What Happened in the 1st Half of 2023 by Howard Freedland

It is hard to believe that it is June, and since we are within a few days of closing the first half out, let’s look at the state of the state in Commercial Real Estate. I’m Howard Freedland, and this is your Echo Commercial First Half Report 2023.

Before we get into it, I need to mention something important. In my experience, the ability to deliver tough news is much more important than knowing how to deliver good news. After all, anyone can say “We Win!” pretty easily (I am, actually, just learning how to do this – I am a Detroit Lions fan). Consequently, knowing how to deliver tough news is more important.

My delivery is direct and factual.  I am not going for hyperbole…I am trying to put our reality into perspective.  It is the only way that I know how to make good business decisions going forward. So, after a few years of booming prosperity, we have met some challenges. You will read about some of them below, but please, read until the end. The outlook is brighter than the past has shown.

1. In the first quarter of 2023, Commercial Real Estate investment declined by 57%, year over year. Global volatility, falling valuations, banking turmoil and broader macroeconomic headwinds have dramatically slowed CRE investment volume. According to CBRE, annual investment volume fell by 57% to $78B in Q1.

Institutional and international investors were the largest real estate purchasers, whereas private investors and REITs were sellers, on average.  Many firms, even those investing in favorable markets like multifamily and industrial, are waiting out the storm. Much of the reason is related to the fed funds rate exceeding 5% at the end of May, with two more increases expected by the Fed before the end of the year. More on that later.

2. According to Green Street’s Commercial Property Price Index, May prices dropped by 15% over the past year, following a peak in Q1 of 2022. According to data from the price index, institutional quality building prices have dipped below pre-pandemic prices for the first time. Rising interest rates, lower occupancy, and uncertainty in financial markets, have largely dampened commercial prices.

According to RCA’s property price index, commercial prices continued to fall in March of 2023. Apartment prices saw the steepest decrease at 10.3% YoY, while retail fell 5.8%. Suburban offices fell by 5.6%, while central business district office pricing fell by only 2.9%. The RCA property price index fell by 8% over one year.

3. Florida, however, has seen stagnation and even escalation in certain sectors in CRE. Industrial Multi-Family rent rates have grown this year, while retail and office have slowed their roll. But, look out for the silver lining…

Effective December 1, 2023, the State of Florida’s sales tax rate on commercial real property lease payments (including base rent and additional rent) will be reduced from 5.5% to 4.5% for payments received for occupancy periods beginning on or after December 1, 2023. Examples of taxable commercial real property rentals include commercial office, retail space, warehouses, convention and meeting rooms, and self-storage units. My projections for the back half of 2023 and into 2024 will be next week’s focus.

4. As high capital costs and ongoing inflation stifle transaction activity, the commercial real estate industry has largely shifted toward biding time until borrowing costs decrease, and investments offer a more attractive expected return.

Furthermore, lending dropped significantly in the first half of this year. The CRE Lending Momentum Index declined by 33% quarter-over-quarter and 53% year-over-year. That is a staggering reaction to bank failures, quantitative stagnation (I would put tightening, but that has only happened recently) and much higher interest rates.

Deep Knowledge Investing’s Gary Brode states “Others are saying that we’ve had a historic decline in the money supply which will lead to disaster. Technically, this language is correct, but ignores magnitude. Yes, M2 is down, but look at the chart below to see this “historic” decline. Do you see the problem?”

This has led to valuations falling as transaction volume stagnates or declines, depending where in the country you are looking. REITS, or Real Estate Investment Trusts, are selling more that buying, and investors with cash are hanging out until prices finally start to subside.

5. Many are preparing for impending refinancing doom. I wrote two weeks ago that The Mortgage Bankers Association (MBA) estimates that “of approximately $4.4 trillion of outstanding commercial and multi-family mortgages, $728 Billion (16%) matures in 2023, with another $659 Billion (15%) maturing in 2024. Approximately 25% of this is in the office sector.  When these come due, the refinancing will be at a significantly higher rate than what the holders are paying, and decisions will have to be made.

Ok. Take a breath. That…was…a lot. I get it. With every boom, there is a decline. And, with every challenge, new, creative real estate investment positions arise, which leads to more growth. Going forward, I see interesting opportunities available, and will shed some light on them in my predictions for the next six months in South Florida CRE. Next week, I will put the back end of 2023 in perspective with my expectations for growth, the economy and liquidity, and will discuss how to make the most out of the opportunities that will arise.

Howard Freedland is our Echo Commercial Properties Real Estate Specialist. As an independent wine broker, Howard has executed international deals with corporations and conglomerates. While working with Echo Fine Properties, Howard is a part of a team currently managing the interests of national and international companies wanting to secure land and property in South Florida. All of his prior business experience has brought him to this point as a professional, effective real estate leader. You can contact him on 561.889.2735 or Howard@EchoCommercialProperties.com.

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Search the Commercial MLS

If you are as old as I am, you remember…

the Michael Jordan vs Larry Bird commercial for McDonalds. They play a game of horse where the loser watches the winner eat a Big Mac. Simple, right? Only, neither of them would miss a shot. The shots got more and more difficult, until they became ridiculous. “Off the scoreboard, bouncing twice, nothing but net!” And then, swish. Today’s discussion talks about nothing but net, more specifically, single, double, and triple net in Commercial Real Estate. I am Howard Freedland, and this is your Echo Commercial Tip of the Week.

So, what exactly is net billing?  With leasing, there are several ways to build the cost for the tenant. Let’s focus on the three nets. Each has a certain number of benefits and risks to both tenant and landlord.

Single net is not very common. This is where the tenant pays for property taxes, but insurance, maintenance, repairs and utilities are the landlord’s responsibility. This is risky for the landlord, because if the tenant is late or does not pay, they are on the hook for the expenses. Therefore, they are usually included in the rent payment. This leads us to-

Double net, which is a more popular choice, especially in Commercial Real Estate. This is where the tenant pays the property taxes and insurance in addition to their rent. The rent is more often lower because of the expenses. All maintenance is the responsibility of the landlord. There is more security in that the larger costs for the property are amortized into the monthly rent, with only upkeep being held out.

The least risky program is the Triple Net. This billing format rolls every cost into the rent. This will lower the base rent quite a bit, and help the landlord make their responsible payments on time. The benefit to the tenant is that with rent lower, and the other costs at a pass-through level, they have more control over the long haul to control their overall rent cost. Obviously, the cost is that the tenant is responsible for paying all the other costs up front every month instead of having the landlord pay for them.

What happens when the maintenance costs are higher than expected? One scenario can include tenants trying to get out of their leases or obtain concessions. To pre-empt this, landlords can set a bondable double net lease, which cannot be terminated before the term date. The benefit is that rent is locked in for a longer term and have a more favorable rent cost.

So, now you know the type of net leases. Simple as draining a jump shot from the rafters that bounces off the mascot, off a seat in the crowd and *Swish*. Remember, though there are choices, landlords often choose nothing but net!

Howard Freedland is our Echo Commercial Properties Real Estate Specialist. As an independent wine broker, Howard has executed international deals with corporations and conglomerates. While working with Echo Fine Properties, Howard is a part of a team currently managing the interests of national and international companies wanting to secure land and property in South Florida. All of his prior business experience has brought him to this point as a professional, effective real estate leader. You can contact him on 561.889.2735 or Howard@EchoCommercialProperties.com.

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Search the Commercial MLS

During the past three years, we have seen a constriction of supply in the commercial real estate market…

 

Howard Freedland, one of our high-powered agents, has focus, aptitude and is excellent in Commercial Real Estate.  I asked him to write about the state of the commercial market in Florida and across the county.  Some of what he wrote can best be explained from a recent trip to my hometown in Highland Park, Illinois, we passed by the old Toys R Us. It was still boarded up since it closed in 2018 (Toys R Us closed nationwide in 2018).  In Palm Beach Gardens, the Toys R Us was snatched up right away and a PGA Tour Superstore retail store took over at light speed.  I saw lots of office vacancies in Chicagoland.  Here in downtown West Palm Beach, the movie theatre at Rosemary Square and office space is supposedly coming in for all the hedge fund and investment players relocating.  It’s a really a prelude to Howard’s article.

• You can read about the state of the Commercial Market here.
• Search the Commercial MLS here.
• Look at our New Commercial website including searching by category here.

Commercial Real Estate is kinda the exact opposite of residential Real Estate.  Residential is for living-in while commercial is more for working-in or making money.  Buying, selling, and leasing office space, medical space, warehouse, industrial, retail, income producing properties and much more. Searching for properties and how the commercial Real Estate world works verses how residential searches operate can best be described by my kid’s personalities. Opposites!

College is out this week and across all of America, the “Summer Interns” will be out and about next week. Like most of you, if you have kids, they get summer jobs.  I was no different. One year I was a Popcorn Vendor at Ravinia Festival in Highland Park.  I had to finish popping the popcorn by the time the Chicago Symphony started or else!!!!  The last time I was there, Gordon Lightfoot sang.  Unfortunately, for old Gordo, the church bell chimed this week, and he joined the Edmund Fitzgerald crew in the big lake they call Gitchee Gumee.  For you youngsters who don’t know the true tale….

I looped like in Caddie Shack and then worked summers for my Dad’s business.  One summer in the warehouse lugging fabric over the shoulder, another keeping track of inventory (I wasn’t very good at it), customer service, and finally sales.  I took a trip by myself selling fabric to Milwaukee and Minneapolis St. Paul.

Went back to school and realized after the selling summer, I learned a lot more as an intern than in college. Simon & Garfunkel had some of it right in the song Kodachrome, “When I think back on all the crap I learned in high school
It’s a wonder I can think at all.”

Fortunately, Paul & Artie are still with us.

Sam and Jade like lots of our kids are polar opposites.  Sam hates pizza.  Jade loves it.  Sam is a film major at UCF and very into animation, moviemaking, and all things computers. Jade is an entrepreneurship major at FSU, loves the beach and is an early riser.

Which brings me back to the commercial market. There is no one way to search for commercial listings. More like 3 ways…

Residential puts everything online.  Commercial does not. So, to properly search for commercial, keep in mind the following……

1. You need to search the Commercial MLS (you can do that here and by category)
2. You have to have a commercial agent check Co-Star which the public does not have access to.  A portion of what is available is on Loop Net but around half is not.  So, this is very much like old time Real Estate.  Only the commercial agents have access to what really is available.  Commercial,  is also vastly different with completely dissimilar sets of negotiations and terminology. In essence, you need a commercial specialist.
3. Your commercial agent has to dial – as in dialing around and networking to see what else is out there (if anything).

The Commercial website we just launched will have lots of tips and tricks that we will post and provide links to, which will explain the commercial world better in case you ever are in the need for such space.  Below is the first update on the state of the Commercial Market.

 

Commercial Real Estate – Florida Gets “Credit” Where None is Due

–Howard Freedland

During the past three years, we have seen a constriction of supply in the commercial real estate market (CRE). In South Florida, there is a serious shortage of cost-effective, quality industrial, retail and agricultural properties available. The fact that we have become a destination state in the past few years, sporting tax and development incentives that many other states do not, keeps our demand much higher than national averages.  However, we may be in a position where that is going to change rapidly. Credit cost and availability may cause many to reconsider their holdings, thereby creating an opportunity to buy more reasonably than in the recent past, or in some negative cases, seeing a rise in defaults.

The premise is that the Federal Reserve has raised the discount rate from near zero to over 5% in less than a year and a half, which has caused revolving credit to become very expensive compared to the time that it was acquired. Furthermore, both large and small banks are seeking inflow rather than outflow (again, the Fed’s idea that taking money out of the system will help wrangle inflation) credit is getting harder to get.

Andrew Nelson, real estate economist with deep experience in the property sector, offers that Vornado Real Estate Trust, a large REIT that focuses on properties in New York, Chicago and San Francisco, reports on their April K-8 filing that they are being cut off from credit.  “There is no new debt available…when a loan comes due, the only refinance available (and that is with a fight) is from the existing lender.” They are referring specifically to office structures specifically, but the problem is permeating other sectors of CRE as well. Nelson Economics analysis of Federal Reserve Bank of Dallas survey offers sees lenders becoming more risk averse, seeing tightening credit standards rise 10-15% from 2022 which correlates to a similar drop in credit volume.

Banks saw deposit outflows in March reach $250 Billion from small banks and $150 Billion from large banks. $400 Billion in withdrawals has increased the concerns that banks need to pay immediate attention to deposits. April has been flat, but stopping the bleeding is not correcting the problem.  Catherine Rampell of FloridaRealtors.org reports that the Federal Reserve reported that commercial bank lending fell by over $100 Billion in the two weeks ending March 29^th. This is the largest cutback in bank lending in dollar terms going back over 50 years.

The Mortgage Bankers Association (MBA) estimates that “of approximately $4.4 trillion of outstanding commercial and multi-family mortgages, $728 Billion (16%) matures in 2023, with another $659 Billion (15%) maturing in 2024.  25% approximately of this is in the office sector.  When these come due, the refinancing will be at a significantly higher rate than what the holders are paying, and decisions will have to be made.

Nationally, property values are falling.  After peaking in 2022, estimates are showing CRE down 15%, led by 25% declines in office and 21% in apartments.  Cap rates are rising, which signifies more risk overall in the market.  All of this supports lower debt levels on the horizon.

Again, South Florida has been a unique entity for the past few years. We have lured hedge funds that have moved their base of operations to the Palm Beaches and have a healthy number of new restaurant groups that are opening successful eateries all over the area. Population continues to grow every year, and where there are people, there are opportunities for growth.

Goldman Sachs offers a potential silver lining to the debt shortage:  Private investors are stepping in to lend to CRE as smaller banks may be forced to step back. There will be capital available to those that can afford it. The caveat is knowing what one can afford. In South Florida, with demand holding tight and supply remaining low, it will be interesting to see if this banking cloud dissipates or turns into a named hurricane.

 

 

Jeff Lichtenstein, originally from Chicago, got his start in the home furnishings textile business where he traveled over 35 weeks a year selling fabrics. After the family business was sold, Jeff moved to Florida and became a real estate agent. Today he is the owner and broker of Echo Fine Properties, a luxury residential brokerage voted best brokerage of the year. Jeff manages a non-traditional model of real estate that mimics a traditional business model. Echo has 80 agents, an average of one million dollars per transaction and over 500 million in annual sales. Between traveling for work and annual family trips to national parks with his wife and 2 now adult children, Jeff has visited 49 states. He is also one of the few Chicago White Sox fans you’ll ever meet.  Some publications he has been quoted in.

Feel free to ask him a question directly at jeff@EchoFineProperties.com including a complementary  valuation of your home.

Welcome to our new ECHO Commercial blog!