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MarketSnapshot
At Northmarq, we are committed to offering our clients the latest trends and expert analysis to power their decision making. Our MarketSnapshot suite of reports contains critical market data covering a variety of commercial real estate property sectors. In each report, you will find: Investment sales volume data Average cap rate information Buyer distribution analysis... and more! Single-Tenant Overall Market Single-Tenant Office Single-Tenant Industrial Single- Tenant Retail Multi-Tenant Retail
Latest Publications
Adapting to Change: An Investor's Guide to Office Building Redevelopment
The office real estate market has been significantly impacted by distress and transformation in recent years. Changing cultural preferences, rising interest rates, and market dislocations have propelled the office sector into uncharted territory. While the COVID-19 pandemic was a significant driving factor, it was far from the only one. Office vacancies are at a 30-year high, as changes in how people work have placed newer and smaller office spaces in higher demand. Declining Class A office rents have indirectly impacted Class B and C rents by creating competition to retain tenants, as there’s been a shifting tide to “cheaper” and newer office space. Alongside higher interest rates, elevated vacancy risks, and lenders' hesitancy to extend debt on office buildings, office cap rates have widened, thus bringing down office values. With these factors in play, the market has shifted toward all-cash or very low leverage transactions, and brokers and investors have made a strategic shift to evaluating the underlying land value for potential redevelopment, due to the suppressed and dislocated office investment sales values. So, how does an investor come out ahead despite all these challenges? Read on for the answers.Market Dynamics and OpportunitiesVacancies are at the heart of office market challenges, as operators have struggled to retain and bring in new tenants. The once-beloved office footprint of '70s–'90s vintage has struggled to stay competitive; couple this with widening cap rates and elevated interest rates, lenders see office building debt as high-risk, and all-cash transactions are commonplace.As office values have declined, it’s created a pivotal moment for astute investors and developers, as they evaluate the underlying land value and look for the best property uses over the long term. If this is done properly, it is possible to do more than simply weather the current upheaval. There is latent potential in the evolving office landscapes, but a keen and studied eye will be required to discern the true opportunities from the potential money pits.Identifying Redevelopment ProspectsIdentifying redevelopment prospects starts with defining the criteria to be used. Both the criteria and how they are weighted can vary based on the specific property. The vintage of the office property plays a crucial role in identifying potential added costs, such as asbestos remediation, and in the case of adaptive reuse, structural integrity and adaptability. Parking, both current and potential, will impact future uses significantly. Occupancy rates will identify underutilized properties, with anything under 70% considered to be low. Investors/developers also want to look at the existing leases, with the ideal range being under three years. And, of course, the surrounding area and factors such as the local job market, walkability, and neighborhood demand drivers will determine whether a planned project will even have the ability to attract residential tenants.At the same time, redevelopment is never a one-size-fits-all situation. Single-phase projects offer simplicity and a focused approach, suitable for redevelopment of existing individual office buildings. Mixed-use multiphase redevelopment projects of large office parks or developments combining residential, hospitality, and commercial elements offer a greater potential reward in exchange for a more complicated execution. Deciding on the right redevelopment approach takes more than just looking for demand in the market. Investors need to understand the property and whether it suits their intended project. In addition, large scale mixed-use redevelopment demands a much more complicated capital execution which frequently involves a lot of structure around the capital stack.To Rebuild or Not to RebuildInvestors in this market must strategically evaluate the underlying land value, as well as the best long-term uses with the highest returns. This means looking at the potential for redevelopment, conversion, and adaptive reuse, all of which require meticulous analysis of criteria such as vintage, parking space (including repurposing existing parking structures), occupancy levels, lease terms, and the vibrancy of high-growth markets. When looking at tearing down and rebuilding, such as when redeveloping from office to multifamily housing, the floor area ratio (FAR) multiple helps investors determine feasibility and align investment with land redevelopment value. FAR makes it possible to estimate the potential square footage of future development based on the existing square footage. In our experience, the minimum multiple of current to projected FAR is 3:1 in order for land value to exceed the current use, all things considered.Overcoming Challenges in Office RedevelopmentIdentifying suitable office properties for redevelopment requires a nuanced understanding of many complicated factors. Properties need to align with the vision of redevelopment and not present significant obstacles that could derail the project or create excessive timelines. Ensuring a positive outcome, therefore, requires meticulous planning and a strategic approach which includes entitlements, existing lease timelines, reciprocal easement agreements (REAs), utility capacity, capital structures, and sometimes multiple product development expertise to name a few.Navigating political obstacles, zoning restrictions, and even local special interest groups is essential to the planning process. Developers should try to understand the larger landscape they are stepping into before delving too deep into a project. From adeptly navigating bureaucratic landscapes to handling local cultural sensitivities, redevelopment requires more than just understanding the property itself. Developers also have to look into all applicable REAs, easements, building code requirements, and rezoning sensitivities and timelines. Most property owners are purely operators and possess little of the required information that developers require, so careful research is necessary.At the same time, developers will have to navigate capital market challenges which can best be described as currently finicky as both debt and equity remain squeamish amid high-rate environments and overbuilding in many markets. In addition, construction costs have increased significantly over the past decade, and developers may have to recalibrate and recalculate even while construction is underway, which means accounting for large contingencies in their development models. With so many potential complications, developers need to be well-versed in a myriad of factors that impact their developments.The Impact of Interest Rates on RedevelopmentThe relationship between rising interest rates and increased cap rates informs a nuanced understanding of the redevelopment landscape. Rising interest rates in recent years have pushed cap rates higher. As the cost of borrowing goes up, the cap rates have to be raised to compensate for the added cost to projects. Investment becomes more expensive, and funding is also more difficult and expensive for investors to acquire. The unpredictability of the market leads developers to widen the cap rate and yield on cost (YOC) gap to maintain profitability, which sends a ripple effect through the market.The resulting landscape is notably more intricate, demanding a strategic understanding of how interest rate fluctuations impact redevelopment feasibility and profitability. The challenges in capitalizing deals under current assumptions come to the forefront as interest rates and cap rates rise. Everyone involved in redevelopment must find new strategies, including developers, who must solve a widening gap between exit cap assumptions and YOC. Construction debt has also become both more costly and anemic, with lower loan-to-cost (LTC) ratios requiring increased equity to even get a project funded. In addition, many lenders require on hand deposits in the 10%-20% range to fund their loans. This can be a checkpoint for determining the viability of a redevelopment project, and redevelopment deals need to be judiciously structured to ensure success.Identifying Funding Sources for Redevelopment DealsAs development funding sources get squeezed, it's important to look at all possible options. Luckily, there are plenty. Many local and regional players, such as regional and national multifamily developers, are funding projects when there is a clear path on entitlements and vacating the existing buildings. Family offices and developers with office exposure who have the capacity to manage existing office properties while working through entitlements and predevelopment work are also able to be a little more flexible with specific scenarios that might drive others away. Often times well capitalized investors seeking to maintain their equity positions are willing to joint venture their office buildings with multifamily developers in a land contribution to Limited Partner or Co-General Partner position.Of course, developers can also take advantage of tax incentives to make up for some of the increased development costs. This usually still assumes that a developer will have the money to cover costs upfront and reap the advantages later. However, that dynamic can change if the incentive is on the investment. One example of this is Opportunity Zones, which are areas that have been designated as desirable for redevelopment. Opportunity Zone Funds are investor vehicles that specifically invest in such areas to reap tax benefits and can serve as a funding source for developers.Similarly, Real Estate Investment Trusts (REITs) can play a key role. Whether private or public, REITs bring a wealth of experience and financial clout to the table. At the same time, the increasing size and sophistication of REITs make them well-suited for large-scale redevelopment projects, and they may partner with developers. REITs may also directly acquire and redevelop properties. Many large REITs not only have significant development experience but can fund developments on balance sheets eliminating the need for outside debt and equity capital.Redevelopment as a Solution to Housing ShortagesThe U.S. has an acute housing shortage, with some areas struggling more than others. Redevelopment stands out as a promising solution to this crisis. This is particularly true for the office real estate market, where the recent depreciation in values make properties all the more attractive for multifamily redevelopment. With high vacancies and a shift in cultural preferences toward work from home and to newer, smaller-footprint office spaces, many traditional large office buildings are simply no longer competitive. This type of redevelopment can also meet the desire for residential space with proximity to work and urban amenities.At the same time, redevelopment does not have to completely transform land use. Mixed-use developments and even hotels can offer an alternative approach that maximizes the potential of the property. This type of strategic diversification also enables development projects to align with the unique demands and characteristics of an area.The availability of government incentives can also influence redevelopment choices. These include federal initiatives such as the Housing Supply and Action Plan and the Community Development Block Grant, which are often designed to encourage redevelopment or development of an area and spur economic growth by encouraging private investment. Such programs provide financial support and incentives for developers and investors transforming commercial spaces into residential units.Sustainability and RedevelopmentSustainability and redevelopment can form a symbiotic relationship that extends beyond meeting regulatory requirements. Redevelopment can actively engage with and enhance sustainability goals, contributing to creating vibrant, eco-friendly urban environments.Almost every jurisdiction in the U.S. has integrated sustainability principles into building codes, setting the stage for a more environmentally conscious approach to development. These codes shape the redevelopment landscape, and compliance ensures that new projects are going to be more sustainable than those built in the past. Older buildings, such as existing office structures, are much less likely to meet these more modern requirements. Tearing them down and redeveloping them as multifamily housing can, by its very nature, greatly improve the sustainability of the area.By conforming to building codes that prioritize sustainability, redevelopment projects actively reduce their ecological footprint compared to existing structures. While tearing down and building new may not seem intuitive, it makes a lot of sense when compared to either leaving older buildings to consume more energy and resources or attempting to rehab an older building under strict constraints.Navigating the Supply Surge in Multifamily Development The multifamily development sector is currently in over supply, but the astute investor's focus should not be solely on the volume of units. The better approach for both investors and developers comes with strategic positioning in areas where long-term demand-supply metrics presents the best opportunities for success.The recent increase in multifamily development supply is a direct response to the evolving dynamics, low vacancies, changing preferences post-COVID-19, and appetite for multifamily development by debt and equity providers. While demand for office investments wains, investors understand the long-term benefits of multifamily developments, and even now that fundamentals have temporarily eroded, the U.S. remains under-supplied in housing.Given the dearth of recent housing starts as we enter our sixth quarter of high interest rates, an inevitable supply gap is forming. New starts in multifamily development are already anemic, and demand for new housing units might outpace the actual construction as early as mid-2025 in some markets. By strategically identifying and acquiring development sites with the potential to bridge the anticipated supply gap, investors and developers can be poised to take advantage when the time comes.A data-driven approach is the key to finding the right property for redevelopment. We recommend looking at the new jobs-to-absorption ratio in a market to help evaluate the need for additional housing. As an example, the long-term job-to-absorption ratio for Austin, Texas is four jobs to one new unit absorbed. With that information, an investor or developer can then look at the projected employment growth in an area and the number of new starts in the previous year to project when the optimal time to begin new construction will occur.All in all, while it’s heavily nuanced, office conversions and redevelopments serve as a meaningful alternative to office owners that are struggling by shifting the near-term focus to evaluating the highest and best use for the asset and underlying land.With vast redevelopment experience, Northmarq’s National Development Services team currently has in excess of three million square feet of office and commercial redevelopment opportunities in the market today. Each of these projects provide the ability for building owners to garner a significant premium to their current investment sales value. hbspt.cta.load(7279330, '87923e55-cb70-4dc6-9679-8873596d53ef', {"useNewLoader":"true","region":"na1"});
March 5, 2024
Orange County 4Q23 Multifamily Market Insights report: Rents trend higher, supported by continued demand
Highlights: The Orange County multifamily market recorded an uptick in vacancy and rising rents during the fourth quarter. The pace of deliveries has quickened since the second half of 2022, after almost no new supply was added a few years ago.Vacancy rose 10 basis points in the fourth quarter, after the rate held steady throughout the middle part of 2023. This year marked the first annual vacancy increase in the market since 2018.Asking rents rose in the second half of the year, ending 2023 at $2,527 per month. Rents advanced 1.5% in 2023 after steep increases in the prior two years.Local multifamily investment activity slowed in 2023, with limited activity during the fourth quarter. Prices have remained elevated for the past three years; in 2023, the median price reached $376,400 per unit.Read the report, or engage with our Irvine office to learn more.
March 5, 2024
San Diego 4Q23 Multifamily Market Insights report: A few more properties sell as 2023 comes to a close
Highlights: The San Diego multifamily posted a modest vacancy increase and minimal rent decline to close 2023, after mostly steady performance during the first nine months of the year. Heightened delivery totals outpaced demand in 2023, although local construction levels have peaked, and future inventory growth is on pace to slow beginning in 2024.Local vacancy trended higher in 2023, including a modest increase during the fourth quarter. Despite the recent rise, the current vacancy rate is only slightly higher than the market’s five-year average.For the first time in nearly three years, asking rents in San Diego inched lower in the fourth quarter. Average rents dropped 0.7% during the period, ending the year at $2,333 per month. For the full year, rents rose just 0.2%.Sales velocity in the region slowed in 2023, but more transactions closed in the fourth quarter than during any other period of the year. Cap rates have trended higher, averaging approximately 5.1%, while the median price dipped to $296,000 per unit.Read the report, or engage with our San Diego office to learn more.
March 4, 2024
Drop-and-Swap Case Study: One Member Cashes Out, Second Does a 1031 Exchange
Our 1031 exchange experts are frequently asked how members in an LLC or partnership can choose different paths in a real estate transaction. For example, what if one wants to cash out of the investment property entirely and the other wants to reinvest their proceeds and defer taxes by executing a 1031 exchange?A version of drop-and-swap can be used to address this situation.The SituationJohn Rosen and Mary Link were college friends. After graduation, they decided to invest in real estate together, pooling their money. They formed JRML LLC, and shortly afterward, acquired their first rental property – an apartment building in Pittsburgh, PA – that cost them $310,000.Over the next 30 years, they maintained the property well, and it brought the two friends significant cash flow, but Mary recently decided she no longer wanted to own the property; instead, she would like to use her share of the sale proceeds to retire. However, John wants to continue investing in real estate. After consulting a local a real estate agent John and Mary learn that they can sell the property for $1.6 million.The ProblemJohn quickly realizes that the sale of the apartment building would result in them owing capital gains taxes on $1,290,000 ($1,600,000 minus their initial $310,000 investment), plus depreciation recapture tax on $310,000. Taxes on the gain would be $258,000, plus $85,000 in additional depreciation recapture tax, as well as state taxes (3.07% tax rate of PA) of roughly $39,603, and net investment income tax of $49,020 at a rate of 3.8%.In other words, the $1.29 million profit would be reduced by at least $431,623 due to associated taxes. John is personally not willing to incur that taxable event, so they need a different solution than an outright sale.The SolutionAfter consulting with tax professionals, John and Mary set up a variation of the drop-and-swap strategy. Mary will withdraw from the LLC according to state laws. In exchange for her 50% stake in JRML LLC, she will become a 50% tenant in common owner of the property, owning a share alongside JRML LLC.At the same time that Mary withdraws from the LLC, John’s brother, Robert, will become a 1% JRML LLC member, allowing its partnership tax status to remain intact because the entity will continue to have multiple members. The LLC will sell the Pittsburgh duplex, and Mary will get her 50% share of the proceeds in a taxable event to her only.At the end of the year, the LLC’s CPA will issue documents that allow Mary to recognize her fair share of the depreciation recapture and capital gains. The financial results for Mary will be no different than if she remained in the LLC and the property was sold without an exchange.John consulted with additional professionals and learned that JRML LLC would need to identify a Qualified Intermediary (QI) to help facilitate his involvement in the 1031 exchange transaction and successfully defer taxes. The QI requirement is necessary as neither John nor the LLC can be in possession of the sale’s proceeds at any time during the exchange. The QI will handle the preparation of all required exchange documents and hold onto the LLC’s portion of the proceeds from the sale.After the sale, JRML LLC will have 45 days to identify an appropriate replacement property or properties. Using the exchange proceeds held by the QI, the LLC will complete the acquisition of their new property or properties worth at least $800,000, exchanging equal to or up from their share of the original property and maximizing the value of the 1031 exchange.The ResultMary was able to cash out of the original investment property, pay all the required taxes, and retire to Florida. John and Robert, as the two members of JRML LLC, continue to own investment property in the Pittsburgh area.John was able to defer the taxes from selling the original investment property by using a 1031 exchange. Those taxes will remain deferred until John completes a real estate transaction without using a 1031 exchange.Taxpayers are encouraged to discuss their plans with their legal and tax advisors before they move forward with the sale of an investment or business-use property, and they must engage the services of a QI as part of a real estate transaction that includes a 1031 exchange.
February 27, 2024
Inland Empire 4Q23 Multifamily Market Insights report: A mixed outlook leading into 2024
Highlights: Operating conditions in the Inland Empire cooled during the final months of 2023. Vacancy has remained within a very tight range, but rents declined. Construction is accelerating, which should result in another vacancy rise in 2024.Local vacancy inched up 10 basis points in the fourth quarter, ending 2023 at 3.4%. The rate rose 40 basis points for the full year, following two consecutive years of declines.Rents dropped in the fourth quarter after remaining fairly flat through the first nine months of the year. Asking rents fell 2.5% to $1,773 per month in 2023.The number of sales transactions in the multifamily investment market slowed throughout the year, with an additional decline recorded in the fourth quarter. The median price in 2023 was $240,600 per unit, with Class C properties accounting for the bulk of the transactions.Read the report, or engage with our Irvine office to learn more.
February 23, 2024
The Impact of Higher Interest Rates: Opportunities and Strategies for CRE Investors
Over the last two years, interest rates headed in one direction: up. Back in January 2022, the Federal Funds Effective Rate was 0.08%. Fast-forward to year-end 2023, and the rate was 5.33%. The question is less about the “what” and more about the “why” and the “how.” Specifically, why are rates rising, and more importantly, how does this impact commercial real estate investing?Why Interest Rates Have Been RisingInterest rates have gone up because the Federal Reserve has been trying to curb inflation. Inflation sat at 8.2% in November of 2022, which was more than quadruple the Fed’s target of 2.0%. So far, the Fed’s strategy has worked. Consumer prices only went up a relatively mild 3.2% through October 2023, which is welcomed news for those waiting to see prices drop. However, higher interest rates can also bring good news for commercial real estate investment strategies.Rising Interest Rates Can Produce More Purchasing OpportunitiesRising interest rates can result in opportunities to purchase properties from distressed sellers — particularly those with variable interest rates. No one can foresee the future, so even prudent investors may have agreed to a variable rate and now find themselves unable to make their payments. Some property owners may be willing to part with their CRE asset for what they owe on their loan — or maybe even less — just to get it off their books. It may also be possible to find good deals in the foreclosure market as banks look to offload properties they’ve reclaimed. At the same time, rising interest rates also make it easier to get better deals in the traditional CRE market because there may be less competition.Higher Interest Rates May Present Negotiation OpportunitiesWhen interest rates rise, fewer people compete for commercial properties, which puts an investor in a better position when it’s time to negotiate prices. When interest rates were low, it cost much less to borrow money, which encouraged many buyers to make sizable offers on properties. Now that interest rates are higher, many of those investors are staying on the sidelines. Without several buyers vying for their property, sellers may be motivated to agree to a lower price. When in front of a motivated seller, a buyer has more power at the negotiating table.Rising Interest Rates Can Strengthen CRE as a Hedging ToolCRE owners may be able to realize better-than-average returns due to higher rental rates during an inflation-driven economy. As is the case in the current economy, interest rates rose because inflation was on the way up. When inflation rises, it often takes rental prices along with it. For instance, while inflation peaked in the summer of 2022, rental rates in many sectors of CRE have continued to grow. For CRE owners, this could mean short-term gains that offset other assets that may have sub-par performances during inflationary periods.While it’s impossible to tell for certain if or when interest rates will reverse course, those investing in commercial real estate can take advantage of the opportunities this presents. If investors have the financing they need, now may be a good time to purchase CRE assets, especially if they can find good deals in the distressed or foreclosure market. With fewer buyers throwing their hats in the ring, it may be possible to negotiate better deals and build a more robust CRE portfolio. hbspt.cta.load(7279330, '7efe8b9e-e5f7-4927-9bb0-4b88cd1bff4d', {"useNewLoader":"true","region":"na1"});
February 22, 2024
2024 National Multifamily Outlook report: Supply-demand imbalance likely in 2024
We're pleased to present our 2024 National Multifamily Outlook, highlighting key economic trends, forecasts for property performance metrics and more.
February 20, 2024
Net Lease CRE Investing: Understanding Credit Ratings in CTL Finance
Net lease investing — purchasing a commercial property that is net leased to a single, creditworthy tenant — is a unique way to profit from commercial real estate (CRE). It offers predictable cash flow and all the benefits of ownership yet requires a minimal level of landlord responsibilities that can vary depending on the type of net lease. When properties and tenants are selected carefully, net lease investing can be a relatively low-risk way to own income-producing properties and enjoy significant tax benefits.How is Net Lease Investing Different from Conventional Real Estate Investing?Net lease investing differs from conventional CRE investing in several significant ways. One of the most unique aspects is the financing. Net lease deals can be funded through a highly specialized finance method called credit tenant lease (CTL) finance. Unlike conventional CRE mortgages, which are backed primarily by the equity in the building being financed, CTL uses the lease that a tenant signs (the income the lease produces) as collateral. In other words, CTL finance depends on the tenant’s ability to pay the rent rather than on the value of the building. A tenant’s credit, therefore, is a critical aspect for success in net lease CRE investing.Understanding the Importance of Credit RatingsCompanies and other corporate entities that lease real estate have credit ratings that are analogous to the individual credit score that most people are familiar with. Professional rating services such as S&P, Moody’s, and Fitch Ratings analyze companies and routinely assign corporate ratings. Each service has its own proprietary methods that differ somewhat, but ratings are typically assigned on a letter grade basis, with “A” being higher than “B” and “B” being higher than “C” and so on down the scale. They will also use capital letters or lowercase letters to emphasize relative strength and will add modifiers such as pluses (+) and minuses (-) or one-digit numbers.The highest credit rating any entity can receive is “triple A” (AAA). A firm or other institution with a AAA rating can be trusted to meet its financial obligations on time and in full. The lowest ratings are “C” and “D.” Low-rated firms represent a high risk of default.Investment Grade vs. Non-Investment GradeWhile there are many gradations in credit ratings, there are only two main categories. They are “investment grade” and “non-investment grade.”Companies, institutions, and governments with an investment grade rating are comparatively low risk. Non-investment grade entities carry more risk for investors, especially debt investors. Investors demand a higher yield from weaker companies. Thus, AAA-rated firms will pay less interest on bonds, and often less rent on real estate, than BBB-rated firms will.How is CTL Finance Structured and Who Qualifies?For accounting and investing purposes, a real estate lease is seen as a debt obligation. CTL finance looks at a lease very much as it would a corporate bond. CTL bankers collateralize the lease and make a loan to investors or purchasers based on the creditworthiness of the tenant.It’s important to understand that only corporate tenants with an investment grade rating from a major rating agency can qualify for CTL financing. In practical terms, that means a BBB- or higher rating from S&P and Fitch Ratings of a Baa3 or better from Moody's.The significance for net lease investors is clear. Non-investment grade and unrated tenants can be financed by other means but should be avoided by investors looking to use CTL finance. Investment grade tenants should be sought out, but with the realization that higher rated tenants, while offering a higher measure of safety, tend to pay somewhat less in rental income.There is no need for CRE investors to be intimidated or confused by the technicalities behind credit ratings and CTL finance.Each major rating agency has only 10 investment grade levels, and Fitch’s levels are the same as S&P’s, and they’re fairly straightforward and simple to understand. While CTL finance is a very sophisticated type of CRE investment banking, from the investor's perspective, the process is practically indistinguishable from conventional financing.Ready to Get Started?Connect with our experts today for more information about net lease investing opportunities or to learn more about CRE financing options, including CTL financing.
February 19, 2024