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Good morning. Capital Economics predicts that office buildings will face a lengthy path to recovery. A top NYC broker reveals the three hottest property sectors that are expected to experience increased activity this summer. Meanwhile, the ‘Extend and Pretend’ strategy in the real estate industry is reaching its limits and running out of time.

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US Office Values Unlikely to Rebound Before 2040

According to Capital Economics, the golden era of US office buildings might be on a long hiatus, with pre-pandemic values not expected to rebound until at least 2040, thanks to the dwindling demand for desk space.

Tough road ahead: Adding to the woes, the London-based firm predicts a steep 35% plunge in office building values by 2025’s curtain call. The architect of this downfall? The rise of hybrid and remote work that has halved office usage since the pandemic, as per Kastle Systems’ data.

The defaults: The storm has already hit some heavyweights. Major institutional investors, such as Brookfield, are pulling back on loan payments, choosing the default path rather than pouring more green into bottomless pits. Brookfield has notched up a $1.1B default linked to three Downtown LA skyscrapers and now flirts with an extra $400M default on another tower.

The distress: As of March, approximately $18B in office real estate was already under strain, with MSCI Real Assets cautioning that an alarming $43B could soon join the default dance. Economist Kiran Raichura suggests that demolishing or converting the least valuable assets might help balance the books somewhat. However, the landlord’s ledger will ultimately feel the sting, setting the stage for a challenging journey for office owners.

➥ THE TAKEAWAY

A twist of déjà vu: The current circumstances echo the decline of shopping malls with the rise of e-commerce, underscoring the transformative impact of technological and social changes on real estate. Landlords and investors will face a tough road ahead, necessitating innovative strategies to navigate this transition, much like the retail industry had to adapt to the surge in online shopping.

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NYC’s Hottest Property Sectors Turning Up the Heat this Summer

Even with a 53% drop in investment sales volume in NYC from Q4 2022 to Q1 2023, some savvy investors view the $2.2B in completed sales as a sign of opportunity. Cushman & Wakefield’s Jonathan Squires elaborates on this, pointing out three attractive investment sectors in NYC’s CRE scene.

Subsidized Housing: A housing crisis and increasing interest rates have led to the devaluation of multifamily properties, making them an appealing option for long-term investors. Especially with the expiration of the 421-a tax exemption, multifamily properties can now be acquired for less than their building cost, making rent-stabilized properties particularly enticing.

Outdoor Parking/Storage Facilities: As infill industrial properties continue to flourish, the demand for outdoor parking/storage facilities has surged. Many of these facilities have been repurposed for last-mile distribution centers, leading to a shortage of supply and subsequent increases in sales prices. Investors keen on these properties must act quickly to seize opportunities due to the limited supply.

Neighborhood Retail: Which refers to local businesses offering services and goods that can’t be ordered online, represents another sector poised for investment. This includes a range of local establishments, from boutiques to bistros to dry cleaners. The potential return on investment is substantial, especially for properties with high-credit tenants, despite the expectation of increasing rental rates for well-located properties.

➥ THE TAKEAWAY

Buy low, sell high: Though prices may drop further in the year, Squires warns against waiting too long, emphasizing the significant value currently present. Prices are at all-time lows, he says, making it a compelling time for investment.

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Time is Running Out for the ‘Extend and Pretend’ Strategy

Commercial real estate is navigating turbulent waters, grappling with soaring interest rates and surging vacancies. Leaders in the industry convened in Times Square to discuss these challenges, placing significant emphasis on the “Extend and Pretend” strategy, which is now under scrutiny.

Post-pandemic market shifts: The pandemic reshaped real estate, shifting the purpose of office spaces and intensifying scrutiny on banks and insurers involved in property lending. Demand for commercial property debt remains robust, but supply is limited, causing property values to inflate and creating challenges for landlords seeking refinancing. This puts the effectiveness of the “extend and pretend” strategy into question.

A looming crisis: The US commercial property market, worth $20 trillion, is teetering on the edge of a crisis. Lower-tier investments risk becoming unviable, and transactions made during the 2021 peak might endure considerable losses. Anticipated depreciation of property values by 30% or more, $1.3 trillion in commercial loans maturing by 2025, and heightened caution among lenders may lead to bank losses and depositors withdrawing their money, thereby pushing banks towards instability.

Understanding the root cause: Historically, financial crises in real estate have been attributed to unchecked profit pursuits. This time, the triggers are different. Regulations post-global financial crisis and 15 years of ultra-low interest rates had painted commercial real estate as a relatively safe investment, but the pandemic disrupted this perception. The sector now faces unique hurdles, including high inflation, increased consumer spending, and rising interest rates.

➥ THE TAKEAWAY

Opportunities amid challenges: Despite these difficulties, some industry players remain hopeful, asserting that properties can still attract tenants at the right price, assuming lenders can endure the turbulent times. However, problems may arise when lenders must acknowledge current values, marking a potential failure point for the “extend and pretend” strategy. The ability to adeptly navigate these complex financial and regulatory terrains may be key to the recovery and evolution of the industry.

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• Last-minute proposal: Real estate magnate Larry Silverstein has joined the race for an NYC gambling license. His proposal calls for a 1.8 MSF development of two 46-story towers.

• Fewer dollars: US money supply saw a fifth consecutive monthly decline in April, an unprecedented trend that provides optimism for a continued decrease in inflationary pressures.

• Deal of the day: Tishman Speyer has secured $750M in financing for the Harvard Enterprise Research campus in Boston, marking the largest construction financing package of 2023.

• “Common sense”: NYC Council Member Chi Ossé introduced the Fairness in Apartment Rental Expenses Act, a bill that transfers the broker fee payment responsibility to the party hiring the broker.

• Relocation trends: New data from BoA indicates a migration pattern among different generations: Baby Boomers are increasingly moving to Las Vegas and Tampa, while Millennials favor Austin.

• Cost of coverage: Americans should proactively plan for the increasing likelihood of non-renewal of their home insurance coverage. Here’s why.

• Real assets: Andreessen Horowitz, a renowned venture capital firm, has disclosed in a recent SEC filing its plans to enter the wealth management sector, expanding beyond its traditional focus on tech investments.

• Boost recovery efforts: San Francisco officials are taking steps to convert office spaces into residential properties, aiming to boost the local economy amid record-high office vacancies.

• Questionable figures: The latest U.S. Census Bureau data shows a significant surge in multifamily construction starts in May 2023. However, there are reasons to doubt the accuracy of these numbers.

• Rent regulation in NYC: Despite the benefits of affordable rent-stabilized apartments, rents are set to rise for the second year in a row.

• SEC in jeopardy: The 1.2 MSF HQ for the Securities and Exchange Commission in Northeast Washington, D.C., which is one of the largest federal government leases to date, is in danger of collapsing.

These are America’s most affordable rental locations: Out of over 300 metro areas, 46 have average monthly rents under $1,000. Among them, 13 are below $900, and three are below $800: Fort Smith, AR ($686/mo); Joplin, MO ($767/mo); and Florence-Muscle Shores, AL ($798/mo).

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