Category: National Economy

Will Cannabis Legalization Present CRE Investment Opportunities?

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

No matter what your personal views on the matter, the cannabis legalization discussion is here to stay. As of the writing of this article, marijuana is fully legal in 11 states and legal for medical use in over half the states in the US. Those numbers are not expected to diminish, with additional states considering full or partial cannabis legalization. What has followed has been a growth in a previously non-existent industry that has affected both micro and macro economics in the US. The question we now ask is: will cannabis legalization change the commercial real estate market?

To answer this question, today we will explore the current state of marijuana legislature as well as future projections, the likelihood that cannabis will become fully legalized in the state of Pennsylvania, and discuss how federal and state legislation on cannabis has and will continue to impact the CRE industry.

The Latest on Cannabis Legalization

There is nothing clear about the current state of cannabis legalization. So let’s stick with the facts. First and foremost, the federal government considers marijuana a class 1 controlled substance. This puts marijuana at the same tier as LSD, heroin, ecstasy, peyote, and methaqualone. While legislation has been proposed, the nationwide legalization of marijuana is likely very far off.

11 states have fully decriminalized marijuana

It should be noted that although we consider these states part of a group, their individual laws on cannabis regulation vary dramatically. What remains constant is that users must be over the age of 21, and distribution is still highly regulated. The states that have legalized marijuana include Washington, California, Maine, Michigan, Alaska, Nevada, Colorado, Oregon, Illinois, Massachusetts, and Vermont.

33 states currently allow the legal use of marijuana for medical purposes

33 states plus the District of Columbia allow residents to own and use marijuana when it is prescribed by a physician. Pennsylvania is one of these states. These laws become even cloudier than the “fully legal” 11 states listed above, as the medical red tape can be quite complex.

Fully illegal vs. decriminalized and beyond

For the 39 states that have not legalized marijuana, there are varying degrees of criminality associated with possession and distribution charges. Some states including Delaware, Connecticut, Maine, and New York, have reduced cannabis charges, meaning previous punishments have been diminished for those.

Will Cannabis be Legalized in Pennsylvania?

Pennsylvania’s laws on cannabis allow for medical use only. Unlike some other states, Pennsylvania has not enacted laws to decriminalize marijuana possession or distribution charges. As we discuss the possibility of the marijuana business impacting commercial real estate in our region, the next logical question becomes: how likely is it that cannabis will become legal in Pennsylvania?

The answer is as complex as you might imagine. Politicians including Governor Tom Wolf and Lieutenant Governor John Fetterman have both gone on record stating that they would consider the legalization of marijuana in the future. In the case of Fetterman, he is openly in favor of full legalization on the state and federal level.

Recent polls suggest that 59 percent of Pennsylvanians support the recreational use of marijuana. This is in stark contrast to a similar poll in 2006, in which only 22 percent of registered voters were in favor of recreational marijuana use becoming legal. The biggest considerations continue to be:

Pennsylvania’s mix of conservative and liberal ideals clashing at the state levels and
Money. If other states see a windfall from marijuana legalization (including commercial real estate), the likelihood of full legalization grows.

How Cannabis Legalization Has Impacted the Commercial Real Estate Market

The legal marijuana industry has already eclipsed $10 billion in the US. The cannabis market is potentially the fastest growing industry in the nation. Commercial real estate investment is a huge part of that growth. Here are a few ways in which marijuana impacts local CRE markets:

The demand exists for large facilities. Cannabis production facilities are quite large, and often include both farming and processing capabilities.
Regulations are a blessing and a curse. CRE investors would be wise to understand state and local laws before entering the cannabis arena. Cannabis producers must jump through hoops at the state level to gain site approval before beginning any type of production.
Cannabis retail is big business. Of course, production is only one side of the equation. Marijuana has a strong retail presence which has injected life into a stagnant retail market.
Local and state economies have been boosted by legal marijuana. Even if you want nothing to do with the cannabis industry, there is now sufficient evidence to make the claim the legalizing pot boosts the economy at the micro and macro level. As we know, stronger economies often create stronger CRE markets.

Going Forward

At the moment, legalized marijuana in Pennsylvania is all a hypothetical. The benefits of legalized marijuana for business and for commercial real estate are well documented. If and when our state (or the fed) chooses to adopt cannabis, there will certainly be an opportunity to pounce. The question going forward will become when that happens and what regulations will come along for the ride.

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.

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.

Lower Federal Funds Rate Impacts Real Estate

Posted on January 23, 2020March 9, 2020 | Leave a comment

Like it or not, federal regulations play a huge role in commercial real estate investment, construction, sales, and everything in between. Perhaps no singular federal policy has more of a direct impact than the federal reserve cutting or raising the federal funds rate. Separate but related to the federal discount rate, the federal funds rate dictates interest charged on a number of loans. The fed has recently decided to once again cut the federal funds rate in late 2019/early 2020. The impact on real estate will certainly be felt, but this is nothing new.

With this in mind, today we define the federal funds rate, discuss the details of the latest rate cuts and a brief history of past cuts and hikes, and finally identify how these changes will likely impact the commercial real estate sector.

Understanding the Federal Funds Rate

According to investopedia.com: “The federal funds rate refers to the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis. By law, banks must maintain a reserve equal to a certain percentage of their deposits in an account at a Federal Reserve bank. Any money in their reserve that exceeds the required level is available for lending to other banks that might have a shortfall.”

The federal funds rate can be changed as many as eight (8) times per year as decided by the Federal Reserve. The actual rate can be influenced by buying and selling government bonds or other investment securities. The federal funds rate is determined separately from the federal discount rate, but these two figures generally have a symbiotic relationship.

As part of the regulations surrounding the federal funds rate, banks and other financial institutions are required to meet reserve requirements that must include non-interest bearing accounts. This secures short term loans and provides assurances for financial institutions and loan recipients alile.

Details on the Latest Fed Funds Rate Cuts

Normally three straight fed funds rate cuts is not a great sign for the economy overall. The last time this many consecutive rate cuts took place was in 2008 amidst the housing crisis and Great Recession. The latest cuts move the effective rate from 1.75% to 1.5%.

Generally, cutting the federal funds rate is intended to spur economic growth. These cuts come at a time when more observers are predicting that a recession is looming in the next year or two. Yet not everything is doom and gloom. Opportunist investors can take advantage of low fed funds rates to secure loans, make investments, and much more. Individuals who are looking to refinance mortgages or open home equity loans are perhaps the biggest winners from these fed rate cuts.

Lower fed funds rates only impact those who are looking to open new loans or refinance existing loans. For this reason, pre-existing loans and mortgages will be unaffected by the cuts. This essentially means that those who are locked into unfavorable loan situations might want to jump on this opportunity to refinance.

How Federal Rate Cuts Impact Commercial Real Estate

There are several ways in which federal rate cuts might impact commercial real estate, including:

Interest rates can impact local property values

Commercial real estate does not exist in a vacuum.The estimated values of surrounding properties go a long way towards CRE valuations. Federal funds rate changes can impact the calculations used to determine property values. Therefore, a change in interest rate can materially impact the value of commercial real estate properties without any other changes.

Interest rates, cap rates, and the spread

Commercial real estate investment can sometimes rely on what is known as “the spread”. The spread is determined by finding the difference between the cap rate and the finance rate. As federal funds rates influence finance rates, this can make CRE investments more or less attractive over time.

Federal funds rates cuts have a trickle down effect

It would be convenient to say that fed rates have a 1-1 impact on commercial and other forms of real estate. In reality, the relationship is far more complicated. Consider the fact that rate cuts are tied closely to poor economic performance. This in and of itself has reduced the positive impact of past rate cuts. Current and future rate cuts seem like they should have a straightforward, positive impact on commercial real estate investment. This simply is not always the case. Rate cuts might boost property values, but also may reduce demand, be tied to inflation problems, and many other potential impacts which are too complex to properly describe (or understand) in a single article.

Going Forward

It is yet to be determined whether the recent trend of consecutive rate cuts will continue as 2020 progresses. Rates are already very low, and can be reasonably expected to stagnate or bounce back in the future. This may also be reactive based on overall economic performance. Metrics point to mild recession in the next few years. How this will impact the federal funds rate will certainly continue to be a major factor in the commercial real estate investment space.

Why the Next Recession Won’t be as Hard on the Real Estate Market

Posted on January 22, 2020March 9, 2020 | Leave a comment

The Great Recession of 2008 has its name for a reason. It has been measured to be the largest economic disaster in American history since the Great Depression of the 1920’s-30’s. The recession was so large that a ripple effect caused a global recession just a year later. While no industry was unaffected, the real estate market took a particularly hard hit. In fact, a collapse in the housing market and other real estate markets in 2007 was one of the falling dominos that led to the inevitable recession just a year later.

Despite all of this (or perhaps because of it), there is reason to believe that our next recession will not take nearly as significant a toll on the commercial real estate market. This is partially due to the fact that the next recession will likely not be as damaging to the overall economy. It is also thanks to administrative efforts to protect the real estate market from present and future turmoil. With this in mind, here is why the next recession likely won’t be as hard on the real estate market.

Why the 2008 Great Recession Crushed the Real Estate Market

There can be no question that any recession would be expected to have a negative impact on the real estate market. The 2008 great recession was particularly damaging to house costs, commercial real estate, and rental vacancy numbers specifically because it was partially caused by a looming housing crisis. After all, when 8.7 million jobs are lost and house prices drop by approximately 28 percent across the country, the value of real estate is going to take a hard hit.

While the housing crisis gets all the press, commercial real estate was heavily impacted by the 2008 Great Recession. It is important to understand that many of the same issues which plagued residential real estate such as lax policies from the Federal Reserve including offering so called “exotic mortgages” did touch the commercial real estate market, but not to the same degree.

The primary cause of the commercial real estate crash in 2008 was an overall recession. Less money for businesses led to lessened spending. Lessened spending led to fewer employees. Fewer employees led to fewer jobs. Fewer jobs led to less need for commercial real estate and/or developing commercial real estate projects. And the list goes on. Still, CRE is heavily tied into federal policy which has been adjusted to be more conservative in the years since 2008. More on this below.

Inevitability of the Next American Recession

It is only natural that the US will soon experience its next recession. There is no economy on earth which is immune to bull and bear markets — such is the way of any large economy. Unfortunately, many economic metrics are pointing towards the next recession coming sooner than later. Here are a few reasons why:

New York Federal Reserve recession probability model: The New York Federal Reserve is one of the most well respected authorities on predicting recessions. Their model has accurately predicted past recessions both in real time and retroactively. The accuracy and detail of this model shows that we are more likely to see a recession in 2020 than any year since 2009.

Inverted yield curve: You may have heard or read something about the inverted yield curve popping up for the first time since the great recession in 2019. Essentially, when short term yields are outperforming long term yields, that is a major red flag of a coming recession.

Unduly inflated economic numbers: The US is currently enjoying low unemployment rates. This is generally great news for CRE investors hoping that a recession is far away. Unfortunately, unemployment is not such a simple statistic. Underemployment numbers and part time employment numbers are on the rise. This is another staple of an upcoming recession.

The Next Recession Won’t be the Same as 2008 for Real Estate

Now that we have established that:

A recession will be upon us at some time in the relatively near future and
The last recession was devastating for the real estate market

Why exactly should we expect the next recession to be any different? The simplest answer is that the federal government and banking institutions have (mostly) learned their lessons. The ridiculous lending practices of the early to mid 2000’s have either been eradicated or constricted. The supplemental answer is that the 2008 was one of the most significant economic events in the past 50 years. It is extremely unlikely that the next recession will be as impactful overall. Whether we are talking about the housing market or commercial real estate, a repeat of 2008 is likely very far off.

Going Forward

The best laid plans of mice and men often go awry. Even with a looming recession, it is probably a good idea for commercial real estate veterans to go about their business as usual. The next recession will almost certainly not be the same cataclysmic event as the last one, and the real estate market is expected to remain much more stable this time around. Obviously, all recessions have an economic impact. History may not be repeating itself, but learning from our past mistakes is always wise.

84 Lumber Looks to Expand After Huge Cash Injection

Posted on January 21, 2020 | Leave a comment

84 Lumber was founded in 1956 by Joe, Norman, and Bob Hardy in the Southwestern PA town of Eighty Four. In 60 plus years of operation, the lumber company has added hundreds of locations across the country including New York, Massachusetts, Florida, and more. As part of this expansion effort, 84 Lumber has recently secured a $310 million loan which will replace a pre-existing $400 million dollar loan secured in 2016. Since that time, the company’s performance has exceeded expectations and its market competition, leading to the opportunity for a more favorable loan arrangement.

Today, we will review the details of 84 Lumber’s $310 million dollar cash injection, review the business history of 84 Lumber, and discuss the impact that this deal and ongoing 84 Lumber projects will continue to have on the local commercial real estate market.

84 Lumber Looking to Expand with $310 Million Loan

There are several key reasons why 84 Lumber’s loan restructuring is significant for the company:

84 Lumber is looking to improve their IT capabilities. Regardless of industry, information technology is a part of any large business. One of the primary drivers of this new $310 million loan is 84 Lumber’s desire to modernize their IT infrastructure to improve client relations and their internal systems.

84 Lumber wants to use funds to expand into new territories. While 84 Lumber has traditionally been a Western PA organization, it has already expanded across the country into several states. This new influx of capital will allow the company to potentially expand into new territories including Sacramento, CA and Northern Virginia.

The loan will allow for financial restructuring. According to recent reports, the final primary reason for this new loan is to refinance. “The proceeds will be used to refinance the $307.5 million outstanding Term Loan B and $400 million ABL Revolver. In addition to extending the maturities, the Term Loan B reduced pricing by 100 basis points to LIBOR plus 425 basis points. As a result of the refinancing, the company now has no debt maturities prior to 2024.”

A Brief History of 84 Lumber’s Business Expansion

To understand the significance of this new loan, we can also explore the history of 84 Lumber’s presence both locally and nationally.

84 Lumber is founded in 1956 by Joe Hardy alongside his two brothers Norman and Bob, and close friends Ed Ryan and Jack Kunkle. The initial business model was a “cash and carry” lumber yard where industry professionals and handymen could come buy affordable, high quality products. The business was modest but immediately successful.
In the 1960’s, the business experienced its first major expansion by growing their local business with new locations, bigger warehouses, and a larger inventory supply. The first years of 84 Lumber’s history involved fast yet sustainable growth.
The 1970’s saw 84 Lumber opening an additional 229 locations, expanding beyond the immediate Western Pennsylvania market for the first time.
The 80’s and 90’s were an era of revamping the 84 Lumber business model. Instead of exclusively catering to professionals, they remodeled many of their stores to make them friendlier for a broader demographic.
84 Lumber hit $1 billion in sales for the first time in 1993.
In 1997, 84 Lumber opened its 400th store.
Today, 84 Lumber is refocusing on its information technology sector to move the business into the next decade seamlessly. The company accrued $3.86 billion in sales in 2018, and continue to enjoy healthy growth.

Impact of 84 Lumber on Local Commercial Real Estate

The relationship between 84 Lumber and local commercial real estate is actually somewhat complex. On one hand, 84 Lumber contribute massively to the local economy by creating jobs, owning local properties, and generally injecting cash into the region. On an entirely different level, having the “nation’s leading privately held supplier of building materials, building supplies, manufactured components and industry-leading services for single- and multi-family residences and commercial buildings” in our backyard has a material impact on the CRE market as well.

Due to this unique circumstance, 84 Lumber is as entrenched as any local company when it comes to commercial real estate. While other organizations like PNC and UPMC may own and operate significantly more locations, 84 Lumber is a major player within the CRE industry itself. Pittsburgh commercial real estate can certainly look to 84 Lumber’s continued success and expansion with recent deals like this $310 million loan restructuring as a sign that our market will continue to hold strong.

Going Forward

84 Lumber’s steady growth and solid leadership is encouraging. With favorable loan agreements and new stores going up every year, the banks clearly agree. Having such a large commercial real estate building supply provider in Western PA offers a unique advantage to local construction crews. While the company continues to expand across the country and perhaps internationally, they retain a large presence in the Pittsburgh area and have no plans to relocate any time soon. 84 Lumber’s continued success can only be a positive sign for commercial real estate in our region.

Commercial Real Estate and US Economic Trends Going into 2020

Posted on January 13, 2020March 9, 2020 | Leave a comment

As with most investor markets and economic issues, commercial real estate is an ever-changing reality. What might look like a safe bet today could lead to huge losses tomorrow. Government regulations, environmental factors, and a looming recession are just a few of the ways that the commercial real estate landscape can change at any moment. Yet seasoned real estate veterans understand that these changes are just a surface disruption of CRE wisdom which generally holds true over time.

With all of this in mind, here is a brief report on the current realities of commercial real estate in the US as well as some insights into the near future.

2019 Commercial Real Estate by the Numbers

The commercial real estate market is currently valued in the ballpark of $1.1 trillion. To put that in perspective, if a trillion dollars represented $10,000, a billion dollars would be $10. Needless to say, there are massive amounts of revenue being generated in the CRE market in 2019. Here are a few other statistics to give a clearer picture of the current state of CRE:

The commercial real estate industry experienced an estimated growth of 2.2 percent in 2019. This is down from an average of ~4 percent annual growth in the CRE industry over the past five years.
Commercial real estate growth has outpaced overall real estate growth, rental rate growth, and leasing growth in 2019.
Seasonalized annual construction values from Q2 2019 are down by about five (5) percent compared to similar estimates from 2018. Newly constructed commercial structures saw the largest value losses over this time period.
Commercial property valuations are on a steady rise beginning with the recovery period in 2009-2010. During this time period, prices have risen the most in the Western United States with the Midwest lagging behind.
Rental rates have flattened to a relatively low 1.4 percent year over year growth from 2018 to 2019. This trend is expected to continue with many market indicators pointing towards a stagnant apartment market overall.

The State of the US Economy Looking to 2020 and Beyond

Before we stare into the proverbial crystal ball, we should first state the obvious: nothing is guaranteed. That being said, here are some likely events in the US economy over the next several years.

A recession is all but unavoidable in the next few years

As of the writing of this article, the latest news is that doom and gloom predictions about the next US recession may have been exaggerated. Despite this sudden onset of optimism, the plain truth is that recessions are a part of modern free markets. The most optimistic, realistic view of the situation is that our next recession may not take place in 2020 but in the years to come. Whether the next economic downturn occurs in 2020, 2021, or beyond, it will almost certainly have a material impact on commercial real estate just as it did during the Great Recession of 2008.

Climate change will continue to be a major player for the economy and for CRE

Recent scientific studies have predicted that extreme weather events in the United States will rise by approximately 50% by the end of the 21st century. This continues the already observable trend of extreme weather patterns like more frequent and stronger tornadoes, hurricanes, floods, and other natural disasters. This will impact both the overall economy and commercial real estate industries for obvious reasons. Building codes are likely to be updated, insurance costs will rise, and other incidental expenses will almost certainly take a hit. Economists warn that climate change will likely cost the US economy 100’s of billions of dollars by the year 2090.

Young adults will continue to struggle financially

Last but not least, the population of adults who should be representing the largest buyers in the US economy will continue to be hit by crippling debt, healthcare costs, and stagnant wages. Barring an unlikely dramatic shift in the political and/or economic landscape, the US Debt Crisis will be a huge factor in the economy for the foreseeable future. This has already played a role in lagging rental rates, home ownership, and spending habits. It is difficult to predict how this situation will play out, but younger generations have proven that they are willing to cut costs, something that is not a great sign for economic health.

Going Forward

The commercial real estate sector has been reliably strong for nearly 10 years now. After a two year dip in 2008-09, investors have enjoyed solid returns and steady growth. While it is reasonable to expect another downturn at some point in the next few years, it is also reasonable to believe that the US economy will bounce back and investments will continue to pay dividends. It will continue to be important for investors to keep up with the latest CRE trends such as co-working, energy construction projects, infrastructure construction, and much more. The commercial real estate world’s evolution is ongoing, and the only certainty moving forward is change.

Commercial Real Estate Lending Standards

Posted on January 8, 2020March 9, 2020 | Leave a comment

According to the Office of the Comptroller of the Currency of the United States: “Commercial real estate (CRE) loans include loans secured by liens on condominiums, leaseholds, cooperatives, forest tracts, land sales contracts, construction project loans, and—in the states that consider them real property—oil and mineral rights. National banks may make, arrange, purchase, or sell loans or extensions of credit secured by liens on interests in real estate.” All of this essentially to say that commercial real estate loans are frequently borrowed against other commercial real estate assets.

When it comes to commercial real estate lending standards, there are federal and state-wide regulations of which any active CRE investor should be aware. Today we will review some of the high level lending standards for real estate investments in the U.S.

Establishing a CRE Loan Portfolio

One of the most important aspects of securing a real estate loan for a commercial property or any other real estate purchase is building a loan portfolio. The onus to create these reports is on the insured depository institution, AKA any bank which is insured with the regulations of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The federal government has strict guidelines which regulate what must be included in these reports, including but not limited to:

Identifying and declaring the terms and conditions of the loan.
Scouting locations in terms of properties and geographical areas for which the loan may be applied.
Establishing a policy of loan portfolio diversification including parameters for investments by real estate type (commercial vs. real estate, etc.) geographic location, and more.
Identify any lending staff including personal qualifications.
Complete a risk assessment to determine any undue concentrations of risk.
Identify zoning requirements.
Identify the underwriting standards which will be used for the loans.
Establish loan-to-value limits (more on this below).
Identify the loan administration protocols which will be followed throughout the life of the loan including disbursement, documentation, collection, collateral inspection, and loan review.

There are more loan portfolio requirements than we will list here, but this is a reasonable sample to give prospective investors an idea of what the federal government expects when clearing future commercial real estate loans.

FDIC Real Estate Lending Standards

The Federal Deposit Insurance Corporation, more often referred to as the FDIC, is an independent federal agency responsible for insuring against bank failures. The vast majority of major financial institutions in the United States are FDIC insured or FDIC supervised. This is important for commercial real estate lending standards, as FDIC regulations come into play for any such organization. With this in mind, here are some high level regulatory standards set forth by the FDIC:

“Each FDIC-supervised institution shall adopt and maintain written policies that establish appropriate limits and standards for extensions of credit that are secured by liens on or interests in real estate, or that are made for the purpose of financing permanent improvements to real estate.”
Real estate loans must be considered within the bounds of standard banking practices.
All written loan policies must undergo an annual review and approval process by an FDIC-supervised board of directors.
Commercial real estate lending procedures must include detailed underwriting protocols, loan-to-value limits, and portfolio diversification demands.
All loans must be monitored by an FDIC supervised institution to ensure that the current real estate landscape continues to support the terms of the loan.
All lending policies for real estate should adhere to the “Interagency Guidelines for Real Estate Lending Policies established by the Federal bank and thrift supervisory agencies.”

Supervisory Loan-to-Value Limits

While there are certainly more details to cover when it comes to CRE lending standards, the last key concept we will hit upon today is loan-to-value limits. Loan-to-value limits or loan-to-value ratios are essentially the calculation reached by dividing the loan amount by the total market value of the investment including any additional collateral being used to secure the loan. It is vital to understand this metric not only to secure loans and adhere to lending standards, but also to gauge how viable a loan and/or real estate investment will be.

Different real estate categories carry different loan-to-value limit requirements.

Raw land investments: 65 percent
Land development investments: 75 percent
New construction: situationally dependent
Commercial, multifamily, and other non-residential property investments: 80 percent
One to four family residential investments: 85 percent
Improved property investments : 85

Transactions Excluded from Loan-to-Value Limit Evaluations

It is important to note that many commercial real estate loans are exempt from loan-to-value evaluations. Examples of these types of loans include those which have been insured or guaranteed by the federal government, those which are backed by the full faith and credit of a state government, or those which are to be “sold promptly after origination, without recourse, to a financially responsible third party.” It is vital to understand precisely how transaction exemptions work before assuming that your loan will not undergo the scrutiny of a loan-to-value limit evaluation.

Going Forward

In most cases, it is not absolutely necessary for commercial real estate investors to understand the in’s and out’s of CRE lending standards. Yet knowledge of how the federal regulations work and what questions will be asked can allow investors and other CRE professionals to better prepare for loan applications. It is also important to understand that even federal regulations are not set in stone. There is no concrete reason to believe that these regulations will be significantly altered in the near future, but the possibility of change is always present.

Sears Continues to Dump Brick & Mortar Locations

Posted on January 2, 2020March 9, 2020 | Leave a comment

Sears has undergone a well publicized downturn in recent years, culminating in Sears Holdings Corporation filing for Chapter 11 Bankruptcy. As a result the once retail stalwart has closed huge percentages of their brick and mortar stores including both Sears and Kmart locations. The impact on retail commercial real estate has already been felt and will continue to make waves in the months and years to come. From the perspective of CRE investors, the news of Sears closing another set of stores isn’t all bad news. Sears is not in trouble simply because they operated as a big box/department store in the modern market, there were large organizational problems which led to the downturn.

Let’s look at the latest round of Sears and Kmart location closures, how these closures are impacting commercial real estate in Western Pennsylvania, and explore why Sears and Kmart retail failures are not necessarily indicative of the state of brick & mortar viability moving forward.

Sears to Close Over 1/3rd of Their Remaining US Locations

The news in Q4 2019 is the announcement that Sears is planning to close 96 Kmart and Sears locations by February 2020. This announcement comes not long after the Sears Holding Company filed for bankruptcy in 2018. To put the latest round of closures in perspective, there were over 2,000 Sears and Kmart locations in 2014. After the 96 Sears and Kmart stores close in early 2020, only 182 locations will remain in the US. Quick math tells us that over 90 percent of retail locations for the company have closed within a 5-6 year period.

There are a few key takeaways from this total story and latest announcement, all of which we will go over in greater detail below:

Brick and mortar locations for “superstores” has been losing value for years. Commercial real estate investors are using new and creative solutions to fill/repurpose these locations. Sears and Kmart closures are an extreme example of an overall trend.
Sears filed for bankruptcy due to terrible business decisions, not their meat and potatoes business model. Poor executive hires, mismanaged assets, and lack of spending have all led to Sears’ downfall. Other similar stores such as J.C. Penney, Kohl’s, and Best Buy are surviving and thriving.
Commercial real estate has been impacted by these closures, but not necessarily in a bad way. Occupancies in prime real estate have been turned into lucrative opportunities from shrewd property owners and investors.

Sears and Kmart Closures in Western Pennsylvania

Bringing the attention to our region: how have Sears and Kmart closures impacted local real estate? The retail giant closed 13 stores in late 2018/early 2019. The latest wave of closures is also leading to 2 Kmarts and one Sears expected to close by end of year 2019. In Pennsylvania, Kmart locations in Leechburg, New Castle, Armstrong County, & Lawrence County are all expected to close by winter’s end. The Washington Crown Center in Washington, PA will be closing as well.

It goes without saying that Sears is in big trouble nationally and locally. For commercial real estate investors, this might have an impact for those with vested interest, but likely will not have a huge impact overall. Retail locations continue to offer a solid return on investment, albeit with a slight downturn in profitability in recent years. The key regionally and nationally might fall on investors to move away from huge, warehouse style locations and develop CRE into move profitable layouts.

What Went Wrong with Sears?

This all begs the question, what the hell happened to Sears? The retail giant began in the late 1800’s and enjoyed more or less on a steady climb for the first 100 plus years of its operational existence. While many point to a joint venture with IBM and CBS called Prodigy as being the beginning of the end, the fact of the matter remains that it took many egregious missteps over many decades to fall so far so fast. Here are just a few:

Sears lost its message and its value proposition. If you are anything like me, you might not remember the last time you thought “Sears is actually where I need to go for x product”. Once a one-stop shop for tools, lawnmowers, and TVs, Sears truly lost its way when they over diversified. Muddying the waters and confusing customers in the process.

Sears made multiple poor investment decisions. At the time Kmart merged with Sears in 2004, the holding company owned massive swaths of commercial real estate. In subsequent years, they have sold off much of this valuable real estate for cash. These locations are worth far, far more today than they were at the time.

Sears executive team doesn’t know how to run a retail business. CEO Eddie Lampert is a Wall Street guy through and through. Unfortunately for him and for Sears/Kmart, large retailers do not operate like hedge funds.

Going Forward

There is likely no short term solution for Sears and Kmart. Store closures may continue or they may freeze, but the damage has been done. Nearly all of the billions of dollars of assets owned by the company has been sold or liquidated in recent years with very little in the way of reinvestment into the business. From the perspective of local and national commercial real estate, Sears may be less of a cautionary tale than a pariah. If Walmart can successfully operate nearly 5,000 locations in 2019, superstores themselves are not the problem.