Ecommerce is Still on the Rise

A recent article about retail sales in the New York Times indicated that, while online retail--especially Amazon--had done very well during the pandemic, it still only amounted to about a quarter of retail sales.  That has some interesting implications for commercial real estate in Connecticut.

Given our location between Boston and NYC, and our high average income within the State, it stands to reason that, if ecommerce has not reached its peak yet, our warehouses, flex spaces, and raw land should do well in the future.  Distribution is the key to timely deliveries, and the ability to get something within a couple of days is a key factor in deciding whether or not to buy it online.  Whether goods are traveling further up into New England, or being delivered to homes around us, there will need to be warehousing available near our highways, railroads, and airports.  

Although our roads and bridges have been a challenge for trucks and overland traffic, Governor Lamont's call for a stronger focus on infrastructure, combined with President Biden's emphasis on the same, seem to point to a brighter future for distribution in and through Connecticut.  Smart buyers will begin to develop properties that have been languishing, and take advantage of changes coming down the pike (pun intended!).  Even if there is only a small continued shift toward home delivery, the amounts in question are enormous. Those developments should get filled, and provide income for the owners well into the next economic cycle.  

Commercial Real Estate in Connecticut is Looking Good

 Much has been written recently about the exodus from the NYC area to Connecticut.  Connecticut is finally one of the hottest markets in the country, thanks to proximity to New York along with privacy and open space.  Residential prices are going up quickly, and supply is short.

And what do we know about the relationship between residential markets and commercial ones?  Commercial needs follow the people who move into the residential spaces.  Once there are more residents, there becomes increasing need for retail and rental units in particular, but also for office space and even investment and industrial properties.  

This is especially true before the election.  With plenty of uncertainty, the stock market is bouncing around.  Tangible property is looking better and better.  Why not invest in a growth area, and take the money out before stock prices possibly tumble?  

In addition to that incentive, there is the added benefit of lower interest rates before any election, especially a presidential one.  That will lower the cost of buying even further.  Banks are eager to lend, and it's a good time to shop for credit.

It's hard to imagine such a rosy report, given what most of 2020 has been like, but there you have it--the silver lining we've all been seeking.

Too Much Space Is Now Just the Right Amount

 For years now, commercial real estate users have been looking to divest property and downsize in square footage.  This trend picked up rapidly as the pandemic set in, and workers began telecommuting from home.  Once we started to take a long view, however, things changed.

Now we can see far enough ahead to realize that bigger buildings may be an asset.  It allows all kinds of users to have space for their workforce to spread out, or for retail tenants like exercise studios or restaurants to occupy enough real estate to have customers socially distance.  As I've been writing for months now, warehouses were already hot, because of the trend toward ecommerce and the need for distribution hubs.  Now we know that they can also be repurposed for other buyers and tenants.  

As we work our way toward the new normal, whatever that turns out to be, the lack of new supply will force creativity on the part of property owners and investors.  New businesses are springing up, and people are finding ways to work and play in new circumstances.  We can see that there may be a demand for space for learning pods for students, for telecommuters who don't want to or cannot work from home, for pick up and drop off sites for businesses that want customers to be able to stay apart while doing errands, for studio space serving online business and arts production, and for last-mile delivery hubs for all kinds of products.  Can you imagine a giant warehouse full of toilet paper?  If you can, you are probably not alone.  

The world has changed in so many ways, but the creativity and resilience of entrepreneurs and existing industries will be up to the task of figuring out a path forward.  If you are a property seeker, or an investor, location should still be a key factor.  However, don't pay as much attention to size, condition, or current usage.  Whatever you have, a buyer or tenant is probably out there looking for something like it.  And those buyers will certainly have favorable financing terms today.  So think about now as a great time to sell, lease, or sublet. There's no time like the present!

Commercial Real Estate Pivots on Product

I have a friend whose job is as a cost estimator for large construction projects.  His biggest job has been paused, not for COVID reasons directly, but rather for the changes in the post-COVID world.  The client feels that the building needs to be redesigned to provide more privacy, and less open work space.  Since most recent buildings have featured open floor plans, it remains to be seen what the demand will be going forward.  It may mean that older buildings, which might not even be Class A buildings anymore, will be desirable just because they have many small individual offices.  It also may mean that flex space will be bought and reconfigured into cubicles.

Retail spaces may also be changed, and smaller spaces may become the sought after ones.  It may also be that stores will have waiting areas, entry turnstiles, or different layouts over larger floor areas.  Some retail may get used by service industries, like exercise studios that now need social distancing room, or salons and even medical facilities, for similar reasons.

Warehouse, as I have said many times, will be prime real estate for some time to come.  The rise of e-commerce has been accelerated by the coronavirus, and that trend will continue.  Location, as always, will determine value.

It's a brave new world, and we don't know everything that will happen, but change is surely in the cards.

A Perspective on What's Next for Real Estate Investors

By Ethan Coleman, Ninth Square Real Estate Partners

By now every American is aware of the unprecedented public health emergency and economic disruption caused by COVID-19. While we remain in the early stages of both the pandemic and the likely severe recession that will result, we can begin to assess the impact on commercial real estate as we position ourselves to capitalize on potential opportunities. Before doing so, I want to first express my gratitude to those on the frontlines fighting the pandemic and helping the sick. Thank you. I also wish well all those who are affected by the virus either directly or economically. My thoughts are with you. Our primary concerns should be with those who are helping and those who are affected. I work from the comfort of my home, writing about a topic that is clearly secondary. My purpose in writing this is to begin to organize my own thoughts and research in attempt to begin for formulate a plan for future acquisitions. As a real estate investor during these times, it is hard to both react to the problems within one’s existing portfolio and simultaneously begin looking for new opportunities. These two things can feel contradictory. The problems at properties we own are real and immediate, while the potential opportunity in theoretical. I try to compartmentalize the two and not let one affect the other. So what is happening out there and what should a real estate investor do?

Real estate, unlike stocks, does not reprice constantly, so we can’t yet see what is happening with pricing for buildings yet. Deals take many months to source and close; those that close today were deals consummated prior to COVID-19. For this reason, we don’t yet have data from the private real estate market on how pricing has changed. Every broker and investor is trying to figure it out.

We have begun to see the disruption in property operations, though, and this will eventually impact pricing. For example, many retailers are closed and asking for rent relief, hotel revenue has cratered, showings are down for vacancies, and office buildings are empty as workers attempt to work from home. If these impacts are short-lived, pricing may not change much, but if many stores never reopen, renters lose their jobs and can’t pay their rent, and companies that occupy office and warehouse properties begin to go bankrupt as revenues fall, we can expect significant re-pricing for the affected real estate. For now, we can continue to monitor these initial impacts and we can look to the public markets pricing of Real Estate Investment Trusts (REITS) to begin to understand how investors are pricing the underlying real estate assets.

To translate a REIT share price to the value of the underlying real estate, I calculate the market cap and add it to the long-term liabilities, which provides the current cost basis of the underlying real estate portfolio. We then take the REITs representation of Net Operating Income from its 2019 annual report and divide it by the current cost basis to arrive at the current market cap rate for the real estate. We can then compare the current implied cap rate for the REIT’s assets with its recent high to see the change in how the public markets are valuing the real estate. This can provide some insight into how real estate values may change.

Retail

With about three-fourths of Americans in some form of stay-home order, tens of thousands of retail establishments are closed. As of March 23, over 47,000 chain stores in the U.S. had temporarily closed. In addition, thousands of independent retailers have also closed by choice or state mandate. Many of these retailers are asking for rent relief or are simply not going to pay rent in April. Some may never reopen. Retail landlords can likely endure a short-term reduction in rent, but longer-term fundamentals may be impacted by retailers going bankrupt.

Based on my analysis of the change in valuation for Realty Income Corporation, a REIT focused on triple-net retail properties, the value for these properties, long perceived as safe, has fallen by 28%. Retail Opportunity Investment Corp, an owner of grocery-anchored centers on the west coast, is down 33%. Clearly the public markets are pricing in a severe disruption to retail real estate.

Hotel

Without long-term leases, hotels must re-rent their space each day, so any change in performance is realized immediately. According to a March 26 webinar from STR, a hotel data company, for the week ending March 21, revenue per available room (RevPAR) was down 69.5%, the third week in a row of double digit declines and the largest ever in 30 years of data. Corporate demand for meetings is now down to zero and U.S. occupancy is down from 65% to 30%. China’s occupancy fell to 10% during its lock down. As a result of this decline in performance hotel franchisors Marriott and Hilton are down 47% and 39% respectively as of March 27. With this level of revenue deterioration, hotels are going to face distress much faster than other types of real estate. Values for hotels seem the most uncertain.

Multifamily

Jobless claims for the week ending March 21 hit a staggering 3.28 million, more than four times the previous weekly high. Some experts project unemployment to reach 20%. With many of the laid off workers coming from shuttered businesses, such as hospitality, tourism, and restaurants, these layoffs may begin to impact renters’ ability to pay rent, particularly in Class C apartments, often termed as workforce housing, and in areas of the country where the employment base is more heavily skewed toward hospitality and tourism. With Congress set to pass a $2 trillion stimulus package that includes increased incentives to keep workers on the payroll and an additional $600 in weekly unemployment benefits from the federal government, these effects could be somewhat ameliorated, but only for a short period of time. If the retailers, hotels, and other employers don’t re-open and quickly ramp up to their former revenue level, many jobs may be permanently lost, which will in-turn impact apartments.

While this is the most sudden deterioration in labor markets in U.S. history, it will still take some time before multifamily operations are impacted to a level that causes owners to exit voluntarily or under distressed scenarios. The extent of this pain will determine the ultimate impact on pricing. Equity Residential, one of the best-known apartment REITs, has seen the value of its real estate decline by about 24% based on my analysis of its current stock price.
 

Office

Like multifamily, the impact on office properties will be determined by the ultimate level of economic impact resulting from COVID-19. Many office workers are now working from home, which should allow companies to limit the short-term, direct effects of the pandemic. As the impact to the economy works its way through the system, though, office demand is likely to wane as companies are forced to cut costs as business activity declines. This will eventually result in some companies failing to pay rent and impact property revenue. As this plays out some property owners may elect to sell or will be forced to sell, dragging down prices.

Franklin Street Properties, an office REIT focused on properties in the Sun Belt and Mountain West, has seen its underlying real estate decline by 20%, according to my analysis. The market appears to be more confident in future of office properties than retail and hotel. But office carries the risk of a faster shift towards work from home as more companies have been forced to adapt to this during the stay-at-home orders.
 

Warehouse

Warehouse appears to be best positioned to weather a recession as vacancy rates are low and demand for logistics and e-commerce has been strong. With more people forced to stay home, e-commerce companies, such as Amazon, are increasing their hiring and look poised to increase their market share. But as overall demand in the economy goes down and consumer spending declines, companies operating warehouses are going to declining sales. Some companies will be well-positioned but others will be unable to pay rent, impacting operations and eventually property pricing. Even ProLogis, a class-A warehouse REIT, has seen its implied real estate values decline by 19% as the public markets anticipate impacts on warehouse properties, according to my analysis.

Conclusion

With property operations quickly deteriorating at retail and hotel properties and future reductions in occupancy and rental revenue likely for multifamily, office, and warehouse, it is not surprising that the public markets have devalued real estate by 20-30% depending on the asset class and location. Real estate investors must be careful as they move through this uncertain environment. Sellers are likely to continue to insist on pre-COVID pricing until they are motivated by or forced by deteriorating operating income. As a result, some firms have put new acquisitions on hold as they wait for the impacts to be reflected in pricing. Every person who is interested in investing in real estate should see this as a time of caution, but one that should eventually give way to opportunity, just as was the case in the Great Recession over ten years ago. The investors that are active coming out of the recession will be those positioned to provide market leading returns.

New Haven Rental Boom

Most people who follow the New Haven area real estate market know that we have had a surfeit of new luxury rental properties come onto the market in the past few years.  Most of them have surpassed their expectations in terms of the speed with which they filled up.  Even the projected decline in other rental interest has not materialized.

Now the question is:  What will pop up to service all these new renters, many of whom work in other parts of the State or even in NYC?  They clearly have been populating the many bars and restaurants that are constantly opening in New Haven, and have been a boon to lots of organizations.  There will be more needed to fulfill all of their needs, however.  Even dogwalkers will see the effects of a young professional demographic increase. Services that appeal to millennials, either because they save time or because they cater to new interests and requests, will continue to grow as this group expands.  Farm markets and other local options for eating will prosper, and traditional goods and services, including hairdressers, nail salons, and dry cleaners, will lengthen their hours to accommodate the needs of users who work later hours.

Although we've seen some increase in the demand for retail and service locations, we expect to see more in the future.  We probably don't even know either the total demand or the range of expectations that will arise, whether it is for breweries or cigar bars or something that hasn't yet been offered.  If you've thought about expanding  your business into our region, or starting a new company, here's your chance!  We're glad to help.

Real Estate in Tokyo

It's always fun on a vacation to see what real estate is like in other places.  I recently vacationed in Japan, and got a chance to see various cities there.  The most interesting, from a real estate point of view, was to see how the 36 million people in Greater Tokyo live and work.  They have lots of very tall buildings, obviously, and they have a lot of diversity in their architecture. They even have one building that is designed to look like a beer stein, with a square lower part, and an upper part that juts out and is the color of foam!

 Another interesting point is that almost all of their hotels are at the tops of buildings, so that the lobbies are on upper floors, with offices beneath.  From a commercial real estate point of view, one would assume that the higher room rates for good views would have been outweighed by the higher rents that could be charged in leases to firms in the buildings.

The main takeaway from Tokyo is just how many people there are, yet how clean and orderly it is.  There are no public trashcans visible, and they have the highest number of vending machines in the world, per person (there are even machines on the tops of mountains and in the woods!), but there is no litter.  And the Ginza district looks like Times Square, but with bigger buildings and more upscale.

There is one intersection that has 2000 people cross every time the light changes; even so, it lacks the chaos and physical contact that crossing a NYC street entails.  People line up for everything, and wait politely for their turn. The main subway station covers at least one city block, but looks more like (and functions more like) a mall.  Departments stores have food halls and restaurants, some of which only serve one thing--and they are still crowded.

So now I am home, enjoying the peace and quiet of our little state, but happy to have seen the vastness of another vista.

CERC survey: View of CT realty upbeat

Written by Gregory Seay

Connecticut landlords and other realty professionals feel better about the near term prospects for the residential-property market than they do the commercial-space sector, a new survey shows.

According to the Connecticut Economic Resource Center (CERC), its latest SiteFinder semi-annual online survey of Connecticut commercial real estate conditions indicates that respondents are generally positive about markets, except for the office market and overall economy.

The 72 respondents included brokers (65 percent) and economic development professionals (22 percent) from Connecticut and out-of-state. Almost one-third of respondents (32 percent) were from New Haven County.

Respondents generally rated local market conditions as satisfactory, with a majority saying the industrial, investment, and residential markets in their respective geographic areas were "excellent" or "good" (53 percent, 50 percent, and 62 percent, respectively).

Respondents were more pessimistic about their local office markets, with one-quarter rating it as "poor" and 56 percent rating it as "fair."

At the state level, residential was the only market for which a majority (51 percent) said it was "excellent" or "good." One-quarter (25 percent) said the office market was "poor," and one-third (30 percent) said the overall economy was "poor."

Respondents are also seeing tangible improvement in the real estate markets in the state. Over half of respondents (57 percent) reported seeing an increase in buyer interest or inquiries compared to this time last year.

Nearly half (48 percent) also reported an increase in the number of deals. There was an increase of those reporting increased number of deals (from 38 percent) and buyer interest or inquiries (from 48 percent) from the first quarter of 2016.

"As the need for large office space continues to decline, the demand for modern industrial manufacturing and distribution space continues to increase,'' said CERC Real Estate Program Manager Erron Smith. "End-users have communicated that they are willing to pay a little more, if it translates into occupying a space that can satisfy their operational needs."

More than half of respondents thought sale prices for industrial, retail, investment, and residential properties would increase in the state in the next three months (63 percent, 51 percent, 61 percent, and 57 percent, respectively). Most expected this gain to be less than 5 percent, but more than 10 percent of respondents thought there would be a gain of at least 5 percent in sale prices for residential.

"There was a similar pattern for lease prices, with expected gains in sale prices for industrial, retail, investment and residential, and a loss for office," said Alissa DeJonge, CERC's research vice president.

Nonprofit CERC is a public-private partnership that provides economic development services. Its SiteFinder Real Estate Survey measures the health of Connecticut's commercial real estate market.

Services for City Dwellers

"Walkability" is near the top of the list of attributes for residential housing these days.  Everybody wants to be able to walk--to work, to restaurants, to public spaces, and to culture.  Even towns now advertise when something is walking distance from whatever town center is closest.  New Haven is enjoying a boom in high-rise living, with prices headed up and supply being absorbed ahead of anyone's predictions.  What does that mean for our commercial sector?

In prior days, retail meant big box stores that could be accessed with little driving time, and abundant free parking on site. That's still true if  you are big enough--IKEA comes to mind.  For almost everyone else, retail now means the old-time corner store, the local market, the neighborhood bar or restaurant, and farmers' markets nearby.  With all the new housing downtown, there are still services needed locally--in this case, hyperlocally.  What about pets?  Drugstores? Grocery stores? Even gift shops?  We've got something for everyone, but there's room for more.  Tenants and downtown homeowners expect to pay more for convenience, and they will.  More boutiques and pop-up stores are in our future, as our more of the ever-expanding restaurant and bar scene, which already draws from around the state.  It will continue to do so, and visitors will complement the city natives who patronize those places. 

For investors or developers, there is money to be made.  Property now seems reasonably priced for commercial, and it can easily be made into space for the uses that walkability-minded folks require.  Think about it--but not for too long, or the window will close!

Follow the Money

Greater New Haven, and especially New Haven itself, have become places where investors are looking at affordable properties.  Many have been priced out of New York and Boston, but know that our market lies just between those two cities, and that real estate is way cheaper here than in those two markets.  Therefore, many buyers have swooped in and bought (sometimes even sight unseen) buildings, especially multifamily housing units.  New Haven had the lowest apartment vacancy rate in the country, so it makes sense that investors would seize on that to buy or build.

But that also opens another avenue, and perhaps one more suited to local owners and investors.  What services will those apartment dwellers need?  We wouldn't have the infrastructure in place for all those new units, so there's a big opportunity.  Would you like to own or develop retail, restaurants, service economy space, or parking?  Here's your chance!  Be the person who provides the missing links for the new citizens of the city, and you may be handsomely rewarded.

Happy New Year!

I've blogged in our residential blog about reasons that we are optimistic for 2016.  There are a few commercial additions to that list. First of all, we had a great 2015 in Commercial. Properties that, in some cases, had been waiting to close for years finally did.  Investors are still definitely in the market, and some of them are coming from elsewhere, since our prices here are so low. Also, the glut of rental units coming onto the market causes demand in the commercial and retail sectors.

These trends are likely to continue next year. In addition, success begets success. As word spreads about prospering investors, others will follow. And the State's late, but seemingly heartfelt, belief that they need to start being nice to the businesses that call Connecticut home should really start to pay off in the intermediate future. Who knows?  We could become the new South Carolina, or Tennessee.  It should be our turn by now!

End of Summer Hopefulness

Greater New Haven's Commercial and Industrial Realtors held their annual outing yesterday, and the mood was upbeat.  Although a lot in August seems to be on hold for Labor Day and the coming of fall, most people were busy, or had the prospect of being busy in the weeks to come. 

That doesn't mean that all the property is being snapped up, however.  Really attractive office space is still begging, in many cases, for tenants.  And New Haven's dependence on not-for-profit employers and institutions leaves us vulnerable to changes in State and national funding.  However, retail has made a comeback, and flex and warehouse space is tight in some places.  There is somewhat of a disconnect between what buyers want and what sellers have to offer, but hey--there are buyers now!

Market Trends Around the Country

According to the National Association of Realtors, tides are turning in the commercial real estate market.  Money is "starting to flow into commercial real estate".  Loan originations more than doubled from the first half of 2010 to the first half of 2011 (although they are still well below peak levels).  REIT values were at an all-time high.

Office vacancies have drastically declined, more due to the lack of new product than the increase in rentals, but owners of Class A space are giving fewer concessions than a year ago.  Tenants are still kings in the Class B and C markets.  Retail space, which tends to fall with housing, had been very depressed, and is definitely on the way back  now.  Industrial space sales were up more than 50 percent, with the majority being warehouses. Hotels were the lagging performers, with average pricing on sales decreasing and average room rates increasing only slightly.

Multifamily property sales more than doubled from 2010 to 2011, and apartments are the highest performing category of commercial real estate.  Effective rent per unit has bounced back to its peak, paving the way for building more capacity.  Also, rents are on the rise, with vacancies and concessions declining.  When this is combined in New Haven with the country's lowest vacancy rate, we can see this strong market continuing.

All in all, while improvement will be slow and steady, the future certainly appears brighter than the recent past, and should build upon itself as others are drawn to agree.

Good News from Arizona

I just returned home from Phoenix, and the headlines out there last week crowed that the fourth quarter was one of the best in years for industrial real estate.  There was also a prediction that more expansion was on the way.  Boy, it's been a long time since we've read anything like that about industrial real estate!  Especially in Arizona, where there has been a long period of retrenchment after overbuilding for a couple of decades. 

And that's not the only good news.  Other markets, including many metropolitan areas, are seeing the return of new tenants in retail and other markets.  While prices still seem relatively soft, there are also reports that deals are tightening and incentives lessening. 

While Connecticut may be behind the curve in the foreclosure and short sale cycle, since states like Nevada and Georgia, for example, don't require court involvement, we are sure to see the uptick in our own market as the business climate improves.  And isn't that a nice way to start a new year?

Investment Real Estate in Greater New Haven

To make money in New Haven real estate, a person needs to know that it is, at heart, a university town.  The growth is in education and health care (the latter being here in some large part because of Yale's medical school), as well as biotech (ditto the sentence above). We are disproportionately employed in the arts, again in part because of schools, and also because our highly educated workforce values the arts greatly in evaluating quality of life issues.

These factors tend to produce a population in some parts of the region that can be quite transient - students, graduate students, residents, artists, and "hired gun" executives.  At the other end of the spectrum, we have a very poor inner city area, with high rates of unemployment. Those two groups combine to produce a high need for rental properties at every price point, and contribute to New Haven having the lowest apartment vacancy rate in the country (about 1 and ½ percent).

If you've read the two preceding paragraphs, you're probably already in the market for residential investment property.  Join the club!  We have a great demand for those types of listings, and are always on the lookout for more.  New Haven now has rentals that exceed $5,000 per month for an apartment, as well as Section 8 housing (in one instance, in the same building).  Investors have a choice, therefore, about the segment of the market where they feel most comfortable.  There is also a shortage of houses for rent, and we are starting to see activity in that sector as well as the strong demand for multifamily homes that has existed, particularly near the colleges and universities.

Of course, where there are students there is also a need for restaurants, bars, retail, and health facilities, so investment property does exist in other sectors as well.  Greater New Haven is considered to be significantly "under-retailed", and 06511 is reported to be one of the nation's hottest mail-order zip codes, the theory being that the people in that part of New Haven have high incomes and not enough retail outlets to satisfy their consumption preferences.

So, whether you'd like to be a landlord, a franchisee, or simply a holder of a potentially valuable future income stream, we can find what you'd like in Greater New Haven, at any time that you think that you've had enough of entrusting your wealth to the increasingly volatile stock market.

First Entry

Welcome to the new and improved Pearce Commercial Real Estate Website, and to my commercial blog.  While I have been blogging for a long time, this is my initial foray into exclusively commercial material.

It's always an interesting feeling to be writing in cyberspace.  You have no idea who, if anyone,  is reading what you post.  Nor do you know, unless they contact you, what they think of what you say.  That's my way of saying that I'm going to write about whatever occurs to me that I think might be useful or relevant to the potential audience, and I would be delighted to get feedback from reader about potential future topics.

By way of introduction, Pearce Commercial Real Estate covers most of Connecticut, largely excluding Litchfield and Fairfield Counties.  We do sales, leasebacks, leases, exchanges, and buyer brokerage for industrial, office, retail, and investment property.  We also have a large residential department, and joint ventures in appraisal services, insurance and mortgages.  We see the market from the "boots on the ground" level, and get enough industry material to also get the view from 10,000 feet above the ground.  I will try my best to balance those two perspectives, and hope that you will find this site useful.