Category: Real estate news

A Chill in the Pittsburgh Office Market

Sometime in October every year, there’s an afternoon when you feel the wind blowing colder. It’s not quantifiable but it’s a chill that you know means fall is serious about setting in.

This past week or so, there was a similar chill in the air about the Pittsburgh office market. This time of year is when all of the real estate service firms issue year-end reports and it looks like 2019 was a year when the metrics slipped into more troubling territory. The 2019 reports are hardly bad news. Net absorption was positive, ranging from around 100,000 square feet to almost 300,000 square feet, depending on which report you read. (That’s a matter of when the researcher times the construction and completion, which varies.) Positive absorption in the face of record office construction is a strong signal. Rents grew again. But there were a couple of yellow signals.

Occupancy declined again, this time getting to mid-double digits. There have been some big spaces coming onto the market over the past few years, especiialy in One Oxford and 525 William Penn Place, and some significant sublease spaces. The effect of that has been to create higher vacancy, especially in the Central Business District (CBD).

Grant Street Associates/Cushman & Wakefield has the direct vacancy rate for Class A CBD at 13.9%. Newmark Knight Frank has it at 18.3%. (NKF excludes owner-occupied buildings from the calculation since they aren’t on the market.) JLL puts direct vacancy at 14.6% in the CBD.

The data, along with the national reports like CoStar’s, has made some of the brokers, lenders, and developers nervous. There are still great economic stories coming from Pittsburgh but with flat job growth, you may see a chill in the speculative office market, especially after the next couple of major projects get underway.

Vision on Fifteenth

Speaking of the next major spec office, Burns & Scalo is bidding packages for the second phase of District 15, now called Vision on Fifteenth, a 275,000 square foot building. Carl Walker Construction is taking bids on a 376-car garage for the project.

In other project news, Al. Neyer will start construction on the 100,000 square foot Astra facility for Krystal Biotech in Findlay Township. The developers of 926 Smallman Street, an 81,000 square foot, 7-story mixed use building, are going through City Planning. Dick Building Co. is the contractor.

How the Housing Shortage Impacts Commercial Real Estate

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It doesn’t take a real estate expert to see that housing prices have been accelerating in recent years. Ten plus years after the Great Recession of 2007-09, residential real estate prices have more than recovered in most areas across the country. In its place, a housing shortage has created a situation where many Americans struggle to afford their rent, let alone to own a home. In fact, a significant portion of the current generation of young Americans have more or less resigned themselves to the fact that home ownership is unrealistic.

 

What is less obvious is how this residential real estate trend has and will continue to impact commercial real estate. It is unlikely that new home construction will be able to keep up with housing demands. Will these developments help or hurt the health of the CRE industry?

 

The Current State of Housing in the US

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Let’s first establish a few key facts. There are approximately 138 million housing units in the United States. About 80 million of these units are occupied by their owners and 43 million are occupied by renters. By most estimations, the US actually has a very healthy ratio of available housing units to individuals or families in need of residence. So what is the problem exactly?

 

The answer lies in the fact that key markets such as California and Austin are being crushed by demand with a limited supply. The problem is that the current supply of housing units does not align with demand when it comes to price or location. This issue is particularly bad for more affordable homes, which cost between $100k-$250k, depending on the market. This creates heightened competition for more affordable homes, which drives up prices and makes these housing units less affordable to buyers and renters. 

 

Ironically, as young adults flee from traditional markets like NYC and San Francisco and turn to hot markets like Pittsburgh and Kansas City, they are bringing big city housing shortage problems with them. For example, Pittsburgh experienced a 16 percent drop in relative housing availability in 2019 vs. 2018.

 

How Residential and Commercial Real Estate Interact

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Based on these trends, one might assume that the commercial real estate rental market would be booming in response. This is not entirely the case. Despite housing prices rising to near-emergency levels, rental rates in 2020 are expected to remain relatively flat. The latest year-over-year numbers put rental rate growth at approximately 1.4 percent nationwide. Again, this is somewhat misleading as some regions have experienced explosive rental hikes while others have actually seen rental rates diminish.

 

Another key factor in this equation is the decision making process of young renters. Millennials and the generations who are growing up behind them have shown a tendency to choose convenience and amenities over square footage and perceived value. This is due to a number of reasons, including their desire to use public transportation and a preference for urban living. 

 

These trends have been favorable for commercial real estate rental units which are focused on offering convenience first and foremost. Well equipped rental units in urban or even “urban suburb” locations continue to see high occupancy rates in 2020. As young adults continue to struggle to afford their own homes, rental properties should remain a safe bet. 

 

Commercial Real Estate Projections in the Coming Years

By all current metrics, our nation’s housing shortage looks to only worsen in the coming years. This is especially true in mid-major markets experiencing a tech boom including Pittsburgh. As for commercial real estate investors in the area, that means that there will be an opportunity to deliver high quality housing at premium prices for young adults who are willing to pay for high level amenities. 

 

For example, young renters are more likely to pay a premium for rental units in so-called “smart buildings”. These types of commercial real estate units are constructed or retrofitted to accommodate desirable features like ultra high speed internet and even 5G when that is released to the public. This is in step with the advantage that CRE has over traditional residential real estate: it can adapt more quickly on a larger scale to new technologies. 

 

The housing market may be in a strange place, but that offers an opportunity to savvy commercial real estate investors. Understanding what young renters want will allow larger rental investments to continue to be profitable for years to come.

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Going Forward

It may be a running gag that millennials can’t afford to buy homes, but that reality is no joke. The wealth of our country might be held disproportionately by older generations, but younger working generations are the key to future CRE success. Where traditional thinking has valued square footage and price first and foremost, young adults today are shifting their focus towards amenities and convenience. This, coupled with the ongoing housing crisis, creates a scenario where well positioned rental properties can dominate the market.

Lower Federal Funds Rate Impacts Real Estate

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Like it or not, federal regulations play a huge role in commercial real estate investment, construction, sales, and everything in between. Perhaps no singular federal policy has more of a direct impact than the federal reserve cutting or raising the federal funds rate. Separate but related to the federal discount rate, the federal funds rate dictates interest charged on a number of loans. The fed has recently decided to once again cut the federal funds rate in late 2019/early 2020. The impact on real estate will certainly be felt, but this is nothing new.

 

With this in mind, today we define the federal funds rate, discuss the details of the latest rate cuts and a brief history of past cuts and hikes, and finally identify how these changes will likely impact the commercial real estate sector.

 

Understanding the Federal Funds Rate

Federal Funds Rate Expected to Drop in 2020 2

According to investopedia.com: “The federal funds rate refers to the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis. By law, banks must maintain a reserve equal to a certain percentage of their deposits in an account at a Federal Reserve bank. Any money in their reserve that exceeds the required level is available for lending to other banks that might have a shortfall.”

 

The federal funds rate can be changed as many as eight (8) times per year as decided by the Federal Reserve. The actual rate can be influenced by buying and selling government bonds or other investment securities. The federal funds rate is determined separately from the federal discount rate, but these two figures generally have a symbiotic relationship.

 

As part of the regulations surrounding the federal funds rate, banks and other financial institutions are required to meet reserve requirements that must include non-interest bearing accounts. This secures short term loans and provides assurances for financial institutions and loan recipients alile. 

 

Details on the Latest Fed Funds Rate Cuts

Normally three straight fed funds rate cuts is not a great sign for the economy overall. The last time this many consecutive rate cuts took place was in 2008 amidst the housing crisis and Great Recession. The latest cuts move the effective rate from 1.75% to 1.5%. 

 

Generally, cutting the federal funds rate is intended to spur economic growth. These cuts come at a time when more observers are predicting that a recession is looming in the next year or two. Yet not everything is doom and gloom. Opportunist investors can take advantage of low fed funds rates to secure loans, make investments, and much more. Individuals who are looking to refinance mortgages or open home equity loans are perhaps the biggest winners from these fed rate cuts. 

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Lower fed funds rates only impact those who are looking to open new loans or refinance existing loans. For this reason, pre-existing loans and mortgages will be unaffected by the cuts. This essentially means that those who are locked into unfavorable loan situations might want to jump on this opportunity to refinance. 

 

How Federal Rate Cuts Impact Commercial Real Estate

There are several ways in which federal rate cuts might impact commercial real estate, including:

 

Interest rates can impact local property values

Commercial real estate does not exist in a vacuum.The estimated values of surrounding properties go a long way towards CRE valuations. Federal funds rate changes can impact the calculations used to determine property values. Therefore, a change in interest rate can materially impact the value of commercial real estate properties without any other changes.

 

Interest rates, cap rates, and the spread

Commercial real estate investment can sometimes rely on what is known as “the spread”. The spread is determined by finding the difference between the cap rate and the finance rate. As federal funds rates influence finance rates, this can make CRE investments more or less attractive over time. 

 

Federal funds rates cuts have a trickle down effect

It would be convenient to say that fed rates have a 1-1 impact on commercial and other forms of real estate. In reality, the relationship is far more complicated. Consider the fact that rate cuts are tied closely to poor economic performance. This in and of itself has reduced the positive impact of past rate cuts. Current and future rate cuts seem like they should have a straightforward, positive impact on commercial real estate investment. This simply is not always the case. Rate cuts might boost property values, but also may reduce demand, be tied to inflation problems, and many other potential impacts which are too complex to properly describe (or understand) in a single article.

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Going Forward

It is yet to be determined whether the recent trend of consecutive rate cuts will continue as 2020 progresses. Rates are already very low, and can be reasonably expected to stagnate or bounce back in the future. This may also be reactive based on overall economic performance. Metrics point to mild recession in the next few years. How this will impact the federal funds rate will certainly continue to be a major factor in the commercial real estate investment space.

Why the Next Recession Won’t be as Hard on the Real Estate Market

Why the Next Recession Wont be as Hard on the Real Estate Market ft

The Great Recession of 2008 has its name for a reason. It has been measured to be the largest economic disaster in American history since the Great Depression of the 1920’s-30’s. The recession was so large that a ripple effect caused a global recession just a year later. While no industry was unaffected, the real estate market took a particularly hard hit. In fact, a collapse in the housing market and other real estate markets in 2007 was one of the falling dominos that led to the inevitable recession just a year later.

 

Despite all of this (or perhaps because of it), there is reason to believe that our next recession will not take nearly as significant a toll on the commercial real estate market. This is partially due to the fact that the next recession will likely not be as damaging to the overall economy. It is also thanks to administrative efforts to protect the real estate market from present and future turmoil. With this in mind, here is why the next recession likely won’t be as hard on the real estate market.

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Why the 2008 Great Recession Crushed the Real Estate Market

There can be no question that any recession would be expected to have a negative impact on the real estate market. The 2008 great recession was particularly damaging to house costs, commercial real estate, and rental vacancy numbers specifically because it was partially caused by a looming housing crisis. After all, when 8.7 million jobs are lost and house prices drop by approximately 28 percent across the country, the value of real estate is going to take a hard hit. 

 

While the housing crisis gets all the press, commercial real estate was heavily impacted by the 2008 Great Recession. It is important to understand that many of the same issues which plagued residential real estate such as lax policies from the Federal Reserve including offering so called “exotic mortgages” did touch the commercial real estate market, but not to the same degree. 

 

The primary cause of the commercial real estate crash in 2008 was an overall recession. Less money for businesses led to lessened spending. Lessened spending led to fewer employees. Fewer employees led to fewer jobs. Fewer jobs led to less need for commercial real estate and/or developing commercial real estate projects. And the list goes on. Still, CRE is heavily tied into federal policy which has been adjusted to be more conservative in the years since 2008. More on this below.

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Inevitability of the Next American Recession

It is only natural that the US will soon experience its next recession. There is no economy on earth which is immune to bull and bear markets — such is the way of any large economy. Unfortunately, many economic metrics are pointing towards the next recession coming sooner than later. Here are a few reasons why:

 

New York Federal Reserve recession probability model: The New York Federal Reserve is one of the most well respected authorities on predicting recessions. Their model has accurately predicted past recessions both in real time and retroactively. The accuracy and detail of this model shows that we are more likely to see a recession in 2020 than any year since 2009.

 

Inverted yield curve: You may have heard or read something about the inverted yield curve popping up for the first time since the great recession in 2019. Essentially, when short term yields are outperforming long term yields, that is a major red flag of a coming recession.

 

Unduly inflated economic numbers: The US is currently enjoying low unemployment rates. This is generally great news for CRE investors hoping that a recession is far away. Unfortunately, unemployment is not such a simple statistic. Underemployment numbers and part time employment numbers are on the rise. This is another staple of an upcoming recession.

 

The Next Recession Won’t be the Same as 2008 for Real Estate

Now that we have established that:

 

  1. A recession will be upon us at some time in the relatively near future and 
  2. The last recession was devastating for the real estate market

 

Why exactly should we expect the next recession to be any different? The simplest answer is that the federal government and banking institutions have (mostly) learned their lessons. The ridiculous lending practices of the early to mid 2000’s have either been eradicated or constricted. The supplemental answer is that the 2008 was one of the most significant economic events in the past 50 years. It is extremely unlikely that the next recession will be as impactful overall. Whether we are talking about the housing market or commercial real estate, a repeat of 2008 is likely very far off.

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Going Forward

The best laid plans of mice and men often go awry. Even with a looming recession, it is probably a good idea for commercial real estate veterans to go about their business as usual. The next recession will almost certainly not be the same cataclysmic event as the last one, and the real estate market is expected to remain much more stable this time around. Obviously, all recessions have an economic impact. History may not be repeating itself, but learning from our past mistakes is always wise.

The Rise of “Urban” Suburbs

The Rise of “Urban” Suburbs

We tend to think of urban areas and suburban areas as completely different entities. One is filled with skyscrapers and buslines and the other is filled with houses with picket fences and well maintained landscaping. In reality, the line between these two residential and commercial real estate areas is continuing to blur in 2020. This trend is holding true in mid major cities like Pittsburgh and large cities like New York and Boston alike. So called urban suburbs are extremely appealing to young renters/home buyers as well as businesses. This is because they mix affordability with convenience and amenities. 

 

This trend is what has driven the surge in investment and migration to neighborhoods like East Liberty, Lawrenceville, and, 20 years ago, the South Side. And it’s what is driving the speculative investment in next-level urban suburbs like Sharpsburg, Millvale, Carrick, and parts of the North Side.

 

With this in mind, today we will discuss the rise of urban suburbs by defining urban and suburban areas, pin down what it means to be an “urban” suburb, and why younger Americans are pushing real estate trends in this direction. 

 

Defining Urban and Suburban in 2020

Defining Urban and Suburban in 2020

Per the Census Bureau, “urbanized areas” are regions in or surrounding a city that have more than 50,000 people living in them. If these neighborhoods are within the limits of a city, they are thought of as urban, and if they are outside city limits, they are colloquially referred to as suburban. Urban clusters, on the other hand, are urban areas with fewer than 50,000 people. In a more general sense, we tend to think or urban areas as being more metropolitan with less space, more people, and greater access to amenities like public transportation and entertainment. 

 

Suburbia exists somewhere between urban and rural living. One of the definitions of the word suburb reads: “the residential area on the outskirts of a city or large town”. While this has traditionally been true and still remains true in many cases, the residential aspect of this definition is changing. Commercial real estate in the suburbs is extremely active and lucrative as many individuals look to live, work, and play close to urban environments without the hassle of fighting against rush hour traffic.

 

What are “Urban” Suburbs?

What are “Urban” Suburbs

Despite a great deal of focus being placed on the idea of a Great Inversion, where affluent Americans are favoring cities over suburbs, the majority of Americans today continue to live in suburbs. Although it is true that some suburbs are facing challenges, many that are referred to as “urban suburbs” are thriving. In lieu of an official government definition of what constitutes a suburb, let alone the different types of suburbs, urban suburbs have come to be defined by their characteristics, namely urban neighborhoods outside of the city that provide a mixture of access to urban centers, universities, a stable housing market, reputable public schools and transportation. 

 

An example of an urban suburb is Mount Lebanon, an affluent neighborhood 7 miles south of Pittsburgh, with a median home value of $209,506, a reputable public school system that has won multiple National Blue Ribbon School awards, and a light rail system that provides easy public transportation to downtown Pittsburgh. Uptown Mount Lebanon has another key feature of urban suburbs: a booming business district with hair salons, cafes, shops, galleries, restaurants, and banks. Other national examples of larger suburbs with a more urban atmosphere include Grandview Heights, OH and Mountain View, CA. 

 

Younger Americans Prioritize Convenience and Amenities

Younger Americans Prioritize Convenience and Amenities

Urban suburbs are particularly attractive to younger American families who do not want to compromise on the convenience and amenities of urban living. They allow families to invest in their stable housing markets, reputable school districts, and enjoy access to business centers and easy transportation to metropolitan areas. Both renting and buying in these markets is attractive, as debt-ridden millennials who are parents may want easy transportation to their city jobs and favor renting in these areas for their school districts. For instance, almost 30% of residents in Mount Lebanon choose to rent, with the median rent coming to $861. 

 

With the numerous websites and mobile apps geared towards renting and buying property, these desirable characteristics are easier to search for than ever. For instance, real-estate websites such as Zillow offer school ratings, commute times, walk scores, and transit scores under each property listing. With 81% of older millennials using mobile apps to find their homes, urban suburbs with high walk, transit, and school scores are coming out on top. 

 

Going Forward

The rise of urban suburbs offer many takeaways. Suburban neighborhoods who are struggling to attract new home buyers can consider ways of increasing access to transportation to a nearby city. Trends show that urban suburbs offer many opportunities for both residential and commercial real-estate. Government agencies may benefit from defining suburbs and sub-types of suburban neighborhoods to better study trends. In the meantime, the rise of urban suburbs are a respite for those who are looking to rent or purchase property in a good school district but do not want to compromise on urban amenities and public transportation

Commercial Real Estate and US Economic Trends Going into 2020

Commercial Real Estate and US Economic Trends Going into 2020

As with most investor markets and economic issues, commercial real estate is an ever-changing reality. What might look like a safe bet today could lead to huge losses tomorrow. Government regulations, environmental factors, and a looming recession are just a few of the ways that the commercial real estate landscape can change at any moment. Yet seasoned real estate veterans understand that these changes are just a surface disruption of CRE wisdom which generally holds true over time. 

 

With all of this in mind, here is a brief report on the current realities of commercial real estate in the US as well as some insights into the near future.

 

2019 Commercial Real Estate by the Numbers

2019 Commercial Real Estate by the Numbers

The commercial real estate market is currently valued in the ballpark of $1.1 trillion. To put that in perspective, if a trillion dollars represented $10,000, a billion dollars would be $10. Needless to say, there are massive amounts of revenue being generated in the CRE market in 2019. Here are a few other statistics to give a clearer picture of the current state of CRE:

 

  • The commercial real estate industry experienced an estimated growth of 2.2 percent in 2019. This is down from an average of ~4 percent annual growth in the CRE industry over the past five years.
  • Commercial real estate growth has outpaced overall real estate growth, rental rate growth, and leasing growth in 2019. 
  • Seasonalized annual construction values from Q2 2019 are down by about five (5) percent compared to similar estimates from 2018. Newly constructed commercial structures saw the largest value losses over this time period. 
  • Commercial property valuations are on a steady rise beginning with the recovery period in 2009-2010. During this time period, prices have risen the most in the Western United States with the Midwest lagging behind.
  • Rental rates have flattened to a relatively low 1.4 percent year over year growth from 2018 to 2019. This trend is expected to continue with many market indicators pointing towards a stagnant apartment market overall.

 

The State of the US Economy Looking to 2020 and Beyond

A recession is all but unavoidable in the next few years

Before we stare into the proverbial crystal ball, we should first state the obvious: nothing is guaranteed. That being said, here are some likely events in the US economy over the next several years.

 

A recession is all but unavoidable in the next few years

As of the writing of this article, the latest news is that doom and gloom predictions about the next US recession may have been exaggerated. Despite this sudden onset of optimism, the plain truth is that recessions are a part of modern free markets. The most optimistic, realistic view of the situation is that our next recession may not take place in 2020 but in the years to come. Whether the next economic downturn occurs in 2020, 2021, or beyond, it will almost certainly have a material impact on commercial real estate just as it did during the Great Recession of 2008.

 

Climate change will continue to be a major player for the economy and for CRE

Recent scientific studies have predicted that extreme weather events in the United States will rise by approximately 50% by the end of the 21st century. This continues the already observable trend of extreme weather patterns like more frequent and stronger tornadoes, hurricanes, floods, and other natural disasters. This will impact both the overall economy and commercial real estate industries for obvious reasons. Building codes are likely to be updated, insurance costs will rise, and other incidental expenses will almost certainly take a hit. Economists warn that climate change will likely cost the US economy 100’s of billions of dollars by the year 2090.

 

Young adults will continue to struggle financially

Young adults will continue to struggle financially

Last but not least, the population of adults who should be representing the largest buyers in the US economy will continue to be hit by crippling debt, healthcare costs, and stagnant wages. Barring an unlikely dramatic shift in the political and/or economic landscape, the US Debt Crisis will be a huge factor in the economy for the foreseeable future. This has already played a role in lagging rental rates, home ownership, and spending habits. It is difficult to predict how this situation will play out, but younger generations have proven that they are willing to cut costs, something that is not a great sign for economic health.

 

Going Forward

The commercial real estate sector has been reliably strong for nearly 10 years now. After a two year dip in 2008-09, investors have enjoyed solid returns and steady growth. While it is reasonable to expect another downturn at some point in the next few years, it is also reasonable to believe that the US economy will bounce back and investments will continue to pay dividends. It will continue to be important for investors to keep up with the latest CRE trends such as co-working, energy construction projects, infrastructure construction, and much more. The commercial real estate world’s evolution is ongoing, and the only certainty moving forward is change.

Private Equity Real Estate Funds are Slowing

Private Equity Real Estate Funds are Slowing

For the commercial real estate investor, private equity funds have historically been safe bets which can be used to invest in a volatile real estate market over the long term. Private equity real estate funds are typically purchased by high net worth individuals, trusts, and/or pension funds to build portfolio value. In recent years, as commercial and residential real estate markets have inflated to the tipping point of true value, real estate funds have lost their luster to some investors. 

 

Today, we will review how private equity real estate funds function and why they are lagging behind when it comes to both performance and participation.

 

Real Estate Equity Funds 101

Real Estate Equity Funds 101

Private equity real estate is a type of asset which pools private and public funds into the real estate market. Similar to how mutual fund ownership entails privately owning a number of stocks, bonds, money market funds, and other mutual funds, private equity real estate funds entail owning multiple properties through a type of pooled vehicle. While the concept of private equity real estate has been around for since the post WWII era, private equity real estate funds truly took off during the boom or bust economy of the mid 90’s.

 

Also like mutual funds, private equity funds are a long term investment. There may be penalties for early withdrawals, funds are tied up in the funds, and investors must understand that most private equity funds come with a lock-up period where assets are unredeemable. Due to the nature of real estate equity funds, there is typically a substantial minimum investment both up-front and potentially over time. As we mentioned in the introduction, private equity funds are typically reserved for wealthy individuals, pension plans, or other long-term wealth building strategies.

 

CRE Equity Funds by the Numbers

CRE Equity Funds by the Numbers

Commercial real estate plays a huge role in private equity real estate funds, but it is not the only player. Let’s take a look at private equity numbers to get an insight into industry trends:

 

  • 2018 saw an overall fundraising downturn of approximately 10.6 percent compared to 2017. Total 2018 investments totalled approximately $118 billion. This is the lowest annual figure since 2013.
  • During that same 2013-2018 time period, commercial real estate has enjoyed a steady growth rate both in terms of average valuations and total commercial real estate investments. 
  • The 10 largest private equity real estate funds make up over 35 percent of the total investment monies raises in 2018. This top heavy trend is likely to continue as the more well-established funds are better positioned to weather the upcoming bear market.
  • The amount of “dry powder” holdings has also gone up approximately 15 percent year over year. This could signal that investors are losing confidence while also accounting for a lack of fundraising overall. 
  • Despite all of this, there are still large sums of money tied up in the private equity market. Recent figures put the total valuation of the industry at approximately $244 billion spread of 670 private equity real estate funds

 

Why Private Equity Real Estate Funds are Losing Steam

There are a number of reasons why private equity real estate funds are slowing down. According to the latest reports, here are some of the biggest sticking points facing private equity investors looking ahead to 2020:

 

A crowded marketplace. Mark Twain once said, “Buy land, they ain’t making any more of it”. In today’s market, this fact of life has been highlighted by population growth, corporate buy-ups, and maturing urban markets. When it comes to private equity firms, prime real estate is going quickly as well. This is yet another reason why firms like Blackstone are dominating the market with multi-billion dollar funds focusing on the highest-value properties.

Real estate market uncertainty and likely recession.

Real estate market uncertainty and likely recession. If you’ve been reading/watching the news lately, you are likely aware of some of the more grim predictions regarding a nearing recession and real estate market downturn. This has led many investors to turn to debt investments and abandon mid to long range real estate investments until the market settles.

 

Other investment opportunities have taken attention away from PERE. Private equity real estate funds are in a strange middle ground of being well established over decades of solid returns but without the pedigree of mutual funds or the investor excitement of new programs like opportunity zones

 

Slow payouts for private equity real estate. Many real estate funds have a problem: they have too much cash. This can result in a number of hiccups, including investor payouts being delayed. This is almost a situation where the success of PEREs has led to a bogged down payout process.

 

Going Forward

Most industry experts agree that private equity real estate funds will continue a modest slide moving into 2020. With economic uncertainty and an already waterlogged investment environment, PEREs will likely take a few years to bounce back. Of course, it is impossible to know how economic performance, consumer spending, CRE, and other outside factors will fall into place over the coming years. Despite all of these huge question marks, private equity real estate funds meet a need for many individuals and organizations looking to buy into potentially high yield, long term investments.

The Devaluation of Traditional Real Estate Capitals

The Devaluation of Traditional Real Estate Capitals

In decades past, the most valuable real estate in the United States was not hard to identify. Commercial real estate in traditional real estate capitals such as Washington, D.C., New York City, San Francisco and other powerhouse markets dominated the landscape. In many ways, this remains true. However, savvy investors are frequently turning to less oversaturated, less expensive markets to make their mark. This has led to a vicious cycle where many traditional real estate capitals have depreciated relative to the overall market. 

 

To better understand why major markets have become less valuable in recent years, today we will discuss stronger markets in non-traditional areas including the Sun Belt and why the largest real estate markets in the U.S. have suffered.

 

Suburban Sprawl and the Rise of the Sun Belt

Suburban Sprawl and the Rise of the Sun Belt

The Sun Belt can be considered any land in the southern third of the United States. It should be noted that the Sun Belt absolutely contains powerhouse real estate markets including Los Angeles, Atlanta, and San Francisco. Yet the largest commercial real estate growth is expected to continue in less traditional markets such as Nashville, Austin, Raleigh, Phoenix, and many others. There are a multitude of reasons for these trends, including:

 

  • Domestic migration favors Sun Belt states. Texas, Florida, North Carolina, and Arizona are the top states for domestic migration over the past ten years. New York, California (a SunBelt state which is an exception to the rule), Illinois, New Jersey, and Ohio are at the bottom of that list.
  • Construction costs and living expenses are lower in many Sun Belt and other non-traditional markets. There is a reason why the largest companies on earth like Apple are choosing to build headquarters in Austin, TX instead of Silicon Valley. Costs are lower and employees are able to live more comfortably.
  • Many Sun Belt states (again excluding California) have less business and real estate regulation. Fewer regulations make for easier, cheaper CRE construction projects in addition to greater flexibility for businesses. 

 

The Largest Real Estate Markets in the U.S. Have Cooled Off

San Francisco is Experiencing High Office Vacancies

San Francisco is Experiencing High Office Vacancies

Perhaps the most notorious real estate market in the U.S., if not the world, San Francisco’s real estate booms and busts are well documented. The outrageous cost of living is driven by insanely high residential real estate values which make it virtually impossible for long time citizens to continue to rent or to purchase new homes. The commercial real estate industry is experiencing many of the same issues. Recent reports suggest that high labor costs, poor living conditions, and very high lease rates have led companies to steer clear of office space in the Bay Area

 

This has extended to store front businesses as well, where less foot traffic and higher rents mean less economically viability. Unfortunately, there does not seem to be an easy fix on the horizon. All markets have their tipping point, and San Francisco appears to be on the precipice. What remains to be seen is how the city will bounce back once the real estate market normalizes. 

 

Traditional Retail Locations in NYC are Struggling

New York is a tough market to pin down. The largest U.S. city could be considered both the healthiest or the most tumultuous real estate market in the country depending on your point of view. And NYC has always been prepared for the recent industry shift towards infrastructure and new construction mega-projects. In this way, the already densely packed city has continued to grow its already robust commercial real estate footprint.

 

However, the retail sector is struggling in a local economy where retail real estate is incredibly expensive and retail business models are needing to adapt to survive. Where some New York flagships survive on tourist money alone, many are closing their doors in the wake of new economic realities. This has led to many CRE properties losing their value in recent years.

 

Boston’s Struggling Multifamily Real Estate

Boston’s Struggling Multifamily Real Estate9

Although younger renters are willing to sacrifice other amenities for ideal locations, luxury multifamily complexes in high end Boston markets are struggling. With price points too high for many young adults and many businesses opting for non-centralized locations, downtown apartment living is becoming difficult for real estate investors. The silver lining of these trends in many expensive cities is that multifamily real estate in suburban areas is increasing in popularity and value. Savvy investors may want to look to different locations to fight against the devaluation of downtown apartment living.

 

Going Forward

Traditional real estate capitals continue to hold a high value when it comes to commercial and noncommercial real estate. That being said, their stranglehold on the most desirable properties has lessened in recent years, giving way for less centralized office buildings and CRE multifamily units. These trends will likely continue with the caveat that major markets like New York and San Francisco will remain extremely desirable to a certain population of businesses and individuals who value urban living.

Commercial Real Estate Lending Standards

Commercial Real Estate Lending Standards

According to the Office of the Comptroller of the Currency of the United States: “Commercial real estate (CRE) loans include loans secured by liens on condominiums, leaseholds, cooperatives, forest tracts, land sales contracts, construction project loans, and—in the states that consider them real property—oil and mineral rights. National banks may make, arrange, purchase, or sell loans or extensions of credit secured by liens on interests in real estate.” All of this essentially to say that commercial real estate loans are frequently borrowed against other commercial real estate assets.

 

When it comes to commercial real estate lending standards, there are federal and state-wide regulations of which any active CRE investor should be aware. Today we will review some of the high level lending standards for real estate investments in the U.S.

 

Establishing a CRE Loan Portfolio

Establishing a CRE Loan Portfolio

One of the most important aspects of securing a real estate loan for a commercial property or any other real estate purchase is building a loan portfolio. The onus to create these reports is on the insured depository institution, AKA any bank which is insured with the regulations of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The federal government has strict guidelines which regulate what must be included in these reports, including but not limited to:

 

  • Identifying and declaring the terms and conditions of the loan.
  • Scouting locations in terms of properties and geographical areas for which the loan may be applied.
  • Establishing a policy of loan portfolio diversification including parameters for investments by real estate type (commercial vs. real estate, etc.) geographic location, and more.
  • Identify any lending staff including personal qualifications.
  • Complete a risk assessment to determine any undue concentrations of risk.
  • Identify zoning requirements.
  • Identify the underwriting standards which will be used for the loans.
  • Establish loan-to-value limits (more on this below).
  • Identify the loan administration protocols which will be followed throughout the life of the loan including disbursement, documentation, collection, collateral inspection, and loan review.

 

There are more loan portfolio requirements than we will list here, but this is a reasonable sample to give prospective investors an idea of what the federal government expects when clearing future commercial real estate loans.

 

FDIC Real Estate Lending Standards

FDIC Real Estate Lending Standards

The Federal Deposit Insurance Corporation, more often referred to as the FDIC, is an independent federal agency responsible for insuring against bank failures. The vast majority of major financial institutions in the United States are FDIC insured or FDIC supervised. This is important for commercial real estate lending standards, as FDIC regulations come into play for any such organization. With this in mind, here are some high level regulatory standards set forth by the FDIC:

 

  • “Each FDIC-supervised institution shall adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens on or interests in real estate, or that are made for the purpose of financing permanent improvements to real estate.”
  • Real estate loans must be considered within the bounds of standard banking practices.
  • All written loan policies must undergo an annual review and approval process by an FDIC-supervised board of directors.
  • Commercial real estate lending procedures must include detailed underwriting protocols, loan-to-value limits, and portfolio diversification demands.
  • All loans must be monitored by an FDIC supervised institution to ensure that the current real estate landscape continues to support the terms of the loan.
  • All lending policies for real estate should adhere to the “Interagency Guidelines for Real Estate Lending Policies established by the Federal bank and thrift supervisory agencies.”

 

Supervisory Loan-to-Value Limits

Supervisory Loan-to-Value Limits

While there are certainly more details to cover when it comes to CRE lending standards, the last key concept we will hit upon today is loan-to-value limits. Loan-to-value limits or loan-to-value ratios are essentially the calculation reached by dividing the loan amount by the total market value of the investment including any additional collateral being used to secure the loan. It is vital to understand this metric not only to secure loans and adhere to lending standards, but also to gauge how viable a loan and/or real estate investment will be.

 

Different real estate categories carry different loan-to-value limit requirements. 

 

  • Raw land investments: 65 percent
  • Land development investments: 75 percent
  • New construction: situationally dependent
  • Commercial, multifamily, and other non-residential property investments: 80 percent
  • One to four family residential investments: 85 percent
  • Improved property investments : 85

 

Transactions Excluded from Loan-to-Value Limit Evaluations

It is important to note that many commercial real estate loans are exempt from loan-to-value evaluations. Examples of these types of loans include those which have been insured or guaranteed by the federal government, those which are backed by the full faith and credit of a state government, or those which are to be “sold promptly after origination, without recourse, to a financially responsible third party.” It is vital to understand precisely how transaction exemptions work before assuming that your loan will not undergo the scrutiny of a loan-to-value limit evaluation.

 

Going Forward

In most cases, it is not absolutely necessary for commercial real estate investors to understand the in’s and out’s of CRE lending standards. Yet knowledge of how the federal regulations work and what questions will be asked can allow investors and other CRE professionals to better prepare for loan applications. It is also important to understand that even federal regulations are not set in stone. There is no concrete reason to believe that these regulations will be significantly altered in the near future, but the possibility of change is always present.

Medical Office Buildings Remain a Safe Bet

Medical Office Buildings Remain a Safe Bet

Commercial real estate, like many investment-based industries, can experience major flux over time. Yet certain CRE investments are safer than others due to strong demand and profitable business models. Medical office buildings have been a strong choice for CRE owners and investors for many years. We believe that this trend will not only continue, but trend towards greater value for investors. Some investors are hesitant to enter into this space for fear of policy change and bureaucratic red tape making the future murky. While these are certainly relevant considerations, today we will be reviewing why the pros of medical office building investment outweigh the cons.

 

The Value of Medical Office Properties

In order for an investment to be a safe bet, it must first be determined that the asset has value. Medical office property values have skyrocketed in recent years. Here are just a few reasons why.

 

Supply and Demand Favors Property Owners

Supply and Demand Favors Property Owners

There is no question that medical office buildings are in high demand. As the nation ages and healthcare becomes an even larger industry, outpatient procedures continue to climb in both quantity and quality. That handles the demand part of the equation. As for supply, medical office buildings often require specific layouts and capabilities which must either be designed from the ground floor or retrofitted into older properties. Simply put, there aren’t enough office buildings to handle the current demand. This obviously puts a premium on those properties which do exist and even those which are good skeletons to be converted into medical offices down the road. 

 

The Medical Industry is Booming

Say what you will about our nation’s healthcare system, but there is more than enough money to go around. No matter if we continue with Obamacare and other current policies, roll back current policies, or go in the other direction and establish Medicare for All, money will continue to pour into our medical care infrastructure. The reason is simple: the medical industry is extremely strong and will likely remain so for many, many years. When you combine favorable supply and demand with a cash-rich industry, that equates to high value investments.

 

Flexible Medical Office Layouts Add Value

On a more specific note, the future of medical technology is moving to a format which enables physicians to perform a wider range of tests within their offices rather than sending patients to specialists. For this and many other reasons, flexible medical office structures offer a unique value to investors and to lessees by allowing for greater capability and flexibility of care.

 

Why Medical Office Buildings are a Wise Long-Term Investment

Why Medical Office Buildings are a Wise Long-Term Investment

There are many reasons to believe that medical office buildings have strong value in today’s marketplace, but how can we be so sure that they will be a wise long-term investment? Medical office properties offer a unique safety net for investors for the following reasons:

 

 

  • Customer convenience means location is becoming more and more important. Nobody likes going to the hospital. This is particularly true when medical offices are more convenient from a location and practical standpoint. 
  • The aging population will require more regular check-ups and routine health care over time. The U.S. population is aging. This is particularly true in areas like our own Western PA region where one in five residents will be 65 or older by 2025.
  • Outpatient procedures are outpacing hospital stays. Outpatient procedures are viewed as more favorable by patients, healthcare systems, and doctors alike in the majority of cases. Obviously some medical procedures absolutely must be performed in hospitals. For more minor procedures and checkups, the future is trending towards medical offices and away from hospitals. 

 

 

Pittsburgh’s Medical Industry and Aging Population = Strong Medical Office CRE Market

Pittsburgh’s Medical Industry and Aging Population = Strong Medical Office CRE Market

As we mentioned in the previous section, our region’s population is aging rapidly. An aging population leads to greater medical care demands. Pittsburgh is also well known for offering world class healthcare. What this means for investors is that the demand for office buildings in our area is expected to climb for decades to come. As this demand climbs, well-funded organizations such as UPMC will have more than enough desire and capability to either purchase or lease medical office buildings at a premium.

 

Given the Pittsburgh region’s population trends, there is perhaps no safer commercial real estate bet than medical office properties. There is every reason to believe that UPMC and other local medical research facilities will continue to attract the best medical professionals from around the globe to keep our local medical economy strong.

 

Going Forward

It is impossible to speculate on the future of real estate, no matter how many positive indicators exist. As far as safe bets go, medical office buildings are about as close as you can hope to get. Aging populations, a demand that outpaces supply, a medical industry flush with cash and resources, and the national trend of outpatient procedures overtaking hospital procedures all add value to medical office properties. Medical office buildings are a unique beast, and all investors are also encouraged to understand the intricacies of medical office layouts and realistic expectations before taking the plunge.