Good morning. In February, job openings dropped below 10 million for the first time in almost two years, indicating that the Federal Reserve's endeavors to decelerate the labor market might be actually working.

In today's issue, we highlight how US government office workers have embraced the flexibility of WFH and hybrid arrangements but at a steep cost of $26B in CMBS debt.

With an impending recession on the horizon, the life sciences industry stands out as a resilient sector. Meanwhile, cities and states across the US have been taking steps to alleviate the housing shortage by changing restrictive zoning laws.

Government WFH Putting $26B in CMBS Loans at Risk

Government workers are no strangers to work-from-home trends, but their reluctance to go back to the office could put $26B in CMBS loans at risk.

It’s not pretty: According to Trepp, about $26B of outstanding CMBS loans are tied to 1,365 national properties occupied by government workers. The popularity of WFH and hybrid arrangements among federal employees is putting pressure on metros with billions in CMBS exposure. Per Stephen Buschbom, research director at Trepp, “It’s not pretty…because we haven’t seen any strong form requirement of return-to-office from the government sector.”

Official office space: The amount of office space filled by government workers is staggering. The federal government is the largest office tenant in the country, with over 43 MSF leased. GSEs make up 20%, or $1.1T, of the $20T CRE market.

Occupancy collapse: Not surprisingly, NY-NJ and Washington DC/Northern VA are the two MSAs with the most exposure, accounting for $10.3B in CMBS loans tied to government tenants. Occupancies are falling across the board, with 13% of government offices in NY-NJ and 25% of DC/Northern VA with occupancy rates of just 60–80%. On the other end of the continental US, 40% of LA’s government offices are at 60–80% occupancy.

➥ THE TAKEAWAY

Zoom out: Trepp warns that if the federal government promotes hybrid or remote work, it could decrease office space needs and occupancy rates, especially in low-occupancies MSAs. In essence, declining occupancy rates may result in a decrease in net operating income (NOI) and subsequently lower the debt service coverage ratio (DSCR) for these loans, resulting in reduced cash flow.

📖 Read about America’s most dynamic metros as they restabilize in a post-pandemic world, according to Heartland Forward.

🎧 Listen to this episode of Bloomberg’s Odd Lots, where NYC landlord Ben Carlos Thypin argues that the golden age of NYC landlords is over.

The Life Sciences Market is Evolving And Flourishing

In contrast to other struggling real estate sectors, Life Sciences has exhibited resilience, per a CBRE report that states the US inventory of life sciences labs and R&D sites has grown by almost 50% in the past five years, to 181.7 MSF in Q4 2022.

In the name of science: The 2023 U.S. Life Sciences Outlook predicts that as new construction is finalized, the properties will consume up to 220 million square feet by 2025. The report states that nearly one-third of this upcoming space has already been pre-leased.

By the numbers: Boston and Cambridge, Massachusetts, continue to be prominent life sciences hubs, with a combined inventory of 52.7 million square feet and 15.3 million square feet of life sciences space currently under construction. The two cities booked significant leases in 2022, with Takeda and AstraZeneca leasing approximately 600,000 square feet of space each.

• San Francisco Bay Area, with 33.7 million square feet of space, also has a rapidly growing inventory, with 9.3 million square feet currently under construction. In contrast, Chicago, with less than 2 million square feet of life science inventory, has the highest vacancy rate of nearly 30%

➥ THE TAKEAWAY

Why it matters: Despite the uncertainty following the SVB failure in commercial real estate, the life sciences industry is expected to remain resilient, according to the report. Though venture capital funding, initial public offerings, and job growth may slow due to bank turmoil, the industry has significant clinical trials, federal funding, and cash reserves, especially among larger biotech companies. Furthermore, the industry's vacancy rate remains relatively low, rising only from 5.1% in Q3 2022 to 5.7% in Q4 2022, compared to other sectors.

Nationwide Zoning Changes Encourage Affordability

Changes to single-family zoning restrictions are making headlines across the country. FL and VA are the most recent states to move towards fixing the housing supply shortage by creating more affordable housing.

Honing in on zoning: St. Petersburg, FL and Washington, DC recently approved zoning changes to allow small multifamily properties (2–4 units) in areas previously zoned for single-family homes. These areas are joining the ranks with other cities and states making less restrictive zoning changes to improve affordability. More municipalities are following suit to overhaul zoning codes and remove hurdles owners might face when adding units.

Supply shortage: Developers are taking interest as less restrictive zoning could lead to more competition in areas experiencing supply shortages. At the end of 2022, there was an estimated shortage of 6.5M single-family homes, up from 5.5M the year prior. According to the Urban Land Institute, “Strong evidence indicates that many current zoning rules limit the housing supply and increase the cost of homes.”

Missing middle: Zoning changes are aimed at filling the gap of the ‘missing middle,’ which typically includes duplexes, cottage-style housing, rowhouses, and small apartment buildings with courtyards. These smaller multifamily properties will offer more options to the middle class in urban areas that prefer smaller properties to larger complexes.

➥ THE TAKEAWAY

Big picture: Fighting for zoning changes can be challenging due to opposition from NIMBY opponents, but cities and states are gradually succeeding in the long-term effort to change zoning laws and promote denser developments. This proves that the fight is a marathon and not a sprint.

• Belt tightening: Higher costs are eating into the wallets of the rich, who are unwilling to pay $500/night for summer getaways.

• Graduation day: St. Francis College sold its Brooklyn Heights campus for $160M to a Rockrose affiliate.

• Renovation relief: Miami-Dade county is offering interest-free loans to condo owners to make structural improvements and avoid Surfside 2.0.

• DFW in distress: The number of properties in DFW on lender watch lists for financial distress has grown by over 30% since January, with multifamily leading the charge.

• Office outlook: The office sector is facing tough times, but the private and public markets are in disagreement over how bad it can get.

• Dropping the hammer: The ECB has called for a crackdown on CRE funds to mitigate the risk that a downturn in the €1T sector could trigger a liquidity crisis if investors rush to withdraw.

• Moving mountains: YIMBY activism could transform the Mountain West from rural to urban living.

• Poor performance: The MSCI Global Quarterly Property Index fell -3.8% in Q4, confirming CRE is in a cyclical downturn.

• Vacation mode: Wander REIT is venturing into vacation rentals, an asset class typically avoided by institutional investors.

• Transformation Tuesday: Discount retailer Tuesday Morning auctioned off 30 of its 264 leases as part of an effort to turn from bankruptcy to profitability.

• Falling funding: VC funding in proptech fell from $6.79B in 2022 to $1.69B in 2023, a staggering 77% drop.

• Changing landscape: Experts at GlobeSt’s Multifamily Conference share their views of the sector and outlook for the year ahead.

The multifamily construction pipeline reached all-time highs at the end of 2022 in the Lone Star State, once again proving that everything is bigger in Texas. Construction was concentrated among the usual suspects, with DFW coming out on top.