Domestic migration, however, was upended in early 2020 when workers and students abruptly went to fully remote status. Coupled with an inability to spend money on recreational activities due to pandemic-induced lockdowns and social distancing, this meant people spent their excess personal savings and stimulus payments on goods instead.

Between more flexible moving seasons and the accumulation of items that might not have otherwise been purchased, households began to scoop up self-storage space in record numbers. The sector shined as a result. Nationwide absorption peaked at just shy of 200,000 units in second-quarter 2021, as did annualized asking rent growth for 10×10 climate-controlled units (4.9%) and non-climate-controlled units of the same size (3.9%).

Today, however, self storage (like so many other pandemic-era superstar property types) is returning to earth. Slower growth and declines are happening across the country, which indicate that consumer spending patterns have shifted away from goods and back to services and entertainment. High inflation also cut into excess household savings, causing consumers to tighten the purse strings on discretionary purchases. This includes self-storage units that they may no longer want or need.

This confluence of factors is directly affecting performance metrics in the self-storage sector. The magnitude and direction of expected outcomes — patterns that have held relatively steady over the history of Moody’s data series — have shifted as the sector deals with new supply-and-demand expectations and moves toward a new state of stability.

For example, from 2012 to 2022, completions during the second quarter of the year averaged about 47,500 units. In second-quarter 2023, however, completions dipped to approximately 12,600 units. The same pattern held true in Q4 2022 and Q1 2023. In addition to demand-side headwinds that suppressed developer appetite for bringing new product to market, new supply has also been constrained over the past two years by surging costs for land and raw materials, as well as a tight labor market and higher project financing costs.

Although it’s partially unintentional, the sharp decline in the delivery of new supply has proven beneficial for sustained performance metrics, despite the slowing demand across the sector. Net absorption, while still positive in Q2 2023 at about 46,000 units, finished well below the long-term second-quarter average of approximately 159,000 units.

But an opposing trend occurred in Q1 2023. With 64,000 units leased during the three-month period, demand was 60% higher than the long-run first-quarter average of 40,000 units leased from 2012 to 2022. And while absorption was negative in Q4 2022, which was consistent with historical trends, the amount of space shed (107,000 units) far exceeded the average amount of space shed during the fourth quarter of previous years (38,500 units).

So, is the self-storage sector’s traditional seasonality coming to an end? Not quite. While there is a major recalibration underway for owners and operators in their ability to easily predict the magnitude and directionality of key performance metrics (including rents and vacancies), it is temporary.

It also appears that, especially on the demand side, unexpected weakness in some quarters is being supplanted — at least in part — by unexpected strength in other quarters. The drastic and unexpected external shocks that led to stratospheric growth in this sector have receded. Self storage is on a path to a new equilibrium and is poised for stabilization in the coming years. ●

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Higher cap rates and the ability to resize spaces may result in multitenant industrial properties being favored over apartments if the economy sours and rents level off.

Changing tides

Value-add strategy

Experience matters

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As investment vehicles, these last-mile warehouses should catch the attention of commercial mortgage lenders, brokers and investors. There are a number of inventive ways to finance these projects.

While the COVID-19 pandemic has been a difficult time for most business sectors, one area of the U.S. economy, e-commerce, has continued to reach new heights. At a time when many people have been working from home and avoiding physical retail spaces, they have been increasingly turning to online shopping for nearly all of their needs.

This habit appears to be continuing even as vaccines, masks and social distancing have lessened the pandemic’s grip. But such success has resulted in a difficult logistics problem: Not only have consumers grown to appreciate the choices and convenience that e-commerce offers, they also expect to receive items almost immediately.

Retailers big and small are rising to this challenge. They’re finding new ways to diversify their inventories and bring goods to consumers more quickly — including many same-day services. These changes are creating new opportunities for investors who are thinking about diversifying their commercial real estate portfolios.

Current needs

Of course, the “click over brick” phenomenon in retail has been going on for years. But the pandemic has sped up this transition by forcing many people to avoid stores out of necessity. Consumers have grown accustomed to having an endless selection of items at their fingertips. Even consumers who are now returning to malls and big-box stores are still frequently buying online since they can expect to receive their orders within 24 to 48 hours — at no extra cost.

This shift in consumer behavior presents unprecedented challenges for retailers. To meet consumer demand, distribution warehouses need to be large enough to accommodate growing inventories, but they also must be close enough to where consumers live to allow for packages to be delivered at an increasingly faster pace.

Unfortunately, older warehouses and complexes are not always a good fit for the demands of the modern supply chain. Many of these facilities are built to dispatch large amounts of cargo along fixed routes. They tend to be located in rural areas, offer limited shipping docks and have low ceilings that are often unsuitable for modern vertical racking systems. What is needed are innovative, last-mile industrial facilities to quickly handle smaller items and diverse inventories.

Urban landscape

Finding the space to build appropriate warehouses has become a major headache for e-retailers. Large parcels of land that are close to urban centers, include abundant parking and have easy access to shipping routes are scarce and expensive. Additionally, such properties are often subject to competing offers from other buyers.

Given the limited supply of these resources, e-retailers have been seeking inventive solutions to repurpose existing facilities. Empty shopping malls and defunct industrial facilities have been two primary sources. Some big-box stores have opted to reconfigure their existing retail spaces to accommodate in-store distribution facilities where customers can pick up online orders.

Retailers also have turned to more unexpected sites, such as an abandoned naval base in Bayonne, New Jersey, and a mammoth underground parking garage in Chicago. With a growing number of people working from home for the foreseeable future, office buildings could be the next target. And some retailers are considering building additional stories on their last-mile industrial complexes to maximize utilization of the footprint.

All of these conversions and developments are transforming the urban landscape in various ways. This includes the revitalization of neighborhoods through new jobs, the redevelopment of obsolete or underutilized retail properties (greyfields), and the cleanup of toxic waste from former industrial sites (brownfields).

Self-sustaining growth

The changing ways that we shop, and our increasing expectations for fast delivery services, are awakening investors and lenders to a new reality. Capital sources understand that last-mile industrial complexes are the most in-demand assets to fulfill growing consumer and business needs.

According to commercial real estate services company Cushman & Wakefield, the demand for warehouse space pushed U.S. industrial rents to a record high of $7.03 per square foot in second-quarter 2021, marking a 6.8% year-over-year increase. Similarly, the vacancy rate of 4.5% at this time was lower than it was 10 years ago, while construction was underway to add another 476 million square feet of industrial space nationwide (and 36% of it was already preleased).

Efforts to build and transform underutilized spaces into distribution facilities that fit with the 21st century are helping to accelerate the economic recovery. What’s more, establishing last-mile industrial facilities creates jobs, many of which are located in economically distressed communities.

Related sectors — including logistics, manufacturing and construction — are benefiting from this ripple effect as they help to meet the demand for more space. And the research and development sector is creating innovative ways to help last-mile facilities be more efficient, including through the use of self-driving vehicles, drones and other logistics solutions.

Project financing

Despite all of the upside, the creation of last-mile industrial facilities presents financial challenges. It’s often a cheaper solution to refurbish existing structures and sites than to build new facilities from scratch, particularly given the rising costs of both materials and labor. Still, the scarcity of suitable locations, coupled with the need to adapt older buildings to the demands of modern e-commerce, lends credence to investing in new developments.

Industrial properties are in high demand and availability is limited across the country, resulting in expensive bidding wars in which investors often come ready with all-cash offers. Commercial mortgage lenders, however, are typically solicited in post-closing periods to refinance projects or fund construction efforts.

At the same time, commercial mortgage brokers are competing with joint ventures to finance last-mile industrial complexes. Lenders are working with brokers to secure developers by offering low interest rates (below 3% in some cases) and other attractive terms. They also are considering lower capitalization rates (3% to 4%) in gateway markets such as San Francisco, Los Angeles and New York City.

The ongoing market restructuring has catalyzed this race and has reinforced the urgent need for these assets. As things currently stand, these developments are considered secure and lucrative investments. The assets offer the advantages of low vacancy rates, long-term leases and tenants with strong credit.

● ● ●

The pandemic dramatically accelerated trends in consumer behavior that were growing for the past decade. Consumers want everything — and they want it now.

This surge in demand has forced e-retailers to get creative with last-mile industrial sites that offer the security of long-term tenants and stable investment returns. Investors and lenders are doubling down on this niche market to meet intense demand, and mortgage brokers also stand to benefit from this growth as retailers of all types embrace the online shopping experience. ●

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Despite the sector’s growing profile, however, misperceptions continue when it comes to financing options. Digging deeper into current trends, it’s clear that old assumptions should no longer apply to commercial mortgage brokers and their clients.

The manufactured-housing sector is the only major commercial real estate asset class that has not experienced a year-over-year decline in net operating income in any year since 2000, according to Green Street Advisors. Not surprisingly, a major driver of the sector’s stellar investment performance is that housing-cost increases have outpaced wage increases.

According to the Manufactured Housing Institute, 22 million people live in manufactured or mobile homes in the U.S., occupying 4.3 million sites in about 43,000 land-lease communities. Homes are manufactured in 136 plants across the country and the average sales price in 2019 (excluding land) was $81,900 for the typical 1,448-square-foot home.

A tenant can expect to pay roughly $450 per month for the pad rental, $75 per month for utilities and $500 per month for the home itself. At $1,025 per month, a manufactured home can be a bargain — especially in comparison to the experience of living in an outdated apartment building and sharing walls with neighbors.

In many U.S. locations, manufacturing housing is the only truly affordable, nonsubsidized form of detached housing available. Strong consumer demand coupled with low supply is why MHCs and MHPs have thrived regardless of economic trends — even during the downturn caused by the COVID-19 pandemic. One measure of the sector’s investment strength is that manufactured-housing real estate investment trusts (REITs) have outperformed the broader REIT index over the past several years.

Limited supply

Today, manufactured housing provides shelter for roughly 7% of the U.S. population. This share would likely be much higher were it not for the high barriers placed on new construction.

With the exception of Florida, Texas and Arizona, most states have seen little development of new MHCs or MHPs in recent years. With fewer than 10 new communities developed since 2008, 68% of MHCs were built before 1980, according to valuation company Datacomp. Prone to old stereotypes, municipalities, zoning boards and neighborhood associations often show great resistance to allowing new communities to be developed or expanded.

Contrary to popular perceptions, however, many MHPs and MHCs are professionally managed and offer safe, secure, high-quality housing at affordable prices. Communities often offer clubhouses, swimming pools, off-street parking and other amenities typical of conventional multifamily communities. Furthermore, today’s factory-built homes increasingly resemble stick-built homes, with luxury finishes and architectural details that blend with conventional home designs — and two-story models have entered the market as well. Well-located and maintained communities can be upgraded and improved, and their values are rising in today’s market.

Despite its potential, manufactured housing continues to be subject to misperceptions. There are multiple indications of how far the sector has come.

First, investments in MHCs and MHPs are thriving outside urban centers. Conventional wisdom claims that location in a primary market with relatively high housing costs is fundamental for the success of these properties. Yet what little new MHC development that has been approved by municipalities is underway in rural areas rather than densely populated ones.

One recent deal, for example, is a $9.75 million first-lien construction loan for a new MHC development in Washington state, in a small but lively community about two hours northwest of Seattle. The community, which will have 217 home sites, will be restricted to residents ages 55 and up. The 38-acre property sits in the city’s downtown area and is surrounded by big-box retail, casinos, golf courses, a country club, churches, cafes and outdoors attractions.

Capital sources

Second, numerous financing options are available for these investments. A decade ago, financing options for MHCs were limited because of misperceptions and stereotypes about factory-built housing. But as these types of homes and communities have become more advanced and sophisticated, financing options have flourished.

Most owners of manufactured-housing communities now use commercial mortgages to finance their properties. Some owners are able to secure chattel financing to buy new homes and rent them out, or they can provide seller financing for new residents. Funding sources encompass a wide range of commercial mortgage lenders — including banks, credit unions, debt funds, commercial mortgage-backed securities (CMBS) lenders, family offices, pension funds, life-insurance companies, and even the government-sponsored enterprises Fannie Mae and Freddie Mac.

Agency lenders are often preferred by investors, but other sources finance a significant volume of transactions for factory-built communities. Private lenders are active in many states. REITs, sovereign wealth funds, institutional equity funds and the like also are active in the sector, although some of these lenders prefer larger transactions valued at $10 million or more.

The financing of individual home purchases is, of course, important for MHC and MHP occupancy rates. Specialty finance firms recognize that lending on mobile homes is quite secure, with the loan amounts being smaller than conventional mortgages, but the default-risk profile is similar as the majority of these homes are the occupant’s primary residence.

Some capital sources, however, continue to be more risk averse than others. Not surprisingly, the COVID-19 pandemic has made banks more conservative and has pushed many large banks to the sidelines. Bank borrowers can expect loan-to-value (LTV) ratios in the 50% to 70% range rather than the pre-pandemic levels of 65% to 80%. The typical debt-service-coverage ratio requirement is likely to be close to 1.25 or 1.3 due to the low interest rate environment.

Securitization growth

Even before the pandemic, some lenders viewed this asset class as special-purpose real estate that warrants more conservative terms. These may include lower LTV ratios or personal guarantees rather than the nonrecourse options that investors naturally prefer.

Life-insurance companies, too, often focus on lower LTV transactions and are highly selective with regard to asset quality. The secondary market is seeing increased investor appetite for the asset class, and CMBS lenders continue to offer competitive rates, cash out and long-term nonrecourse loans.

Mortgages for MHCs and MHPs are often securitized, a significant change from previous eras. Over the past decade, however, Fannie Mae and Freddie Mac became the lenders of choice for investors, especially after Freddie entered the sector in 2014.

In 2019, for instance, Fannie provided $2.5 billion in MHC financing while Freddie injected another $1.4 billion, according to Wells Fargo data. As investors in these securities have come to appreciate the performance of MHCs, securitization opportunities have grown to bring more liquidity to the sector.

Favorable terms

Loan terms can be investor friendly. With greater recognition of the MHC sector’s potential, lenders have become increasingly comfortable. Some banks and credit unions, for instance, have a good understanding of mobile-home parks from a credit perspective and will offer aggressive loan terms under normal conditions.

The previously mentioned project in Washington, for example, was funded through a bank-participation loan that covered 69% of the upfront costs. While it is a recourse loan, the five-year term includes a two-year, interest-only period, followed by an amortization period of three years based on a 25-year schedule.

In another recent example, $9.53 million in first mortgages for two MHPs in the Texas markets of Dallas-Fort Worth and Corpus Christi were secured for a repeat borrower. Five years prior, the borrower obtained funding to acquire the two properties and execute a value-add business plan that created a strong position for permanent cash-out financing.

The 10-year, nonrecourse CMBS loans provided by a Wall Street firm feature a fixed interest rate; a three-year, interest-only period; and amortization over a 30-year schedule. Proceeds from the loan were used to pay off a previous loan, cover closing costs and return equity to the borrowers.

● ● ●

Limited supply and strong demand suggest that the outlook for MHC investments will remain positive. This asset class has long suffered from misleading stereotypes and a lack of understanding of the market dynamics for this housing segment, creating constraints on new development. While limited supply sustains the strong investment performance of parks and communities already in place, growing consumer demand points to additional opportunity for investors and lenders to build in the right communities.

Interest rates also continue to be low and the demand for affordable housing has never been higher. For owners, the opportunity to refinance and tap equity to enhance their properties or to buy new ones has never been better. With awareness of current financing trends, savvy investors and commercial mortgage professionals stand to profit while meeting a critical marketplace need for attractive, affordable housing. ●

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Commercial mortgage lenders, however, have remained cautious. Even aggressive, asset-based private lenders that look most closely at the value of a property have been reluctant to approve high-leverage loans on homes that have recently seen huge increases in prices. Consequently, commercial mortgage brokers may wonder why lenders aren’t providing loans to help them and their investor clients catch up to the blazing market.

When the pandemic first appeared in March 2020, lenders feared the housing market would see a significant downturn. Anyone with money in a project faced several unsettling possibilities. Is the market going to go down? How long will distressed properties be tied up in foreclosure given the federal moratoriums and health mandates? Will an investor be able to carry the property for an extended period and pay both principal and interest if the home can’t be sold or rented within a reasonable time?

Everyone held their breath to see if another Great Recession-like crash was about to happen. Fortunately, so far, the opposite has occurred. Not only has the housing market avoided a downturn, it has rarely been stronger. Even investors that made bad bets on properties have been saved by a market on fire, with over-budget projects breaking even or turning a profit as values climbed.

Projects that ran into money problems and still needed renovations could be resold to other investors. Effectively, the past year has bailed out numerous investors in tight spots and has yielded unexpected profits to almost everyone involved in the single-family housing market. So, again, why aren’t lenders matching this hot market while things are going so well?

Every lender is different and some are definitely comfortable making high-leverage loans in a market with rapidly rising prices. The majority of commercial mortgage lenders, however, remain in a defensive posture. In general, lender confidence in this market does not match the rapidly rising sales prices seen around the nation. To explain their hesitancy to accept these new values, it is worth looking at some of the major areas that factor into a lender’s thinking when establishing a loan size.

In general, lender confidence in this market does not match the rapidly rising sales prices seen around the nation.

Remaining skeptical

Underwriting a deal involves many factors but, in the end, it boils down to accurately assessing the value of a project in the current market. In today’s market, record-high prices have combined with record-low inventory. To establish a value on a property, the typical investor will use the closest comparable property and expects that their lender will use the same information to approve the highest possible loan amount. But this isn’t what’s happening. 

When home prices shoot up, lenders have a tendency to err on the side of caution. It takes time for lenders to trust the market’s new price point. Lenders are always worried about a price correction following periods of rapid price increases. This attitude can be viewed as a seasoning period for lenders that are looking for clues on the market’s true value. There is no hard formula, but given how sharply values have increased since June 2020, do not expect commercial mortgage lenders to use the latest comparable prices unless these properties can hold their current values until the start of next year.

The faster a price grows, the longer that a lender will typically need to confidently move to the new price point. For example, starting in 2012, home-price growth gradually accelerated, but lenders still felt confident in using the sales prices of comparable properties to determine value. In 2017, for instance, home prices rose by about 6%. This spike caused the typical lender to temporarily look back for a few months, but any delays were hardly noticed as the market began to steadily gain value again for the next three years.

The recent surge in prices reached a level unseen since 2006. The run-up doesn’t necessarily mean that the market is headed for a crash, but lenders are naturally going to be cautious. When home prices rise quickly and reach new heights, lenders typically prefer to use comparable sales of similar properties anywhere from six months to a year earlier. Lenders become defensive in extreme buyer or seller markets, and they stay conservative with underwriting until the market reveals where it is headed.

Recouping properties 

Aside from closely watching the course of home prices, lenders also are concerned about foreclosure trends. During the COVID-19 crisis, the federal government and several states placed moratoriums on evictions and foreclosures. Since each locality has tended to implement its own rules during the pandemic, the foreclosure process has largely been outside of a lender’s control and it remains in flux. This has made it difficult for lenders to estimate the cost to recover an asset, if need be.

When foreclosing on a property, lenders also need to account for legal fees, taxes and carrying costs that go into a typical foreclosure. Early this past summer, it was still unclear how long foreclosure proceedings would take in many cities and whether the residents of these properties could be evicted so the properties could be resold. There also is a backlog of foreclosures that dates back to 2020, further complicating the calculation.

Additionally, on behalf of their clients, attorneys can use pandemic-era laws that forestall evictions or foreclosures, so foreclosure cases that were once considered routine aren’t likely to be so easily resolved. In response, many commercial mortgage lenders are tightening their requirements on borrowers by demanding higher credit scores, more experience and higher reserves than in pre-COVID days. Borrowers with lower credit scores will likely need to put in significantly more equity or show other mitigating factors. Otherwise, lenders need assurances that they can weather a multiyear foreclosure process without losing money, should the process go sideways.

Although much of the country has reopened, and some foreclosures and tenant evictions are being allowed again, lenders will need to see foreclosures and evictions moving through the system for at least six months before believing the process is returning to pre-pandemic norms. With so many municipalities adopting their own policies, there are too many unknowns. Also, even though progress has been made with vaccines, the health crisis has yet to end and there remains a possibility of more lockdowns. Lenders are factoring all of these issues into their calculations when assessing a deal.

The faster a price grows, the longer that a lender will typically need to confidently move to the new price point.

Hidden costs

Lastly, lenders also are troubled by rising costs for construction materials. Typically, homes sold to investors need substantial renovations, so lenders must factor any spikes in construction costs into the overall project cost. Lumber costs rose by 180% from June 2020 to April 2021. Although lumber is by far the fastest-increasing material cost, almost all materials used in renovations or new construction have increased by at least 20% in the past year. Whether vendors are inflating prices to make additional profits or there is a legitimate material shortage as a result of supply problems caused by the pandemic, the fact is that the typical home renovation costs more than it did a year ago.

So, a renovation budget that normally would cost $40,000 now is closer to $50,000. Mortgage brokers and investors, however, often are not accounting for these added costs when they approach lenders. Prior to COVID-19, lenders would normally account for a 10% variable in renovation costs due to unexpected events, but now that variable is about 20%. 

Even projects that have gone smoothly are winding up 10% to 20% over budget due to rising building-material costs. Until these costs show signs of slowing down, lenders need to account for this additional expense in their maximum loan size. As a result, your investor clients may have to contribute more equity toward the overall project costs.

While it does appear that the country is slowly returning to pre-pandemic norms, expect many commercial mortgage lenders to take some time before their behind-the-scenes processes match the current market prices. Wait for material costs to stabilize, for foreclosure and eviction courts to no longer be behind schedule, and for home-price growth to cool off to a more steady level. When these things happen, lenders will begin to catch up with the market. ●

The post Playing Catch-up appeared first on Scotsman Guide.

This, in turn, will again make it possible for commercial mortgage brokers to secure financing via the CMBS route. Expect positive, increasingly stable trends to continue in the coming months. 

Undoubtedly, the COVID-19 crisis badly hurt demand for CMBS. According to the Mortgage Bankers Association, CMBS origination volume was down by 26% year over year in first-quarter 2021, the second-largest annual decline among major investor types after commercial bank originations. Similarly, CMBS delinquency rates for retail and lodging properties remained in the double digits this past June, Trepp reported, even as the overall CMBS delinquency rate has decreased significantly since the height of pandemic-induced distress.

That said, the outlook is improving on both the demand and supply side of CMBS financing. First, investors are showing renewed appetite for CMBS loans, which generally have a favorable view compared to other structured products in the capital stack.

Despite the improving outlook for lending and the economy, COVID-19 was a shock that affected how CMBS lenders evaluate borrowers and deal proposals. Although CMBS lenders generally showed discipline pre-pandemic, they tend to be more cautious today. Lenders are scrutinizing the primary borrowers more closely than ever. The borrower’s relevant experience within an asset type and their knowledge of a particular region are critical factors in the lending decision.

Lenders are looking for a strong credit profile, including verification that the principal borrower is of a strong character. This is often the first and most important item reviewed, followed closely by the quality and credit profile of a particular property. Generally speaking, lenders will not approve loans that exceed the borrower’s net worth, although this is a guideline rather than a hard-and-fast rule. When loan amounts get much larger or when circumstances warrant, lenders may consider moving away from this standard.

To ensure that the loans don’t fall into delinquency and the bond investors get paid, CMBS lenders are typically looking for borrowers to hold enough reserves to cover several months of debt service or as much as 10% of the loan amount. This depends largely on the risks associated with a particular property, including tenant rollover, costs to re-tenant, leverage and location.

Lenders are looking for a strong credit profile, including verifying that the principal borrower is of a strong character.

Evolving standards

Typical conduit leverage sits anywhere between 60% to 75%. The range can be broad, depends on the circumstance and reflects many factors — including property type, market, sponsorship, the leverage level of the principal borrowers, cash equity and ownership history. Typical debt yields are 7% and up. For example, 7% is often the lowest level for very strong multifamily assets in top-tier markets and debt-yield requirements increase from there. Interest rates from conduit lenders today are in the range of 3.5% to 4.25% and, for 10-year spreads, could be 200 basis points or less depending on leverage and the property-specific underwriting criteria.

Delinquency and distress metrics across CMBS are improving. Trepp’s CMBS delinquency rate continued to decline this past May with the rate posting its largest drop in three months. Following two huge jumps in May and June of last year, the rate had declined for 11 consecutive months.

Today’s conduit finance activity is busiest where the
asset performance has been the strongest: multifamily and
manufactured housing, followed closely by industrial.

Improving performance

The overall delinquency rate for CMBS loans shot up to 10.3% in July 2020 at the height of virus-induced lockdowns, Trepp reported. As of this past June, the rate had fallen to 6.1%. There were still areas of concern. Lodging and retail delinquencies remained at 14.3% and 10.7%, respectively, but the delinquency rates of office, multifamily and industrial assets were hovering near 2% or less.

Not surprisingly, today’s conduit finance activity is busiest where the asset performance has been the strongest: multifamily and manufactured housing, followed closely by industrial. Self-storage, office, retail and mixed-use properties also are back in favor as lenders aggregate loans to meet demand from CMBS bond investors.

On the multifamily side, conduits often compete directly with agency programs, including Freddie Mac and Fannie Mae. Many factors play into which path is chosen. The scales often tip differently depending on the appetite of lenders and investors, market preference and year-to-date production goals. Some private lenders offer both agency and conduit loan programs. These can give borrowers multiple options that take advantage of the natural ebbs and flows within multifamily finance.

Despite the stress caused by COVID-19, finance activity within both the retail and office sectors also continues to rebound. Lenders now have some pandemic operating history as a baseline for how these property types will perform. Retail properties that are anchored by grocery stores and pharmacies, and even those that are shadow anchored or unanchored, are experiencing relatively strong performance and have fared well over the past few months.

Likewise, multitenant office properties with limited single-tenant exposure and reasonable occupancy levels are performing well. There’s a growing openness to these deals as investors demonstrate a willingness to accept these assets. Lenders now pursue these transactions when they include well-located properties and strong sponsorships, which is a polar shift from peak pandemic times when lenders heavily shied away from these deals.

Eye on hospitality

COVID-19 hit the lodging sector the hardest of all commercial real estate asset classes — not a surprise given the sheer volume and intensity of damage inflicted once all business and leisure travel ceased globally. Hospitality is still struggling to recover, but it is starting to see signs of improvement.

In May 2021, hotels added 34,600 jobs, according to the U.S. Department of Labor. This suggests that leisure travel is bouncing back. Hotels also are demonstrating impressive declines in their shares of delinquent loans, with a year-over-year drop of about 10 percentage points this past June. As the economy continues its return to normal, delinquency rates should continue to fall.

But this is minor progress in the grand scheme of hospitality. While everyone is rooting for the economy to stay on track and bolster the recovery of hotels, it’s still predicted to be a long time before the operating performances of many assets recover.

CBRE is predicting an uneven recovery for the hotel industry over the next three years, with domestic leisure-travel destinations recovering first and business-travel destinations rebounding more gradually. The overall outlook, however, is brightening as leisure-travel volume is up and companies are starting to resume business travel.

One thing is certain with CMBS: The market reacts to interest rate changes, partly due to their impact on capitalization rates. Interest rates and cap rates significantly impact the investment-sales market, which has historically been a meaningful demand driver for CMBS loan activity.

Additionally, the industry is continuing to monitor a key structuring element as the economy recovers — the confidence of lenders to continue to relax cash reserves when appropriate. This trend is already well underway and these decisions are being made based on the individual property in question, including its type, history and other variables. And finally, eyes are on investor demand for CMBS bonds. The return of retail-property financing has been a positive for lenders looking to meet bond demand.

The bottom line for commercial mortgage brokers and their clients is that the worst of the pandemic is likely behind us. CMBS is once again a viable option for many borrowers. ●

The post On the Rise appeared first on Scotsman Guide.

The low- and middle-income rental market needs a fundamental realignment to make it easier for developers to build these units and for workers to rent them. This means a need to change zoning regulations, reduce development costs, expand housing aid, and reduce the segregation of neighborhoods based on income or race.

New housing that is affordable to moderate-income working households has the potential to be the biggest growth area within the multifamily sector. This is a sector of opportunity for commercial mortgage brokers and lenders, as they can play a large role in providing solutions. No city in the country has enough rental units at moderate and lower price points to meet the housing demands of the local workforce.

The lowest-income renters rely on federal vouchers or tax credits to secure housing. But since no state or city has an adequate supply of subsidized rental housing, even residents who qualify for vouchers often can’t find places to use them.

According to the National Low Income Housing Coalition, the U.S. lacks 6.8 million rental homes that would suit extremely low-income renters — those at or below 30% of the area median income. In the nation’s 50 largest metro areas, the number of available homes ranges from 16 units per 100 extremely low-income renter households in Las Vegas to 50 per 100 in Providence, Rhode Island. Nationally, the figure is 37 per 100.

No city in the country has enough rental units at moderate and lower price points to meet the housing demands of the local workforce.

Affordability crunch

With market-rate rental housing, few cities offer enough units at prices the local workforce can afford. Options for Americans making 80% of an area’s median income are sparse.

Nationally, a median of 98.42 attainable units are available per 100 households at this income level, according to the Urban Land Institute (ULI) 2021 Home Attainability Index. Smaller cities place this ratio at nearly one to one. Albany, New York; Ogden, Utah; Tucson, Arizona; and San Antonio are among the top-performing metros for affordability. In general, however, big cities have the least affordable rental stock for households making 80% of area median income. Los Angeles has only 56 rental units per 100 households at this income level while Miami has a paltry 49.

The supply crunch means that many Americans face severe cost burdens for housing in cities, especially the largest ones. Nationwide, a median of 6.2% of households making between $35,000 and $50,000 per year are severely cost burdened by housing. But nearly 30% of San Diego residents at this income level are severely cost-burdened, as are 28% in both Los Angeles and Washington, D.C. New York, Boston, San Francisco and Baltimore all have high levels of severely cost-burdened, low-income residents as well.

The COVID-19 pandemic made affordability even worse. Unemployment soared and remains higher than pre-pandemic levels. The problem is particularly stark for workers such as frontline teachers, nursing and home health aides, and retail and restaurant workers, who often already struggle to afford moderately priced rentals.

Rent moratoriums allowed tenants to defer payments and stay in their homes. But now, low-income households have accrued deferred rent obligations over the course of the pandemic to the tune of at least $70 billion. The full consequences of the rent backlog still aren’t clear. But as the U.S. opens up, a wave of evictions and an uptick in homelessness could follow.

Racial disparities in the rental-housing market existed prior to the pandemic. According to this year’s ULI and PwC Emerging Trends in Real Estate report, 31% of Black renter households were classified as severely cost burdened in 2018, compared to 21% of white renter households, and Black renter households often spent more money for inferior units. Having accrued a disproportionate level of deferred rent debt over the past year, Black households are at particular risk of eviction and homelessness.

Oversupplying luxury

According to the recent ULI/PwC report, the rental market will likely pick up in 2021 after hitting a low point in the pandemic-altered 2020. But current rules and regulations make luxury units the most viable type of new construction.

New rental supply is geared to so-called “renters by choice” who have higher incomes. This supply, however, is not suitable to all renters from a design perspective. One-third of all renters are families, but the average new apartment comes in at 900 square feet, hardly big enough for a household with kids.

Demand for owner-occupied units also affects the rental market. Young families with moderate incomes often rent first, then save up to later climb a rung of the so-called “housing ladder” when they own a starter home. Eventually, they might move to a larger property before finally downsizing when their needs change as empty nesters.

The system works when every time someone moves up a rung, someone else gets on the ladder. When a family with a young child buys a starter home, it vacates a rental unit, creating new supply without the construction of any new rental units. But families often can’t save enough for a downpayment and don’t move out of their rental units. They stay put and so do vacancy rates.

And even if they had savings, many renters would struggle to buy a home due to soaring prices. The for-sale single-family housing market is booming, with price-to- income ratios on home sales hitting new highs in one-third of large U.S. cities.

Supply and demand pressures don’t operate in a vacuum but within a framework of rules and regulations that can create inefficiencies and even market failures — as is the case here. A working rental-housing market would have developers building lower-cost units for lower-income tenants, aligning the supply side with pent-up demand. But that’s not happening and it can’t until the framework shifts.

Multifamily units could play a role in homeownership. Townhomes, duplexes and condominiums can be perfect starter homes.

Getting on track

There are some obvious rule changes that would create a rental market that works for people at all income levels. Consider zoning. Major cities typically lack enough rental units to meet demand because neighborhoods simply say “no.” So, as the population and workforce grow, rents go up.

It will take political will from city councils to implement zoning-based solutions. These policies could unleash a wave of new supply, providing market-based rent relief nationwide.

By shifting zoning policies away from restrictions on use and density, and by allowing for greater definition regarding the scale and form of buildings, cities could enable more townhomes, low-rise apartments and duplexes to be added to historically single-family home neighborhoods. As a result, cities could rapidly increase their rental supplies. Accessory dwelling units in backyards or driveways, sometimes called “granny flats,” could add significantly to the rental stock in Washington, D.C., and other major cities.

Multifamily units could play a role in homeownership. Townhomes, duplexes and condominiums can be perfect starter homes. Greater density can enhance available ownership options for moderate-income renters for whom a traditional, detached single-family home is just out of reach. This also would reduce pressure on older rental stock, a process known as filtering, that helps to lower median rents.

Longer-term fixes also are clear. Discrimination based on source of income should be prohibited, making more units available to those with housing vouchers. Governments at the local, state and federal levels should expand voucher programs to include more than the 40% of eligible households served through the Section 8 and low-income housing tax credit programs.

These changes would improve racial and economic integration, too. Banning housing-voucher discrimination would enable more lower-income and minority households to access high-performing neighborhoods with better schools, health care services and the like.

Cities have, thankfully, started to address redlining legacies that create de facto segregation. In Kansas City, Missouri, for example, leaders want to improve the parks and open spaces in predominantly Black neighborhoods while ensuring that residents of multifamily housing have access to these parks and natural resources. The resulting neighborhoods could provide attainable rental options in previously low-density areas.

The pandemic may have shown that serving middle-income renters is a good business bet. While rents for luxury properties in large coastal cities have declined during the pandemic, vacancy rates have stayed low and rents stable among properties that serve moderate-income households — those earning at or slightly below the area median income.

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Likewise, in the future, developers that serve the middle class — and the commercial mortgage brokers and lenders that finance their projects — will find a market robust enough to provide a steady supply of reliable renters over the long term. Rental housing can work for everyone as long as developers, lenders, brokers, and local and federal policymakers create the conditions for a building boom. ●

The post Solving the Rental Puzzle appeared first on Scotsman Guide.

Co-living has become a popular lifestyle choice for working professionals in expensive major metros, such as New York City and Los Angeles, but it’s not only for young urbanites. The model just happens to be a perfect fit for supplying an affordable and better place to live for students all over the country.

Co-living is a relatively new term in commercial real estate that refers to a living arrangement where, typically, five or more adults share space in a portion of an apartment building. Normally, a person rents a private room with many of the same amenities as an apartment but shares certain common areas with others. These complexes are professionally managed and maintained.

This model has tremendous potential for growth outside of big cities, where co-living has already taken off as a niche sector of multifamily housing. Student-housing is an especially good fit for the co-living model given the large size of the U.S. student population and the demand for better housing options near college campuses.

Commercial mortgage brokers should be watching this sector. Investors need financing to do ground-up construction projects or acquire older buildings that may be suitable for conversions. The co-living model has the potential for a much higher return-on-investment ratio by yielding more rentable rooms at a less expensive per-room construction cost than a traditional apartment building.

Investor appeal

Multifamily investors will be naturally drawn to investments in co-living properties because the per-bed construction costs are substantially lower than that of a traditional apartment building. Design company Arco Murray, for example, compared the costs of creating a pair of 10-story, 138,000-square-foot buildings in Chicago using both models. The overall construction costs were 6% higher to build a co-living complex, but the per-room cost was 50% lower.

The key difference was that the co-living layout significantly increased the density of residential space. According to Arco Murray’s modeling examples, the traditional one- and two-bedroom apartment building supported only 135 beds, whereas a co-living building accommodated up to 288 beds. The per-room construction cost of the co-living apartment complex ($124,000) was less than half that of a traditional apartment ($250,000).

This student-housing market also has the potential to grow across the country. According to Statista, there were about 19.6 million U.S. college students in 2019. Some 14.5 million students attended public schools and 5.1 million were at private schools. The total number of college students is projected to grow to 20.1 million by 2029, creating a massive demand for housing.

Another factor that is bound to attract investors is that competition is inadequate. Today’s students want something more than to rent a bed in the basement of an old house or a studio apartment in a sketchy neighborhood. Other traditional housing options for students, such as dorms and off-campus apartments, can be unappealing for several reasons.

On-campus option

Dorms are typically the first choice of first-year students, who are often away from home for the first time, new to the area and want to get to know the campus. Student dorms, however, have a number of potential problems. Privacy is one. Normally, each room is shared by up to four students of the same gender.

Many schools also randomly assign students to rooms, which can cause personality clashes and conflicts over different living habits. Schools also may impose strict rules, which are necessary to ensure safety but can prove to be inconvenient and unsuitable for mature students who would prefer more freedom.

Dorms also vary widely in quality. Resident halls tend to be old and lack updated facilities. Additionally, they usually lack an in-unit laundry room. Students have to share the laundry with the entire floor. Students who live in dormitories also are normally required to purchase meal plans. The total cost for the entire school year can be expensive and the quality of food offered by school cafeterias is inconsistent.

Colleges often have a limited supply of rooms available to students, so even first-year students are forced to look off campus for living space. Yet off-campus housing options can be equally unappealing.

Student housing is an especially good fit for the co-living model given the large size of the U.S. student population and the demand for better housing options near college campuses.

Off-campus choices

Renting a room in a house is one of the cheaper off-campus options that provides an alternative for students who don’t want to live on campus but don’t have enough of a budget to live alone. But there are a number of disadvantages with this arrangement.

As with dorm rooms, there is a lack of privacy. The student will almost always have to share a kitchen, living room and bathroom with other people. Second, renting a house with others can cause disputes over living habits, shared cleaning duties and financial responsibilities. The leasing terms, for example, can be a source of conflict, particularly if one or more of the roommates fails to pay the rent on time.

Also, the student is typically renting a room directly from the owner. Typically, there won’t be a professional manager to ensure the property is maintained and that broken appliances, furnaces or leaky pipes are fixed promptly. The landlord may choose not to renew the contract or may raise the rent due to various reasons. In some cases, students are forced to hunt for a new place to stay midway through the semester.

Private rooms and homes for rent also tend to be unfurnished, forcing cash-strapped students to find couches, chairs and tables when and where they can. Also, students often must sign the lease and move in sight unseen. Any pictures posted on the listing website might differ from the actual rooms and many landlords won’t reveal hidden problems in the house.

Another popular off-campus option is a traditional apartment complex. Many apartment buildings have amenities, such as a gym, lounge, pool or rooftop. But these properties tend to be on the luxurious side and are unaffordable to most students. If the student shares the apartment with roommates, many of the same problems crop up regarding privacy, personality conflicts and competing lifestyles.

Co-living advantage

The co-living model can solve a number of these problems. Although co-living designs and layouts can differ, the student usually has a private room with its own bathroom. The typical co-living apartment building includes a modern furnished living area and kitchen. There is usually an in-unit laundry along with space to study, hang out and watch television.

Another feature that co-living fosters is a sense of community. In co-living units, the student is likely to meet like-minded people but without as much risk of conflict over bill payments and house rules. Remember that these facilities are professionally managed. The lease agreement is with a single tenant, so the student is only responsible for paying their share of the rent and doesn’t have to worry if other tenants fail to pay.

In summary, the co-living model provides the best aspects of dormitories and apartments. By offering affordable, private bedrooms in a fully furnished unit and implementing systematic management service, much of the co-living space in today’s market provides students with a better living experience in an ideal location at a lower cost. In addition, co-living apartments usually offer a safe and well-equipped social space for tenants to hang out with their friends.

The popularity of co-living is driven by an ongoing need for systematic management and the desire to have better-quality living arrangements. The ability to minimize the hassles involved in moving and renting while providing affordable, standardized living communities will be appealing to students and recent college graduates. For developers, investors and the mortgage brokers who do business with them, the high demand and optimal return on investment for these properties illustrate their promising future. ●

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Business methods have changed in ways nobody could have predicted even if they had a magic 8 ball, the old-fashioned game where you seek answers to hidden mysteries of the future. Companies are allowing more employees to work from home. People have more flexibility to leave metropolitan areas. As a result, vacancies for all types of commercial properties have increased in major cities. Downtown cores are somewhat out of favor. And, yes, hospitality occupancy rates are down, but will they stay down? Realistically, the answer is probably “yes” in many markets.

If companies downsize their space in central office buildings or relocate outside major cities altogether, the hotel sector has a long-term problem. In this scenario, fewer businesspeople will book rooms in these cities. But even for companies that opt to keep their employees at the office, hotels are still bound to lose some business. This is because COVID-19 and modern technology have changed how we do business.

Rather than jump on an airplane for a meeting in a crowded hotel conference room or one at a company’s headquarters, we’ve become accustomed to logging into Zoom via our high-speed internet connection from the comfort of our home office. The remote meeting is now an accepted alternative to a face-to-face meeting.

According to the Global Business Travel Association’s 2021 outlook, worldwide business travel is expected to increase by 21% this year after dropping by 52% in 2020, an increase attributable to widespread vaccine rollouts. But the trade group projected that business travel isn’t likely to recover to pre-pandemic levels until the middle of this decade. For the U.S. hospitality sector, the fallout from this shift is obvious. Hotels can expect less business travel for the next several years.

Rather than jump on an airplane for a meeting in a crowded hotel conference room or one at a company’s headquarters, we’ve become accustomed to logging into Zoom.

Foggy future

The outlook for destination-based business conventions is yet another question mark. Although live conventions have resumed this year, it is not yet clear if these events will be as popular as in the past.

Do we really need to physically place ourselves in a crowded bar after a day on our feet in a convention center to hear exactly what we could have heard on a live, online conference feed while resting on our couch? Opinions differ about the benefits of face-to-face meetings, but many companies may choose to stay home.

It is widely assumed that vacation travel will rebound quickly. Many people want to get away after a year of being cooped up at home. All of us desire a change of scenery and hotel operators can count on these travelers. But is this increased demand enough to make up for losses in business travel and conventions? It is unclear how many guests will occupy a hotel, how much debt service can be generated from occupancies and for how long. Can a market support a new venue? These are difficult questions that have no clear answers. One would do almost as well by asking a magic 8 ball for the answer.

Orlando is an example of how uncertain the outlook is in some markets. The city’s hotels did well in a market supported by convention attendees, as well as family vacations to Disney World and other attractions. Today, however, Orlando’s hotels can no longer automatically count on large convention business as they have over the past decade.

But Orlando’s hotels also will be hurt because local theme parks have implemented coronavirus-related restrictions and, in some cases, are limiting the numbers of park guests. In this regard, Orlando’s hotels have short- and long-term problems involving a temporary reduction in vacation travelers, and a possibly permanent reduction in convention business. This same scenario applies in other cities with a mix of themed attractions and conventions.

This isn’t to say that there isn’t some good news on the hospitality front. There are proven markets that have an unfilled need for hotel rooms. Many hotels located in suburban markets could get a boost if more companies relocate their offices from the downtown cores of major cities.

With the relocation of many corporate offices to suburban markets, a need exists for hospitality services in underserved markets.

Tepid forecast

With the relocation of many corporate offices to suburban markets, a need exists for hospitality services in underserved markets. For example, corporate offices have been moving to Palm Beach County, Florida, which once relied almost exclusively on vacation travelers. Several financial-services companies plan to relocate to downtown West Palm Beach. This city, located just north of Fort Lauderdale, is even being dubbed “Wall Street South” due to the interest being shown by these types of companies.

With an influx of corporate offices, Palm Beach County can now morph into a mixed market as more business travelers stay overnight. This likely means that it can sustain more hotel rooms, and lenders will be more willing to fund these projects if the proposal can be substantiated with the hard data needed to support a new commercial mortgage.

Domestic travel also has increased in many markets as people hunger for a break from living and working from their homes. A May 2021 article in The Wall Street Journal, for example, indicated that domestic air travel was already surging to destinations in Florida such as Key West, Sarasota and Orlando. Certain parts of California, North Carolina, Arizona, New England and other markets also have seen a spike in demand for hotel rooms.

On a national basis, forecasters brightened their outlook for hotels after a stronger-than-expected first quarter of this year. STR, for example, predicted that hotel occupancy rates will rise nearly 12 percentage points this year to reach 53.3% and will climb to more than 60% in 2022. The recovery in revenues, however, will take longer. At the end of 2022, revenue per available room (RevPAR) is estimated to remain 18% lower than its 2019 level, according to STR, and is not expected to reach its pre-pandemic level until at least 2024. Likewise, CBRE projects that RevPAR won’t eclipse its 2019 level until 2024.

Winning proposals

One thing the pandemic has taught lenders is that hospitality markets have changed — and likely for the longer term. Although the outlook is still cloudy in many markets, lenders are actively searching to fund solid hospitality opportunities.

Mortgage brokers who are looking to place debt for construction of a new hotel or the refurbishment of an existing one shouldn’t let the asset type scare them. If your foundation is solid and you can show the lender a logical proposition, there is a good chance of success.

You’ll need to show a logical sources and uses statement, and prove that the market can support the hotel. The borrower should expect to make a realistic equity investment and come to the table with a reasonable projection for debt-service coverage. If you can check these boxes, you will have an excellent opportunity to reach the closing table.

Keep in mind that debt providers are in business to disperse capital, but they will only consider logical opportunities supported by real equity in a market where the data and demographics speak to the likely success of the venture. A good presentation based on factual data will provide the information needed to make your lender an ally and partner for success in financing hotels during these uncertain times. ●

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The facts on the ground remain unclear and each side has evidence to support its view. The future of office space is the most interesting unknown facing the commercial real estate market, and the stakes will be high for mortgage lenders, brokers and investors in the coming months and years.  

There are those who think that central business districts (CBDs) are poised to do well, reasoning that trophy assets in prime locations will be winners in an era of uncertain demand. Others are convinced that suburban offices will outperform as tenants look for less density and shorter commutes.

To some, the relevance of U.S. gateway cities — New York, Chicago, Boston, Washington, D.C., San Francisco and Los Angeles — will inexorably decline as tenants migrate to lower-cost, lower-density locations. These markets, others note, have tremendous advantages that will continue to draw tenants and premium rent prices.

Some seem certain that coworking companies represent the future, despite the travails of WeWork. Others look at the big coworking names and are reminded of AOL and Netscape — firms that were early pioneers in recognizing that the internet would become a monumental global phenomenon but were unable to capitalize on it commercially. 

Here’s one answer based on what we have seen so far: Pick the geographic markets that are prospering and identify what these markets have in common. Do the same with the markets that are struggling. Beyond that, at this stage, it is impossible to generalize about the office market.

Pick the geographic markets that are prospering and identify what these markets have in common. Do the same with the markets that are struggling.

Spotting trends 

Commercial mortgage brokers will likely benefit from understanding the demographic trends that are driving marginal demand. Within a given metro area, however, lenders may prosper by returning to their roots and underwriting specific assets on a deal-by-deal basis. Preconceptions about suburban properties versus those in CBDs may not be helpful in such an ambiguous environment.

Much has been written about the COVID-19 pandemic’s intensification of the trend away from high-cost gateway markets towards alternatives in Texas, as well many Southeast and Mountain West metros. Anyone living in Austin or Raleigh is struck by the number of out-of-state license plates on the roads, and available data supports these anecdotal observations. 

As CBRE put it in its first-quarter 2021 office leasing report, “persistently low leasing velocity further weakened market fundamentals, producing one of the lowest quarters for demand on record. Larger, more expensive coastal markets were affected more than lower-cost and high-growth markets like Atlanta, Denver and Dallas.” These lower-tax, business-friendly markets were growing consistently before the pandemic and few dispute that the pandemic has accelerated these trends.

In 2020, California’s population shrank for the first time since it became the 31st state in 1850. Meanwhile, the top-five states for population growth last year were Texas (374,000 new residents), Florida (241,000), Arizona (130,000), North Carolina (100,000) and Georgia (81,000). In the past 10 years, Texas added 4 million people and Florida grew by almost 3 million, while North Carolina and Arizona added about 900,000 and 800,000 new residents, respectively, according to the U.S. Census Bureau.

It seems fairly obvious that commercial mortgage lenders and brokers would benefit from focusing on these markets — and indeed they are. While office properties around the country are seeing an increase in short-term renewals from tenants who are already located in a given market, booming Sun Belt markets have been benefiting from large-scale, multimarket searches for long-term corporate relocations.

An unclear future

Beyond these top-down demographic trends, it is difficult to predict what types of office assets will prosper. Older suburban office parks, which encircle many sprawling Sun Belt cities, were commonly wrestling with oversupply before the pandemic. Many tenants in these Class B and C properties are professional-services companies, such as local law firms, accountants, consultants and engineering firms. The largest fixed cost for these businesses is their office lease and it seems likely that many of them are reconsidering their space needs.

Yet some suburban office landlords are raising rents and have a waiting list of prospective tenants. These landlords generally own well-located assets in established, prosperous suburbs where supply is constrained, and from which the commute to the traditional CBD is lengthy and unpredictable. Demand for this kind of space comes from tenants that still want a traditional office — and would prefer an environment with food, drink, shopping and entertainment options — but would like to reduce or eliminate their commute.

It also is difficult to predict demand in the traditional CBDs. In general, they have suffered during the pandemic for reasons of which all market participants are aware. Yet here, too, there are some assets that are thriving. These properties demonstrate strong fundamentals as newer, well-located buildings with good amenities in healthy growth markets. There will likely be tenant interest in amenities such as air purification systems, touchless entry points and touchless fixtures in restrooms.

Demand for flexibility 

Concerns about the safety of working in close quarters with a rotating group of strangers dealt a heavy blow to coworking spaces, which many pundits consider a casualty of the pandemic. But the most important driver of coworking is flexibility, and the pandemic has certainly boosted demand for this.

Many tenants are attracted to short-term leases along with the ability to lease more or less space as needed while facing uncertainty about the composition of their workforce and the number of staff who will work from home. Tenants with large national sales organizations and small regional offices spread around the country, for example, may start to offer these dispersed sales-team spaces in a coworking location along with the option of working remotely.

This doesn’t mean, however, that the large coworking specialists are sure to be winners. Local and regional coworking companies, large office landlords, brokerage firms and even individual building owners can offer similar options. There may be an increasing realization that what coworking tenants want most are well-run, well-maintained facilities.

For many coworking tenants, however, cost is a primary factor and the national players are easy to undercut in any given market, since larger players have tended to lease space in trophy buildings. Even with major tenants that care more about a one-stop solution and strong operations than the lowest possible price, the established players must compete with landlords such as Tishman Speyer and Boston Properties, and brokerages such as CBRE are entering the market with capital and scale.

Accordingly, at this stage in the post-pandemic recovery, the Sun Belt markets are clear winners. With these markets, however, mortgage lenders and brokers need to look from the bottom up at the specific characteristics of a given asset. Coworking is here to stay, but the new supply is significant. The pandemic’s wild ride has yet to stop. ●

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