Industrial Sector Update 11/8

E-commerce and the Shortage of Big-Box Industrial Space”

For the past five years, the net industrial absorption rate (the rate at which property is bought over time) has exceeded the rate of space completion, resulting in a scarcity of available space. This year, industrial space absorption is expected to exceed the completion thereof by 48 million sq. ft., and it is predicted that this shortage of space will continue into 2016. This supply imbalance has predominantly influenced the big-box market (industrial spaces exceeding 500,000 sq. ft.), since the major reason for the imbalance is the rise of e-commerce and its increasing demand for large warehouses. Amazon, for instance, has recently built a 1.1-million-sq.-ft. warehouse in Kenosha, Wisconsin, after having been unable to find sufficient space in Chicago. Another consequence of rising e-commerce is an increasing number of outdated properties, since technology tenants want new features like higher ceilings, more parking, space for racks, and electricity for robotics, with which most of the older buildings are unequipped. As a result of the lessened big-box supply in primary markets, most users are moving from primary markets like Chicago and Philadelphia, to secondary markets like Indianapolis and Lehigh, which have close proximity and strong connectivity to the industrial centers; this trend is likely to continue into the near future.

“Increasing Demand Leads to Decreasing Industrial Vacancy in New Jersey”

According to New Jersey market reports released last month, industrial vacancy in the state has dropped to its lowest rate since the recession. This has come about as a result of the sustained, high demand within the industrial market, and as more firms move southward from the lack of available space in New York. More specifically, as absorption of real estate continues to exceed new development, occupancy rates and competition for space are rising steadily. With projected retail and online sales continuing to increase, the trend is likely to continue into 2016. The greatest gains in space occupation have been in central New Jersey around the Turnpike (most of the gains, totaling 5 million sq. ft., have been in Middlesex County), as more and more tenants are moving from New York City because of the high demand for space and low supply of industrial real estate in New York and northern New Jersey. The state’s industrial rents continue to be lower than those in New York, which is attractive to new tenants. Rents are, however, steadily increasing as a consequence of New Jersey’s rising manufacturing sector and its decreasing vacancy rates, and are currently at an all-time high in certain areas. The majority of new construction is concentrated around the main Turnpike, and, as this continues, firms are moving toward the construction of spaces with smaller footprints (all but five of the current projects are under 200,000 sq. ft.).

Office Sector Update 11/8

“Future Tenant Seeks to Create Tech Hub at Hudson Yards Development”

Related Companies and Oxford Properties Group are nearing the completion of 10 Hudson, a 52-story office tower that marks the beginning of the New York City’s Hudson Yards development. The tower is now 85% leased with the signing of VaynerMedia, a social media company, as a tenant occupying 88,000 square feet. VaynerMedia joins the German-headquartered SAP on the growing list of technology companies looking at space in the Hudson Yards development. VaynerMedia’s CEO stated that there is an opportunity to create a serious tech hub akin to Silicon Valley. Starwood Property Group brokered a $475 million construction loan for the developers to build 10 Hudson in a deal that included $350 million in funding from Starwood. Other firms leasing office space in 10 Hudson include Coach, L’Oreal, and Boston Consulting Group. Also nearing completion on the site is 30 Hudson Yards, a 92-story office tower that contains over two million square feet of office space. Tenants at 30 Hudson Yards include Time Warner Cable, KKR & Co., and both Related Companies and Oxford Properties Group. The developers recently broke ground on 55 Hudson Yards, a 51-story, 1.3-million-square-foot tower on the site as well. In its entirety, Hudson Yards is estimated to cost $20 billion, making it the largest private real estate development project in the history of the United States. It will include nearly 10 million square feet of office space spread among several towers.

“Office Vacancy in Detroit Trending Downwards”

Detroit’s office market has steadily improved in recent years following the last U.S. recession. The good news continued as both Amazon and Lear Corp. announced that they would be leasing more office space in the city’s Central Business District. Lear will soon be opening its new Innovation and Design Center to foster new growth. Amazon has plans to bring several hundred employees into Detroit in the future. New data from CBRE predicts office vacancy rates of about 15% in Detroit, down from over 30% experienced during the recession. There is a very limited supply of class-A office space in the city, and tenants looking for large contiguous spaces are expected to have a difficult time. A market study by Colliers International partly attributed the scarcity of class-A space to a lack of new construction. Still, the drop in office vacancy rates and the strong multifamily rental market have helped revitalize central Detroit.

Hospitality Sector Update 11/1/2015

While it may seem counter-intuitive to purchase a property in a country with a sinking economy that is in danger of defaulting on its immense $72 billion debt, others see this as an opportunity to add a very inexpensive property with lucrative potential to their portfolio. Hedge-fund manager John Paulson is one such thinker as he recently acquired the San Juan Beach Hotel for $9.5 million. Because the property was in bankruptcy, he was able to buy it at a very low price. Sources close to Paulson claim he will invest in the renovation of the hotel to convert it into a luxury hotel. Hospitality investors on the island have frequently converted old or low-rent hotels in order to attract a wealthier clientele. Due to the debt crisis, several Puerto Rican investors, including Blackstone Group LP, have been sellers on the island. Despite the struggling economy in Puerto Rico, tourism has actually increased due to Puerto Rico’s portrayal as an ideal beach destination, and thus so have hotel revenues. The ultimate task in Puerto Rico, as with any other struggling economy, is evaluating the potential risks, which include increased crime and potential riots, versus the potential reward – lucrative profits.

Much like Uber has done to the taxi industry, Airbnb, an online marketplace for people to list and book places to stay, has come into direct competition with the hospitality industry. The main problem the hospitality industry is facing from Airbnb is decreased pricing power during popular one-time events such as the Pope’s U.S. tour or annual events such as the Kentucky Derby and Ultra Music Festival. In addition, hotels are losing clients to Airbnb who pay their own way to events, as they seem to have a preference for Airbnb’s cheaper rates. Other members of the hospitality industry, however, claim Airbnb is not actually in direct competition with hotels because they serve another type of clientele entirely. This distinct clientele is made up of consumers that are particularly price sensitive because, unlike business travelers, they do not have someone else to fund their trips. In addition, one Morgan Stanley lodging analyst noted that since 2009, the number of hotels achieving a 95% or higher occupancy level has increased. Furthermore, the premium room rate hotels can charge during the season and during special events has not changed significantly since the emergence of Airbnb. In short, there seems to be a market for both hotels and Airbnb, whether they overlap with each other remains a point of contention.

Sam Nazarian, an Iranian-American billionaire entrepreneur, recently agreed to sell his 10% stake in the SLS Las Vegas to Stockbridge Capital Partners. SBE, the brand Nazarian founded, will no longer be able to collect management fees from the hotel, but they will still receive licensing fees for the brand. Stockbridge’s executive manager Terry Francher praises the deal because by converting SBE’s management agreement into a license agreement, Stockbridge will be able to introduce new brands or restaurants to the hotel. Nazarian first partnered with Stockbridge to renovate the Sahara hotel for $415 million and later reopened it as the SLS Las Vegas. After downsizing the staff size, Nazarian also brought in Scott Keeger, a veteran of the industry, to be the new president of the property. Even after these moves, the owners reported a net loss of around $84 million during the first six months of 2015. Despite the hotel’s lack of success, Nazarian and SBE still own two nightclubs in Las Vegas and many more properties across the country, making him a considerable force in the hospitality industry.

Retail Sector Update 11/1/2015

Don and Eli Ghermezian of the Triple Five Group have awakened a massive commercial development project in the Meadowlands of North Jersey that has been dormant for the past six years. The $5 billion project includes plans for a 300-foot Ferris wheel, North America’s largest indoor amusement park and water park, an indoor ski hill, and over 500 stores. After two other organizations had their finances foreclosed on the development, Triple Five Group was able to acquire the land, and has a goal of raising $1 billion in financing through bonds – a risky endeavor as interest rates in the bond market have been steadily rising, increasing the degree of success the project demands. In addition, a large portion of funding for the project has been from public sources because the project is creating jobs and acts as a huge stimulant for the North Jersey area. The mall complex, entitled American Dream, plans to garner over fifty percent of its patrons from New York City’s constant inflow of tourists. This has caused real estate research firms, such as Green Street Advisors, to provide mixed feelings on the mall’s projected success. Considering only 12.4 million of last years 56.4 million visitors to New York City ventured as far as Lower Manhattan, skeptics have been asking what, if anything, would bring tourists across the Hudson and outside the allure of Manhattan. Despite this skepticism, Triple Five Group, which already owns two of the largest retail complexes in North America, has put the project into high gear with a projected date of completion sometime during Summer 2017.

The redevelopment of the World Trade Center site includes plans for a 365,000 square foot, 100-store retail complex that houses high-end retailers and luxury goods. The incorporation of the complex with the Oculus, a transportation hub and center of the World Trade buildings, is set to make this area a retail hub that has been lacking in the lower part of Manhattan. Westfield Corp., the developer of the retail portion of the World Trade Center, has been working to create an enticing environment with premium domestic and international retailers. The organization has also been working to bring restaurants such as Eataly to the complex in an effort to give the area a feel similar to that of the borough of Brooklyn. The new retail development is also bringing companies like London Jewelers to the area, opening these companies up to a new clientele as the development plans to attract patrons from all over the city and the world. A retail complex coupled with art galleries and stunning architecture is exactly what Westfield believes will pull people to the development and create a feeling similar to that of the stores along the Broadway corridor and Howard Hughes Corp.’s redevelopment of the South Street Seaport area. Above all, the development project represents a regeneration of the World Trade Center area that has been ongoing since the September 11 attacks in 2001.

In a time when more and more retailers are spinning off their real estate assets into REITs, Macy’s is left with deciding what to do with their flagship store, the prized Herald Square building. Retailers have been pressed by investors lately to sell off their real estate assets into REITs and lease them back. This allows the company to pay off debt and improve return on invested capital. REITs also protect investors from income tax on the real estate, leading to higher dividends. Macy’s, however, does not have a clear-cut path for its flagship store, largely because the value of the building is not clear. Speculation ranges from less than $3 billion to more than $4 billion on the central Manhattan building that contains 1.1 million square feet of retail space with additional room for offices and storage. As investors such as Starboard Value LP pressure the company, it will have to make a decision both on its real estate assets as a whole and its flagship Herald Square store.

As Bed Bath and Beyond finds itself in steep competition with online retailers, its decision on how to compete becomes crucial to the success of the company. The company has announced plans to invest heavily in its omnichannel strategy of selling in stores, on the web, and on mobile devices. Bed Bath and Beyond, however, only generated 8% of its revenue online last year and may need to look in other directions. Online margins are much lower than brick and mortar sales due to free shipping and fulfillment costs, and with the recent acquisition of Cost Plus and 30% expansion to a total of 1,513 stores, Bed Bath and Beyond has to be very careful about maintaining its margins on that large of a scale. As displayed by Williams-Sonoma and Pier 1 Imports, whose profit margins were destroyed due to online sales, online expansion does not always have a positive effect on the company.

Multifamily Sector Update 11/1/2015

There are rezoning concerns in the Bronx about whether the new apartment buildings, meant to replace older auto-repair shops on Jerome Avenue, will be too expensive for the residents who live nearby. There are further concerns that the loss of the auto-repair shops will lead to a loss of local jobs as well. This re-zoning arose from Mayor Bill de Blasio’s strategy to improve poorer neighborhoods with “higher-density development” that will increase the number of affordable homes and improve neighborhoods. This strategy includes doubling the budget to $600 million per year in subsidies for developers to build affordable housing, and $1 billion for new parks and playgrounds. South Bronx residents are now protesting the new development, as a recent study taken claimed 80% of residents fear displacement due to rezoning. The Bronx Coalition for a Community Vision released a report asking the government to make a larger percentage of the apartments permanently affordable, to set aside 50% of the units for current residents of the neighborhood, and to both protect and create local jobs. In response, City Planning commissioner Carl Weisbrod made the valid point that housing can never be affordable to everyone who lives in a certain neighborhood, although they were trying their best.

The Stuyvesant Town and Peter Cooper Village complex, which consists of 11,200 apartments in multiple separate buildings, was inches away from foreclosure five years ago, with its value down to $3 billion from its sale price of $5.4 billion. This past Tuesday, however, Blackstone Group LP and Ivanhoé Cambridge (a Canadian pension investor) announced that they are in a deal to buy the 80-acre complex for $5.3 billion. Some investors have said this deal showcases the “remarkable recovery” of the Manhattan real estate market since the downturn, which can be explained by two main reasons. Firstly, investors who left during the downtown are hungry for anything in Manhattan, especially investors from Norway and Middle Eastern countries. Secondly, there is a growing demand due to a growing population. This, in turn, is driving average rent prices up to over $4,000 a month. Tishman Speyer, who purchased the property in 2006 and handed it over to creditors in 2010, over-projected the amount of income that would come in from converting rent-regulated apartments to market-rate. Now, about 45% of residents pay a regulated rent, down from 71% in 2006, which has led to a doubling in income since the ‘unregulated rent’ (market rate rent) is significantly higher. However, a large chunk is required to be rent-regulated for at least 20 years under government mandates. The deal is unusual in the fact that it is between Blackstone and New York City officials, instead of a real estate development firm like Tishman Speyer. Jonathon Gray, head of Blackstone real estate, has said they will not move forward until the tenants’ association, which wants to ensure that rents are kept affordable for current residents and those in the neighborhood, approves the deal.

Industrial Sector Update 11/1/2015

A report from CBRE stated that, as of second quarter 2015, an increasing number of automotive companies are reshoring manufacturing in the U.S. This has significantly affected international industrial markets, as the restructuring continues to restore America to its role as a center for production. Companies like Volvo Car Corp., which will begin operations at its first U.S. manufacturing facility in 2018, are relocating from Asia, where there are growing production costs and supply chain complexity, to the U.S. and Mexico. The American South (particularly cities near seaports) has leveraged its productive advantages — particularly its port infrastructure, comparatively low costs of labor, and government incentives — to become a growing industrial hub. Mexico has seen the greatest benefit of all, experiencing a dramatic increase in auto production through 2015, and a significant future investment from the auto manufacturers. This will prompt long-term growth of U.S. distribution and logistics, especially in Texas and the Midwest, where there will be increasing auto distribution demand.

Rapidly increasing occupancy and absorption rates are making it difficult for industrial properties to be built fast enough to meet demand. With such high demand and low vacancy rates, the industrial sector continues to see a higher average cap rate (the potential percentage return an investor would receive on his or her investment) of any asset class. In addition to new developments currently under construction, a growing share of supply is speculative development, indicating expected future growth. Following the recent recession and its accompanying supply shut-off, companies focused on acquisitions because of an increase in vacant space and a difficulty in leasing property. Now, in light of improved leasing, most industrial firms are redirecting focus to construction. This can be attributed largely to e-commerce, which has changed the speed at which orders are processed and goods are transported, and has consequently necessitated acquisition of industrial space. In addition, an upsurge in U.S. development, especially in major distribution centers like Dallas, Los Angeles, and Kansas City, has resulted from the rising demand for industrial manufacturing space, and companies are acting quickly to buy and develop the land in light of this growth.

Office Sector Update 11/1/2015

A recent report from CBRE indicated that office vacancy rates across the U.S. fell to 13.5 percent during the third quarter of 2015. Vacancy rates have fallen in every quarter since the recession, and the most recent data shows a yearly decrease of 80 basis points from this time last year. Growth in the demand for office space is expected to continue to outpace growth in supply as firms are leasing more space than is being delivered by new construction. As a result, vacancy should continue to decline, keeping rent growth above inflation in most U.S. office markets. The report stated that office rents increased by 1.6 percent during the third quarter, resulting in a yearly increase of 4.3 percent since the beginning of the year. Groundbreakings for new office developments will begin to accelerate in the coming months, fueled by the Federal Reserve’s decision to delay a hike in its interest rate. The Fed’s low interest rate makes borrowing money relatively cheap, incentivizing new construction as developers can more easily repay construction loans. Landlords of new spaces will likely charge rents well above market rate, as more companies are relying on their office space as a recruitment tool in the increasingly competitive employment market. With job growth occurring in all professional services sectors, office demand is expected to be tight through at least the middle of 2016.

Brandywine Realty Trust, Philadelphia’s largest office landlord, has recently agreed to sell some of its properties at the Laurel Corporate Center in Mount Laurel, New Jersey. The offices at those properties encompass more than 560,000 square feet of Class A office space. The price of these sales have not yet been disclosed, though it is speculated that the company will use the cash raised to fuel development projects it is planning for several recently acquired properties in Philadelphia. The company sold another office building in Mount Laurel for $16.5 million last month. Brandywine is also rumored to be searching for a purchaser for the IRS Building across from 30th Street Station, on which the company spent $252 million in renovations in 2010. The properties for which Brandywine is currently developing plans include parcels on the 2100 block of Market Street, a parking garage on the 700 block of Market, and a plot on JKF Boulevard across from 30th Street Station. The first image below shows the completed Cira Complex with Brandywine’s currently under construction FMC Tower and its yet-to-be-developed Cira II tower behind 30th Street Station. The second image below shows conceptual renders of a mixed-use residential and creative office building it has planned for the 2100 block of Market Street.