How Rising Interest Rates are Impacting CRE Borrowers

Good morning. Fed Chair Powell went to Congress to talk about curbing inflation and ended up curbing the stock market instead. The S&P took a nosedive while the Fed's terminal rate expectations shot up to 5.60%.

In today’s email:

• Rising Rates: Commercial property owners with floating-rate debt face more pressure due to the high costs of protecting against rising interest rates.

• Property Metrics: Recent data reveals a shifting tide in the health and perception of U.S. manufacturing and what it means for the industrial sector.

• Silver Lining: A new kind of senior affordable housing development plans to make its residents work a little (literally) to secure their units.

Before we dive in…we want to give a special shoutout to all the women who read CRE Daily to say happy International Women's Day: we see you, you’re awesome, and we thank you for choosing to read this newsletter every morning.

RISING RATES

Sky-High Insurance: When Taking The L Makes More Business Sense

The cost of interest rate caps, which protect CRE borrowers against floating-rate debt, has surged, further pressuring owners. These caps are set to expire soon, making it even more difficult for those who purchased them before the Fed began raising rates last year.

Eye-popping prices: Last year, the Fed raised rates a whopping seven times, with four straight hikes of 75 basis points from June through November ending with a quarter-point increase in January. Rate caps were previously a modest part of the CRE process, but due to changes in the Secured Overnight Financing Rate forward curve, a two-year cap on a $25 million loan at a 4% strike rate shot up from $97,000 a year ago to $569,000 today, according to Chatham data.

Left with no good choices: Many owners are being forced to sell their assets rather than take the hit of purchasing a more expensive interest rate cap for a refi loan. Increased borrowing costs are already affecting CRE lending, with originations down 54% in Q4 compared with Q3, according to the Mortgage Bankers Association. They predict a 15% drop in CRE lending in 2023, but project a 32% rebound in 2024, when rates (and the U.S. economy as a whole) should have stabilized.

➥ THE TAKEAWAY

Selling pickaxes and shovels: Making the most of a bad situation, the prohibitively high cost of caps present opportunities for brokers, since there are likely to be more sellers hitting the market soon. Holding on just ain’t worth it. Sponsors with struggling properties may sell for a loss or return the keys to their lenders, leading to more transaction and loan sales volume.

HALF STEAM AHEAD!

Manufacturing & Industrial Are Stabilizing, But Still Solid Investments

The industrial sector is usually associated with retail assets and consumer demand, but it also includes manufacturing, which impacts production. And recent manufacturing data has been very telling. While the industrial sector has performed very well in the past few years, data shows early signs of stabilizing sentiment.

Shifting tides: Recent manufacturing activity data reveals a shifting tide in the health and perception of U.S. manufacturing, given negative quarterly growth. This will likely impact the goods trade, which will face downward pressure in 2023, causing a domino effect that might shrink manufacturing, warehousing, and distribution needs, lowering demand for industrial properties.

Reshoring boosts demand: On the other hand, reshoring and nearshoring are increasingly common, which means property subtypes across the industrial sector could benefit due to the higher domestic need for space to house research, production, assembly, storage, and distribution facilities. As industrial production accelerates, industrial occupancy rates also increased across the board and higher rents followed.

➥ THE TAKEAWAY

Early signs of stabilization: Lower absorption rates are showing up across distribution, warehouse, and flex R&D spaces despite more completions. The vacancy rate for distribution and warehouse space stabilized at 4% in H2 2022. However, industrial properties remain healthy from a capital-markets perspective. The share of all industrial property loans that are at least 60 days delinquent was at a 14-year low of 0.51% in November, according to Moody’s.

🌐 AROUND THE WEB

📖 Read about how Citadel beat Bridgewater to become the most successful hedge fund in the world by predicting the weather better.

🖥️ Watch Mark Dixon, CEO of flexible workspace company IWG, discuss his company’s outlook for remote and hybrid work.

🎧 Listen to how retailers are navigating slower consumer demand, high rates, and rising prices on this episode of Exchanges at Goldman Sachs.

WIN-WIN

Seniors Who Want Affordable Housing Have to Literally Work For It

Construction began near Boston on Monday for a rare senior housing project that will provide affordable housing for middle-class residents—with a twist.

That’s one way to keep costs low: 2Life Communities, the developer of the $100M, 174-unit Newton, MA affordable housing development, will charge monthly rents as low as $1,800 (compared to the $4,200 area average). 2Life plans on keeping costs low by only serving group dinners three times a week and by requiring residents to volunteer 10 hours a month to upkeep the properties.

Affordable golden years: The project has seen a surge of interest as the average cost of private senior housing rose 5.2% last year. A 2019 study projected that by 2029, half of middle-income seniors might be unable to afford their housing. 2Life’s entrance price is $395,000, nearly ⅓ the entry price of other senior housing facilities. And when a resident passes, 80% of the entrance fee will be refunded to their next of kin.

➥ THE TAKEAWAY

Cost-cutting competition: With the senior housing industry slowly recovering from the pandemic, more companies are exploring cost-saving measures to cater to a growing demand for more affordable senior housing. Other companies, like Atria Senior Living and Merrill Gardens, have also begun to offer more affordable housing by cutting costs and repurposing older complexes. Merrill Gardens’ Seattle-area Truewood community, for example, rents studios for $2,240 a month and one-bedrooms for $3,280 a month.

✍️ Daily Picks

• Hot dog economics: Can hot dog sales explain how inflation and unemployment rates change seasonally? You bet your frankfurter they can.

• Charging up: Are you looking for a way to attract high value residents and improve NOI at your multifamily property? Upgrade with Xeal Energy.

• Pooh-pooh Powell: Contrary to popular opinion, the Fed does not care how your stock portfolio is doing, because Powell just told Congress that interest rates will start going up faster.

• If you can’t beat ‘em, exploit ‘em: Despite the ERAP portal closing, tenants are still finding ways to exploit it and receive rent relief, leaving landlords in a difficult position.

• If you can buy it here: What makes U.S. homebuying and selling much more streamlined and consumer-centric than in other countries? Great question.

• Get on our side for once! The AAGLA has sued the LA City Council to overturn tenant protections that make it harder for landlords to evict tenants and raise rent.

• Clear winner: CBRE Group (CBRE) held the top spot for CRE investment sales globally in all three major regions and across all five major asset classes in 2022.

• Miami on my mind: Miami has become a boomtown for offices, with rents jumping significantly since 2021 and developers launching new office projects despite the rise of remote work.

• Back on the elevator: Discounts helped fuel an 18% increase in luxury sales in Manhattan and a 44% increase in Brooklyn in February, compared to pre-pandemic levels.

• Not the best coast? Zillow (ZW) expects only 39% of major markets to post a home price decline over the coming year, with the West Coast expected to be the weakest region.

• What now, Freddie? HUD's multifamily lending fell over 28% to $21.01B in FY 2022, and multifamily transactions dropped 17% YOY to $294.1B, leading to fewer loan opportunities.

• Don’t discount them: No one asked for it, but Ross Stores (ROST) is ready to deliver with 100 new planned Ross and DD’s Discounts locations in 2023.

• Country living: Single-family housing starts have dropped most in high-density markets, while rural markets saw positive single-family home building growth rates in Q4.

💼 Talent Collective

In partnership with Bullpen

Bullpen's new contract roles this week include a particularly fascinating development position with hospitality real estate in Texas. Join today for access to the below roles, as well as several other freelance openings.

• Development Manager, Hospitality

💰 Full-time or part-time (Remote) ❗️ Focus on a ground-up project in Texas

• Development Associate, Multifamily

💰 Hourly (Remote) 📍 Emphasis on Miami-area multifamily

• Marketing Specialist

💰 Hourly (Remote) 📍 Emphasis on markets in the Southeast

Looking to hire? Connect with Bullpen 

🤝 Deals & Dealmakers

• The wheels of industry: Burton Katzman and DRA Advisors formed a $240M JV that will launch with the recapitalization of 24 infill light industrial properties in the Midwest spanning 2.2 MSF.

• Major test: The rental and retail section of Brooklyn's tallest building has been listed for sale by JDS Development at a price range of $600-700M, a major test for the investment sales market in the city.

• Bottoms up! Northmarq secured a $25.3M loan to build a bourbon barrel storage facility in Shelbyville, KY, to meet record demand for new bourbon production.

• Biggest of its kind: RFR Holding plans to build a mixed-use building in Brooklyn with 426 apartments (375 of them market-rate) and 137.9 KSF of commercial space.

• Snapped that one up quick: Rowin Capital and Penny Lane Associates acquired the Forest at Fenwick multifamily property in Johns Island, SC, for $16.3M with CWK representing the seller.

• EV housing: Aurora Capital and William Gottlieb Real Estate secured a $33.6M gap mortgage loan from Webster Bank for their six-story mixed-use office building in Manhattan.

• Not in my backyard: A development firm is facing opposition over its plan for a gated 55+ community on a 24-acre site in Suffolk County, VA, comprising 180 luxury townhomes.

• Pretty impressive: Find out how Andrew Joblon, founder of Turnbridge Equities, amassed a $2B+ portfolio through a mix of ‘chutzpah and calculation.’

• Moving on to better things: Roblox (RBLX) plans to 2x its Silicon Valley footprint by relocating its corporate HQ to to take over a San Mateo tech campus.

• Garden State aspirations: Adoni Property Group acquired a two-building, 217 KSF office campus in Basking Ridge, NJ previously sold for $50.3M in 2002, for an undisclosed amount.

• Big-name investors: Lynd Development and Tuttle Land Investments began construction on The Villas at Tuttle Royale, a 401-unit multifamily complex in Royal Palm Beach.

📈 Chart of the Day

Last week, office occupancy levels surpassed 50% for only the third time since the beginning of the pandemic. According to the 10-city Back to Work Barometer, the occupancy rate stayed at 50.1%. Austin (68.1%), Houston (61.8%), and Dallas (54.3%) continue to maintain levels above the national average.

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