The bank, which saw Moody’s Investors Service lower its credit grade to junk status, suffered a drop of 70% in its stock price before recovering toward the end of the week. The recent troubles for NYCB began when the bank announced on Jan. 31 that it suffered a surprise loss of $252 million in the fourth quarter of 2023. The bank had notched a $172 million profit for the same period in 2022. It also reported $552 million in losses from bad commercial real estate loans. The hobbled bank slashed its quarterly dividend from $.17 per share to $.05 per share.

This might be just the beginning of tough times for NYCB, however. The bank’s poor performance was being blamed on the acquisition last year of $40 billion of assets from Signature Bank, which was among the three banks that failed early last year. Those failures set off alarm bells that the banking sector was in danger due to an increasing number of commercial real estate defaults.

NYCB is in the process of merging with Flagstar Bancorp, Inc., which operates 420 branches throughout the country, with an emphasis on the Northeast and Midwest. The acquisition of Signature Bank and merger with Flagstar makes the combined company one of the largest regional banks in the country, with more than $100 billion in assets. NYCB plans to start operating under the Flagstar name later this month.

There are worries that the troubles facing NYCB could spread to other top regional banks also holding loans for commercial real estate, including office buildings and retail properties, which could sour in the coming months and potentially create a repeat of last spring’s bank crisis.

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JLL’s U.S. retail outlook report for third-quarter 2023 stated that 145 million square feet of retail space has been demolished in the past five years. What has been the result of this change?

The reality is we are in a sub-5% vacancy environment right now. There’s literally no new space to lease. At the same time, there is a significant amount of retail demand for growth and expansion, and that is putting a lot of upward pressure on rents.

This year, we’ve seen rent growth in retail, something that hasn’t been achieved for a really long time. Compounding that is just the lack of new retail construction. If you go back to the 2006 through 2008 time frame, we were delivering about 150 million square feet of new retail space each year. But in the past couple of years, it’s been closer to 15 million square feet.

Do you see retail construction increasing this year?

In the short term, the answer is no. There are limited construction starts that are permitted and approved, or are already in the ground for 2024 and 2025. Given that there has been a reset in land values over the past 12 to 18 months, perhaps there will be an increase in retail construction. But it will have to be in 2026 and beyond. Costs have significantly increased, so it’s just really hard to make the economics work for new retail construction in primary and secondary market locations.

What do you see for the retail sector in 2024?

Rents are going to continue to rise in 2024, but the growth in retail is going to slow down a bit. I think we are still coming out of the pandemic-fueled environment, with retailers having great balance sheets and a lot of pent-up demand from consumers. But the consumer is coming under a little more pressure today, so I think that retail is going to continue to be really healthy, but consumers will be less exuberant and more realistic in their buying.

How will retailers handle the lack of new space?

Healthy retailers are going to be looking for creative ways to expand their footprint. They may retrofit vacant spaces that aren’t their typical prototype in order to build new stores. They may go into secondary and tertiary markets where they otherwise might not have gone before. You are likely to see some consolidation of retailers and that, perhaps, will create some opportunities either for expansion or addition through subtraction. If rates cooperate and we are in a lower interest rate environment — and given the amount of new capital that wants to be in retail — there is going to be a ton of investment activity in the retail space.

The JLL retail report showed that malls were still suffering due to negative absorption in 2023. What do you see happening with malls this year?

What’s happening in the mall space is continued bifurcation between models that are thriving and properties that require reinvention. The best-in-class, fortress-style malls are actually seeing increased productivity and really strong same-store sales growth. In most instances, the best of the best assets are performing as well, if not better, than they ever have.

How are malls reinventing themselves?

In some cities, you continue to see multifamily developments at malls. You will also see more medical offices. Malls are sort of living, breathing organisms, and I think they drive a lot of traffic. So, they have the ability to sustain and generate other uses at the mall as well.

A lot of the better-quality malls have more outward-facing food, beverage and entertainment elements to them. It’s not just pass through a door and enter a cavernous mall space today. There is a lot of activity in terms of repositioning and redevelopment, including creating exterior spaces around entrances. It is not just an inward-facing product anymore. ●

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Known as a top tourist destination because of its warm climate, sandy beaches, historic sites and enchanting cities, Spain is a nation of nearly 47.5 million people. Beyond tourism, Spain’s top industries include auto manufacturing, agribusiness and energy.

During the year ending in second-quarter 2023, Spanish investors proved to be quite interested in U.S. commercial real estate. During this period, some of Spain’s top companies acquired 17 U.S. properties totaling more than $2.2 billion, according to MSCI Real Assets. This amount alone is impressive enough. But the shocker is that the figure is 5,000% more than what Spanish investors spent from mid-2021 through mid-2022.

The increased activity vaulted Spain to fourth place on MSCI’s ranking of the top 25 sources of capital into U.S. commercial real estate. Spain trailed only Japan, Singapore and Canada on this list. Spain’s ascent has been meteoric as it ranked No. 7 in calendar year 2022 and No. 25 in 2021.

One of the main reasons for this considerable growth in activity was the real estate expansion of Pontegadea, a multinational investment company owned by Spanish billionaire Amancio Ortega. He made his fortune by founding the fashion retailer Inditex, the largest fast-fashion group in the world and the owner of the multinational clothing chain Zara.

Pontegadea, which is developing a large real estate portfolio, has been spending hundreds of millions of dollars to acquire a variety of U.S. properties. These range from Amazon-leased office space in Seattle to warehouse and distribution centers in California, Florida and Pennsylvania.

According to MSCI, Pontegadea acquired 12 industrial properties and one apartment complex in 2023. The main seller of the industrial assets was Blackstone, one of the largest landlords in the U.S. Pontegadea appeared to be capitalizing on Blackstone’s need for cash amid the commercial real estate downturn. Blackstone was known to be selling parts of its portfolio, including casino assets and various industrial properties that were performing well.

In 2022, Pontegadea acquired five logistics centers located in Tennessee, South Carolina, Virginia, Pennsylvania and Texas. The largest single U.S. deal by Pontegadea in 2023, according to MSCI, was the August acquisition of a 45-story apartment complex in Chicago for $231.5 million.

Pontegadea isn’t the only Spanish company that has recently expanded its real estate empire. The Mallorca-based travel conglomerate RIU Hotels & Resorts acquired a six-story office building in Manhattan for $173 million. The October 2023 purchase was an intriguing move for RIU, which owns 96 hotels in 20 countries. The building was slated to be demolished to make way for a hotel tower, but the previous owner was unable to secure permits from the city. It will now be up to RIU to convince officials to back a new plan.

Only time will tell if Spain’s major investors continue to find U.S. apartment complexes, offices and industrial space enticing. But it seems like a safe bet that the wave of acquisitions by Spanish investors has yet to end. ●

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The danger is that the current high interest rate environment will make refinancing the loans on devalued properties difficult and expensive, resulting in waves of defaults and more pain for everyone involved. A lot of numbers have been bandied about concerning the volume of loan maturities, but according to the Mortgage Bankers Association (MBA), of the $4.6 trillion in existing commercial real estate loans, about $2.6 trillion will mature in the next four years.

This issue became real in February 2023 when Canadian real estate conglomerate Brookfield walked way from $784 million in loans connected to two office towers in downtown Los Angeles. At the time, media outlets reported that Brookfield had made it clear months earlier that it might not be able to refinance debt obligations on the properties. Brookfield was described as a bellwether for where the office market was headed — and it wasn’t alone. That same month, Columbia Property Trust defaulted on about $1.7 billion in debt tied to seven major properties.

The defaults by two high-profile landlords helped to solidify a sense of foreboding, which has continued to this day. In this issue of Scotsman Guide, in fact, author Rob Finlay writes about the refinancing problem (“Scale the Wall of Maturities” on Page 30) and discusses what mortgage originators can do to help mitigate the impact.

What’s unclear is how large this massive wave of refinancing needs will be. Yes, the default rate is up and there have been a few high-profile cases, but the disaster has yet to hit commercial real estate on a wide scale. Is it possible it won’t?

Jamie Woodwell, the MBA’s vice president of research and economics, explains that there are aspects of this problem that industry watchers need to keep in mind. This includes the fact that loan maturities are spread over a long period of time, in a wide variety of industries and in every geographic location, so the results will be as varied as the properties in question.

Other factors may help to lessen some of the damage, or at least spread it out. For instance, Woodwell found that of the $4.6 trillion in commercial real estate debt, nearly $2 trillion is for multifamily properties, a relatively strong sector with typically longer loan terms than other asset classes. Less than 10% of multifamily debt was set to mature in 2023, but there will be more in later years. For instance, about 16% of current multifamily debt will be due in 2032 when the economy is bound to look much different than today.

Woodwell remembers when the MBA began creating its lending survey during the global financial crisis of the late 2000s. There were worries then, too, about a wall of maturities combined with limited capital availability.

“One of the key takeaways that we found then, that I think continues to be true today, is that commercial mortgages tend to be a relatively long-lived asset,” Woodwell says. “You have an awful lot of loan types out there and, among them, commercial mortgages tend to be longer in nature. So, even now in the peak of 2023, with the greatest volume of maturities in our survey, it’s still only 16% of the total outstanding balance.”

Inflation was also reported to be falling quickly at the end of 2023 and Federal Reserve members have said that rate cuts are in the offing. Such a move would greatly lessen the sting of refinancing.

That’s not to say that commercial real estate isn’t stressed. Property values have cratered, with Capital Economics recently estimating that overall commercial real estate values fell 11% in 2023 alone and are expected to shed another 10% this year. The office sector, alone is expected to lose another 20% in 2024.

Woodwell says there’s a great deal of uncertainty about where property values stand. But it’s clear that delinquencies are on the rise. Woodwell points out that, through the first 10 months of last year, delinquencies rose in all asset classes, with the office delinquency rate exceeding those of hospitality and retail for the first time since the onset of the COVID-19 pandemic. “We are seeing stress in the market,” Woodwell says. “Pretty much every capital source has reported an increase in delinquency rates.”

One sector that may do better than expected is retail. Capital Economics expects retail valuations to increase by 6% per year through 2028. Plenty of retail sites remain under stress, but Chris Angelone, the co-leader of JLL’s national retail group, believes that poorly run operations have already been flushed out, so the owners now in place at the better-performing malls are often the best operators. Lenders would be loathe to take back those properties when quality operators are already in place.

“I think, generally speaking, that lenders are going to work with their borrowers on performing assets,” Angelone says. “But obviously, the valuations are going to be much different than before.” ●

The post Will the market avoid the worst of the looming refinance crisis? appeared first on Scotsman Guide.

The subject of at least two books that was also mythologized in a Hulu documentary, WeWork — which at one point was estimated to be worth $47 billion — filed for chapter 11 bankruptcy this past November. The charismatic co-founder Adam Neumann, with his rock-star hair and flair for excess, is long gone, fired by the company’s board of directors in 2019 and walking away a billionaire, at least on paper.

When it comes to studying what went wrong with WeWork, the list is long, including a flawed business model in which the company made long-term leases on office space and then offered short-term rentals to individuals, startups and small businesses. The operation lost money during the best of times, leaving it unable to cope with the COVID-19 pandemic and changing attitudes about office work.

“WeWork is going to reject more leases than ‘The Golden Bachelor’ rejected potential suitors.”

Eric Sussman, adjunct professor of accounting, UCLA Anderson School of Management

There are many ironies to this story, including how some of the most powerful investors in the world were sucked into the WeWork vortex. They apparently believed Neumann’s hype that his operation would be a disruptive force in commercial real estate. But surely one of the most surprising twists is that the story doesn’t seem to be ending — at least not yet. WeWork, which still maintained 777 locations across 39 countries as of June 2023, is still alive and may end up coming out of bankruptcy as a viable company.

“The purpose of chapter 11 reorganization is to give the business a second chance at life,” says attorney Anthony Sabino, who specializes in bankruptcies. “Under chapter 11, a debtor company is explicitly allowed to continue to operate its business and maintain possession of its assets.”

Sabino says that WeWork will be able to accept or reject each of its unexpired leases. The accepted leases will either be paid or sold off while the rejected leases will become unsecured debts. “They will go to the back of the line with all the unsecured debtors scrambling for pennies,” Sabino says.

Additionally, the management team stays intact. “That is one of the zany things about chapter 11,” Sabino says. “The incumbent management team is allowed to stay in place, unless creditors unite and go to court to have them removed.”

All indications are that WeWork’s management team is moving fast on the reorganization. The Wall Street Journal reported that WeWork was proposing to reject 69 poorly performing leases, including 40 locations in New York City, and was negotiating with more than 400 landlords to amend existing leases.

“WeWork is going to reject more leases than ‘The Golden Bachelor’ rejected potential suitors,” quips Eric Sussman, adjunct professor of accounting at UCLA’s Anderson School of Management, referring to ABC’s hit dating show. As for whether the company’s fall will cripple the coworking sector, Sussman, who started a business in a coworking space, doesn’t believe so.

“Coworking has been around for decades,” he says. “WeWork was a flash in the pan with a new variant of the model, with beer kegs, pingpong tables and video games, but I don’t think there is any issue with the traditional coworking space.”

When it comes to lessons learned from this debacle, the last word goes to Aswath Danodaran, a professor of finance at New York University’s Stern School of Business. He made it clear in an email response that he was ready to move on from the WeWork story.

“The bottom line is simple: WeWork has always been a bad business with an awful management team,” Danodaran writes. “One VC (Softbank) pushed their pricing up to $47 billion before they fell apart, brought down by arrogance. It was deserved and no tears are being shed.

“If there are lessons to be learned, they are don’t be arrogant and [then] compound that arrogance with greed. But that lesson will never be learned. There will be more WeWorks in the future, with different players and different motives.” ●

The post The story of WeWork has yet to find an ending appeared first on Scotsman Guide.

Where does Cushman & Wakefield stand on the potential for a recession in 2024?

We have not been in the soft-landing camp for some time and that is still our position. We believe that the material change in monetary policy will continue to filter through the economy and that eventually we will see a contraction in output. Our forecast is that as we head into the second quarter, we will be reaching that tipping point. That being said, it’s a very uncertain business to predict turning points.

What are some of the market indicators you’re watching?

There are a number of indicators pointing to resilience and strength in the economy, and those tend to be tied to the consumer economy. They include factors such as the labor market, which is strong. We keep adding jobs but at a slower and slower pace. So, those are great signals of resilience, but they are not forward-looking. They don’t tell you anything about the future, but there are a number of leading indicators pointing to a turning point in the economy. They include the 10-year yield curve, which has been inverted for some time. Inverted yield curves tend to be very accurate predictors of recessions.

There are a lot of recessions where the yield curve is inverted about a year in advance. There are other instances where the inversion happened 24 months in advance. Given the sheer fiscal support and monetary accommodations across the economy in recent years, it’s going to take time to work through that. But we are seeing some interest rate-sensitive sectors already in contraction. And on top of higher credit costs, the availability of credit is significantly lower than it was 18 months ago. The tightening of credit standards tends to lead the economy by six to nine months.

What do you see for commercial real estate in the new year?

Both the multifamily and industrial sectors have tremendous supply waves coming. In both sectors, we expect demand to soften, but it will be positive. We estimate between 140 million and 150 million square feet of absorption in the industrial sector, with vacancy rates peaking at about 6.2%. We expect about 320,000 multifamily units to be absorbed and for vacancies to rise to about 9% at their peak.

How about the retail and office sectors?

Our data shows that the vacancy rate for retail is sitting at a 40-year low of about 5%. While we expect demand to soften and turn mildly negative next year, we still see vacancy rates only rising to the low-6% range, which is consistent with mildly positive rent growth.

The greatest challenge is in the office sector. We still believe the sector will be recording negative demand in 2024. This masks a tremendous amount of variation, though, around the country. We’ve seen incredible resilience in many smaller markets, especially in the South. In cities like Miami, vacancies have barely budged since the pandemic.

Then you have San Francisco and New York City, which are experiencing record-setting vacancy rates. Manhattan’s vacancy rate is about 22% right now. We think it will go up to about 24%. But even here we are seeing a lot of variation. We track roughly 1,400 office buildings in Manhattan. There are about 105 or so that have vacancy rates of 50% or higher. If you take them out of the equation, the vacancy rate falls to about 15%. So, there is an uneven concentration of weakness across markets and assets. ●

The post Q&A: Rebecca Rockey, Cushman & Wakefield appeared first on Scotsman Guide.

There is no end to the projects underway, including an ongoing adaptive-reuse plan for Los Angeles, which has been active since 1999, mostly in the city’s downtown core. In the first 15 years of the program, more than 12,000 housing units were developed, many in converted bank buildings. This year, planners have decided to expand the program citywide.

“We are in the Wild West with these projects, and developers like predictability and certainty in what they do.”

– Brooks Howell, residential leader and principal, Gensler

In Chicago, former mayor Lori Lightfoot is championing the LaSalle Street corridor revitalization, a massive $1 billion project that will repurpose 2.3 million square feet of vacant space in the city’s famed central business district into 1,600 mixed-income apartments. New York City also has a conversion program in place, but officials this year proposed state and city zoning changes that would extend flexible conversion regulations to an additional 136 million square feet of office space.

Many academic groups and private research firms are joining up with the adaptive-reuse movement. Many believe this process is a partial answer to the nation’s housing problem. A 2022 Rand Corp. report, for instance, identified 2,300 commercial properties in the Los Angeles area that, if fully utilized for residential purposes, could produce between 72,000 and 113,000 apartments, depending on the mix of unit sizes. This would equate to 9% to 14% of the housing units that Los Angeles County will need to produce by 2030. The report found that adaptive-reuse projects to convert hotel and motel rooms into studio apartments is typically a lower-risk proposition than converting office and retail spaces.

For all the excitement about such projects, however, there isn’t as much activity happening as one might expect. CBRE found that an average of 41 office conversions were completed annually between 2016 and 2022. The real estate services company estimates that the number of projects is expected to double, due to increased incentives and other help from state and local governments.

There are many difficulties for these projects to overcome, but the one aspect that may be insurmountable for many buildings is that the projects don’t tend to pencil out. Most office building conversions are too expensive to make the process financially feasible.

“There’s a lot of ink being spilled on this subject right now,” says Brooks Howell, residential leader and principal at Gensler, a global architecture, design and planning firm. “But the biggest challenge is the major cost mismatch. These buildings are going to have to sell really, really cheaply to make conversions work.”

Howell points to many parts of the building that can be problematic, including the size of the property. The sweet spot for most apartment buildings is about 350,000 square feet, which allows for the greatest efficiency in using all of the space. Larger buildings often need to be mixed-use projects with some floors remaining as office space. This is a problem because, under current circumstances, the office space may not have tenants and would essentially be unused, reducing the value of the building.

But there are many other problems with conversions, from replacing the skin of the structure, to putting in windows that open or adding balconies, which endanger the integrity of the facade. Other than the building itself, there are a variety of zoning regulations that vary from city to city which can upend a project.

There are also mechanical issues. Howell says that some of the reasons that office-to-apartment conversions are so expensive aren’t always the obvious ones. For example, it’s common to single out plumbing and other infrastructure aspects needed for apartments. Howell maintains that plumbing is a set cost and not as much of a problem as the building’s mechanical systems, including heating and air conditioning, which may cost tens of thousands of dollars per apartment unit if upgrades are needed.

“We are in the Wild West with these projects, and developers like predictability and certainty in what they do,” Howell says. “And you’ve introduced more unpredictability and uncertainty in this process. Not a lot of developers are comfortable with that, and I think that’s really what’s slowing the process.”

Due to the added costs, Howell maintains that most, if not all, of the buildings currently being converted are receiving some form of tax credits, usually because the properties are considered historic. It’s the only way for the numbers to make sense. He believes that for more conversions to work, it will require a coordinated effort by federal, state and local governments to develop tax breaks and other forms of financial incentives.

“The federal government is going to have to come up with some plan that allows this process to move quicker,” Howell says. “I’d love to see them step in and incentivize the conversion process. There are many reasons for it, including the fact that converting buildings is the most carbon-neutral way to build housing.

“The question is, how do we overcome all the different roadblocks? There is no coordinated and concerted effort to solve these problems, and there’s not one entity that seems to be in control.” ●

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“I don’t see anything changing unless and until there is a material shift in the economy. In fact, I see the trend getting stronger and I see downsizing by downtown office users continuing.”

One of the hardest-hit areas has been Chicago, which posted a suburban office vacancy rate of nearly 30% at the end of September, up from 27.3% a year earlier, according to real estate services firm JLL. One reason for the high number of vacancies may be that workers are digging in and demanding to work from home.

One recent estimate shows that 13% of full-time employees work exclusively from home, while 28% use a hybrid model. These estimates come after many months of corporate efforts to get employees back in the office. Scotsman Guide recently spoke with Richard Traub, partner at the real estate practice of Smith, Gambrell & Russell LLP, for his perspective on the suburban office dilemma and what it might take to break this paradigm shift of employees working from home.

What is your perspective on the suburbs being new centers for satellite offices?

I think the original assumption was that, following the pandemic, many employers realized that their employees didn’t want the long commute involved with coming back to the office. So, they thought, ‘We’ll bring the jobs to the employees by opening suburban offices.’ But I don’t think the employees have materialized, and now some suburban office owners are caught up in the same paradigm shift that office owners in the city are facing.

The idea of employees wanting to work from home seems to have either gotten stronger or held its ground. I think that instead of even commuting a shorter distance to a suburban office, people want the efficiency and flexibility of working from home.

What will it take to lure employees back to the office?

The problem is that you try and mandate or enforce a return-to-the-office policy, even one that could be considered flexible and not onerous, and people are simply going to vote with their feet and leave. They are saying, ‘If you mandate that I come back to the office, even if it’s in a more convenient location in the suburbs, I’m simply not going to do it.’ Perhaps a satellite office with all the latest and greatest amenities would change the equation. But with the unemployment rate at about 3.8% and businesses fighting for skilled workers, the employee still has a lot of negotiating power.

How do you expect businesses to deal with this paradigm shift?

You know, I’ve been wrong 4 billion times in the last few years. When COVID hit, I thought we’d be back in the office in three months, once I realized it was going to be with us for a while. Then I thought the vaccine would bring everybody back. When that didn’t work, I thought there would be a flight to the suburbs and satellite offices. None of those things have completely proven to be true.

My theory is that a portion of the employees of the world have the leverage right now to dictate where office work will take place. And they are voting that it take place at home. I think it’s going to take a seismic shift in the marketplace to change that dynamic, such as the unemployment rate has to rise dramatically and technology jobs have to disappear. Then the companies will be able to dictate that employees have to be in the office, or they won’t have a future with their company.

How companies deal with this issue really depends on which industry they are in and the power of the company. J.P. Morgan Chase, for instance, is demanding employees come back to their downtown offices. They are a major financial corporation, have immense power and can do that. But a law firm, for instance, has to be very careful about the demands they place on the members who pretty easily can move to a different firm or city.

What do you see happening in the coming year?

I don’t see anything changing unless and until there is a material shift in the economy. In fact, I see the trend getting stronger and I see downsizing by downtown office users continuing. I see more businesses shifting to newer buildings with more amenities in downtown Chicago, where I’m located. As I’ve said, the whole office situation is just a reflection of the overall economy and the power of the employee right now. We’ll see if and when that changes. ●

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In first-quarter 2022, West Virginia was the only member of this region to record positive economic growth. In Q1 2023, the region was led by the District of Columbia, which posted yearly gross domestic product (GDP) growth of 1.4%. North Carolina, South Carolina and Virginia each registered gains of 1%, with Maryland at 0.7% and West Virginia at 0.2%.

The region’s most powerful economy is North Carolina, which had a GDP of nearly $716 billion in 2022. Once known as a center for textiles, furniture and tobacco, the state is now a hub for manufacturing, research and technology. It boasts a manufacturing workforce of more than 455,000, the largest in the Atlantic Region. North Carolina also has more than 250 automotive manufacturers. Vietnamese automaker VinFast announced plans last year for a $4 billion electric vehicle plant at the Triangle Innovation Point southwest of Raleigh.

Virginia is second in the region with a GDP of $663 billion in 2022. The northern part of the state benefits from proximity to Washington, D.C. It’s estimated that 30% of Virginia’s economy is tied to federal agencies, workers and contractors. Many of the nation’s military headquarters and top federal agencies (including the CIA and the Pentagon) are in Arlington and other parts of Northern Virginia. Long an agricultural center, Virginia is now known as a trade, technology and manufacturing leader, but it remains a major producer of vegetables, tobacco, cattle and poultry.

Maryland has a GDP of $480 billion. Like Virginia, the state’s proximity to the U.S. capital is a major influence on its economy. The Capital Region, which includes five counties closest to Washington, D.C., accounts for about half of Maryland’s GDP. Top economic sectors there include IT, telecommunications, aerospace, defense and biotechnology.

South Carolina has a GDP of $297.5 billion. Its largest employment sectors include trade, transportation and utilities; government; professional and business services; leisure and hospitality; and manufacturing. The Palmetto State is No. 1 in the nation for exported sales of tires and passenger cars. BMW, Mercedes Benz and Volvo are among the automakers with operations there.

The District of Columbia had a GDP of $165 billion last year. The main industries include the various aspects of the federal and local government. Professional, scientific and technical services combine with administrative positions to account for more than 40% of all employment. The technology, hospitality and tourism industries also are key economic drivers.

West Virginia has the smallest economy in the region with a GDP of $97 billion. But it continues to be one of the nation’s most important mining states through the production of coal and natural gas. ●

The Richmond area continues to be in growth mode, with total employment increasing by 4.2% during the year ending in third-quarter 2023, according to Cushman & Wakefield. Such growth has also influenced the industrial property sector, where more than 1 million square feet (msf) of new space was delivered in the quarter.

About two-thirds of this space wasn’t preleased, helping to push up the marketwide vacancy rate to 3.3%. Some of the projects that were added in Q3 2023 include a 400,000-square-foot block of sublease space and a 242,000-square-foot data center.

While industrial starts have slowed compared to prior years, Cushman & Wakefield reported that the city’s current project pipeline totals more than 4.6 msf, with about 84% of this total preleased. Such figures point to a strong industrial marketplace. Leasing activity in the third quarter topped 1 msf and exceeded 3.8 msf for the year. A strong fourth quarter was also expected.

Another sign of the sector’s strength is evident in rent growth, which rose an impressive 11.6% during the first nine months of the year and was 57% higher since the start of 2020. New leases and renewals for second-generation space are going for $8.50 to $9 per square foot, better than the marketwide asking rent of $7.60.

What the Locals Say

Raleigh is probably in a better position than most cities right now, in all honesty. The city has become a hotspot for people from all over the country, whether they are from the West Coast, the Northeast or even Florida. That attraction of new people has trickled down to the commercial space, so businesses in general are still growing here.

That means properties are still being sold and refinanced, but that isn’t true of all buildings. Like the rest of the country, there are some properties that are vacant and others where landlords are offering free rental space to make it appear that there are tenants. With that said, Raleigh is one place where things are still moving and lenders have yet to hit the pause button.

Industrial and multifamily properties are still doing well. Airbnb rentals are OK. They are still able to rent but they are not as strong as they were a year ago. Retail is doing OK in Raleigh as well. Where you see the most vacancies right now are in the office sector. Those properties are having a hard time filling up, probably because of the work-from-home movement.

As for 2024, we are expecting more of the same. We’re getting more calls from borrowers telling us that some lenders are no longer lending. I see that continuing. I think the number of lending sources is going to shrink. But there will still be some lending, which means the market isn’t going to freeze. That is very important. If the market freezes, everybody has a problem.

3 Cities to Watch

Annapolis

The state capital of Maryland is steeped in American history and boasts a strong tourism industry. The charming port city of 40,000 people is situated on Chesapeake Bay, and it’s known for its various boatyards and as the home to the U.S. Naval Academy. St. John’s College, with roots dating back to 1696, is also located in the city. State and federal government agencies are the region’s largest employers, but there’s also a thriving technology sector.

Raleigh

Often rated as having one of the nation’s best economies, this fast-growing North Carolina city of 477,000 residents is one of the nation’s leading technology and science research hubs. Nearby is the famed Research Triangle Park, a 7,000-acre innovation center that houses more than 375 companies, including science and tech firms, government agencies and startups. Raleigh is also home North Carolina State University and a variety of business incubators.

Charleston

Founded in 1670, the South Carolina city of 153,000 people is a favorite with tourists who come for its beauty, history and Southern charm. This past April, The Wall Street Journal named Charleston as the sixth-best labor market in the country among small metro areas. The Port of Charleston, the deepest on the East Coast, is among the top 10 container ports in the U.S. The city is also home to Joint Base Charleston and a large Boeing operation.

Sources: Charleston.com, City-Data.com, City of Raleigh, Cushman & Wakefield, Data USA, Economic Development Partnership of North Carolina, Federal Reserve Bank of St. Louis, Maryland Daily Record, North Carolina State University, Research Triangle Park, St. John’s College, South Carolina Department of Commerce, South Carolina Ports Authority, Substack, The Wall Street Journal, Virginia Economic Development Partnership, Visit Annapolis, Visit Raleigh, Washington DC Economic Partnership, WFAE-FM, WJLA-TV, WorldAtlas.com

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After seemingly endless growth to feed an unquenchable economic hunger for warehouse and distribution space, one of the strongest areas of commercial real estate throughout the COVID-19 pandemic appears to be finally hitting the proverbial wall. According to Cushman & Wakefield’s Q2 2023 national market report on the industrial sector, two years of record-setting demand and cumulative rent growth of 30% has come to an end. Industrial properties, which many had hoped would continue to prop up the troubled commercial real estate industry, are evidently reverting to the norm.

While it may not feel like it, the report points out that demand for industrial space remains historically healthy. Absorption levels in the first half of 2023 were roughly on par with the levels seen in the years leading up to the pandemic.

“If interest rates continue to stay high, I wouldn’t be surprised if 2024 actually ends up with less activity than what we’ve seen this year.”

– Lonnie Hendry Jr., head of commercial real estate and advisory services, Trepp

On the bright side, Southern markets were continuing to expand and accounted for about 61% of total absorption. Savannah, Georgia; Dallas; and Houston led the way as each absorbed more than 3 million square feet (msf) in Q2 2023. A total of 21 U.S. markets posted at least 1 msf of net growth, more evidence of strength for the sector.

Conversely, a sobering figure is that 273 msf of space was delivered during the first six months of the year, but only 116 msf was absorbed. Many more properties are on the way. The industrial construction pipeline declined by 5.1% between the first and second quarters to sit at 624 million square feet of future development, so while construction starts are falling, that’s still a lot of space set to hit the market in the next few years.

Lonnie Hendry Jr., a senior vice president and head of commercial real estate and advisory services for data provider Trepp, isn’t worried. He says the industrial slowdown is part of the natural progression of the sector as it slows from its earlier frenetic pace.

“We are just naturally plateauing from the post-pandemic highs,” Hendry says. “There’s been a lot of new supply added during the past three-plus years, most of which has been absorbed. But if you read the headlines about the sector, Amazon.com has put a pause on any new developments, and they were a primary driver for a lot of the industrial development and absorption. So, I think this is just a natural part of the cycle.”

Trepp doesn’t see anything in its data that shows the sector is in decline or merits overly negative sentiment, Hendry says. Instead, the industry is just at a cooling point. He points out that while many of the properties on hold are the large distribution centers used by Amazon and other major retailers, there is still a lot of interest in Class B warehouses in the right geographic areas where demand is growing, such as the Sun Belt states.

“I think that sector is still on fire,” Hendry says. “Good urban Class B industrial property is hard to come by, so if you have a reasonable clear height and dock-height doors or access points, those properties are still coveted in the market.”

Doug Ressler, manager of business intelligence at commercial real estate research firm Yardi Matrix, agrees that the current slowdown in the industrial sector is about normalization. He argues that there is still a lot of money going into the industrial sector that has yet to be seen in action.

“Everybody wants to put a fork in industrial and be the first ones to call its demise,” Ressler says. “They want to be the first to say, ‘I told you that it was going to heck in a handbasket.’ But really, when you look at the money going into supply chains, we still haven’t seen the money from the CHIPS and Science Act (the $52 billion legislation backed by the Biden administration to support semiconductor manufacturing in the U.S.) reach the economy yet. We haven’t seen the resupplying issue that will bring a lot of money for an improved supply chain and benefit the industrial sector. That may take three to five years.”

Recent troubles with low water levels in the Panama Canal have slowed international trade while raising the prices to import goods. Ressler says that these difficulties could mean further reshoring of industrial production to the U.S., along with rebuilding of the infrastructure for manufacturing and other areas of industrial production.

“(The U.S.) is still late in getting the reshoring effort into gear,” Ressler says. “But once that does kick in, you are going to see that the biggest recipients are the industrial companies.”

In the short term, Hendry says that the health of the industrial sector and the rest of the economy will be tied to the Federal Reserve and its fight with inflation. The industrial sector is likely to continue its cooling trend for at least the first few months of 2024.

“We just haven’t really felt the full impacts of those interest rate hikes that have taken place during the past 18 months,” he says. “If interest rates continue to stay high, I wouldn’t be surprised if 2024 actually ends up with less activity than what we’ve seen this
year.” ●

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