The annual Allen Matkins View From the Top brings together the top real estate economists, owners, investors, developers, and brokers in Western Region commercial real estate. Now in its 15th year, View From the Top remains a key source for market trends and predictions. Here are the top takeaways from this year’s CRE brain trust:
According to Michael Van Konynenburg, President of Eastdil Secured, although capital markets have been choppy, the positives outweigh the negatives in today’s environment. With increasing replacement costs, growing rents, a very strong job market, strong balance sheets, limited overleverage and high liquidity ($4.1 trillion on deposit at the Fed), commercial real estate is well-positioned for strong momentum in the second half of the year. He reminds us that historically, CRE performs well in a rising rate environment. But until FOMO starts to kick in, transactions will tend to be more “bespoke” placements.
There are a number of unanticipated challenges impacting commercial real estate firms right along with the rest of the country, including the war in Ukraine, inflation, rising rates and the prospect of a recession, but the work from home syndrome is still top of mind for most CEOs. As Owen D. Thomas, CEO and Director of Boston Properties, points out, “It has now become about balance of power – management versus labor.” He believes the issue is split by industry, job function, seniority, and geography. For TMG Partners Chairman and CEO Michael A. Covarrubias, the issue is still evolving as it has moved past fear of the COVID-19 virus to more of a cultural change. Thomas points out that there is a dramatic gap in performance between East Coast and West Coast. New York City is doing well, but the business district in San Francisco is suffering, with so many tech companies still working from home, the drop in Asian tourism, and the homeless problem. Thomas sees the primary business districts becoming more mixed use. “We need to work together to reactivate the cities through the arts, restaurants and the entertainment industry,” Covarrubias sees the industry becoming more project specific. “There are 4 kinds of recession: global, US, real estate and my building. Real estate is a local business.”
While the retail and residential sectors are making a strong comeback, Kilroy Realty Corporation’s CEO John Kilroy sees commercial real estate developers acting more cautiously. “For people to make decisions and be aggressive, they need to have confidence and right now, there aren’t a lot of places to feel confident.” With inflation, an inconsistent tax system and so much political rancor, there isn’t a lot of stability to be found. “Companies act like most families do,” says Kilroy. “If you’re uncomfortable about something, you wait, and that’s the pattern we’re seeing.” In this type of environment, there are big buying opportunities to be found, mostly for newer buildings. With the demand for activation and extraordinary amenities, old buildings are obsolete. By keeping what worked best in the office space, and incorporating what makes working from home desirable, reimagined offices can be a wonderful work environment and a wonderful people environment.
Elizabeth Hart, Vice Chairman, Newmark believes that what the pandemic taught us was the need for collaboration, cross-selling and a sharing of best practices, to create the best communities for tenants and to grow the real estate industry as a whole. According to Andrea Pierce, Managing Director Head of US Office and Industrial Asset Management, Starwood Capital Group, “We’re seeing such positive momentum thanks to the willingness of owners, service providers and law firms to work together as peers not competitors.” The flight to quality and experience continues, with tenants seeking new or reimagined space with large windows, full amenities and more open space to allow for greater collaboration, while activation also remains a key driver. Pre-built suites are in high demand; there is not a lot of interest in renovating because tenants want efficient space that is ready to go on Day 1.
In these uncertain times, businesses are not basing their leasing decisions solely on rental costs. Improvements and concessions are now playing a key role. According to Robert Paratte, Executive Vice President of Leasing and Business Development, Kilroy Realty Corporation, “Tenants have more questions beyond rental rates, like what does my labor force look like, where do I want to be located, is my space ready to go.” There will likely be more dynamic pricing on a lease-by-lease basis rather than sweeping rate cuts. While high interest rates aren’t going away any time soon, the experts on the Major Western Region Leasing Markets panel expect that the next six to nine months should give some clarity on the path forward. The bottom line is, until employees come back on a regular basis, companies can’t and aren’t making decisions.
While all the major bubbles – crypto, SPAC, tech stock and real estate – have essentially now burst, there are some positive investments to be found. According to Stephen Van Dusen, Managing Director, Eastdil Secured, “From a sector standpoint, fundamentals are the best – industrial, multi-family and also across the alts – data centers, single family build for rent and student housing.” For those that are sitting on debt, loan maturities are coming up at a very difficult time. But, according to Christopher Peatross, Founder and CEO, Swift Real Estate Partners, “Low unemployment spells hope in the office market. If we get people back in the office this could turn around quickly.” The public markets are saying asset values are going to move, while the private markets haven’t quite gotten there yet. ”There is an abundance of opportunity forthcoming,” says Jonathan Lange, Senior Vice President, Los Angeles Region, Boston Properties. “We feel it more on the public side. Our shares are nearing pre-pandemic close, which is very compelling for us and our teams as we think about how we deploy capital.”
The Western Region Investment Sales Markets panel also took a look ahead to potential topics for 2023. With inflation (hopefully) gone, the war in Ukraine hopefully coming to an end, and employees back in the office, there will be opportunities. We will know the definition of distressed and how high is high when it comes to inflation. Rates will be improved, the lending environment will be better and the debt markets will be operating better. The industrial and multi-tenant sectors will be doing fine. We’ll be talking more about adaptive reuse – conversion of office to life sciences, residential and hospitality. “In times of uncertainly, you have to have conviction,” says Van Dusen. “A lot of deals happen early in the cycle. It will look and feel a little different, but we’ll be trending in the right direction.”
In times of uncertainty, there is a flight to quality. “In these periods, quality really reigns supreme,” says Eliott Trencher, Senior Vice President and Chief Investment Officer, Kilroy Realty Corporation. “We’ll see winners and losers in the different sectors as well as a heightened bifurcation between high quality and low quality assets.” Peatross sees the haves at about 15% of the market and the have nots at 85%. “We need to get leasing going. Banks will not lend if they can’t see leasing,” he says.
Although construction costs remain high and schedules face long delays, projects continue to be built and delivered, particularly in industrial and life sciences. Due to staff shortages, the entitlement process in some jurisdictions can now take 18-20 months, up from 8-10 months pre-Covid. Applications that once took 30 days can now take 60-90 days to be approved. However, developers have continued to be served by their contracts, with force majeure clauses implicated in many of the discussions. Thanks to long-time, trusted partnerships with contractors, issue are being resolved without major disruptions. “We’re not in the business of putting our contractors out of business, “says Sam M. Cheikh, Managing Director, Assets Management and Assets Development, Hines Interests Limited Partnership. “When cost escalation issues come up, we try to partner with the GCs as much as possible so everyone is satisfied at the end of the day.“
While the first nine months of the year have been sluggish throughout the real estate industry, there are feelings of optimism based on the results of this year’s commercial real estate survey. Among the four asset classes, the sentiment for industrial continues to be positive. Retail is seeing mild optimism in most markets. The San Francisco and Los Angeles retail markets are still battling with the work from home dilemma but the booming housing market will help. There is also mild optimism in the multifamily sector, The office sector sentiment is neutral is Northern California and pessimistic in Southern California, although the slowdown is considered temporary. Companies see real value in employees returning to work and feel it will be embraced again as they recognize the benefits of culture, loyalty, creativity and mentoring.
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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