Will the Frozen Capital Markets Thaw in Spring? 🥶

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In today’s email: Voters in Los Angeles have taken a drastic step towards creating more affordable housing and reducing homelessness. The availability of financing remains a top concern among institutional investors for 2023. And while most headlines today about the office market are doom and gloom—the reality looks quite a bit different. Let's dive in!

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MANSION TAX

LA Approves Tax Increase on Real Estate Deals Over $5 Million to Boost Housing

LA voters have just approved Proposition ULA to create more affordable housing and reduce homelessness. Starting April 1st, 2023, Proposition ULA will boost the one-time transfer tax to 4.0% for deals between $5–$10M, and 5.5% for deals over $10M (up from just 0.45% on all sales).

Mind the gap: According to a report by the California Housing Partnership, LA County residents need 120% of the area median income to rent a 2-bedroom apartment. It’s no surprise that nearly 42,000 people sleep on the streets, inside cars, or in shelters each night. At the same time, mansions in Beverly Hills often sell for upwards of $100M.

Potential side-effects: The approval of Proposition ULA was not unanimous, to say the least. While the measure was backed by housing advocates, neither Mayor-elect Karen Bass nor her opponent Rick Caruso supported it. Critics argued the initiative could make housing even less affordable because of increased buying costs for landlords. 

➥ THE TAKEAWAY 

The bottom line: Proposition ULA will raise an estimated $600M to $1.1B of tax revenue per year, with 70% of the funding going to affordable housing, and the rest to homelessness prevention. In 2016, LA city taxpayers approved similar legislation (Measure HHH), a $1.2B bond measure to finance more than 10,000 housing units for the homeless. So far it has proven to be a success. But only time will tell if ULA can do the same.

DEEP FREEZE

Will the Frozen Capital Markets Thaw in Spring 2023?

Investors are praying for financing liquidity to return to normal next year. Fortunately, Marcus & Millichap’s (MMI) Institutional Property Advisors division shared some positive predictions despite unrelenting economic uncertainty. 

Cash remains king: Permanent bank debt and debt-fund bridge debt spreads are expected to remain high early next year. In other words, cash buyers unconstrained by the capital markets will have a leg-up to buy quality assets at attractive price points. 

CRE sharks lurking: With substantial loan maturities in 2023, rescue capital, mezzanine debt, and preferred equity from CRE funds will be in high demand. Expect these funds to take advantage of dislocations, underwriting 15–20% IRRs.

➥ THE TAKEAWAY 

Spring is coming: MMI’s capital markets team expects inflation will fall lower than CPI indicators, so the Fed should slow rate hikes going into the new year. A rate hiking slowdown, barring any other black swan events, should lead to a gradual thaw in the capital markets by mid-to-late 2023. 

Investors are Still Waiting to Capitalize on Office Sector Distress

Weakening demand and increasing tenant leverage are all we’ve heard about the office market. Yet despite all these gloomy discussions, we haven’t quite seen the office apocalypse play out.

Numbers don’t lie: Fitch reported office CMBS delinquency of 1.23% in October, which is well behind delinquencies for hospitality, retail, and mixed-use assets. While investors continue waiting for distressed office sales, properties in less-desirable locations, or those with deferred maintenance issues, are the most at risk.

Different this time: Aaron Jodka, director of research at Colliers (CIGI), notes a major difference between today’s real estate environment and 2008. After the Great Recession, low rates and quantitative easing (QE) essentially let loans work themselves out. With today’s higher rates, it’s unlikely for a QE program to alleviate the pains of near-term loan maturities.

➥ THE TAKEAWAY 

Patiently waiting: While many office assets will be repositioned into life science properties, government facilities, or schools, costs and zoning laws are often prohibitive. Investors who’ve dreamt about acquiring office properties at steep discounts may have their opportunity soon enough.

📰 Editors' Picks

• Airbnb crackdown: The Real Estate Board of New York has proposed a law that would allow landlords to determine whether to allow short-term rentals in their buildings. 

• Retail rewinding: Despite a slight boost from domestic travel, a staggering 66% drop in international tourism is crushing retail foot traffic in the US.

• Too much, too soon: Starwood (STWD) CEO Barry Sternlicht says the Fed increased rates far too quickly, creating significant uncertainty that will surely lead to a recession. 

• Bye-bye: Black Friday may be losing its luster. Not only did this year’s discounts start earlier, but inflation has also left consumers with smaller shopping budgets.

• Better days ahead: While property valuations have fallen considerably nationwide, the worst of the property slump should already be behind us. 

• Guilty as charged: Former President Trump's family business was found guilty of criminal tax fraud on all 17 counts levied against them, with potential fines of up to $1.6M.

🤝 Deals & Dealmakers

• Long Atlanta: Construction has topped out on Phase II of The Interlock, a 670-unit student housing development for Georgia Tech.

• Joining forces: DR Horton Inc. (DHI), the nation’s largest homebuilder, is set to acquire the homebuilding operations of the Riggins family in Arkansas.

• Shopping spree: GBT Realty has sold a 78 KSF portion of its Bermuda Square shopping center in Chester, VA to an unnamed investor.

• Flock to Florida: RSR Capital is planning a 52-unit luxury condo development as people continue moving into Clearwater, FL. 

• Midsize mania: Three commercial properties valued between $10M and $40M traded hands in New York City last week. 

• If you can’t beat ‘em: Auction platform RI Marketplace and property showcase site Buildout will cooperate to leverage each other’s users.

• Semiconductor splurge: Taiwan Semiconductor Manufacturing Co. (TSMC) will build a second plant in Phoenix, AZ, marking one of the largest foreign investments in the history of the US.

 📈 Chart of the Day

US Workers Say They'd Rather Quit or Take a Pay Cut Than Return to the Office Full-Time

Nearly 40% of U.S. workers say they would quit their jobs if denied the option to work remotely, while 66% of employees said they would immediately start looking for a job that offered flexibility. Do you agree? 

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.