Diamonds in the Rough

The mid-year edition of CRE Direct opens with a Letter from the Editor, immediately calling out the question on everyone’s mind: When will the next recession take hold?

“How long [the economic recovery] will last is anybody’s guess. But, based on what’s happening in the commercial real estate sector, it may go on for a while.”

~Orest Mandzy, Managing Editor, CRE Direct

Within this just-released edition of the magazine is an article I authored which highlights that while Phase I environmental site assessment volume was up by only 3 percent in the first quarter–an indication of a slowdown in property investment activity–it’s ballooned by more than 20 percent in certain secondary markets. So investors indeed are going further afield in their search for yield. The entire article is reprinted below with permission from the publisher. 

DIAMONDS IN THE ROUGH: Finding Yield During Record Economic Recovery 

Here we are approaching the midpoint of 2018 and the economy just passed an important milestone: This is now the second-longest expansion on record.

Thanks in part to the stimulus of federal tax reform, there is a very high probability that this will become the longest expansion in history. As recovery marches onward, debt originations for commercial property investments remain healthy. Lenders are still being very disciplined with their underwriting, particularly for construction loans. One of the biggest challenges lies with investors, rich with available capital and a massive appetite for yield, facing the difficult task of finding properties for sale that offer an attractive return on investment. Market fundamentals are driving investors to look at opportunities in smaller metros as well as seeking properties in good locations that have the potential for value-add opportunities.

 

 

 

 

 

 

 

 

 

Yesterday’s Mall…Tomorrow’s Medical Center

While market conditions are favorable thus far in 2018, and property fundamentals are still strong, underwriting is being viewed through a shorter time frame. Some institutions are more cautious about extending seven- or 10-year loans, as talk of the next recession increases. Property price increases are no longer guaranteed as some metros hit the peak of their recovery. This is driving the attention of investors to value-add opportunities: “Where can I get a good deal on a property in a strong market, improve it, and sell it for a profit down the road?”

In every major asset class today, the way space is used is changing. Nowhere is this more true than in retail. Outdated malls are either being redeveloped into alternative uses, such as medical centers, senior housing or warehouses. In the office sector, owners face competition to lure tenants with cutting-edge technology designed to appeal to today’s young professionals or energy efficient improvements to reduce operating costs. Whether you’re talking about an apartment building, office or retail site, owners are looking at site improvements that will help attract tenants.

“Site use today may be something entirely different five years from now. As investors seek out value-add opportunities, it is creating strong demand for site redevelopment and repurposing.”

Quest for Yield in Smaller Metros
Environmental due diligence is conducted prior to most commercial property deals, so a look at the geographic hot spots reveals another interesting trend this year. The pace of commercial real estate transactions has been moderating over the past few years, and along with it, the volume of property due diligence.

Yet, while the number of commercial property environmental assessments grew by a modest 3 percent in the first four months of this year compared to the corresponding period of 2017, activity in the highest-growth primary metros averaged a much more robust 23 percent growth. Similarly, the top secondary markets averaged 20 percent growth this year to date. Investors are looking beyond metros like Boston, Chicago, Los Angeles and New York City, where investors are aggressive and available properties are scarce. Their quest for yield is taking them to smaller metros where prices may be lower and competition less fierce. Detroit, a city whose story of urban revitalization is well-told, sits at the top of the list this year, followed by Jacksonville, Fla., San Francisco, San Diego and Charlotte. Also on the list is Houston, a metro that withstood a devastating hurricane last year and is recovering from the recent fall in oil prices. Investors are shaking the trees in the metros in the table for promising adaptive reuse avenues that could pay off in the long run.

 

Better, Stronger, Faster: Property Due Diligence and CREtech
It’s hard to think about the state of the commercial real estate market this year without giving attention to the impact of technology. The pace of technological change is accelerating in every sector of the economy and the commercial real estate sector is no exception. The MIT Center for Real Estate is now tracking 2,300 startups that are promising to make commercial real estate investment more efficient. In May, the keynote at MIT’s Real Estate Forum, Erik Brynjolfsson, director, MIT initiative on the digital economy, observed that:

“Commercial real estate is on the cusp of moving from a potentially inefficient industry to one that is notably more efficient. This sector is ripe for machine learning simply because of the huge and growing volume of data that isn’t yet being tapped.”

Thanks to growing traction of technologies like machine learning, data analytics and platforms, the entire commercial real estate ecosystem will soon have better tools for decision-making in ways that we can’t even fathom today.

Times Are Good, But the Market Will Turn
Amid strong market fundamentals, interest in site reuse, rapid technological advancement and intense competition, commercial real estate is performing well this year. As anyone who’s been in this industry for a few decades will tell you, the cycle will turn. Based on the latest forecast, the highest risk of recession isn’t until 2020 or 2021. So let’s enjoy them while they last, but don’t take your eye off the ball in planning for the next downturn. As Ryan Severino, chief economist at JLL, said at EDR’s May PRISM conference:

“It’s difficult to plan for the end of the party when you’re still there drinking and having a good time, but there will be bumps in the road at some point.”

Dianne Crocker is principal analyst at EDR Insight, the analytical arm of EDR, a national provider of data, risk management and technology tools and insight for property due diligence and compliance.

The magazine also showcased the winners of this year’s EDR PRISM Awards, presented at May’s PRISM conference in Scottsdale, AZ.

FOR MORE INFORMATION

The full edition of CRE Direct’s Mid-Year Update is full of articles by industry leaders sharing insights on the engines that make the CRE sector tick:

  • CMBS Lenders, Property Investors Remain Disciplined in 2.0 Era by Orest Mandzy
  • How to Measure Risk as Values Continue to Climb by Catherine Liu and Manus Clancy
  • Multifamily Sector is Biggest Winner Post Crisis. Can the Growth Continue? by Jen Loukedis
  • First Quarter Review: Still Healthy, but Decelerating Growth by Barbara Byrne Denham and Victor Canalog