Mix together mortar and lime with pressed hay and you too can construct a Tower of Gold, or at least the illusion of one.
If you have any doubts, pop on over to Seville, yes, the one in Spain, and have a look at the original Torre de Oro. Particularly entrancing is the vision of this 13th century dodecagonal watchtower at night. The gilded color reflected on the waters of the Guadalquivir River is as rich as you’ll ever be fortunate enough to behold.
Commercial Real Estate
The Spanish tower was originally one of two anchor points for a massive chain that blocked the river forming a defense against the Castilian fleet under Ramon de Bonifaz in the 1248 Reconquista. Unfortunately for the city’s residents, the chain did not hold and the besieged Muslim mecca eventually succumbed to the Christian forces. Despite its having been repeatedly under assault down through the ages, the Torre has withstood a series of attacks of the sort Mother Nature and revolutionary looters have thrown at it. So adored was the golden edifice, its destruction was never allowed. The Sevillians have demanded it be restored and re-restored over and over again. The time value of the building has clearly held strong to our aesthetic and architectural benefit.
As for the current generation of erected structures, today’s investors in commercial real estate (CRE) can be forgiven if they’ve got the urge of late to go soft on the sector. Fine, so the current CRE cycle is long in the tooth. The same could be said for the length of the rally in just about every other asset class and for that matter the current economic expansion.
What differentiates CRE from other asset classes is that it’s been hyper-driven by monetary policy gone wild. Flows into both U.S. commercial and high end residential real estate reflect the currency tug of war that started over three years ago. You remember that hissy fit the bond market threw at the mere mention the Fed might throttle back on its quantitative easing (QE) machine. Would inflation waltz hand in hand back onto stage? If so, might an inflation hedge into a hard asset naturally, dare say, logically follow? Well, then – let’s all join hands and pile hand over fist into real estate! For safety (never works out that way in numbers) that is.
In what can only be described as a full 360-degree turn from the initial days that followed the summer of 2013’s ‘taper tantrum,’ the Wall Street Journal recently ran an article titled, “Chinese Rethink U.S. Plans.” To say those trolling the Twittersphere took umbrage is an understatement. Vitriolic accusations of pots calling kettles black and casting stones in (overpriced) glass houses flew for days (good thing Tweets are capped at 140 characters as less is blessedly less when tempers flare).
Though few real estate consultancies are foolish enough to bite the hand that feeds them, there is a nascent acknowledgement that supply is becoming conspicuous in its abundance. “Supply rising but generally not over supply,” and “Real estate is late cycle,” are but two tentative subtitles to one to remain unnamed firm’s 2017 outlook. The real kicker, though, was, “Foreign buyers – from tailwind to headwind.” That gem speaks to the nitty gritty in the WSJ article, namely that foreign buyers, for all of their enthusiasm to jettison their capital, have hit their valuation threshold.
The specific deal punctuating the article draws the reader to a Street in Brooklyn, or more precisely, “a 22-acre, 15-building mixed use project in various stages of construction (that) is facing stiff headwinds.” As a nominal nod to said headwinds, the U.S.-based partner of the Chinese investor has taken a $307.6 million impairment charge and declared it will, “delay future vertical development.” The Chinese unequivocally deny any construction interruptions, insisting that they are, “meeting the goals and targets that were established when we invested in 2014.” Hmmm. Raise your hands if you want to read between those lines, in Mandarin, no less.
Rather than be plagued by such deep thoughts, perhaps at this point it would be best to step back and examine some basic metrics gauging the health of the commercial real estate market. If we start in the most amply supplied sectors and move our way down the spectrum, you may note that a pattern begins to emerge.
Let’s start with home away from home, as in hotels. To say we’ve built a few more lodging units in recent years than justified by the fundamentals insults veteran developers. In polite parlance, hotel room supply will outstrip corporate demand in 2017. In less genteel jargon, the main metric measuring the health of hotel profitability, as in RevPar, the product of a hotel’s daily room and occupancy rates, has tanked. The latest month’s read has RevPar nationwide growing at 1.6 percent over last year. In the event you like to keep score, that’s half the 3.2-percent rate thus far this year, and half the rate again of the 6.3-percent pace clocked in 2015. So yes, there’s a light on at the inn.
As for that stopover station in life, otherwise known as your apartment years, it’s a good thing cultural norms have shifted. It’s now cool to rent well into your prime earning years. Coming soon: it will also be economical as record supply finally chokes off rent growth. Over the past 12 months, 190,000 units were delivered across the 54 largest U.S. metros, a tad bit more than the 140,000 15-year average. But wait, there’s more! Another 244,000 units are slated for delivery in 2017, taking the bull run that started in 2013 in multifamily construction to a neat million unit. In the supply crosshairs, and in order of expected deliveries, are Houston, Dallas, New York, Washington D.C. and Austin. The deluge has finally cooled nationwide rental growth to 2.99 percent from a five percent pace a year ago.
It will come as no surprise that rents are outright falling in Houston (what’s the opposite term for ‘liftoff’?). But sliding rents are also a reality in New York. Would you believe Kings County, aka Brooklyn, is largely to blame? Just two years ago, as the Chinese were breaking ground on that mixed-use monster, 18 percent of the Big Apple’s supply entering the market was in Brooklyn; as of the third quarter that share had doubled.
It’s easy enough to attribute emerging stresses in CRE loans to oil patch woes. Take a drive through anywhere in suburbia and you’ll conclude quickly enough that retail is the next major source of loans behaving badly. Retail is a subject in and of itself. Rather than take a deep dive, take it on faith that there’s no way all of the excess supply can be absorbed and repurposed. E-commerce momentum cannot be contained and will push more household names into the netherworld. The true visionaries among real estate developers have long since slipped away from brick and mortar’s never ending funeral. They’ve got their sights set squarely on the lucrative potential for the fire sales of the land sitting under all those shuttered stores.
Less visible to the naked eye is the trouble brewing in office space. Be that as it may, the numbers don’t lie. Commercial mortgage-backed securities (CMBS) comprise a mere tenth of commercial real estate debt. Still, they provide an ideal prism into the health of the overall market given they are publicly traded; performance metrics are readily available. With that said, the most recent batch of data reveal that office delinquencies have been ticking up since midyear. Moreover, at $5.1 billion, the balance of delinquent office CMBS is second in size only to retail, which is saddled with a $5.9 billion pool of debt gone bad.
Did a lightbulb just gone off over your head as