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Together with
Good morning. CRE deal activity for 2Q23 saw a 50% YoY decline. San Francisco’s office sales are on the rise as sellers recalibrate prices. Multifamily builders remain optimistic, despite potential luxury oversupply. Meanwhile, real estate tycoon Jeffrey Soffer is finally launching his $3.7B Vegas resort after 23 years.
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Today’s issue is brought to you by VantagePoint—AI forecasting for Stocks, Futures, Options, Forex, Cryptocurrencies, and ETFs.
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Market Snapshot
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*Data as of 9/18/2023 market close.
INVESTMENT SALES
2Q23 U.S. Sales Volume Drops 50% YoY, Says Green Street Report
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Second-quarter commercial real estate (CRE) sales volumes decreased by 50% compared to the same period last year. However, they remained stable from the previous quarter, according to Green Street.
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Macro challenges: Daniel Ismail from Green Street highlighted that the broader macro conditions currently do not favor CRE transactions. Several factors have contributed to this: tightened credit availability, increased interest costs, persistent wide bid-ask spreads, and a lack of forced sellers, which altogether hinder deal progress.
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Sector-specific insights: The office sector, especially in cities like Houston, New York, and Atlanta, underwent the most significant reductions relative to market value predictions. Both multifamily and strip centers also witnessed pronounced year-over-year volume drops. However, the volume of net lease deals showed a more favorable trend.
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Absence of forced sellers: The lack of forced sellers is another significant factor impacting CRE transaction activity. Without the urgency to sell, owners are less motivated to engage in transactions, further contributing to the decline in deal volume. A persistently wide bid-ask spread doesn’t help the situation.
➥ THE TAKEAWAY
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Zoom out: In the third quarter, REIT M&A activity increased, providing optimism despite market difficulties. San Diego and NYC experienced smaller declines in commercial real estate transactions (around 37-38%) compared to cities like Atlanta, Philadelphia, and Washington, D.C. (with an 86% decline). This suggests potential investment opportunities at attractive prices, highlighting varied effects of economic issues on city markets and sectors.
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FROM THE ASHES
San Francisco’s Office Market Shows Promising Signs with Rising Sales and Leases
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After being one of the hardest-hit office markets in the U.S. since 2020, San Francisco’s office market is showing promising signs of revival.
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Impact of the pandemic: The tech industry’s swift pivot to remote work, amplified by rising crime rates and deteriorating quality of life, nearly hollowed out SF’s business heart. With soaring vacancy rates, property valuations took a sharp dive. Yet, tides have begun to turn, and there’s now a revival in the city’s office landscape.
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Signs of life: The appetite for office spaces is reaching its highest in years, driven significantly by the burgeoning AI sector. This trend reinforces San Francisco’s appeal as a tech hub. Additionally, as property owners recalibrate price expectations, sales momentum is building, making 2023 the most active year for sales transactions since 2019.
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Market reset is here: Sellers are finally adjusting their expectations, accepting prices significantly lower than those from four years ago. A notable example is the sale of 350 California Street at $61 million, a fraction of its pre-pandemic valuation. Many other properties are selling at half or even less of their former worth. While such deals are a blow to the original asking price and affect the overall property value in San Francisco, many believe that such adjustments are crucial for the rebound of a plummeting real estate market.
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Revised valuations are reshaping office rents: For instance, Swig Co. and SKS Partners now offer spaces at 350 California Street for $50-$70 per SF, down from the pre-pandemic rate of $90. Moreover, investors like K. Cyrus Sanandaji of Presidio Bay Ventures are leveraging these lowered prices to enhance properties. Sanandaji bought 60 Spear Street at a 62% discount from its 2014 price, enabling the addition of amenities like a rooftop eatery and fitness center.
➥ THE TAKEAWAY
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Path to recovery: While San Francisco’s office market isn’t fully back on its feet with a vacancy rate of over 25%, there’s a silver lining. The combination of reduced rents, adaptive strategies from property owners, and heightened interest from investors suggests that the city’s office sector is gradually finding its new equilibrium in a post-pandemic world.
🌐 AROUND THE WEB
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📖 Read: While big-name office owners like Brookfield can absorb losses and re-invest elsewhere, smaller Class-B and C office owners sitting on over 2.1BSF of older properties don’t have that luxury. Here’s why.
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▶️ Watch: Here are 5 reasons that retail real estate is more valuable than you might think, according to Karly Iacono and Chris Ressa, in this episode of What’s in Store from the CRE Fast Five.
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🎧 Listen: Bill Gross, known as the ‘Bond King’ from his prosperous stint at Pimco during the bond bull market era, discusses the current market and the viability of purchasing bonds in a bearish bond climate.
MONEY TO BE MADE
Multifamily Contractors Bullish Despite Luxury Market Oversupply
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Many multifamily contractors are optimistic about multifamily demand, particularly in the luxury and high-end market. However, a potential luxury oversupply problem needs to be considered.
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By the numbers: The aftermath of the Great Recession saw a decline in rental vacancy rates, leading to a rebound in multifamily starts built for rental purposes. This trend continued until the end of 2019, with sustained levels of around 80–90K units per quarter. Post-COVID quarters saw a full percentage point decrease in vacancy rates, resulting in a 60% increase in multifamily starts. In 3Q22, multifamily rental starts surpassed 140K units quarterly.
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Equilibrium concerns: With an influx of contractors adding supply to the market, some are concerned about the supply and demand equilibrium. Will there be enough renters to fill all the new construction and achieve the expected return on investment? Additionally, an oversupply of luxury units could impact the mid-priced market if luxury rental prices decline.
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Impact of single-family market: The rental market dynamics will also be influenced by changes and shocks in the single-family market. Single-family homes are historically unaffordable, leading potential renters to consider luxury units. However, expectations of falling mortgage rates in the coming years could result in a recovery in the volume of existing single-family homes on the market, potentially diverting luxury unit renters back to the single-family market.
➥ THE TAKEAWAY
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Considerations for contractors: Contractors should be cautious about the potential oversupply risk in the multifamily market, especially in the luxury and high-end segment. With many participants making similar bets, greater supply hangovers and profitability pressures may occur in highly desired geographies. Contractors may want to explore second-tier geographies that have attracted less attention from developers as potentially more promising bets.
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GRAND OPENING
Newest Vegas Resort a $3.7B Palace 23 Years in the Making
Jeffrey Soffer. Photographer: Kyle Grillot/Bloomberg
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Real estate mogul Jeffrey Soffer has finally realized his 23-year dream of opening the Fontainebleau Las Vegas resort.
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Cutting the ribbon: With a price tag of $3.7B, the 67-story resort (now the tallest hotel in Nevada) boasts 7 pools, 36 restaurants and bars, and a private club on the top floor with breathtaking skyline views. The long-awaited project suffered numerous setbacks from 2008–2009 and underwent many ownership changes before Soffer regained control and completed construction in 2021.
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An epic journey: The Fontainebleau Las Vegas is the culmination of an incredible journey spanning over two decades. Acquiring the land in 2000, Soffer faced significant challenges during the Great Financial Crisis. Ultimately, he successfully reacquired the unfinished building in 2021 at a fraction of its original cost. This long-awaited opening marks a significant milestone for Soffer and his storied real estate career.
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Tribute to Miami Beach: Soffer drew inspiration from his family’s successful Fontainebleau resort in Miami Beach, one of the most profitable non-casino hotels in the country. Like its Miami Beach counterpart, the Fontainebleau Las Vegas features bowtie-shaped accents, a distinct blue and coral pink color scheme, and French midcentury modern-styled furniture in the rooms.
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Overcoming challenges: One of the major challenges for Fontainebleau Las Vegas is its location, far from established properties that offer easy access between casinos. However, Soffer believes that investments in renovations and new properties in the area will eventually attract more visitors, creating more traffic on the North Strip.
➥ THE TAKEAWAY
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Luxury on his mind: As the long-awaited Fontainebleau Las Vegas opens its doors, it signifies the remarkable completion of a project that took 23 years to complete. Despite challenges and ownership changes, Jeffrey Soffer’s vision has become a reality with a $3.7B palace offering visitors a luxurious North Strip escape. Drawing inspiration from the family’s successful Miami Beach resort, Soffer aims to bring the same level of luxury and opulence to Las Vegas.
✍️ DAILY PICKS
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Unlocking LA’s potential: A City Council motion in LA aims to remove density restrictions on public facility zones to facilitate housing development.
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Powder Mountain: Reed Hastings, co-founder of Netflix (NFLX), became a majority owner of Powder Mountain, UT, with a $100M investment in the largest ski resort in North America.
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REIT rebound: REIT share prices have dropped by around 30% due to higher interest rates and CRE distress, presenting an attractive entry point for investors.
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High-stakes power struggle: Debt holders, including Goldman Sachs (GS), CitiBank (C), and Deutsche Bank (AG), battle over control of a CRE portfolio valued at $2.3B.
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Demolishing retail: Over the past 5 years, more than 130MSF of US retail space has been demolished, leading to a multi-decade low of 54.3 SF per capita in the 45 largest markets.
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The financing chameleon: PACE financing has emerged as a successful funding source, offering long-term, low-cost financing that can reduce equity, increase leverage, and boost returns.
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Bidding wars: Estes Express Lines has made a $1.52B offer for Yellow Corp.’s real estate portfolio, surpassing a previous bid from Old Dominion Freight Line.
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Multifamily marvel: Calvera Partners acquires Saddlehorn Vista Apartments, a 192-unit multifamily community in Fort Worth, Texas, for $13.9M.
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Crowdfunding collapse: PeerStreet, a real-estate crowdfunding site, filed for bankruptcy after its lending business dropped from $695M in 2021 to $5.4M, revealing issues with nonperforming loans and ownership disputes among investors.
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Tenant troubles: Elon Musk’s refusal to pay rent for X’s offices has led to financial struggles for Columbia Property Trust (CXP), with Moody’s downgrading their mortgage security at the 245-249 West 17th Street building in Chelsea.
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In the name of industry: The industrial sector saw a 28.6% increase in industrial deliveries in 1H23 compared to 1H22, with DFW leading the way with 29.3MSF added.
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Rent rebound: Rent in the 3-star multifamily market increased by 1.7% in 2Q23, while 4- and 5-star properties experienced negative growth, according to CoStar.
📈 CHART OF THE DAY
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Analyzing Real Estate Trends in Commodity Cities
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12-month real estate returns have been less sensitive to commodity prices since the pandemic compared to prior decades and downturns. Notably, global returns are nearly 5x higher than in 2009–2010 despite much higher commodity prices.
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