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The Differences in Real Estate in the Last 30 Years: Part IV

1/9/2020

Investment & Industrial

Photo credit: MetroCreative

(See Part III: Hospitality & Land)

Investment:

This is such a broad category, that it has to be discussed almost globally to start. To begin with, since 1990, several entities with huge pools of available capital have concluded that real estate risk is less than that of equity markets, or at least a balancing asset class, and that portfolios should include good quality net-leased properties. These entities, insurance companies, pension funds, managed equity funds for high net-worth individuals, sovereign funds from outside the U.S., etc. have entered the commercial real estate investment market in a big way. Another factor for holders of wealth is that with U.S. inflation rates and interest rates so low, a much lower return is acceptable for a real estate investment – therefore individual properties and portfolios of properties can be sold at much higher prices than ever believed possible. In 2019, new developers who had sprung up since the beginning of the U.S. economic recovery, since about 2010, came to discover that they could buy land, develop property on a speculative basis, fully lease that property, and sell it for a huge spread over actual hard and soft costs of development. Many of these new development firms were lean and mean, offshoots of some of the larger players of the early 2000s, but without the overhead. And in many cases, without being a public company or beholden to one source or a few sources of income.

Another recent trend: we're seeing huge portfolio sales by major players such as Blackstone, Exeter, Stag, Ivanhoe Cambridge, sovereign funds from the Middle East and Singapore. Prologis, a REIT, (publicly-traded Real Estate Investment Trust) bought two other REITS, first DCT in August 2018 for $8.5 billion and then announced in October 2019 its intent to purchase Liberty Property Trust for $12.6 billion. Blackstone, in four days in September, 2019, purchased the U.S. Logistics assets of Colony Capital for $5.9 billion, and then the U.S. Logistics assets of China’s GLP for $18.7 billion.

Industrial:

The big change from 1990 to 2020 has been the fallback in manufacturing and the dramatic increase in large bulk distribution centers. Refrigerated food buildings continued to, and always will, service America’s breadbasket. Printing companies died by the hundreds, with survivors having huge investments in specialized machinery. But for the biggest change -- e-commerce fulfillment — nobody is a bigger part of this story than Amazon. Several buildings they occupy are more than a million square feet, in many cities. In Memphis, they are building a 4.2 million square-foot facility; in Nashville, a 3.6 million sf building, and in Northern Kentucky, their new Prime Air Hub at the airport will be 2.8 million sf. They claim to have created 100,000 new jobs by beginning their last mile delivery initiative just a little over a year ago in 2018.

In 1990, new bulk warehouses were mostly 24’ clear height. In the months preceding the dawn of 2020, most new bulk buildings were 36’ or 40’ clear height. In 1990, concrete floors were leveled with strings and straightedges measured by humans; now they’re precisely flat with new technologies with lasers and dozens of computer calculations, in all directions.

Another big change in new warehouse development is the presence of adequate truck trailer parking away from the building; such parking was rare in the ‘90s. Also, though it costs more to do this, column spacing is almost always over 50’ in all directions, with 52 x 60 not uncommon. In the ‘90s it was sometimes 40 by 40. Wider spacing provides more racking configuration options. In addition, in the early ‘90s it was quite common to have rack sprinklers to provide better response in case of fire with dense flammables, whereas now with ESFR (Early Suppression Fast Response) sprinkler systems, fire protection is as good without in-rack sprinklers.

Lighting is another big improvement. Thirty years ago there were fluorescent bulb systems, sodium vapor lighting (yellowish quality) and metal halide systems. All were energy hogs and expensive to repair. The first breakthrough in the early 2000s were the new efficient small diameter fluorescent systems, T-5 and T-8. They had a short time on the stage, as soon thereafter, highly-efficient LED lighting systems came out, and with motion sensors as the previous upgrades had, further saving bulb life and energy costs.

Most big bulk warehouses before 2008 were constructed with precast panels, which were factory-produced and with insulation sandwiched in and rated. A few developers stayed with the older tilt-up technology for cost reasons (where the building slab is poured first, and after curing, the wall panels are poured on top of the new floor and tilted up). When the recession hit, many of the pre-cast panel factories went out of business, so when things picked up later, most of the first buildings went back to tilt-up as the lead times for the few panel manufacturers still in business could be over 12 months. Eventually new plants opened or re-opened, and lead times got more reasonable.

But with more big bulk warehouses built more than ever before in the years between 2015 through 2020, led by Amazon, with many firms re-configuring their historic distribution patterns, and with many new players building facilities just for e-commerce, almost all being leased by good credit tenants, net-leased industrial was the new darling in the institutional investment community. And, as previously mentioned, with a long-term lease with a solid credit tenant, in tier one, or primary markets, CAP rates were often below 4 percent, which means the property values were astoundingly higher than in past years.

To conclude: industrial (just ahead of multi-family) is the new darling of institutional investment: never before has so much money been chasing so many buildings at so many record prices. The investment market and the industrial leasing market has the same marquee star: the net leased e-commerce distribution center, or fulfillment center! And free one-day delivery!

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The Differences in Real Estate in the Last 30 Years: Part III

1/9/2020

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Hospitality & Land

Photo credit: MetroCreative

(See Part II: Multi-Family & Medical)

Hospitality:

The face of the hospitality industry has changed radically in 30 years. In major cities, convention centers have gotten bigger and bigger, (and the accompanying hotels, too) and larger in scale. Consolidation has occurred with the major brands. Emerging as the leaders of the pack are Choice Hotels International, Wyndham Worldwide, Hilton, and Marriott.

Choice Hotels? Of course, not a known name – but its economy-minded clientele will recognize Comfort Inn, Econolodge, Quality Inn and Mainstay suites. They have popped up everywhere on the interstates. Wyndham, while itself a luxury brand, features mostly economy-class products with familiar names such as Days Inn, La Quinta, Howard Johnson's, Super 8, and Travelodge - and even the slightly tarnished Ramada Inns.

Hilton, long a luxury brand, now also features Waldorf-Astoria in that category, and has promoted next-level brands such as Homewood Suites and Doubletree. Hilton has also funded the rapid growth of Embassy Suites and Hampton Inns. Marriott, the 800-pound gorilla, has separate marketing strategies for luxury brands such as Ritz Carlton, St. Regis and Westin, longer-stay brands such as Residence Inn and Springhill, and old standbys, Sheraton, Courtyard, and Fairfield Inn.

Occupancy rates are high in the booming 2020 economy, averaging a solid mid-60s percent but the impact of Airbnb and Vrbo has been noticeable, with lobbyists working hard to quash the upstart disrupters and to subject them to the same regulations as hotel chains. Big investments made by the major chains in new brands designed to be chic, less stodgy, and attractive to Millennials and Generation Xers show the pressure felt by the iconic brands.

All told, though, with more money globally seeking stable assets, accepting lower CAP rates, the values of the good products in the hospitality industry are dramatically good, and will probably stay that way as U.S. citizens continue robust travel habits.

Land:

In 1990, there was barely ever a mention of tertiary markets by large commercial real estate developers, many of them being national. Primary markets such as the “Gateway Cities” e.g. New York, Boston, Atlanta, Dallas, Houston, Chicago and Los Angeles were everybody’s targets. Secondary markets peeked through; Indianapolis (Chicago Jr.), Memphis (Fedex), Louisville (UPS), Seattle (Microsoft, Boeing, Starbucks), Kansas City (rail from Mexico), and Denver and St. Louis, just because. Dense population is a major factor as 70 percent of the U.S. Gross Domestic Product is from consumer spending, mostly impacting retail. But, population drives all asset classes and institutional investors, many still new at investing in real estate, feel more comfortable with major metro areas.

Tertiary markets were those just beneath those mentioned, partially based on size of the trading area, partially on sheer population and prospects for growth, and all impacted by the health of the local economy, with south and western areas inching ahead of northern and eastern metroplexes. As for land needs in industrial, in the ‘80s and early ‘90s it was important to be near existing power and water for manufacturing, though labor was an increasing factor and non-union was preferred. Thirty years later, however, land needs for industrial were for large big distribution centers that could service a good part of North America’s population such as Nashville, Salt Lake City, , Orlando, Columbus, and Cincinnati. Different criteria for each was based on geography.

But, the bigger the market, the greater the demand for land at major intersections for fast food growth. (Heaven help you if you’re not on the right side of the street during commute times). It became more likely for a developer to tear down an older facility to build a new one (where land prices were so high, demo work made sense). In the older cities, it's harder to do inner-city development from a regulatory, infrastructure, and cost perspective. And for major land purchases for mega-warehouses? Hey, if you’re in Indianapolis or Columbus, where land is flat and stable, you’re in much better shape than in Los Angeles (where regulations add a good year to a pro forma), Louisville or Nashville (where soils, flood plain, or nasty topography get in the way) or Boston (where 500 years of history can turn up in an excavation. Case in point; The Big Dig, estimated in 1982 to cost $2.8 billion and take seven years, ended up costing more than $8 billion and took 15 years).

So land, at best, anywhere, is an iffy proposition, taking months to properly evaluate and incorporate into a business model that is economically viable.

Big changes in 30 years in land acquisition include properly handling Native American burial sites when uncovered, properly designing storm water and water run-off characteristics with proper retention, so as not to unduly impact neighboring properties, proper harvesting of woodlands without disturbing mating patterns of endangered avian or other species, and in many more rural areas, properly relocating family cemeteries, some of which can contain dozens of graves.

Technology has of course helped. In 1990, a project known as a “cut and fill” site with rolling topography could often end up with a need for hundreds of truckloads of fill dirt. Or, the opposite, a project might have needed to dispose of that extra dirt. Today, within minutes, a topo can be created and a design suggested, with proper runoff in the right direction – with an accurate estimate– without importing or getting rid of dirt. Moreover, with laser and GPS technology, earth moving machines can be programmed to carve up the site exactly to design without much operator input.

But, land is land. As the old saying goes: “They ain’t making any more of it." So as metropolitan areas develop, the trade offs are: pay more, take more risk away from the owner/farmer (i.e. pay dearly for an option to buy), compromise on what’s the best location, or buy an older facility and raze it properly.

It’s difficult to assess trends in land values, but in a strong economy, common sense says that the supply will dwindle and the demand won’t stop – so up go the prices. And in certain sections of the country, they have skyrocketed. Scarcity and certain land price rises have given rise to some multi-story warehouses in the U.S. for the first time since the 1950s. (One major difference: those were all freight elevator-dependent; these new versions have truck loading and unloading on every level!) We're also seeing the success in other countries such as Japan and Singapore in multi-level. Less land is needed at the exorbitant prices, but it requires much more expensive construction to accommodate truck traffic on upper levels.

What will eventually hold land prices in check will be even a mild hike in inflation, now hovering around 2 percent or lower with 10-year T-bills yielding below 1.8 percent. When both rise, today’s historically low investment CAP rates will, too, putting downward pressure on real estate vale, and squeezing profit out of new development. Land will be the first place cuts will be made in new development.

Stay tuned for Part IV: Investment & Industrial

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The Differences in Real Estate in the Last 30 Years: Part II

1/8/2020

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Multi-Family & Medical

Photo credit: MetroCreative

(See Part I: Retail & Office)

Multi-Family:

In the early ‘90s, home ownership was still the American Dream, and the percentage of people owning homes was in the mid-60 percentile. It had just taken a hit with the Savings & Loan debacle, but a robust economy and desire to own prevailed, and the national housing stock increased dependably every year with local and national-brand home builders. Apartments were a choice only when affordability was a factor. Condominiums flourished also, where apartments in fact, could be owned.

Despite the usual fluctuations that occurred when the economy soured, home ownership continued to rise, and lenders often lent 100 percent – or even more – to provide mortgages for ever-rising home values, with a national push to increase home ownership to 70 percent. To lenders, the risk was low as their mortgages were mostly bundled into financial securities, often recklessly. The rating agencies looked the other way when securities, including subprime mortgages, were created, and in 2007, a crash occurred that lasted almost three years, flushing out the home buyers who probably weren’t really capable of performing. A boom began in multi-family units that hasn’t stopped since, fueled also by the billions of dollars in college tuition debt incurred by a whole generation of erstwhile homeowners now relegated, by financial constriction, to the rental market. In almost all communities nationwide, apartments appeared everywhere, and condominium developments, unable to be sold individually as units, converted to apartments as well. The local communities which stifled apartment development because of the burden on the school systems (with not enough property tax generated per student) relaxed somewhat when the per-unit children ratios went down, and in a full-employment economy, apartments were needed for local labor force increases.

The effect on real estate? Values of modern multi-family units have skyrocketed, and older, smaller complexes have appreciated nicely as well. There is a trend to create new walkable communities, many of which contain far more rentals than any time in the past. And in today’s full-employment economy, living units near metro areas mean more people to hire.

Medical:

The United States, unlike the UK, Germany, Czechoslovakia, France and Japan, to name other countries, has had population growth sufficient to sustain the drift toward an aging population. Natural growth (without immigration) has been 2.1 children per family of two parents in order to even stay at current levels; the rest coming from immigration. Politically, immigration as an issue has had an up-and-down effect on a country’s population. But with people living longer, and medical advances adding many new life-sustaining techniques, medical facilities – hospitals, urgent care centers, and medical office buildings–have grown in number far more rapidly than the general population. For countries with shrinking or event stagnant population growth, the era of diminished medical care may be coming, as there aren’t enough healthy and young people to pay for it at today’s growth rates. Though the trend appears to have nothing changing its inflection, it appears unsustainable economically in the long run. In 2020, billions of dollars have been invested in major new hospitals around the country, mostly in locations away from their historical centers, gravitating to the suburbs where the aging population resides. New smaller hospitals with fewer beds –and even some that are almost exclusively outpatient– have become a new asset class. Medical office buildings, on the rise for most of the new millennium, are now plateauing due to the downward pressure on physician income levels. Those doctors who continue to prosper are orthopedic surgeons, heart and vascular specialists, cancer practitioners, and dermatologists and plastic surgeons. Those struggling include pediatricians, family practice physicians, anesthesiologists, and others.

The values of the real estate for hospitals appear to be rising, especially for the newer, more nimble models, but medical office buildings attached to them are a little more uncertain, and remote medical office facilities may not keep pace over the long run, especially those owned by groups of doctors. More expensive to build than conventional office space, they may find themselves someday unable to compete with lower rental rates.

Stay tuned for Part III: "The Differences in 30 Years": Hospitality & Land

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The Differences in Commercial Real Estate in the Last 30 Years

1/7/2020

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Photo credit: MetroCreative

Part I: Retail and Office

Retail:

In 1990, the economy was booming, and enclosed shopping malls around the U.S. were everybody’s favorite for shopping. Anchored by such stalwarts as Sears, Macy’s, Hess’s, Montgomery Ward, Saks Fifth Avenue and the like – all were thriving. Bookstores, (Waldenbooks, B. Dalton, Barnes & Noble) shoe stores, (Kinney, Thom McAn, Foot Locker) and electronics retailers (Sharper Image, Circuit City, Radio Shack) peppered the malls, with the larger ones often being single destination. Strip malls were the darling of small investors, and grocery-anchored centers as choice real estate investments were still in their infancy. Blockbuster, Media Gallery and Hollywood Video were soon to displace the Mom & Pop video rental and music stores (Sam Goody and Media Play suffering a similar fate) with thousands closing by the mid-2010s leaving Redbox kiosks in grocery stores the lone survivor. Large footprint electronics stores, regional and national (HH Gregg, Steinberg’s, Best Buy, Circuit City) were thriving on large TV and new personal computer sales, but they were soon to feel the pinch from online sales.

By the beginning of 2010, the American buying public had transformed radically. The largest single factor was the emergence of online sales, now 10 percent of all retail, and destined to climb dramatically. (In comparison, 35 percent of all retail sales in China today are online). Large retailers such as those mentioned above were finished. Kmart merged with Sears, and then folded the entire empire. Even Walmart, the king of the big discount stores back then, had to radically alter its platform to accommodate e-sales, as did Target, and Kroger as well as others had to offer food delivery to compete with Amazon’s Whole Foods.

Amazon! The single biggest disrupter of retail, (38% of all e-commerce sales) along with smaller forces such as eBay, has transformed the buying landscape. The demise of so many shopping malls and big-box retailers happened while e-commerce warehouse construction flourished. The last mile was still elusive, and drones, timed combination lock boxes, and the traditional delivery players (UPS, FEDEX, USPS) filled the bill – until Amazon decided to go all-in – or all-out – with their own Prime network of contract delivery drivers, and by the end of 2019 fully half of Amazon deliveries were through this “Last Mile Program."

The impact on retail real estate? Malls, for the most part, are severely devalued. Neighboring shopping centers/strip malls are suffering high vacancy rates with little leasing activity in a booming economy. Restaurants that fail are usually razed, or often radically revamped, to add more seats and squeeze down the kitchen size. Different outlot players appeared, but fast food was still dominant.

And “Lifestyle Centers” sprang up – retail, residential, hospitality, parks, entire new mini-communities. The concept is still in its beginnings, often struggling for identity, but it has caught on in many places with Gen Xers and Millennials, who prefer apartment and walkability to suburban car-dependent home ownership.

Office:

In 1990, having a downtown office was the ultimate, but suburban office parks with free parking were springing up, and slowly vacancy rates in CBDs climbed above suburban. Many new CBD office buildings built in the ‘80s became a little dated, older ones more so, and there was little downtown residential to offset the suburban advantage of proximity to homes. But all company employees were in the office, clustered by departments, and being near the courthouse and county records kept attorneys and commercial real estate players nearby.

Slowly the Internet age took over, accelerating in the new millennium, and gradually, WiFi-connected employees started working from coffee shops and other cafes – and from home. The growth in office space stopped, and actually reversed when shared space – first called “hoteling” (where employees, at different times, shared work stations) began to flourish. And in the post 2010 era, companies like WeWork began offering space with WiFi on a monthly rental basis, so satellite offices in urban areas didn’t need a leased space-- which when not in a small suite, would be in Regus or HQ offices that provided clerical help. As laptop/WiFi usage evolved, the need for the assistance vanished--only copiers/scanners/printers were needed, along with amenities like coffee, beer, big screens. Flexibility was the goal, though the WeWork model appears to have grown too fast and a bit recklessly.

The effect on office real estate? Lease rates plateaued, and only the best-located buildings increased in value. The conundrum included parking now being more uncertain, the impact resulting from driverless cars, and more and more employees who don’t drive cars to work. And with lease rates leveling out and yet construction costs and land costs continuing to escalate, far fewer new office buildings are being built as this segment of the industry struggles to meet the needs of tomorrow. Open office plans, more included services in tenant space, and high-capacity Wi-Fi lead the suite of attractions to lure new tenants in existing Class A buildings. Class B buildings struggle, with only painful price reductions as an offering, and Class C? Many are being converted to residential, especially in active urban Primary and Secondary markets, as younger workers seek walkable living. Time will tell on the office market and its future prospects.

Stay tuned for Part II: "The Differences in 30 Years": Multi-Family & Medical

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The Differences in Real Estate in the Last 30 Years: Part IV

Investment & Industrial

The Differences in Real Estate in the Last 30 Years: Part III

Hospitality & Land

Stay tuned for Part IV: Investment & Industrial

The Differences in Real Estate in the Last 30 Years: Part II

Multi-Family & Medical

Stay tuned for Part III: "The Differences in 30 Years": Hospitality & Land

The Differences in Commercial Real Estate in the Last 30 Years

Stay tuned for Part II: "The Differences in 30 Years": Multi-Family & Medical

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