appealing to Atlanta: Tony Ressler's team, which includes Shaquille O’Neal, Grant Hill, and Andrew Young, holds approximately 35% ownership in the development project. CIM Group owns the remaining 65%. Ressler believes that supporting small businesses, particularly those owned by minorities, benefits the economy and business. The project has pledged 38% participation from minority contractors. The project is receiving an estimated $2B in incentives, with all city and state taxes collected at the project over a 30-year period going to developers, who will also get a 20-year property tax break.

➥ THE TAKEAWAY

Big plans: With Atlanta co-hosting the 2026 World Cup soccer championship, Tony Ressler believes that there is an increased sense of urgency to develop the Centennial Yards project in order to showcase its progress to the world. He also noted that Atlanta's appeal to businesses is evident due to its diverse and well-educated workforce, affordability, and supportive policies at the city and state levels. Despite struggles in downtown Atlanta, such as CNN's move to midtown, there are indications of untapped potential surrounding Ressler's development.

📖 Read about how discount retailers such as Marshalls, TJ Maxx, and Dollar General may be attracted to the vacant storefronts left behind after Bed Bath & Beyond’s (BBBY) bankruptcy.

🖥️ Watch this explainer video from Break Into CRE about how to use ChatGPT to analyze real estate deals, raise capital, and even land jobs in the industry.

🎧 Listen to Jesse Stein, Airbnb’s (ABNB) global head of real estate, discuss the company's tenant-friendly apartment venture, a product allowing renters to list units with landlord consent.

Blackstone's Default Risk Persists Despite Record-High Manhattan Rents

Manhattan apartment rents are hitting new highs this year, despite rents leveling off or declining elsewhere in the country. Nevertheless, Blackstone Inc. faces the prospect of losing a portfolio of Manhattan apartments.

Special servicing: Blackstone's loan for its 11-building portfolio constructed between 1900–1987 has landed them in special servicing because the cash flow from the properties isn't covering the cost of the debt. The buildings are predominantly market-rate and have been enjoying Manhattan's rising rents. But expenses related to maintaining and improving these buildings far surpassed expectations when Blackstone took out the loan in 2019. Expenses are rising too quickly, putting the company in a precarious position.

The floating-rate predicament: Notably, the properties are financed with floating-rate debt, causing the cost of debt to skyrocket as the Fed kept raising rates. Despite a rebound in rent prices in Manhattan, data suggests that many tenants have maxed out on how much of their income they can devote to housing. Many multifamily owners in NY and elsewhere have reported increased costs in several areas, and it doesn’t take a genius to know it’s unsustainable.

Approaching D-Day: Blackstone's securitized loan comes due this August with the option to extend for one more year. They purchased an interest rate cap that partially limited exposure to rising rates but also expires in August. The high cost of replacing it—likely millions more than they anticipated—would further eat into Blackstone's profits. If they choose to cut losses, they could hand the properties to a special servicer or decide to renegotiate loan terms.

➥ THE TAKEAWAY

Buyer’s remorse: Bonds backed by CRE mortgages have dropped to their lowest level since the pandemic's start as investors grow increasingly wary of the risks across various markets. Up to $37B of securitized multifamily loans will expire in the next 2 years, with income not covering debt payments—more than twice the amount of at-risk office loans.

• Best buds: Real estate mogul Harlan Crow doesn’t view his friendship with Supreme Court Justin Clarence Thomas as a problem, despite his history of political giving and influence in Dallas.

• Manhattan's misfortune: With pandemic-related office closures and rising interest rates, NYC’s largest corporate landlords face falling property values and higher borrowing costs, potentially leading to a recession nationally and a budget crisis for the city.

• A-list collaboration: Developer Mark Bellissimo is teaming up with golf legends Tiger Woods and Ernie Els, along with Justin Timberlake, the Tavistock Group, and eBay founder Jeff Skol to build a 600-acre luxury community in FL for $1.5B.

• Moderate movement: The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index reported a 2.0% annual gain in Feb, down from 3.7% in Jan, with Miami, Tampa, and Atlanta leading the way with the highest YoY gains.

• Large losses: Taconic Investment Partners sold their 14-building apartment portfolio in the Bronx to Intervest Capital Partners for $60M, a significant loss from their $100M purchase price.

• Mastering your niche: Many investors are turning towards niche sectors such as golf properties, car washes, and other less explored corners of RE due to increased uncertainty surrounding the CRE industry.

• Leveling the playing field: LA City Council is considering offering tenants facing eviction free legal counsel, funded by the ULA transfer tax, to give tenants a fair fight.

• Cannabis competition: Due to falling prices and increased competition, the cannabis industry prefers leasing properties over purchasing to stay flexible.

• Making moves: Private equity firm Carlyle has joined forces with Stonehenge NYC to buy RiverEast, a 32-story, 196-unit property on the Upper East Side, for $114M from UBS.

• CMBS slowdown: Due to rising bond spreads and interest rates, CMBS issuance plummeted by 79% YoY to $5.98B in Q1 2018, its lowest level since 2012.

• Pain for pensions: Apart from banks, other big holders of CRE debt, such as pension funds, REITs, and insurance companies, which account for over 22% (or $1.2T of the $5.62T total debt), are starting to experience difficulties due to work-from-home trends.

• Earnings report: CoStar Group (CSGP) saw a 13% rise in revenue YoY during Q1 2023 while observing a 17% growth in net new bookings, totaling $80M. Apartments.com climbs to 20% revenue growth.

When comparing CRE interest rates on different types of property loans over the past 60 days, debt funds/REITs are charging the most by far across property types, while banks are still offering the lowest rates on average.