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The Reinvention of Retail and its Impact on CRE

Posted on February 26, 2020March 9, 2020 | Leave a comment

Ask around or cruise the internet and you are likely to find some pretty dire information on the retail industry. Yet you are also likely to find individuals and organizations that understand a simple fact: retail isn’t dead, it is just evolving. This is true for brick and mortar retail and e-commerce alike. With customers having more choice than ever, even disruptive companies like eBay are being disrupted by other innovators like Etsy.

For those of us in the CRE business, the question then becomes: “how does the reinvention of the retail industry impact commercial real estate?” Today, we will aim to answer that question by discussing how the retail industry has and is evolving, the types of CRE projects still paying dividends within the retail industry, and an outlook on commercial real estate in the retail sector.

How Modern Retail has Changed Over the Years

To understand how retail and CRE impact one another, we will start by understanding the current state of the retail industry. Due to major market shifts, the retail industry has undergone some key paradigm changes in recent years. These changes include:

Customers are more informed than ever. The old days of coming into a store knowing next to nothing are behind us. Any individual or organization with internet access can be nearly as knowledgeable as a salesperson before making a purchase.

Retailers know more about customers than ever. On the flipside, modern data collections and analytics also allow retailers to know more about customers before they ever set foot in a store.

Mobile devices drive in-store visits. The average consumer has internet access at all times. This means that the average consumer finds businesses through their mobile device a large percentage of the time. An example might be searching “Thai restaurants near me” to find a place to eat.

Reviews from critics and customers are available for all to see. Online reviews are a major disruptor of the retail industry. This can be both an opportunity and a threat to retailers.

How Retail Struggles Hurt Commercial Real Estate

There is little question that the struggles of the brick & mortar industry have had a negative impact on the retail commercial real estate industry. There are a few key ways in which the downturn of traditional retail business has hurt CRE:

The US is “over-retailed”. It is important to understand that the retail industry is still big business. As a recent article put it, “The problem with U.S. retail? There’s too much of it.” When we talk about CRE and retail, the primary issue is an overabundance of existing real estate with insufficient demand. The key will be re-positioning or removing this excess supply of space. Or as CBRE’s Jason Cannon humorously put it at last week’s NAIOP Pittsburgh chapter meeting, “The problem isn’t that we are overbuilt; it’s that we are under-demolished.”

Malls are dying. To illustrate this point, we need to look no further than the dying malls of America. The epicenters of American retails well into the 2000’s have since lost viability in the face of e-commerce. Retail CRE used to focus on megastructures and large retail presences, but will likely need to adapt to survive (more on this in the following section).

New construction for retail is on the downturn. As a result of items 1 and 2 alongside other key factors, new construction for retail real estate is down about 5% in 2019 year over year.

Retail Commercial Real Estate Adapts to Industry Change

Moving on to the question of the hour, how can the retail CRE industry adapt to a changing retail industry? While there is no one answer, there are several ways in which commercial real estate investors can remain competitive in the retail space.

Repurposing old retail spaces

Earlier we discussed how the US is “over-retailed”. This creates a supply and demand issue without question. It also creates an opportunity for investors to snap up undervalued retail real estate and repurpose those properties into money makers. This can include revamping dead malls, vacant spaces left by a dying big box industry (think Sears and JC Penney), and much more.

Investing in mixed-use properties

There are countless success stories of dead malls being turned into local community colleges, places of worship, or even bowling alleys. The point being, real estate is real estate. Retail spaces in good locations tend to be undervalued in today’s CRE environment. Turning these spaces into mixed-use properties which allow for retail, industrial, residential, and/or commercial properties is one way to adapt to a changing marketplace.

Going Forward

Retail is not a dead industry, it is merely one undergoing rapid change. Although we discussed some of the latest changes and retail industry problems, there will always be a sizable market for retail in the commercial real estate industry. For commercial real estate investors, the biggest takeaway might be that CRE must adapt as retail continues to adapt. Retail and e-commerce will continue to move forward as technology advances and customer behavior adapts.

For all the doom and gloom, there are still 65.9 million square feet of real estate under active construction in the US. Americans still shop at traditional retail centers in huge numbers. What remains to be seen is how both the retail and CRE industries adapt to new technologies moving forward.

Commercial Real Estate Investment by the Numbers

Posted on February 24, 2020 | Leave a comment

Commercial real estate is a major influencer of our local, state, and national economy. For those of us in the industry, we understand the symbiotic relationship between commercial real estate and overall economic health. With many financial experts predicting a recession in the coming months or years, today we will be taking a look at the current state of commercial real estate by the numbers.

Commercial Real Estate Facts Facts and Figures

To start things off, let’s take a look at some high level CRE statistics. According to statista.com, the first half of 2019 brought us the following numbers:

The value of commercial construction for new projects and additions to existing properties in the US was approximately $89.52 billion.
The value of private office new construction projects was around $8.12 billion.
The value of new warehouse construction within the private sector in the US was around $33.8 billion.
The value of lodging (hotel) construction in the US was valued at about $30.76 billion.
By Q3 2020, it is estimated that U.S. office vacancy rates will hover around 12.5%, retail vacancy rates will be at 13.9%, and industrial vacancy rates will sit at around 6.5%.
There were 4,577 restaurants and/or bars opened in the US in 2017 and 2018 combined.

Commercial Real Estate Trends Over the Past ~20 Years

All of those numbers in a vacuum can mean different things to different people. $89.52 billion might seem like a healthy number, but how does it stack up in the US CRE market worth upwards of $17 trillion? To understand the health of CRE, let’s take a look at some recent trends.

The volume of commercial real estate transactions in the US is cooling off.

In terms of CRE transactions completed, the industry has been tapering off since hitting its recent peak in 2015. In 2011, commercial real estate transactions totaled just $96 billion dollars. That number steadily rose to 2007, where it reached an all-time high of $580 billion. That was directly before the real estate collapse and the Great Recession of 2007-09. In 2009, the total value of CRE transactions dipped to $71 billion. Again, this number recovered quite quickly until 2015, where it neared 2007 levels at $569 billion. Since 2015, the volume of CRE transactions by dollar amount has gone down every year. This number reached $394 billion in 2018.

The commercial real estate industry has mostly outperformed other real estate sectors

Coming back to The Great Recession, it is important to note that while all real estate sectors were hit hard, the CRE sector was the fastest to recover and has since recovered to the highest degree. The US commercial real estate industry has also “ increased faster than the Real Estate and Rental and Leasing sector overall.” The commercial real estate industry remains strong, and is “the 1st ranked Real Estate and Rental and Leasing industry by market size and the 2nd largest in the US.”

Commercial Real Estate Investment Trends

So far we have talked about overall CRE health and growth, but what about investment activities? Here are a few key facts and figures on commercial real estate investment.

Multifamily Units are an investor favorite in the CRE market

From 2009 to 2017, the multifamily home sector has quadrupled. Hitting an industry low during the Great Recession, multifamily homes have since been a huge hit for investors, outperforming traditional single family investments by about double. In 1999, approximately 13% of newly constructed multifamily buildings included 50 or more units. That number has since grown to over 50% of newly constructed multifamily buildings having 50 or more units in 2017.

CRE Investors are turning towards senior citizen needs

A major driving force in the commercial real estate market today is the aging population of the US. This is causing many CRE investors to look into housing solutions for senior citizens, but that is just one piece of the puzzle. Older Americans also will require more medical facilities, different types of multifamily homes, and much more.

CRE Investors are eyeing the energy, infrastructure, and high tech sectors

Last but not least, the commercial real estate industry is following overall US economic trends. Three of the most profitable sectors include the energy sector, infrastructure market, and high tech sectors. Savvy CRE investors will understand that these sectors are relatively safe bets for overall growth in 2020 and beyond, and are therefore relatively safe bets for commercial real estate projects. With the White House continuing to make promises in the areas of infrastructure and many state and local governments shifting towards renewable energy options, the opportunity for growth is there.

Going Forward

Commercial real estate as an industry and as an investment opportunity is in a healthy place in 2020. There is no longer a steady, rapid growth as was experienced after 2007, but the market has leveled off in a sustainable way. Despite calls for an imminent recession, real estate experts have all but unanimously declared that the next recession will not hit the real estate market like it did over 12 years ago. Going forward, there are more reasons than not to remain bullish on CRE investment.

Uber Purchases 600 Acres in Findlay Township, PA

Posted on February 18, 2020March 9, 2020 | Leave a comment

Uber is a now well-known ride sharing service which has 100’s of millions of active users. Uber has been a major disrupter of the taxi and car service industries by offering a unique (at the time) business model of matching passengers to drivers with independently owned vehicles. Today, those 100’s of millions of active users have adopted ride sharing into their daily lives for commuting, when traveling, or even just getting home responsibly from a night on the town. In the Pittsburgh area, Uber is also known as a pioneer in autonomous vehicles and has established a technological headquarters where they are testing their new self-driving cars and trucks.

As part of this testing process, Uber recently made another large commercial real estate purchase west of Pittsburgh. Today we will review the details of that purchase, give some background on Uber, and explore how Uber’s presence in Pittsburgh might impact the local CRE industry.

Details on Uber’s Recent CRE Purchase near Pittsburgh

Uber’s autonomous car shop in the Strip District is expanding its reach. Uber had been looking for additional facilities to test its self-driving vehicles. In late 2019, it found a new home by purchasing a nearly 600 acre lot in Findlay Township, PA. The land was sold for approximately $9.5 million by Imperial Land Corporation. The new facility will replace the old Uber testing ground at Hazelwood Green along the Monongahela River. Uber’s current lease at the Hazelwood Green expires in 2023. However, the pace at which the Findlay facility is advancing makes it likely that some portion will open as soon as 2021.

As part of the deal, Uber will be testing its autonomous vehicles in a newly constructed facility. The land was vacant at the time of purchase. Uber has not yet publicly announced the details of their plans for the location, but they have announced that their autonomous car facility in the Strip District will remain operational.

Uber’s Pittsburgh Presence has Grown in Recent Years

By now, most Pittsburgh locals have seen the Uber self-driving cars patrolling the streets from their strip district research facility. Yet the testing of these experimental vehicles is only a small part of their Pittsburgh footprint. Uber has made it no secret that they intend to grow their Pittsburgh presence around their autonomous testing facilities. The latest land purchase is part of Uber’s plan to add more facilities, employees, and testing to the area. Uber is based in San Francisco, and has found Pittsburgh to be a desirable mix of affordability and access to highly skilled and educated employees.

According to Mobility21.cmu.edu: “The [Findlay Township] facility is expected to employ as many as 200 people and come with an observation (sic) tower and other developments to create a 24-hour simulated environment in which to test Uber’s autonomous vehicle technology that brought it to Pittsburgh in 2015.” The decision to purchase land and build a test track rather than leasing one is significant.

From a commercial real estate perspective, Uber’s expanded investment in the local economy will likely lead to related projects. As for the Findlay Township facility, much more than a test track is planned. While Uber has made no announcements, plans are being reviewed for entitlement and permit purposes. The first phase includes a 140,000 square foot testing facility with entrance doors that are tall enough to accomodate trucks. The site plan shows more buildings in the future, in excess of one million square feet under roof.

Uber by the Numbers

To understand how Uber might impact Pittsburgh in the near and distant future, it can be helpful to understand a bit more about Uber’s story and their impact by the numbers. Here are some highlights which give recent events some context:

Uber was founded in 2009, and has since become the most highly valued private startup company in the world.
Recent estimates place the valuation of Uber at around $90 billion.
Uber is currently operating in 700 cities and 63 countries across the globe.
While Uber’s employee numbers range from 19,000 to 27,000 thousand, the total number of Uber drivers likely exceeds 4 million.
Uber generates approximately $12 billion in gross bookings per quarter.
Uber has completed over 5 billion trips since its inception.
While these numbers are declining as the market matures, Uber has enjoyed a 70-75% market share of ride sharing services for several years.

These numbers illustrate the impact of Uber as a market disruptor and an economic force. Uber’s corporate decision to invest in the Pittsburgh area has already had a material impact on local economy and CRE landscape. While a 600 acre construction project might not be the biggest in the city this year, the real question becomes what will come next for the ride sharing service.

Going Forward

Uber’s preeminence in autonomous vehicles was short-lived. Shortly after establishing Pittsburgh as its global AV headquarters, Uber was joined in the region by Argo AI, Aurora, and Aptiv, along with the testing that Carnegie Mellon does on its own. As an employer and consumer of commercial real estate space, Uber has grown by leaps and bounds. Its competitors have expanded their presence as well. Autonomous vehicles appear to be an inevitability, maybe even morphing into fling vehicles or some other form of mobility we can’t as yet imagine. The beachhead that Uber has established by building a major testing facility makes it that much more likely that whatever the future of AV brings, Pittsburgh will be at the heart of it.

Fundamental Factors that Drive Commercial Real Estate Markets

Posted on February 14, 2020March 9, 2020 | Leave a comment

While most of you reading this come from the commercial real estate industry, it can be useful to brush up on the fundamentals. With this in mind, here are some of the fundamental factors that drive the commercial real estate market.

The Local, State, and Federal Economy

Without a doubt, the state of the economy is a primary mover of the real estate market. Understanding exactly how the economy impacts commercial real estate is more complex. First, we must measure the health of the economy using metrics including gross domestic product, gross national product, productivity, spending, unemployment, and much more. Ask ten economists which metrics matter most, how to properly measure them, and what trends will impact commercial real estate most, and you are likely to get ten different answers.

It is not vital for commercial real estate professionals to understand the intricacies of the economy. It is more important for CRE professionals to keep an eye out for dramatic economic shifts like the next recession.

Interest Rates – CRE Loan Rates

Another key factor in CRE health are the past, current, and future interest rates. Similar to an individual seeking a mortgage for a home, investors looking into commercial real estate properties seeking a loan must consider interest rates for their loans. When interest rates rise, demand for properties is generally lowered. Conversely, lower interest rates frequently spur new investments/restructuring for commercial real estate loans. The factors that determine interest rates are many, but essentially boil down to lenders covering their costs and risks of loaning money.

Unlike mortgages for residential properties, commercial real estate loan rates can vary from 3.5 to 20 percent. This wide range of rates stem from the different property types, investment types, loan types, and details of the individual/group seeking the loan. Because there is such a gap between different CRE loans, it is prudent to understand one’s unique situation before assuming a range of rates.

Regional Population Demographics and Behaviors

The national landscape of commercial real estate might not extend to your region. A simple example would be state population increases and decreases within certain demographics. If your state is experiencing a large influx of young professionals, the commercial real estate market is likely to experience a boost. Yet the CRE environment is not a 1-1 relationship with population alone. In our Western PA region, we are simultaneously seeing a growing demand for convenient housing for young professionals in urban areas and a growing need for senior citizen housing and resources such as medical facilities.

Demographics that influence commercial real estate also stem from shifts in demographic behavior. Where Baby Boomers were reliable home owners for many decades, they have recently begun a shift towards renting their homes for financial and convenience reasons. For this and many other reasons, “there are more of group x moving to our area” is not a slam dunk when it comes to CRE forecasting.

Governmental Policies on Commercial Real Estate

Buying, renting, and selling properties all involve government regulation. These regulations have always existed, but have increased in the years following the Great Recession of 2007-2009. Because the recession was tied into the lending crisis, federal and state regulations on real estate loans and transactions become stricter and more invasive. The commercial real estate industry is built to adapt to these changes. It has been argued that one of the major reasons why CRE bounced back faster than other real estate industries in the wake of the Great Recession is that adaptability to changing government regulation.

CRE professionals might want to stay abreast to the changing regulations through the Code of Federal Regulations (CFR). “CFR stands for Code of Federal Regulations. The CFR is the codification of the general and permanent rules and regulations published in the Federal Register by the executive departments and agencies of the federal government of the United States. This codification of what is sometimes called “administrative law” has been published annually since 1938. The CFR is divided into 50 “titles” that are meant to cover broad areas such as Commerce and Foreign Trade, Federal Elections, Employees’ Benefits, Internal Revenue, and Education, just to name a few.”

Going Forward

The current outlook of the commercial real estate market in Western PA and across America remains cautiously optimistic. The US economy has been relatively strong over the past few years, with a few cracks starting to form in recent months. Loan rates remain appealing for commercial real estate investors, and the overall trend for real estate has continued to rise. However, many of the industry drivers we listed here today are beginning to flatten or even regress. This, and many other complex factors, have led economists to predict a looming recession in America. Recessions are an unavoidable part of a free economy, and we are overdue based on historical precedence.

The silver lining in these predictions is that the Great Recession of some 12 years ago has left the commercial real estate industry more hardened against economic downturn. Remember that economic strength is only one of the driving forces of CRE markets. Understanding the bigger picture allows us to accurately predict what we can expect going forward.

Coal Country, Alternative Energy Infrastructure, and Energy-Related Construction Projects

Posted on February 12, 2020March 9, 2020 | Leave a comment

“Coal country” can refer to any areas where coal has historically been a major business. For those of us from the American Northeast, coal country usually refers to the Appalachian areas of Pennsylvania, West Virginia, Ohio, Kentucky, reaching southwest all the way to Mississippi. This corridor has been a staple of American industry for well over a century. Yet modern energy infrastructure upgrades and a shifting view on fossil fuels have changed the landscape of coal country.

With all of this in mind, today we will take a look at how coal country is modernizing, how alternative energy infrastructure is taking root across American, and examine current and future energy construction projects are impacting the commercial real estate market.

Climate Change’s Impact on Coal Country

Politics aside, there is irrefutable evidence that the side effects of coal mining and using coal as an energy source do have a material impact on our environment. According to the U.S. Energy Information Administration (a federal agency), coal emissions include sulfur dioxide, nitrogen oxides, particulates, carbon dioxide, mercury, heavy metals, fly ash, and bottom ash. It should also be stated that many modern efforts within the coal industry have been made to burn “clean” coal, which reduces, but does not eliminate, many of these emissions.

As federal and state regulations tighten on coal and other fossil fuel emissions, where does that leave the businesses, employees, and economies of coal country? Thankfully, where there are alternatives to coal, there are also alternative economic opportunities. For example, New York State has recently doubled down on their commitment to clean energy, a decision that is “expected to create $3.2 billion in economic activity and more than 1,600 jobs.”

While such a massive change may take longer to implement in states like Pennsylvania and Kentucky, the impact such a paradigm shift would have on energy infrastructure and energy jobs in coal country would be significant. The workforce that previously made their living in the coal industry might have opportunities in new, renewable energy sectors.

Renewable Energy Infrastructure and Commercial Real Estate

So far we have mostly been talking broad strokes and how coal transitioning into alternative fuel sources might affect the working men and women in coal country. From the perspective of commercial real estate, the shift from traditional fossil fuels to alternative fuel sources could be similarly significant. Let’s take a look at how shifting regulations and public perception on alternative fuel sources might influence the commercial real estate in Western PA and across the country in the years to come:

Energy infrastructure will need massive updates

It is no great secret that America’s infrastructure is aging. Our energy sector is certainly no exception to this rule. Upgrading America’s energy infrastructure is an effort which is/will be necessary regardless of the debate between coal and alternative fuel sources. From a CRE angle, this means that infrastructures will either require massive updates, new construction, or most likely, both. It should also be noted that the energy sector is just one area of our infrastructure in need of updating. Government buildings, roads, bridges, schools, and many other government funded expenditures must compete for limited funding.

Energy megaprojects likely to continue in 2020 and beyond

Oil, gas, coal, and alternative fuel technology have advanced to the point that facilities must adapt to keep up. Due to this and many other reasons, constructiondive.com states: “energy-related megaprojects are expected to make up a big part of the U.S. construction industry in coming years.” With a governmental commitment to revamping our infrastructure and an emphasis on adapting to new technologies, the CRE market for energy related construction and renovation efforts should remain robust for years to come.

Education and other resources are available for sustainable infrastructure

A sign of things to come begins with many colleges, universities, and trade schools offering programs for students interested in working in the renewable energy construction fields. For example, The University of Washington offers a master’s program titled: “Construction, Energy, and Sustainable Infrastructure” through their Civil & Environmental Engineering school. Like many similar programs, it is available on-campus or through online courses.

While a master’s program might not be for everyone, these types of opportunities will likely play a huge role in transitioning the workforce in American towns across coal country from their experiences in the coal industry to a new field working in renewable energy or sustainable infrastructure construction. A qualified workforce will then create greater opportunities to improve our nation’s infrastructure, greater opportunities for commercial real estate investors, and ultimately will benefit our region’s economy.

Going Forward

Again trying to avoid politics or any other contentious topics, it is very likely that a transition away from fossil fuels in favor of renewable energy sources is a matter of when, not if. For those of us living in coal country, this can be viewed as an opportunity to invest in our future. With the right planning, changing our local energy infrastructure can lead to economic growth, more jobs, and of course commercial real estate opportunities.

5 Reasons Why Hotel Investments Remain a Risky Bet Moving Forward

Posted on February 11, 2020March 9, 2020 | Leave a comment

Like many industries, the hospitality business has been steadily regaining its footing since the end of the Great Recession around 2009. Many recent estimates project a flattening or even reverting trend of hospitality growth in the US. There are also industry disruptors to contend with including Airbnb and other home sharing services. At the end of the day, the hospitality industry has endured — but investing in hotels has always been a risky bet. Today, we will review some of the biggest reasons why investing in commercial real estate within the hospitality market remains a high risk endeavour.

The Problems with Hotels as Investment Properties

1. Hotel/hospitality industry growth is expected to slow

As mentioned in the introduction, the hotel business has had a very solid decade. All major metrics have risen steadily thanks to a resurging economy and an industry that learned many lessons after the Great Recession. The past few years have painted a slightly different picture. Growth has slowed, and the projected fallout is likely to result in lower occupancy rates, and lower nightly rates.

CBRE points to “growth in local market supply, low inflation, competition from the sharing economy and the expansion of intermediaries in the sales process” as major reasons for this decline. It should also be noted that the stalling within the hospitality industry may be a sign of a looming recession (more on this below).

2. Hotel investment can be prohibitively expensive

While the majority of commercial real estate construction projects tend to come with high price tags, hotel construction costs should not be overlooked. Hotel construction costs can vary dramatically from a few million to hundreds of millions of dollars. Fixr.com puts the median hotel construction bill at approximately $22.2 million not including land acquisition or demolition costs. For CRE veterans, that number may not ruffle many feathers. Yet in conjunction with some of the other risk factors we are discussing today, an investment of that size can be a tough sell to investors.

3. The hospitality business is seasonal and volatile

A well known risk of the hospitality business is the seasonal, volatile nature of occupancy and room rates. This is particularly true for “tourist” hotels in areas near ski resorts or beaches. For investors, the word “volatility” does not often inspire great faith. For an even more extreme example, consider a traditional hotel powerhouse: New York City. In the wake of the 9/11 tragedy, the usually rock solid hotel business in NYC plummeted. Vacancy rates were high and nightly rates were low. Experienced, well-equipped investors stayed pat and waited for the regional economy to bounce back. Yet this is a cautionary tale that investors should be prepared to take losses on the path towards a return on their investment.

As a brief counterpoint, investing in hotel REITs is an appealing alternative for investors who believe in the profitability of the hospitality industry without risking large dollar amounts on single hotels. REITs work in a similar fashion to mutual funds or ETFs, where investors can buy shares in commercial real estate collectives.

4. Estimating ROI for hotels is more difficult than many other commercial real estate properties

Estimating returns on investment is not an exact science. Yet some investments are easier to project than others. For example, if a young couple buys a starter home for $100k in a neighborhood where most houses are selling for $200k, they can feel relatively confident that some renovations will net them a solid return when they sell. When it comes to investing $20 million for a hotel, that calculation is significantly more intricate. Factors which remain fluid include: occupancy rates, taxes, room rates, inflation, other hotels opening or closing in the area, staff turnover, overhead costs, and much more.

5. Hotels are notoriously susceptible to recessions

Recessions are a part of any free economy. Our last true recession began in late 2007 and the effects lasted for three solid years. Many economics experts believe that our next recession will hit sometime between now and 2022. That being said, no matter when the next recession comes, it will almost certainly hit the hospitality industry hard. Travel is amongst the first “luxury” expenses that individuals and businesses cut when the economy slows. Much like seasonality and day-to-day volatility, hotel investors should plan to absorb recession hits with some regularity.

Going Forward

Hotels can be profitable real estate investments when handled properly. There will always be a demand for lodging from economy motels to luxury suites. The hotel business has been growing at a steady pace since the economic crisis in the late 2000’s. Yet many commercial real estate investors believe that the risks outweigh the potential benefits due to slowing hospitality industry metrics, industry volatility, high upfront costs, difficult to calculate ROI, and going into a business that is susceptible to recessions.

Going forward, it is likely that the hotel business will stall or even backtrack for a short period of time. Political and economic uncertainty may have a heavy influence on this volatile market. The key to investing in hotels is understanding the risks involved and planning accordingly. As with all commercial real estate ventures, there is certainly money to be made in hotels.

Short Term Rentals for Multi-Family Property Owners

Posted on February 10, 2020 | Leave a comment

Short term rentals have gained popularity due to the rise of companies like AirBNB, Tripping.com, FlipKey, and others. Multi-family properties have long been a staple of residential real estate investment or larger commercial real estate groups where single buildings are built or transformed to accommodate two or more units. When this new real estate trend met a stalwart in the CRE world, the results have been mixed. As we will review today, short term rentals of multi-family properties do offer a lucrative opportunity, but one that comes with a number of practical, legal, and financial risks.

With all of this in mind, we will be discussing the potential benefits of multi-family real estate investment, the potential benefit of short term rental agreements, and the pros and cons of combining these two concepts into a real estate management/investment plan.

Potential Benefits of Multi-Family Real Estate Investment

Multi-family real estate investment is well-known for paying solid dividends for investors. This has remained true for decades, centuries, and even beyond. There are three primary reasons why multi-family real estate investment remains appealing in 2020 and beyond:

Multi-family properties are easier to finance. According to investopedia.com: “In most cases, if not all, the cost to acquire an apartment building will be significantly higher than the cost to purchase a single-family home as an investment. A one-unit rental could cost an investor as little as $30,000 while the cost of a multi-family building can go well up in the millions.” The benefit? Multi-family units generate far greater returns on those investments with more regular and stronger cash flow. This means that lenders are more willing to provide larger loans for superior terms for multi-family financing agreements.

Multi-family investment is more efficient. Those in the commercial real estate market will understand that purchasing and renting 50 individual homes is far less efficient than building a portfolio of 50 rental units in one or two multi-family apartment complexes.

Managing multi-family properties is more practical and cost-effective. Continuing the idea of efficiency, paying a small staff to manage an apartment complex is far more viable than a staff responsible for properties spread out all over town.

Potential Benefits of Short Term Rental Arrangements

Moving on to the other side of the conversation, what are the potential benefits of short term rental agreements? Here are just a few of the reasons why property owners are opting for short term rentals as a money-making operation:

Short term rentals can charge higher rates. This is perhaps the most obvious advantage of short term rentals. While $100 a night for a short term rental might seem reasonable for many areas, $3,000 per month in those same areas almost certainly would not. Rates are adjusted depending on the length of the rental, but the property owner typically makes more money per day/week than they would on a longer term arrangement.

Short term rentals offer greatly flexibility. The other main advantage of short term rentals is the flexibility offered to both property owners and renters. Consider the construction of a new apartment building. Certain sections/units might be done at odd intervals. Short term agreements allow the property owner to fill those units more quickly and on a more varied timetable.

Pros and Cons of Short Term Rentals for Multi-Family Property Owners

The concepts of multi-family rentals and short term rentals are time-tested. When combined, the results can be quite different. With this in mind, here are some pros and cons of multi-family property owners offering their spaces as short term rentals:

Con: restrictions on short term rentals for multi-family properties: Cities like Boston have recently implemented strict guidelines on what properties can be leased for short term rentals. CRE properties may be exempt entirely depending on local and state law.

Pro: closing the gap of vacancies: as mentioned in the previous section, even the largest apartment complexes may go through times of unforeseen occupancies. Short term rentals can be used as either a long term strategy or a stop-gap solution to keep cash flow coming in.

Con: short term rentals for multi-family properties can harm cash flow: on the other hand, one of the main benefits of multi-family properties (regular, reliable cash flow) is directly negated by short term rental arrangements.

Pro: short term rentals can always be turned into long term rentals: last but not least, a real estate investor can easily transition a short term rental space into a long term arrangement. In other words, there is minimal risk in trying a short term strategy for a short period of time.

Going Forward

Short term rental agreements aren’t going anywhere any time soon. Whether or not these types of arrangements will take a major market share of apartment complexes and other multi-family home units remains to be seen. It seems likely that governmental restrictions on short term rental agreements will continue to become more restrictive in coming years, which might also impact the viability of short term rentals moving forward. For now, CRE investors would be wise to consider all of their options when leasing their properties.

Increased Senior Housing Needs’ Impact on Commercial Real Estate

Posted on February 4, 2020March 9, 2020 | Leave a comment

It is no great secret that our country is aging. In fact, recent estimates provided by the US Census Bureau project that “older people (are) projected to outnumber children for the first time in US history” within the next 10 years. Not only will this put an economic strain on our nation, but it will also challenge our existing resources and infrastructure. An example of this strain is the existing problem of demand for senior housing outpacing our current supply. This dynamic is likely to impact the landscape of commercial real estate for years to come, but how?

Today, we will review the current reality of seniors’ housing needs, what those needs are likely to look like in the near future, and how these shifting realities will impact the CRE industry today and moving forward.

Senior Citizen Demographics by the Numbers in 2020 and Beyond

To understand senior housing, we must first understand the senior citizen demographic in the US. Here are some fast facts on senior citizens in America:

Over 50 million Americans are aged 65 or older. It should be noted that this estimate is on the conservative side based on available Census data.

The population of senior citizens isn’t just projected to rise, it is expected to explode. Where 2018 statistics put the number of Americans aged 65 plus at 52 millions, that number will be approximately 95 million by the year 2060.
Older Americans are also getting more diverse over time. Today, approximately 77 percent of Americans 65 plus are white. That number is expected to fall to 55 percent by 2060. Despite this increase in diversity, older generations will continue to lag behind younger generations in terms of ethnic diversity.

Additional facts about senior citizens that remain relevant to our conversation about housing and CRE include: aging generations having higher levels of education, longer life expectancies, and significantly lower poverty rates.

Low Affordable Housing Supply May Price Seniors Out of Their Communities

While senior citizens are in better shape than ever before in American in terms of wealth and education, they are still vulnerable to rising real estate costs. For extremely low-income renter households, only 35 rental homes are available for every 100 families in need. This is an example of a problem for senior citizens: they are particularly susceptible to being priced out of their own neighborhoods. Coupled with a national housing shortage and a rapidly aging population, rising real estate costs are a very real problem for seniors.

In Pittsburgh, we can see this in neighborhoods like Lawrenceville. From the years 2010 to 2017, the median home sales price jumped from $95k to $237k. That is nearly a 150% increase in less than a decade. Many working class families who have been living in Lawrenceville for decades have been forced to look elsewhere for affordable housing options. Again, senior citizens find themselves being hit the hardest.

How America’s Aging Population will Impact Commercial Real Estate

The Baby Boomer generation is in prime retirement age in the US. With that paradigm shift, the commercial real estate market is looking to adjust. Baby Boomers have been driving the residential real estate market for 20 plus years. Now they are about to drive the rental and commercial real estate markets in a new way.

Baby Boomer retirement likely to increase demand for multifamily housing

Retiring adults have been showing more inclination towards “downsizing” as they approach retirement age. This means that the Baby Boomer generation is going to be predominantly looking for affordable housing and/or rental opportunities for the first time in many years. This change in desired housing will likely come with a higher demand for multi-family housing, including:

Apartment complexes aimed toward senior citizen needs
Gated townhome communities
Any residential plans which take care of lawn care, home maintenance, etc.
Convenient living with senior-friendly amenities such as ramps, elevators, etc.

Another key factor to remember is that many senior citizens desire to stay local as they downsize. This means that these amenities are going to be desired in their current suburban/urban neighborhoods for affordable rates. This creates a potentially lucrative opportunity for commercial real estate developers and/or investors to get ahead of a rapidly aging US population.

Going Forward

All signs point to senior citizens moving away from their single family homes into smaller single family homes, multi-family homes, or other senior-friendly accomodations. This is nothing new. What is new is that the population of Americans aged 65 plus is expected to nearly double over the next 40 years. As life expectancy continues to climb, older generations will be looking for affordable and convenient housing options in record numbers. From the perspective of the commercial real estate professional, the question becomes how our industry will adapt to this change.

Western Pennsylvania has already had an upturn in new construction for senior citizen centers, medical facilities, and other infrastructure to accommodate an aging population. Yet housing shortages and other factors will continue to create a situation where senior citizen demand for affordable and convenient housing will likely outpace the supply.

Real Estate Investment Trusts (REITs) Continue to be a Great Choice for Small Investors

Posted on February 3, 2020March 9, 2020 | Leave a comment

Perhaps the biggest problem being a modern real estate investor, or any type of modern investor for that matter, is an overabundance of choices. Stocks, bonds, mutual funds, options, annuities, direct real estate purchases, REITs, retirement accounts — the list seems to have no end. This leads to a situation where investors might miss out on potentially great opportunities in a sea of options. One such option is a real estate investment trust, frequently shortened to REIT.

Today, we will explore REITs, how they differ from direct real estate investment, and review why REITs remain a perfect choice for individuals in 2020 and beyond.

What are Real Estate Investment Trusts (REITs)?

According to reit.com: “REITs, or real estate investment trusts, are companies that own or finance income-producing real estate across a range of property sectors. These real estate companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer a number of benefits to investors.”

Let’s break that down. REITs are a unique way of investing in commercial, industrial, and/or residential real estate that is available to investors of all wealth levels. REITs are generally hands off, meaning that investors may have a vote, but will not directly control the buying and purchasing of real estate assets held within their REIT.

Real estate investment trusts are generally used as investment opportunities to grow the investor’s wealth. Most REITs focus on a particular subset of properties such as commercial apartment building, medical properties, data centers, hotels, and so forth. In this way, investors can choose the area of real estate they believe will make the best investment.

REITs vs. Traditional Commercial Real Estate Investment

So how exactly do real estate investment trusts compare to direct real estate investment? There are several ways we can compare and contrast the two:

REITs are the mutual funds/ETFs of the real estate world

As we described above, REITs give investors access to a multitude of properties through a trust. This means that REITs are more stable than direct real estate investment as one-off losses or gains will be balanced out by a larger portfolio. This also means that the potential for extreme gains with an REIT is generally lower than direct real estate investment.

Direct commercial real estate investment gives investors all the power

If you own a piece of real estate, you are in full control of that asset. You are free to buy, rent, renovate, or whatever else you might choose assuming you don’t have a contractual or legal obligation preventing such an action. REIT investors do not share this level of control or power. Instead, they buy into REITs which are managed by industry experts. A loss of control might be a non-starter for some investors, but the ability to diversify real estate holdings with REIT gives investors a much safer bet in the long term.

Direct real estate investment generally comes with a larger buy-in

REITs are extremely affordable. Much like stocks, bonds, or mutual funds, investors need only to be able to afford shares rather than making massive investments to purchase a real estate property. In this way, individuals and organizations of all levels of wealth can invest in the real estate market. This is a primary reason why REITs are perfect for individuals and small investors (more on this below).

REITs have guaranteed dividends

Another huge advantage of REITs is that a minimum of 90% of all payouts must come by way of dividends. This is a legal obligation based on federal REIT law. It is important to note that according to investor.gov: “The shareholders of a REIT are responsible for paying taxes on the dividends and any capital gains they receive in connection with their investment in the REIT. Dividends paid by REITs generally are treated as ordinary income and are not entitled to the reduced tax rates on other types of corporate dividends.”

REITs Remain a Solid Investment Opportunity

REITs are not meant to replace a solid investment portfolio by way of a retirement account and/or traditional investment account. Instead, they should be thought of as a perfect supplement to those investment opportunities which allows individuals of all levels of available capital to invest in the real estate market. A few reasons why REITs will remain a great investment opportunity include:

Guaranteed dividends
Real estate investment without the need for industry expertise
REITs are completely hands off/passive (unlike direct real estate investment)
REITs are liquid just like stocks or other traditional investments. Again, this differs dramatically from typical real estate investments
A traditionally strong performance compared to other investments

Going Forward

REITs were first introduced in the early 1960’s, and they don’t show any signs of going away any time soon. In fact, the total monies invested in REITs around the world has exploded from $300 billion in 2003 to a massive $1.7 trillion in 2017. Real estate investment is not just for the wealthy or the connected thanks to REITs. Anyone looking to build equity or expand their investment portfolio should consider a real estate investment trust.

What to do with America’s Dead Malls

Posted on January 31, 2020March 9, 2020 | Leave a comment

It wasn’t long ago that the traditional American mall was the staple of retail commerce. In 2020, it can feel like you are equally likely to find a mall completely abandoned than thriving with shoppers. In reality, recent estimates project that almost one in four malls will close or have closed all within a five five year period. Yikes. Commercial real estate investors have been taking huge losses in the brick and mortar space in recent years. Yet some investors have viewed losses like mall closures as opportunities to transform these spaces into revenue generating properties.

With this in mind, what can be done about the epidemic of American mall closures?

Option 1: Find New Tenants for Mall Spaces

In a perfect world, mall owners would simply find new tenants to fill their existing vacancies. The obvious benefit of this plan is that it does not require a massive renovation or redevelopment. Redeveloping a space as large as a mall would take years and incredible investment dollars to complete. Repopulating existing spaces with new renters is certainly a simpler undertaking. Despite all of the upsides, the question then becomes: is this a reasonable expectation?

One of the key factors that led to the downfall of the American mall was the rise of e-commerce. E-commerce giants like Amazon and eBay have syphoned sales away from brick and mortar retailers since their inception in the 90’s. The problem with finding new tenants for existing mall spaces is that most spaces were designed for flagship renters including department stores, clothing stores, and other struggling industries.

Option 2: Double Down on Amenities

The American mall infrastructure is dated, and it shows. It isn’t just the concept of shopping in an indoor mall that is old, it is also the gargantuan redundant architecture. Some malls have doubled down on the retail mall concept by renovating their facilities with modern amenities. Of course, this is an additional financial risk being put towards an already-dying industry. Yet many success stories are floating around about dead malls being brought back to life.

A key here is understanding the mall’s location, key demographics, and potential for growth. An example of a subset of malls who continue to thrive are upscale, “luxury” malls which cater to the upper class. The Bal Harbour Shops in Miami rent spaces to some of the most famous and expensive designer outlets in the world. This works for the Miami strip, but it of course will not translate across most of America.

Option 3: Repurpose Dead Malls

Many dead malls have found a new purpose after slight modifications turned their defunct spaces into fitness centers, medical clinics, places of worship, and even educational facilities. Despite the death of brick and mortar businesses being largely exaggerated, there are still plenty of industries starving for large, accessible spaces. Ample square footage is still desirable for gyms and churches, and these types of demand are not as volatile to market changes when compared to department stores and retailers.

As with our previous option, repurposing dead malls often includes renovation and/or redevelopment that could eat up a chunk of time and money. Mall ownership groups are often diverse and heterogeneous. Deciding to embark on such a dramatic shift in strategy is often what stalls these types of projects.

Option 4: Sell the Mall and Associated Properties to Developers

At some point, all investors and/or owners of struggling commercial real estate properties have to make a decision to fish or cut bait. Many mall owners are doing just that and selling these massive properties. Of course in order to sell you must first find a buyer. The benefit of selling to a new group is that modern commercial real estate investors may be better equipped to face the challenges of finding new tenants, improving amenities, or repurposing existing infrastructure to make a dead mall profitable again.

The downside of selling a dead mall in today’s real estate market is that the valuations have gone down in recent years. Where some dead malls have shown signs of life through creative problem solving, the majority of malls continue to struggle, dead or not. The business of major retailers has changed since the invention of the internet and it will likely never fully recover. The decision facing mall owners and managers now is which of these (and other) options will offer the best return on investment in a bleak marketplace.

Going Forward

Malls aren’t what they used to be. It is very unlikely they ever will return to their glory days as the hub of modern commerce. Instead, these massive structures have been repurposed, renovated, and updated to bring their aging architecture into the modern era. Thriving malls have one major concept in common: they are being proactive rather than reactive in their approach. The “do-nothing” method simply is not an option for today’s dying malls. While the four options presented above are certainly not the only options on the table, they lay out the basic concepts of how current malls can retain their relevance for years to come.