Category: Real estate news

Pittsburgh’s Tech Boom is Driving the Local Real Estate Market

Pittsburgh’s real estate landscape has changed significantly since the slowdown of the manufacturing and steel industry decades ago. The influx of technology giants such as Uber and Google has brought a rise in the demand for both commercial and residential real estate. The low cost of property relative to cities like New York and San Francisco has been attracting companies such as Duolingo, a language learning app that moved its headquarters to Pittsburgh and subsequently put up billboards in San Francisco in 2018 advertising, “Own a Home. Work in Tech. Move to Pittsburgh.” Although plenty of attention has been paid to the effects of the tech industry on residential real estate, not as much as has been placed on commercial real estate.

Today, we will try to connect the dots between the influx of high profile tech companies, trends in local employee behaviors, and how this new Pittsburgh business atmosphere is having a major impact on the local commercial real estate market.

The Current State of Pittsburgh’s Tech Boom

Most of us in Western PA have noticed the recent boost in high tech presence in our local regions. Splitting from our historical business ventures like steel and coal, Pittsburgh is becoming an affordable alternative for tech companies who are no longer willing or able to pay for spaces in Silicon Valley, San Francisco, and other bloated commercial real estate markets.

Much of this tech boom is reliant on the rich talent pool being churned out by local universities. In particular, computer science, robotics, and other high tech programs at Carnegie Mellon University are routinely ranked amongst the best in the world. In recent years, companies like Google and Uber have been working hard to keep these young tech professionals in the local Pittsburgh area after graduation. Those efforts are starting to pay dividends.

Today, there are significantly more jobs (approximately 41%) in research and development than there are in iron and steel mills. Pittsburgh is also experiencing attention from investors. “SoftBank Group Corp (9984.T) last year led a $93 million investment in Pittsburgh-based AI company Petuum. Innovation Works recently hosted 30 Chinese investors interested in robotics and health care start-ups.”

Office Spaces for Google, Uber, Duolingo, and More

While there are many players in the technological revitalization of Pittsburgh, there are a few key players who are leading the way.

Google has long made massive investments in Pittsburgh, particularly with their Bakery Square office spaces. The refurbished Nabisco factory is a fitting transition from the old to the new. Much like Duolingo, Google has actively pursued bringing tech talent to the Pittsburgh area to live and work in the East End.

Uber employs thousands of workers in the Pittsburgh area, which of course does not include the drivers themselves. Perhaps more importantly, Uber has selected Pittsburgh as a research center for self-driving cars. This move ties the ridesharing tech giant to our region for years to come.

Duolingo was founded and is currently headquartered in Pittsburgh. In December, Duolingo became Pittsburgh’s first tech “unicorn” when a fundraising round pushed the company’s value above $1 billion. Rather than going the route of other tech giants and selecting our region as an affordable alternative, Duolingo has always been committed to revitalizing the Pittsburgh area. Duolingo employs 200 workers in local offices.

The Impact of Tech Companies on Commercial Real Estate in Pittsburgh

Beyond the obvious connection of tech companies’ presence being an injection to the local economy, here are some concrete ways in which tech companies have impacted the local commercial real estate industry:

  • Office jobs are on the rise: commercial real estate value for office spaces have been increasing as tech companies continue to occupy more and more space. Thousands of jobs were added in the summer of 2019 as a continuing trend of higher occupancy rates for local office space.
  • Tech companies are investing in properties: not all CRE impacts are directly related to office spaces. For example, Uber recently purchased 600 acres of commercial real estate in Findlay County, PA. This space is going to be used for a self-driving test track for their latest vehicles.
  • Tech workers are driving occupancy in apartment complexes: large multi-family CRE complexes have been going up around the Pittsburgh area, particularly in areas like East Liberty, Lawrenceville, and South of downtown. These complexes are being built in part to accommodate a rising number of tech employees in our area.
  • More tech investment = more local wealth: last but not least, it is undeniable that tech dollars drive local economies. A strong local economy often means a strong commercial real estate market.

Going Forward

There are no signs that the trend of high tech companies choosing Pittsburgh will slow any time soon. An industry-wide trend of shifting away from California and other west coast markets towards traditionally affordable markets is driving the tech industry overall. Other cities experiencing similar growth include Nashville, TN and Austin, TX. The Pittsburgh commercial real estate market has responded in turn, focusing more on offering high scale amenities at premium prices.

What remains to be seen is whether any other large companies like Amazon will set up additional headquarters in our area. Regardless, the effort to keep local talent and recruit local talent to our area will certainly continue to have a major impact on our economy and real estate markets.

Understanding Triple Net Lease (NNN) Agreements

Understanding the intricacies of different commercial real estate lease agreements allows investors, property managers, and lessees to come to an arrangement that is mutually beneficial. One common “special” type of lease arrangement for commercial real estate is known as a triple net lease or a NNN lease. These types of lease arrangements are typically utilized in situations where a single tenant rents out an entire space. While NNN leases are almost always for commercial real estate agreements, they apply to other real estate ventures as well.

With all of this in mind, today we will define triple net leases in detail, explain how they differ from standard leases, single net leases, and double net leases, and finally discuss why NNN leases can benefit both investors and tenants for medium to long term commercial real estate agreements.

What is a Triple Net Lease (NNN) Agreement?

As mentioned in the introduction, a triple net lease may also be called a NNN lease or a net-net-net lease. In a triple net lease agreement, “tenant(s) agree to pay the property expenses such as real estate taxes, building insurance, and maintenance in addition to rent and utilities.” In other words, the landowner will not be responsible for many, if any, maintenance expenses on the property during the term of the lease.

For a multitude of reasons, NNN leases are less common for short term leases. It is more common for triple net leases to range from 10 to 15 years with stipulations for rate increases over the term of the loan as appropriate. As we will discuss in greater detail below, the primary benefits of NNN leases are lower risk for investors/property owners and lower rates for lessees.

Single vs. Double vs. Triple Net Lease Agreements

Net leases are not necessarily an all or nothing proposition. Instead, there are also single and double net leases that are sometimes used to balance risk vs. cash flow. Here are the similarities and differences between single net leases, double net leases, and triple net leases:

Single net leases are less common than triple net leases, particularly for commercial real estate. According to investopedia.com, single net leases are when: “the landlord transfers a minimal amount of risk to the tenant, who pays the property taxes. This means any other expense—such as insurance, maintenance and repairs, and utilities—are the landlord’s responsibility. The landlord is also responsible for any maintenance and/or repairs that must be done during the course of the lease within the property.”

Double net leases are much more common for commercial real estate agreements. In double net leases, tenants are responsible for insurance premiums and property tax on top of their rent owed. Maintenance costs remain with the landowner.

Triple net leases put the biggest responsibility on the tenants, essentially making the tenants responsible for any ongoing fees and costs related to the property. These include all three of the costs discussed above: insurance premiums, property tax, and maintenance costs.

Gross vs. Net Leases for Commercial Real Estate

Of course, not all commercial real estate agreements are considered “net”. There are also gross leases in CRE in which the property owner maintains fully financial liability for the property during the course of the lease. All commercial real estate leases are considered either gross or net, with single, double, and triple net lease agreements being the differentiator for the degree of responsibility that will reside with the tenant(s).

Benefits of NNN Agreements for Commercial Real Estate Properties

This leads us to our last question: why are NNN leases preferable to other commercial real estate leases? The answer is that they aren’t preferable in all situations. All types of leases from gross to triple net lease arrangements have their share of benefits and risks. Here is a high-level checklist of the benefits of triple net leases:

  • NNN leases carry the lowest risk for investors. The primary benefit of a triple net lease from the perspective of the investor/property owner is the low risk. If insurance premiums go up or if a major repair is required, with a NNN lease, that onus falls on the tenant.
  • Triple net leases are more affordable for tenants. On the flip side, the selling point for NNN leases to tenants is their affordability. Lessened risk for the commercial real estate investor also means lower rental rates.
  • Triple net cap rates are easier to calculate. While this is all relative, calculating NNN cap rates is more reliable than calculating gross cap rates. This is tied into the concept of risk and a more reliable return on investment.

In Summary

Double and triple net leases are likely to remain an appealing option for commercial real estate investors and tenants for many years to come. In the right circumstances, NNN leases are mutually beneficial with their ability to reduce risk for investors and reduce total costs for tenants. Yet they are not appropriate for all CRE lease agreements. As with many decision-making processes, understanding all options available before entering into a commercial real estate lease agreement is a great way to make the best possible choice.

Construction Underway at Beaver Valley Mall

Recently, we discussed what commercial real estate investors were doing to solve the problem of America’s dead malls. As part of that article, one of the solutions which have effectively brought life back to struggling retail real estate is to invest in renovations or other related construction projects. The Beaver Valley Mall in Beaver County, PA has recently broken ground on a new construction effort. If successful, this revitalization could be a blueprint for other dying malls in the Western PA region.

Today, we will review some highlights of the Beaver Valley Mall, discuss the details of the newest construction project, and how this project might impact the local commercial real estate landscape.

CBRE Heads New Strip Mall Construction at the Beaver Valley Mall

Funded by commercial real estate giant CBRE, plans to redevelop a now-defunct Macy’s location are underway at the Beaver Valley Mall. The former site of a Macy’s megastore will be turned into a mini strip mall. This is part of a plan to redevelop large retail locations that were struggling in the region. This new mini strip mall is to be named The Shops at Beaver Valley Mall. JJO Construction started work on the first building in the fall of 2019.

As reported by timesonline.com: “The Shops at Beaver Valley Mall, which will include about 50,000 square feet of retail, office and service space with mall access available in various sizes. According to a CBRE press release, there will be nearly 27,000 square feet of retail space facing Brodhead Road. The Shops at Beaver Valley Mall will join other anchor tenants, such as JCPenney, Dick’s Sporting Goods, U-Haul, Rural King, Planet Fitness and Boscov’s.”

This is not the first renovation and/or construction effort that has recently taken place at the Beaver Valley Mall. Recent construction updates for restaurants and entertainment venues including escape rooms have been part of the shift away from large retail locations and towards smaller, more profitable business partners.

Beaver Valley Mall History and Current Climate

Beaver Valley Mall is located less than an hour north of downtown Pittsburgh. The location first opened in 1970 and boasts over 100 individual stores, a gym, restaurants, and is getting more involved in the entertainment space. Beaver Valley Mall is also dedicated to offering free programs and events for local community members and their families.

As with many American malls, Beaver Valley Mall enjoyed financial success through partnership with anchor tenants including JCPenney, Gimbels, The Joseph Horne Company, and Sears. The location of this latest construction, a now-empty Macy’s, is just one example of these retail giants struggling in the 21st century. Sears and Macy’s locations closed in 2016 and 2017 respectively.

Despite all of the hyperbole surrounding the detail of traditional retail, many malls remain successful. Recent history has shown that successful malls have been willing to make updates to both their facilities and their business model. With the recent backing of CBRE, Beaver Valley Mall is looking towards the future.

Following the Beaver Valley Mall Template

As a continuation of this point, Beaver Valley Mall is by no means in a unique situation. Other large, local malls such as Ross Park Mall, Monroeville Mall, and The Pittsburgh Mills, are all in relatively similar situations. In particular, the Galleria at the Pittsburgh Mills has an uncertain future. Despite promises by Mason Asset Management that renovations were high on the priority list, no action has yet been taken.

The four most recent tenants of the Pittsburgh Mills: Allegheny Health Network Citizens’ School of Nursing, Focus on the Arts, Chicken Connection, and Himalayan Salts Co, tell the story of a shift away from large retailers and towards alternative mall tenants. Many Western PA malls are considering what these new tenants might require from an infrastructure perspective.

Beaver Valley Mall is amongst the local commercial real estate leaders investing significant capital into their retail facilities. With backing from a well-financed organization such as CBRE and a commitment to investing in the space, local commercial real estate professionals and residents will be watching how this new construction effort pays dividends.

Going Forward

As all commercial real estate professionals know, there is not much room for waiting in this industry. As the retail space continues to evolve, so too will commercial real estate investors’ mindsets about malls and other large spaces. The process of revitalizing America’s dead malls is already well underway. In the local Western PA area, it remains to be seen which malls will be able to successfully adapt to a changing retail reality. The truth likely lies somewhere in between exaggerated reports of the demise of traditional retail and the rosy reports of modern retail evolutions.

The mall industry will need to adapt to changing consumer behaviors. Beaver Valley Mall is using a now-defunct mega-retail location as an opportunity to develop a location for multiple, smaller, more profitable tenants. Whether this investment will pay dividends remains to be seen. In either case, the success or failure of mall renovation projects will inform future decisions in our area.

Renovations have Brought the US Steel Tower Back to Prominence in Pittsburgh

The US Steel Tower, also referred to as the Steel Building and the USX Tower, has been a trademark of the Pittsburgh skyline since its construction was completed in 1970. The building is now also known as the UPMC building, and has a long history of importance to the Pittsburgh people, identity, and economy. Recent renovations have breathed new life into the now 50-year-old building. Office spaces in Pittsburgh have become more decentralized in recent years with tech companies like Google and Uber electing to headquarter outside downtown offices.

With all of this in mind, today we will review the recent work being done on the US Steel building and what impact this might have on the building itself and downtown as a whole.

Details of Steel Tower Renovations

Although there is no onset of renovations, the US Steel Tower has undergone some major facelifts in the past months and years which will be noticeable to regulars in the area. Here are some of the highlights:

The US Steel Tower is now the second-largest LEED Silver Certified office building in the world

LEED stands for Leadership in Energy and Environmental Design. While the US Steel Building may be thought of as a 50-year-old dinosaur, it is likely the most economically and technologically advanced building in downtown Pittsburgh. This is thanks to recent renovations aimed at efficiency and eco-friendliness.

The US Steel Tower renovations modernized the infrastructure

As a continuation of the above, the US Steel Tower has implemented a number of modern changes that improve cost and environmental inefficiencies. Modern renovations/improvements include retrofitting water supplies, sustainable energy practices, offering alternative transportation services, installing eco-friendly LED lights, installing eco-friendly HVAC products, and much more.

US Steel Building has renovated office spaces

As part of UPMC moving in, several large renovations took place to the office amenities of the US Steel Building. These renovations included:

  • Renovation of seven (7) full floors of office space to be used for UPMC headquarters
  • Changing cubicle like layouts to more modern designs including high-end, high-tech offices and support areas
  • Updates to the 60th floor “Center for Connected Medicine (CCM)”
  • Overall renovations to existing workspaces and offices

These renovations covered a total of 185,000 square feet over 11 months and were all part of the LEED silver certification process.

Pittsburgh Steel Building Facts

To understand why renovations of the US Steel Building are so significant to the local Pittsburgh economy and atmosphere, let’s look at some quick facts on the building itself.

  • The US Steel Building stands at approximately 841 feet tall, making it the 66th tallest building in the United States.
  • Those 841 feet are spread across 64 floors, which are mostly comprised of office space.
  • The single floor area equals 41,163 square feet, which is only ~2,000 square feet shy of a full acre.
  • The facilities include a 2,900,000 square foot grass area which is used as a local park for the public.
  • The US Steel Tower underbelly holds a three-level parking garage which can accommodate 700 cars.
  • The building holds 11,000 windows, 54 elevators, and boasts a massive lobby area with full amenities

List of Recent US Steel Tower Updates

In a five year period, over $60 million was invested into the US Steel Building in total renovations with no end date in sight. These changes include:

  • Lobby updates including renovations to many interior businesses
  • The addition of two (2) garage elevators
  • Newly installed brick and granite in the plaza area
  • A new fire alarm and security system
  • A new tenant and building sprinkler system
  • Renovated restroom facilities
  • Energy-efficient upgrades (as mentioned above) including closed water loops, HVAC upgrades, energy-efficient light installations, and more
  • Improved facilities to comply and exceed the American with Disabilities Act (ADA) requirements
  • New infrastructure including improved electric distribution panels and “base building mechanical improvements”

Going Forward

For those of us native to Pittsburgh, the US Steel Tower is probably the building we think of when we think of the downtown area. While the name and ownership may have changed hands, the importance of this structure remains. Recent renovations have improved both the work lives of the office tenants within and the amenities for the public passing through the building for a bite to eat or just to take in the sights. With major backers including CBRE and Jamestown L.P., it is likely that we will continue to see investments being made into the tallest and most historic Pittsburgh skyscraper.

Will Cannabis Legalization Present CRE Investment Opportunities?

Will Cannabis Legalization Present CRE Investment Opportunities?

No matter what your personal views on the matter, the cannabis legalization discussion is here to stay. As of the writing of this article, marijuana is fully legal in 11 states and legal for medical use in over half the states in the US. Those numbers are not expected to diminish, with additional states considering full or partial cannabis legalization. What has followed has been a growth in a previously non-existent industry that has affected both micro and macro economics in the US. The question we now ask is: will cannabis legalization change the commercial real estate market?

To answer this question, today we will explore the current state of marijuana legislature as well as future projections, the likelihood that cannabis will become fully legalized in the state of Pennsylvania, and discuss how federal and state legislation on cannabis has and will continue to impact the CRE industry.

The Latest on Cannabis Legalization

First and foremost, the federal government considers marijuana a class 1 controlled substance. This puts marijuana at the same tier as LSD, heroin, ecstasy, peyote, and methaqualone.

There is nothing clear about the current state of cannabis legalization. So let’s stick with the facts. First and foremost, the federal government considers marijuana a class 1 controlled substance. This puts marijuana at the same tier as LSD, heroin, ecstasy, peyote, and methaqualone. While legislation has been proposed, the nationwide legalization of marijuana is likely very far off.

11 states have fully decriminalized marijuana

It should be noted that although we consider these states part of a group, their individual laws on cannabis regulation vary dramatically. What remains constant is that users must be over the age of 21, and distribution is still highly regulated. The states that have legalized marijuana include Washington, California, Maine, Michigan, Alaska, Nevada, Colorado, Oregon, Illinois, Massachusetts, and Vermont.

33 states currently allow the legal use of marijuana for medical purposes

33 states plus the District of Columbia allow residents to own and use marijuana when it is prescribed by a physician. Pennsylvania is one of these states. These laws become even cloudier than the “fully legal” 11 states listed above, as the medical red tape can be quite complex.

33 states plus the District of Columbia allow residents to own and use marijuana when it is prescribed by a physician. Pennsylvania is one of these states.

Fully illegal vs. decriminalized and beyond

For the 39 states that have not legalized marijuana, there are varying degrees of criminality associated with possession and distribution charges. Some states including Delaware, Connecticut, Maine, and New York, have reduced cannabis charges, meaning previous punishments have been diminished for those.

Will Cannabis be Legalized in Pennsylvania?

Pennsylvania’s laws on cannabis allow for medical use only. Unlike some other states, Pennsylvania has not enacted laws to decriminalize marijuana possession or distribution charges. As we discuss the possibility of the marijuana business impacting commercial real estate in our region, the next logical question becomes: how likely is it that cannabis will become legal in Pennsylvania?

The answer is as complex as you might imagine. Politicians including Governor Tom Wolf and Lieutenant Governor John Fetterman have both gone on record stating that they would consider the legalization of marijuana in the future. In the case of Fetterman, he is openly in favor of full legalization on the state and federal level.

Pennsylvania’s laws on cannabis allow for medical use only. Unlike some other states, Pennsylvania has not enacted laws to decriminalize marijuana possession or distribution charges.

Recent polls suggest that 59 percent of Pennsylvanians support the recreational use of marijuana. This is in stark contrast to a similar poll in 2006, in which only 22 percent of registered voters were in favor of recreational marijuana use becoming legal. The biggest considerations continue to be:

  1. Pennsylvania’s mix of conservative and liberal ideals clashing at the state levels and
  2. Money. If other states see a windfall from marijuana legalization (including commercial real estate), the likelihood of full legalization grows.

How Cannabis Legalization Has Impacted the Commercial Real Estate Market

The legal marijuana industry has already eclipsed $10 billion in the US. The cannabis market is potentially the fastest growing industry in the nation. Commercial real estate investment is a huge part of that growth. Here are a few ways in which marijuana impacts local CRE markets:

  • The demand exists for large facilities. Cannabis production facilities are quite large, and often include both farming and processing capabilities.
  • Regulations are a blessing and a curse. CRE investors would be wise to understand state and local laws before entering the cannabis arena. Cannabis producers must jump through hoops at the state level to gain site approval before beginning any type of production.
  • Cannabis retail is big business. Of course, production is only one side of the equation. Marijuana has a strong retail presence which has injected life into a stagnant retail market.
  • Local and state economies have been boosted by legal marijuana. Even if you want nothing to do with the cannabis industry, there is now sufficient evidence to make the claim the legalizing pot boosts the economy at the micro and macro level. As we know, stronger economies often create stronger CRE markets.

Going Forward

At the moment, legalized marijuana in Pennsylvania is all a hypothetical. The benefits of legalized marijuana for business and for commercial real estate are well documented. If and when our state (or the fed) chooses to adopt cannabis, there will certainly be an opportunity to pounce. The question going forward will become when that happens and what regulations will come along for the ride.

Construction Labor Shortage and Commercial Real Estate Projects

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Most commercial real estate professionals already know that there is a construction labor shortage in our country. This is true for major construction projects and renovations alike. There are a number of contributing factors which have caused this shortage which are likely to continue this shortage moving forward. As CRE professionals, this labor shortage has a material impact on construction deadlines, construction prices, and much more. 

 

Today, we will explore this topic by identifying the current state of the construction labor shortage, discuss what factors are causing the labor shortage, and finally how the construction labor issues are impacting and will continue to impact commercial real estate construction.

 

The Current State of the Construction Labor Shortage

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According to a new survey from the Associated General Contractors of America (AGC) and Autodesk, 80 percent of construction firms say they are having a hard time filling hourly and craft positions – which represent the bulk of the industry’s workforce. That same report suggests that labor shortages are the biggest threats to the construction industry. By extension, that’s a significant risk for the commercial real estate industry as well.

 

According to the US Bureau of Labor Statistics, there were 263,000 available jobs in the construction industry as of June 2018. The BLS predicts that the number of available jobs will increase over the next 10 years faster than average, with an above average median annual wage. Estimates place the total number of construction jobs at about 7.2 million.

 

Perhaps the most telling statistic is that 79 percent of construction companies are looking to hire new employees this year, but many are having a difficult time finding workers with the appropriate skills. To make matters worse, the disparity between the need for skilled construction workers and the availability of skilled construction workers is expected to increase moving forward.

 

What is Causing the Construction Labor Shortage?

The construction labor shortage would perhaps be more appropriately called a skilled construction labor shortage. Yet the reasons for the labor shortage are diverse. Some of the primary reasons for the current construction labor shortage include:

 

The industry is still recovering from 2008

 

The Great Recession of 2008 shook the commercial real estate world. A healthy construction industry in the early and mid 2000’s was suddenly placed into a depression where workers were laid off and construction projects were slowed or canceled altogether. The CRE industry has since recovered, but in the 10 plus years since 2008, the construction industry has been less appealing to prospective workers, leading to a shortage.

 

A decline in young workers with the necessary skills

A steady stream of young men and women graduated from technical schools and other training institutions ready to come into the construction workforce up until 2008. The Great Recession made construction a much less appealing option, which essentially slowed the flow of students and the flow of new employees needed for skilled positions.

 

The construction industry has grown and worker supply can’t catch up

Last but not least, it would have been difficult for construction companies to keep up with new hires even if there was the same level of skilled workers entering the workforce. Consider the labor statistics cited in the previous section regarding how many available jobs there are in construction. 

 

How the Labor Shortage Impacts Commercial Real Estate Construction

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Recent estimates suggest that ~70 percent of contractors are having difficulties meeting deadlines due to labor shortages. This simple fact causes a number of trickle down effects including:

 

  • Overall construction costs are increasing
  • Skilled laborers being asked to do more work
  • Investors are unhappy with contractors and construction crews
  • New projects are being rejected by construction crews
  • Many more

 

Labor costs make up about half of any building construction budget. Perhaps more importantly, no construction project can be completed on time and on budget without the appropriate construction crew. Construction labor shortages have a direct impact on the viability of commercial real estate construction projects for new construction and renovations alike. 

 

One of the keys for CRE professionals in the current construction is being realistic about costs and timelines. Labor shortages are a bottleneck for any construction project. They are even more of a detriment for large scale, commercial real estate projects.

 

Going Forward

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All of the available data points towards the construction labor shortage continuing in the immediate future. It is likely that the market will balance itself out as wages rise and skilled construction jobs become more appealing to younger generations. The question moving forward will become when the scales tip and the workforce begins to fill the available jobs. It is also worth noting that while many economists are predicting an imminent recession, most predictions also lean towards the next recession being much less impactful on the commercial real estate market

 

It is likely that a long term, stable construction labor demand will sort itself out. In the meantime, construction crews and commercial real estate investors alike will do well to understand how the labor shortage will impact construction costs, construction timelines, etc.

The Reinvention of Retail and its Impact on CRE

The Reinvention of Retail and its Impact on CRE

Ask around or cruise the internet and you are likely to find some pretty dire information on the retail industry. Yet you are also likely to find individuals and organizations that understand a simple fact: retail isn’t dead, it is just evolving. This is true for brick and mortar retail and e-commerce alike. With customers having more choice than ever, even disruptive companies like eBay are being disrupted by other innovators like Etsy

 

For those of us in the CRE business, the question then becomes: “how does the reinvention of the retail industry impact commercial real estate?” Today, we will aim to answer that question by discussing how the retail industry has and is evolving, the types of CRE projects still paying dividends within the retail industry, and an outlook on commercial real estate in the retail sector.

 

How Modern Retail has Changed Over the Years

How Modern Retail has Changed Over the Years

To understand how retail and CRE impact one another, we will start by understanding the current state of the retail industry. Due to major market shifts, the retail industry has undergone some key paradigm changes in recent years. These changes include:

 

 

  • Customers are more informed than ever. The old days of coming into a store knowing next to nothing are behind us. Any individual or organization with internet access can be nearly as knowledgeable as a salesperson before making a purchase.
  • Retailers know more about customers than ever. On the flipside, modern data collections and analytics also allow retailers to know more about customers before they ever set foot in a store. 
  • Mobile devices drive in-store visits. The average consumer has internet access at all times. This means that the average consumer finds businesses through their mobile device a large percentage of the time. An example might be searching “Thai restaurants near me” to find a place to eat.
  • Reviews from critics and customers are available for all to see. Online reviews are a major disruptor of the retail industry. This can be both an opportunity and a threat to retailers.

 

 

How Retail Struggles Hurt Commercial Real Estate

How Retail Struggles Hurt Commercial Real Estate

There is little question that the struggles of the brick & mortar industry have had a negative impact on the retail commercial real estate industry. There are a few key ways in which the downturn of traditional retail business has hurt CRE:

 

 

  • The US is “over-retailed”. It is important to understand that the retail industry is still big business. As a recent article put it, “The problem with U.S. retail? There’s too much of it.” When we talk about CRE and retail, the primary issue is an overabundance of existing real estate with insufficient demand. The key will be re-positioning or removing this excess supply of space. Or as CBRE’s Jason Cannon humorously put it at last week’s NAIOP Pittsburgh chapter meeting, “The problem isn’t that we are overbuilt; it’s that we are under-demolished.”
  • Malls are dying. To illustrate this point, we need to look no further than the dying malls of America. The epicenters of American retails well into the 2000’s have since lost viability in the face of e-commerce. Retail CRE used to focus on megastructures and large retail presences, but will likely need to adapt to survive (more on this in the following section).
  • New construction for retail is on the downturn. As a result of items 1 and 2 alongside other key factors, new construction for retail real estate is down about 5% in 2019 year over year. 

 

 

Retail Commercial Real Estate Adapts to Industry Change

Investing in mixed-use properties

Moving on to the question of the hour, how can the retail CRE industry adapt to a changing retail industry? While there is no one answer, there are several ways in which commercial real estate investors can remain competitive in the retail space.

 

Repurposing old retail spaces

Earlier we discussed how the US is “over-retailed”. This creates a supply and demand issue without question. It also creates an opportunity for investors to snap up undervalued retail real estate and repurpose those properties into money makers. This can include revamping dead malls, vacant spaces left by a dying big box industry (think Sears and JC Penney), and much more. 

 

Investing in mixed-use properties

There are countless success stories of dead malls being turned into local community colleges, places of worship, or even bowling alleys. The point being, real estate is real estate. Retail spaces in good locations tend to be undervalued in today’s CRE environment. Turning these spaces into mixed-use properties which allow for retail, industrial, residential, and/or commercial properties is one way to adapt to a changing marketplace.

 

Going Forward

Retail is not a dead industry, it is merely one undergoing rapid change. Although we discussed some of the latest changes and retail industry problems, there will always be a sizable market for retail in the commercial real estate industry. For commercial real estate investors, the biggest takeaway might be that CRE must adapt as retail continues to adapt. Retail and e-commerce will continue to move forward as technology advances and customer behavior adapts. 

 

For all the doom and gloom, there are still 65.9 million square feet of real estate under active construction in the US. Americans still shop at traditional retail centers in huge numbers. What remains to be seen is how both the retail and CRE industries adapt to new technologies moving forward.

Commercial Real Estate Investment by the Numbers

Commercial Real Estate Investment by the Numbers

Commercial real estate is a major influencer of our local, state, and national economy. For those of us in the industry, we understand the symbiotic relationship between commercial real estate and overall economic health. With many financial experts predicting a recession in the coming months or years, today we will be taking a look at the current state of commercial real estate by the numbers. 

 

Commercial Real Estate Facts Facts and Figures

Commercial Real Estate Facts Facts and Figur

To start things off, let’s take a look at some high level CRE statistics. According to statista.com, the first half of 2019 brought us the following numbers:

 

  • The value of commercial construction for new projects and additions to existing properties in the US was approximately $89.52 billion.
  • The value of private office new construction projects was around $8.12 billion.
  • The value of new warehouse construction within the private sector in the US was around $33.8 billion.
  • The value of lodging (hotel) construction in the US was valued at about $30.76 billion.
  • By Q3 2020, it is estimated that U.S. office vacancy rates will hover around 12.5%, retail vacancy rates will be at 13.9%, and industrial vacancy rates will sit at around 6.5%.
  • There were 4,577 restaurants and/or bars opened in the US in 2017 and 2018 combined.

 

Commercial Real Estate Trends Over the Past ~20 Years

All of those numbers in a vacuum can mean different things to different people. $89.52 billion might seem like a healthy number, but how does it stack up in the US CRE market worth upwards of $17 trillion? To understand the health of CRE, let’s take a look at some recent trends.

 

The volume of commercial real estate transactions in the US is cooling off.

In terms of CRE transactions completed, the industry has been tapering off since hitting its recent peak in 2015. In 2011, commercial real estate transactions totaled just $96 billion dollars. That number steadily rose to 2007, where it reached an all-time high of $580 billion. That was directly before the real estate collapse and the Great Recession of 2007-09. In 2009, the total value of CRE transactions dipped to $71 billion. Again, this number recovered quite quickly until 2015, where it neared 2007 levels at $569 billion. Since 2015, the volume of CRE transactions by dollar amount has gone down every year. This number reached $394 billion in 2018.

The commercial real estate industry has mostly outperformed other real estate sectors

The commercial real estate industry has mostly outperformed other real estate sectors

Coming back to The Great Recession, it is important to note that while all real estate sectors were hit hard, the CRE sector was the fastest to recover and has since recovered to the highest degree. The US commercial real estate industry has also “ increased faster than the Real Estate and Rental and Leasing sector overall.” The commercial real estate industry remains strong, and is “the 1st ranked Real Estate and Rental and Leasing industry by market size and the 2nd largest in the US.”

 

Commercial Real Estate Investment Trends

So far we have talked about overall CRE health and growth, but what about investment activities? Here are a few key facts and figures on commercial real estate investment.

 

Multifamily Units are an investor favorite in the CRE market

From 2009 to 2017, the multifamily home sector has quadrupled. Hitting an industry low during the Great Recession, multifamily homes have since been a huge hit for investors, outperforming traditional single family investments by about double. In 1999, approximately 13% of newly constructed multifamily buildings included 50 or more units. That number has since grown to over 50% of newly constructed multifamily buildings having 50 or more units in 2017. 

 

CRE Investors are turning towards senior citizen needs

A major driving force in the commercial real estate market today is the aging population of the US. This is causing many CRE investors to look into housing solutions for senior citizens, but that is just one piece of the puzzle. Older Americans also will require more medical facilities, different types of multifamily homes, and much more.

CRE Investors are eyeing the energy, infrastructure, and high tech sectors

CRE Investors are eyeing the energy, infrastructure, and high tech sectors

Last but not least, the commercial real estate industry is following overall US economic trends. Three of the most profitable sectors include the energy sector, infrastructure market, and high tech sectors. Savvy CRE investors will understand that these sectors are relatively safe bets for overall growth in 2020 and beyond, and are therefore relatively safe bets for commercial real estate projects. With the White House continuing to make promises in the areas of infrastructure and many state and local governments shifting towards renewable energy options, the opportunity for growth is there.

 

Going Forward

Commercial real estate as an industry and as an investment opportunity is in a healthy place in 2020. There is no longer a steady, rapid growth as was experienced after 2007, but the market has leveled off in a sustainable way. Despite calls for an imminent recession, real estate experts have all but unanimously declared that the next recession will not hit the real estate market like it did over 12 years ago. Going forward, there are more reasons than not to remain bullish on CRE investment.

Fundamental Factors that Drive Commercial Real Estate Markets

Fundamental Factors that Drive Commercial Real Estate Markets

While most of you reading this come from the commercial real estate industry, it can be useful to brush up on the fundamentals. With this in mind, here are some of the fundamental factors that drive the commercial real estate market.

 

The Local, State, and Federal Economy

The Local, State, and Federal Economy

Without a doubt, the state of the economy is a primary mover of the real estate market. Understanding exactly how the economy impacts commercial real estate is more complex. First, we must measure the health of the economy using metrics including gross domestic product, gross national product, productivity, spending, unemployment, and much more. Ask ten economists which metrics matter most, how to properly measure them, and what trends will impact commercial real estate most, and you are likely to get ten different answers. 

 

It is not vital for commercial real estate professionals to understand the intricacies of the economy. It is more important for CRE professionals to keep an eye out for dramatic economic shifts like the next recession

 

Interest Rates – CRE Loan Rates

Interest Rates - CRE Loan Rates

Another key factor in CRE health are the past, current, and future interest rates. Similar to an individual seeking a mortgage for a home, investors looking into commercial real estate properties seeking a loan must consider interest rates for their loans. When interest rates rise, demand for properties is generally lowered. Conversely, lower interest rates frequently spur new investments/restructuring for commercial real estate loans. The factors that determine interest rates are many, but essentially boil down to lenders covering their costs and risks of loaning money.

 

Unlike mortgages for residential properties, commercial real estate loan rates can vary from 3.5 to 20 percent. This wide range of rates stem from the different property types, investment types, loan types, and details of the individual/group seeking the loan. Because there is such a gap between different CRE loans, it is prudent to understand one’s unique situation before assuming a range of rates.

 

Regional Population Demographics and Behaviors

Regional Population Demographics an

The national landscape of commercial real estate might not extend to your region. A simple example would be state population increases and decreases within certain demographics. If your state is experiencing a large influx of young professionals, the commercial real estate market is likely to experience a boost. Yet the CRE environment is not a 1-1 relationship with population alone. In our Western PA region, we are simultaneously seeing a growing demand for convenient housing for young professionals in urban areas and a growing need for senior citizen housing and resources such as medical facilities. 

 

Demographics that influence commercial real estate also stem from shifts in demographic behavior. Where Baby Boomers were reliable home owners for many decades, they have recently begun a shift towards renting their homes for financial and convenience reasons. For this and many other reasons, “there are more of group x moving to our area” is not a slam dunk when it comes to CRE forecasting. 

 

Governmental Policies on Commercial Real Estate

Buying, renting, and selling properties all involve government regulation. These regulations have always existed, but have increased in the years following the Great Recession of 2007-2009. Because the recession was tied into the lending crisis, federal and state regulations on real estate loans and transactions become stricter and more invasive. The commercial real estate industry is built to adapt to these changes. It has been argued that one of the major reasons why CRE bounced back faster than other real estate industries in the wake of the Great Recession is that adaptability to changing government regulation.

 

CRE professionals might want to stay abreast to the changing regulations through the Code of Federal Regulations (CFR). “CFR stands for Code of Federal Regulations. The CFR is the codification of the general and permanent rules and regulations published in the Federal Register by the executive departments and agencies of the federal government of the United States. This codification of what is sometimes called “administrative law” has been published annually since 1938. The CFR is divided into 50 “titles” that are meant to cover broad areas such as Commerce and Foreign Trade, Federal Elections, Employees’ Benefits, Internal Revenue, and Education, just to name a few.”

 

Going Forward

The current outlook of the commercial real estate market in Western PA and across America remains cautiously optimistic. The US economy has been relatively strong over the past few years, with a few cracks starting to form in recent months. Loan rates remain appealing for commercial real estate investors, and the overall trend for real estate has continued to rise. However, many of the industry drivers we listed here today are beginning to flatten or even regress. This, and many other complex factors, have led economists to predict a looming recession in America. Recessions are an unavoidable part of a free economy, and we are overdue based on historical precedence.

 

The silver lining in these predictions is that the Great Recession of some 12 years ago has left the commercial real estate industry more hardened against economic downturn. Remember that economic strength is only one of the driving forces of CRE markets. Understanding the bigger picture allows us to accurately predict what we can expect going forward.

Increased Senior Housing Needs’ Impact on Commercial Real Estate

Increased Senior Housing Needs’ Impact on Commercial Real Estate

It is no great secret that our country is aging. In fact, recent estimates provided by the US Census Bureau project that “older people (are) projected to outnumber children for the first time in US history” within the next 10 years. Not only will this put an economic strain on our nation, but it will also challenge our existing resources and infrastructure. An example of this strain is the existing problem of demand for senior housing outpacing our current supply. This dynamic is likely to impact the landscape of commercial real estate for years to come, but how?

 

Today, we will review the current reality of seniors’ housing needs, what those needs are likely to look like in the near future, and how these shifting realities will impact the CRE industry today and moving forward.

 

Senior Citizen Demographics by the Numbers in 2020 and Beyond

Senior Citizen Demographics by the Numbers in 2020 and Beyond

To understand senior housing, we must first understand the senior citizen demographic in the US. Here are some fast facts on senior citizens in America:

 

 

  • Over 50 million Americans are aged 65 or older. It should be noted that this estimate is on the conservative side based on available Census data.

 

  • The population of senior citizens isn’t just projected to rise, it is expected to explode. Where 2018 statistics put the number of Americans aged 65 plus at 52 millions, that number will be approximately 95 million by the year 2060.
  • Older Americans are also getting more diverse over time. Today, approximately 77 percent of Americans 65 plus are white. That number is expected to fall to 55 percent by 2060. Despite this increase in diversity, older generations will continue to lag behind younger generations in terms of ethnic diversity.

 

Additional facts about senior citizens that remain relevant to our conversation about housing and CRE include: aging generations having higher levels of education, longer life expectancies, and significantly lower poverty rates.

 

Low Affordable Housing Supply May Price Seniors Out of Their Communities

Low Affordable Housing Supply May Price Seniors Out of Their Communities

While senior citizens are in better shape than ever before in American in terms of wealth and education, they are still vulnerable to rising real estate costs. For extremely low-income renter households, only 35 rental homes are available for every 100 families in need. This is an example of a problem for senior citizens: they are particularly susceptible to being priced out of their own neighborhoods. Coupled with a national housing shortage and a rapidly aging population, rising real estate costs are a very real problem for seniors.

 

In Pittsburgh, we can see this in neighborhoods like Lawrenceville. From the years 2010 to 2017, the median home sales price jumped from $95k to $237k. That is nearly a 150% increase in less than a decade. Many working class families who have been living in Lawrenceville for decades have been forced to look elsewhere for affordable housing options. Again, senior citizens find themselves being hit the hardest.

 

How America’s Aging Population will Impact Commercial Real Estate

The Baby Boomer generation is in prime retirement age in the US. With that paradigm shift, the commercial real estate market is looking to adjust. Baby Boomers have been driving the residential real estate market for 20 plus years. Now they are about to drive the rental and commercial real estate markets in a new way.

 

Baby Boomer retirement likely to increase demand for multifamily housing 

Retiring adults have been showing more inclination towards “downsizing” as they approach retirement age. This means that the Baby Boomer generation is going to be predominantly looking for affordable housing and/or rental opportunities for the first time in many years. This change in desired housing will likely come with a higher demand for multi-family housing, including:

 

  • Apartment complexes aimed toward senior citizen needs
  • Gated townhome communities 
  • Any residential plans which take care of lawn care, home maintenance, etc.
  • Convenient living with senior-friendly amenities such as ramps, elevators, etc.

How America’s Aging Population will Impact Commercial Real Estate

Another key factor to remember is that many senior citizens desire to stay local as they downsize. This means that these amenities are going to be desired in their current suburban/urban neighborhoods for affordable rates. This creates a potentially lucrative opportunity for commercial real estate developers and/or investors to get ahead of a rapidly aging US population.

 

Going Forward

All signs point to senior citizens moving away from their single family homes into smaller single family homes, multi-family homes, or other senior-friendly accomodations. This is nothing new. What is new is that the population of Americans aged 65 plus is expected to nearly double over the next 40 years. As life expectancy continues to climb, older generations will be looking for affordable and convenient housing options in record numbers. From the perspective of the commercial real estate professional, the question becomes how our industry will adapt to this change.

 

Western Pennsylvania has already had an upturn in new construction for senior citizen centers, medical facilities, and other infrastructure to accommodate an aging population. Yet housing shortages and other factors will continue to create a situation where senior citizen demand for affordable and convenient housing will likely outpace the supply.