Why Obsolete Warehouses on the ‘Last Mile’ Are Attracting Institutional Investors

Institutional investors are now competing for small, previously obsolete class-B, -C and -D industrial buildings in urban locations.

Every $1 billion in e-commerce sales requires 1.25 million sq. ft. of distribution space, said Scott Marshall, executive managing director of advisory and transaction services | investor leasing with CBRE, during a meeting of the Chicago chapter of NAIOP earlier this year. He noted that with e-commerce sales poised to grow by more than 10 percent year-over-year, to $491 billion in 2017, e-commerce companies will require an additional 50 to 60 million sq. ft. of warehouse distribution space this year alone.

The distribution space along the “last mile” to consumer makes up a big chunk of this need, according to Marshall. This has created a new niche for institutional investors who are now competing for small, previously obsolete class-B, -C and -D industrial buildings in urban locations and are snapping up whole portfolios in this asset class.

Among this group of investors is Canada-based Ivanhoe Cambridge, the real estate subsidiary of the Caisse de dépôt et placement du Québec, one of Canada’s leading institutional fund managers. The company recently announced the acquisition of a 16-million-sq.-ft. property portfolio from Boston-based Evergreen Industrial Properties. This portfolio consists of more than 150 light industrial facilities in strategic infill locations in high-growth U.S. markets, including Seattle, Denver and Charlotte, N.C., as well as major distribution markets Atlanta, Chicago and Dallas.

U.S. investment specialist DRA Advisors also recently acquired a portfolio of 184 small- and mid-sized warehouse, distribution and light industrial properties in infill markets across the nation from Cabot Properties for $1.6 billion.

According to research firm CoStar, investors covet class-B urban industrial facilities because these facilities are outperforming other industrial assets. With increasing e-commerce sales and customer demand for same-day and next-day delivery, rents at these types of properties rose 10.4 percent nationally in the fourth quarter of 2016 compared to a year earlier, while industrial rents overall rose just 6.4 percent.

Vacancy at distribution facilities within three to five miles of downtown Seattle currently averages 1.0 percent, according to Bill Condon, a Seattle-based senior vice president with real estate services firm Colliers International. Regardless of the age of the facilities, rents at properties in close proximity to downtown rose by 15 percent to 20 percent year-over-year and are generating $1 per sq. ft. triple net, nearly double the rent at facilities 10 to 15 miles from downtown, which range from $0.53 to $0.60 triple net.

Last mile class-B industrial assets in urban Seattle locations are also trading at significantly higher values than newer product in suburban locations, bringing in $175 to $190 per sq. ft., compared to $120 to $140 per sq. ft. for facilities located 10 or more miles from the urban core, Condon adds. Noting that institutional investors are pursuing the few urban assets available, he says, “We aren’t seeing any private investors in this market because they can’t compete for deals chased by institutional investors.”

Every infill sub-market in the Los Angeles region is affected by increasing e-commerce sales, which represent about 11 percent of the region’s total retail market, says John DeGrinis, Colliers senior vice president in the San Fernando Valley sub-market. With land and vacant last mile space extremely scarce, vacancy is at 1.0 percent or lower. In the San Francisco Valley, it’s at 0.2 percent, he says.

“Every sub-market is constrained for product,” notes DeGrinis. “It’s safe to say that any user with an expiring five-year lease is looking at sticker shock to renew, with rents at least 25 percent higher than they had been paying.”

The typical triple net rent has gone up 40 percent over the last six years, he adds.

Kevin McKenna, Colliers executive vice president based in Orange County, notes that Southern California currently has 1.8 billion sq. ft. of industrial stock, but will never have enough space to meet demand because of growing e-commerce needs. “Products that used to be in stores are now in warehouses,” McKenna points out.

In addition, warehouse space is disappearing as developers reposition older industrial facilities as residential lofts, mixed-use properties and creative office space. Orange County, for instance, has lost 3 million sq. ft. of infill industrial space to other uses since 2010.

McKenna points out that the Los Angeles/Orange County region is so large that industrial values vary greatly depending on location and size, from $150 to $250 per sq. ft. With older class-B, -C and -D structures, the primary value is in the land. So the value of a warehouse in Westwood, for example, is much higher than that of a warehouse in Vermont, where the facility’s value is the land it seats on—about $150 per sq. ft.

The only critical component for these buildings, according to McKenna, is the site’s ability to accommodate a large number of delivery vans, both inside and outside the facility.

Last mile warehouse values will continue to escalate because these facilities are located on valuable infill sites, which McKenna compares to the value of beachfront property. He notes that rents will continue to increase because it takes a couple of years to get entitlements to develop more space, and the cost of land, construction and government impact fees continues to rise.

As a result, a last mile hybrid has evolved, with big-box stores like Walmart doubling as e-commerce distribution facilities. Noting that 70 percent of the U.S. population lives within five miles of a Walmart store, McKenna says that customers are buying online and picking up the merchandise at their neighborhood Walmart without paying a shipping charge. Other big-box and department stores have followed suit, providing online customers a list of stores nearby where items they want to buy are available for pick-up.

Building multistory warehouses is the only alternative for increasing last mile distribution space in highly populated urban areas like Los Angeles and the Bay Area as e-commerce sales increase, according to DeGrenis. McKenna, who traveled globally to study logistics solutions, notes that Australian developer Goodman is already building multistory warehouse facilities around the world and cited a 27-story warehouse Goodman built in Hong Kong with trunk ramp access to the first 13 floors and elevator access to floors above. Global logistics space operator Prologis is building a three-story warehouse in Seattle and is considering another one in Oakland, Calif.

“This is obviously a thing in our future, but it isn’t something you want to do,” says McKenna, noting that these buildings cost three times as much as a traditional, one-story facilities. “This happens when the cost of land hits a certain price per square foot and the only alterative is to go vertical.”

McKenna also notes that cities will not like the idea of multilevel warehouses in infill locations because it will put more trucks on city streets and increase traffic congestion.

Rent Spikes Are Creating Fine Dining Deserts in New York City

Union Square has been gentrified beyond recognition.

(Bloomberg)—In 1995, the restaurateur Jonathan Morr opened a 3,800-square-foot noodle shop called Republic on Union Square West in New York City, paying an annual rent of $220,000. “The rent was relatively inexpensive for what it was,” he said. “But remember, when I opened, Union Square was very different than it is today. There was very little there along with the drugs in the park. At the time we were taking a risk.”

Twenty-two years later, Union Square has been gentrified beyond recognition. It’s home to a Whole Foods supermarket and an apartment building whose penthouse sold for more than $16 million. And now Republic is on its way out. Morr said he expects to close the space by the end of 2017, three and a half years before the lease expires. “It’s just a fact of life—there’s no way that we’re staying there after the lease is up,” he said. Taking advantage of an impatient landlord, Morr plans to leave the space early and will “split the difference between what [the landlord] gets from us and what he’ll get from the next tenant, and call it a day,” he said.

Republic is joining a slow but distinct restaurant exodus from the area, following in the footsteps of Danny Meyer’s Union Square Cafe, whose prohibitively high rent forced it to search for a new space in 2015.  “There’s no such thing as a New York restaurant that’s immune to real estate,” says Richard Coraine, the chief of staff for Union Square Hospitality Group. He notes that the original, 1985 rent for USQ was $4,500 a month. A roughly fivefold increase over 30 years is what prompted Meyer to move his beloved restaurant to its current home, on a corner a few blocks northeast of Union Square.

The space currently occupied by Blue Water Grill, also on Union Square West, is being formally marketed to potential tenants for close to $2 million a year, according to Leslie Siben, a principal at LB Realty Services LLC, who has been approached about the property. “There’s no way there won’t be a lot of turnover there as tenants who have been there for a really long time face the notion of ‘fair market value,'” she said, adding that the astronomical rents are an unsurmountable barrier to many potential food service occupants. “Think about those numbers: That area is going to have to become a food desert, [because] no normal restaurateur with any experience would touch that as it is now.”

“The rent at this location was just recently raised to well over $2 million,” wrote a spokesperson for Landry’s, the owner of Blue Water Grill. “Even though this is one of New York’s most successful restaurants, it can’t be successful with a $2 million plus rent; therefore, we will be relocating within the next year. In the meantime, it is business as usual.”

Deserts Where There Were Once Oases

Rising rents and real estate turnover are hardly new phenomena, but Union Square West—along with other desirable residential areas of New York such as Smith Street in Brooklyn and lower Bleecker Street in Manhattan—have seen their rents become so prohibitive that most of their restaurants—with the exception of chains, or flagship “loss-leaders”—are forced to move elsewhere.

Twenty years ago, Union Square West represented the most dynamic culinary blocks in New York. Republic was a very early pan-Asian restaurant with a focus on noodles and bowls, where the bestselling Pad Thai cost about $6 and the most expensive dish was marinated salmon on rice for $8. Blue Water Grill, set in a former bank, specialized in grand seafood tableaus. The Coffee Shop Bar, which opened in 1990, featured towering models serving mojitos, plantain chips, and pressed sandwiches late into the night. (Coffee Shop Bar looks like it will remain open, but the original Heartland Brewery, which had lived next door to Republic since 1995, closed on New Year’s Day 2015.) For people looking for future food trends around the city, Union Square West was the place to be.

Now the storefronts around those restaurants have been taken up by Starbucks and Dylan’s Candy Bar, and rumors are that yet more spaces will soon have a For Rent sign out front. “When rents go up, it makes the viability of restaurants harder,” said Stephen Sunderland, the senior managing director of Optimal Spaces, a tenant broker in the city. “You have to think of restaurants as artists, or neighborhood pioneers,” he explained. “They come into a neighborhood, it becomes hip, and that’s the source of their demise,” he said. “They create the trends that undo them.”

Restaurant leases tend to be on 15-year terms, which means that to outside observers, a “food desert” can appear to creep up without warning. A neighborhood is seen as up and coming, and exciting restaurants begin to move in. Roughly two decades later, when leases come up, prices spike because gentrification followed, and those restaurants are forced out. The net effect is a replacement of independent food entrepreneurs with a smattering of chain restaurants.

“What happens to a retail neighborhood where there’s nowhere to eat?” asked Sunderland rhetorically. “The desirability goes down” for future residents.

Here’s the Math

Morr, the co-owner of Republic, said that about 80 percent of his revenue comes from food and only 20 percent from alcohol, which is traditionally much more lucrative. “Republic was about the food, not the alcohol,” he said, which meant that to pay rent and turn a profit, it had to serve a vast number of dishes a day. “The volume was tremendous,” he said. “Like 1,200 bowls [of noodles] a day” to diners who crowded into long bench tables and shuffled in and out relatively speedily.

For restaurants that lack the space or the ability to turn over customers as quickly, the math is even more daunting. “The simple math used to revolve around rent being 10 percent of sales at most,” said Robert Guarino, the manager partner of 5 Napkin Burger, which has four locations in New York, one of which is around the corner from Union Square.

“So take the example of a $1.5 million annual rent,” Guarino explains. “That means you need to make $15 million a year in sales.” Break it down on a daily basis, he said, and assuming the restaurant is open 365 days a year, you need 822 customers a day spending $50 per person, on average, or, if the fare is cheaper, 1,644 people a day spending $25 a day, on average. “It’s not easy to get to $15 million in sales by just serving lunch and dinner in a standard sit-down format,” he said.

Laurent Gras, a chef and consultant who opened the restaurant L2O in Chicago, said the financials can be punishing when it comes to fine dining. “You’re supposed to make your rent in one night,” he said. For example: a $1.5 million annual rent means that a single day’s rent is $4,100. On top of that, there are additional costs namely labor and food, Gras said, meaning that on a single day a restaurant would need to bring in tens of thousands of dollars more than its daily rent.

For Morr and Republic, recent rent increases represented a tipping point, whereby he was profiting less from his business than his landlord. “When we opened Republic, we made six, seven, even eight times what the landlord made,” he said. Now that’s changed dramatically. “Even if you do the math and make money a little bit, you don’t want to make less than what the landlord’s making.”

Marty Feinberg, whose company Winner Communications owns Republic’s building, noted that taxes have gone up dramatically on the building since the restaurant first signed its lease. “Taxes have gone from $90,000 to $476,000,” he said. “Yes, it’s gone up in value since I bought it in 1983, and rents have escalated dramatically, but people are paying them,” he continued. “And people are paying because they can still make money. People aren’t renting space to lose money.”


Not many neighborhoods in New York or Brooklyn are left to gentrify. As a result, Sunderland, the broker, said that both landlords and restaurateurs are looking for alternative business models. One of the most appealing, he said, is food halls: “They lower the barrier to entry,” he said. “Instead of spending $300,000 to $500,000 in fixed costs, they’re probably paying a slightly higher percentage of their revenue, but they can open in a food hall for very little money. It’s limited risk, both incoming and outgoing: If the landlord takes someone and no one wants their food, after a couple of months they can just say, ‘hey, I can’t pay my rent,’ and leave.”

Because restaurant leases are on a 15 year cycle—a virtual eternity in the ever-changing character of a neighborhood—the impact of rent increases can last for decades. “There are always trends and countervailing trends,” said Sunderland. “Look at Madison Avenue: How many restaurants are there? Very few. And chances are the ones that are there are equity owners in the buildings. You don’t see new restaurants moving into that area.”

“Everyone isn’t leaving,” said Feinberg, the building owner. “But even if they do, in due time rents would stabilize at a level that people feel comfortable with, and they’ll all fill up again. It’s not going to be the end of the neighborhood.”

Morr, for his part, isn’t sure if he’ll reopen Republic once he leaves. “Listen, if the rents weren’t that crazy, we could have stayed there forever,” he said. “Maybe we should all just become landlords instead.”

To contact the authors of this story: Kate Krader in New York at kkrader@bloomberg.net James Tarmy in New York at jtarmy@bloomberg.net To contact the editor responsible for this story: Chris Rovzar at crovzar@bloomberg.net


© 2017 Bloomberg L.P

10 Must Reads for the Commercial Real Estate Industry Today (July 20, 2017)

Forbes claims investing in REITs is a better alternative to direct investment in property. Companies should be offering their employees help with housing as a retention incentive, according to CNBC. These are among today’s must reads from around the commercial real estate industry.

  • Data Proves REITs are Better than Buying Real Estate “The iron is hot when it comes to real estate investing. Over the past 5 years, both residential and commercial real estate have rewarded investors with annual returns greater than 7%. What’s more, current home ownership rates are declining and residential and commercial vacancy rates are also declining, reflecting the fact that the total pool of renters is increasing. Overall, these trends show us that investing in real estate, and more specifically, owning income-producing rental properties, continues to be a good investment strategy.” (Forbes)
  • The Perk Companies Should Be Offering Employees: Help with Housing “Housing has proven elusive in many markets and often the case is affordability — whether it’s sky-high prices or a personal financial matter — difficulty scraping together a downpayment or a bad credit history affecting a mortgage or rental agreement. So, what do you do if you are an employer trying to lure employees to come and work for you? One solution is for companies to actually start helping employees with housing.” (CNBC)
  • Downtown Yonkers: a Cleaner, Greener Place to Call Home “Developers are digging in on either side of the new Van der Donck Park, constructing high-rises and retrofitting old factories, adding residences to what was once strictly a business and government district, and banking on the greener look of downtown to lure people priced out of New York — or simply looking for a change of pace.” (The New York Times)
  • Corporate Lobbying Helped Derail Border Tax: Senior U.S. Republican “An aggressive corporate lobbying effort to derail a Republican-backed border tax has forced lawmakers working on tax reform to seek alternatives, Kevin Brady, chairman of the tax-writing U.S. House Ways and Means Committee, said on Wednesday. The proposed border adjustment tax on U.S. companies that move jobs abroad and import products back into the U.S. market was meant to be a linchpin of a Republican tax overhaul in the House of Representatives.” (Reuters)
  • Fosun Looking for $800M to Refi 28 Liberty “Fosun International is seeking a loan of up to $800 million to refinance 28 Liberty Street, sources told The Real Deal, taking the next step in its repositioning of the 2.1 million-square-foot Lower Manhattan tower it bought for $725 million in 2013. The Shanghai-based conglomerate tapped CBRE’s Tom Traynor and James Millon, both recent hires from Deutsche Bank, to secure the loan, at terms that would value the property at roughly $1.45 billion – twice what it paid to buy the building three-and-a-half years ago.” (The Real Deal)
  • LaSalle Street Office Building Selling for $165 Million “A Loop office building is selling for about $165 million in a deal that shows how a rising market lifts many properties, even ones that underachieve. Boston-based investment firm Beacon Capital Partners has agreed to acquire the 20-story office building at 231 S. LaSalle St. from a venture led by New York investor Michael Silberberg, according to people with knowledge of the transaction. Beacon is paying about $165 million, or $176 per square foot, for the Art Deco tower that was built in 1924, the people said.” (Crain’s Chicago Business)
  • The Titans Behind LA’s Trophy Tower Sales “The bromance between Jonathan Gray and Roy March is on full display in Los Angeles this year, as the CEOs have teamed up to sell a $2 billion-plus treasure trove of office towers. But the bond between Gray and March has a history. It was set in stone more than a decade ago, with a haircut. It was 2006, and March, the CEO of Eastdil, told Gray, the CEO of Blackstone Group, that he was scared to cut his hair.” (The Real Deal)
  • Rodents Reportedly Fall from the Ceiling at Dallas Chipotle “The sky might not be falling but the alternative isn’t pretty. Rodents were spotted at a Dallas-area Chipotle Mexican Grill on Tuesday. One customer told NBC DFW her lunch was ‘ruined by rodents falling from the ceiling.’ A Chipotle statement said it was ‘an extremely isolated and rare incident.’ Diners captured cellphone video inside the restaurant that show rodents crawling around the floor and one climbing up the wall. According to the story, customers claim the rodents fell from the ceiling.” (CNBC)
  • Tech Scene Stays Hot, Rent Growth Cools in San Jose “Silicon Valley is the nation’s largest tech hub, a top-performing venture capital market and one of the most prominent locations for startups. The metro continues to thrive as an attractive destination for businesses and young, educated workers, as a result of consistent employment and wage growth. However, the rental market is cooling as San Jose becomes increasingly unaffordable, even for higher-paid workers. Rents dropped 1.3 percent year-over-year through May to $2,675, more than double the national average.’ (Commercial Property Executive)
  • Kohl’s CEO Says Tech Will Spare His Stores from Retail’s Shakeout “The year 2017 has generated a constant drumbeat of mass store closure announcements by major retailers hit by chronically declining sales. But Kohl’s, which earlier this year said it would reconfigure hundreds of stores to shrink them rather than close them, is bucking that trend, saying that physical locations, with a few tech tweaks, are essential as rivals wither and e-commerce rises. Kohl’s Chief Executive Kevin Mansell takes umbrage at his company being lumped in with struggling department stores like J.C. Penney, Sears and Macy’s, noting that in contrast to those rivals, only 5% of his stores are in malls.” (Fortune)

Fannie-Freddie Reform Might Hinge on Keeping Small Lenders Happy

On Thursday, a key Senate committee plans to hold a hearing on the nation’s system for funding home loans that will feature small lenders.

(Bloomberg)—A decade ago, Brian Koss was a senior vice president at Countrywide Financial who saw firsthand how big lenders muscled out small ones during the housing boom by cutting special deals with  Fannie Mae and Freddie Mac.

Now, as a senior executive at a mid-size lender, he says a positive outcome from the bust is that government policies have mostly leveled the playing field.

U.S. lawmakers largely agree they want to keep it that way. But finding consensus on how to do it could be a sticking point in the latest effort to overhaul the housing-finance system.

On Thursday, a key Senate committee plans to hold a hearing on the nation’s system for funding home loans that will feature small lenders. It’s the third housing-finance hearing held by the Senate Banking Committee this year as Congress takes another stab at figuring out a long-term solution for Fannie and Freddie, which underpin nearly half the mortgage market. The companies have been under the government’s control since the 2008 financial crisis.

Increased Dominance

Small lenders are seen as a pivotal to the debate because some lawmakers are adamant that consumers and taxpayers benefit when such firms are active in the mortgage market. Small lenders argue that they provide better and more personal service than their bigger rivals. And some policy makers worry that increased market dominance by mega banks will enhance their status as being too big to fail, potentially putting taxpayers at risk should a giant lender run into trouble and need a government rescue.

Senator Sherrod Brown, the banking panel’s top Democrat, signaled last month that helping small lenders would be one of his primary focuses in any legislation that reforms housing-finance policy.

“For all of its faults, the current system does provide access to small lenders,” Ohio’s Brown said.

Fannie and Freddie don’t make loans themselves, but buy them from lenders, wrap them into securities and make guarantees to investors in case the loans default. The companies became a flashpoint of the financial crisis, after being thrown a $187.5 billion federal bailout as the housing market cratered. To reduce the government’s role in the mortgage market, Congress has tried but failed to pass legislation over the past decade that would overhaul or wind them down.

Bank Competitors

This time, some small lender trade groups say they fear the Senate might adopt a plan that shunts more business to big banks. They say that could happen if lawmakers take up a proposal from the Mortgage Bankers Association that would allow lenders to invest in new Fannie-Freddie competitors.

The MBA disputes that. On Wednesday, the trade group sent to lawmakers a letter signed by 110 small and midsize lenders supporting their plan, arguing that the bigger risk to small lenders without a law is that future regulators could reverse the protections they have now.

Another small-lender worry is that a new system will allow big banks to issue mortgages on better terms. The fear stems in part from how things worked before the crisis.

Fannie and Freddie charge fees to back home loans, which are ultimately passed on to borrowers in mortgage rates. During the housing boom, Fannie and Freddie competed intensely for market share, so they often lowered fees if big lenders agreed to funnel the bulk of their business to just one of the companies.

Because large lenders got such steep discounts, it often made sense for the small lenders to sell their loans to the bigger companies rather than directly to Fannie or Freddie. As part of that, small lenders had to give up the process of servicing mortgages, which meant losing an income stream.

Countrywide’s Bidding

“Fannie had to do the things that Countrywide wanted,” said Koss, now an executive vice president at Mortgage Network, a non-bank lender that made about $3 billion in loans last year.

After the government took over Fannie and Freddie, their regulator, the Federal Housing Finance Agency, stamped out the preferential treatment.

In 2006 near the housing market’s peak, the top 10 mortgage lenders made up more than two-thirds of Fannie’s total business and more than three-quarters of Freddie’s business, according to trade publication Inside Mortgage Finance. In the first half of 2017, the top 10 represented less than half.

For small lenders “any change in the status quo brings up the question, ‘How do we know we’re going to be treated equally?”’ said Inside Mortgage Finance publisher Guy Cecala.

Bypassing Congress

Some shareholders of Fannie and Freddie, including Paulson & Co. and Fairholme Funds, have advocated letting the companies build up capital and then releasing them to private investors without making major changes to the market. They say a benefit of the plan is that the Trump administration can get it done without legislation.

While small lender groups agree that the mortgage market isn’t in need of a dramatic shake up, the Independent Community Bankers of America and the Community Mortgage Lenders of America say releasing the companies without congressional action would be a mistake.

That’s because they want requirements that Fannie and Freddie provide equal pricing enshrined in legislation. Otherwise, the groups are concerned that the preferential deals offered to big lenders will return, said Glen Corso, executive director of the CMLA.

To contact the reporter on this story: Joe Light in Washington at jlight8@bloomberg.net To contact the editors responsible for this story: Jesse Westbrook at jwestbrook1@bloomberg.net Gregory Mott


© 2017 Bloomberg L.P

As Other Retailers Downsize, Skechers Debuts New Superstore Format

Within the 24,000-sq.-ft. space, the company aims to debut features that will appear in other stores throughout its retail network.

Footwear designer Skechers was already having a fiscal year of mixed operating results, with strong net sales in its global wholesale and retail business lines, offset by higher expenses. The result was lower net earnings. So when the company opened a new superstore concept in Ontario Mills, Calif., industry experts wondered whether the move would be enough to even the playing field between Skechers and its competitors.

Within the 24,000-sq.-ft. space, the company aims to debut features that will appear in other stores throughout its retail network. Skechers did not specify whether the new superstore format would be expanded throughout the U.S., and declined to comment on the development further.

The superstore in Ontario Mills offers a range of features meant to help shoppers buy their footwear more efficiently. Merchandise is organized into departments including women’s lifestyle and performance, men’s lifestyle and performance and work footwear, among others. For parents with their hands full, the store also offers a kids’ area furnished with a candy shop and theater space screening custom Skechers cartoons and characters.

The Ontario superstore is among just several large-format stores that Skechers operates (the others are in Las Vegas and Gardena, Va.), but it does have one unique element—a 5,000-sq.-ft. apparel an accessories interior store.

The superstore is designed to give the shopper “the finest retail experience possible,” according to the company. “With footwear, accessories and apparel, we’re delivering Skechers products from head to toe,” Michael Greenberg, president of Skechers, said in a statement. “We look forward to introducing features debuting here in more stores throughout our retail network through the second half of this year and into 2018.”

The question, according to retail experts, is whether that fine experience will allow Skechers to compete effectively in a very tough category.

“They are in a good category, but they have a hard fight on their hands,” says Howard Davidowitz, chairman of Davidowitz & Associates Inc., a national retail consulting and investment-banking firm headquartered in New York City. “If they build stores, they have to have a lot of interactive elements where the customer can be interested and entertained, or else they will buy online from Amazon, Nike or anyone else.”

Nike stores include such features as treadmills that measure customers’ feet. Adidas has made a name for itself with its BOOST technology, and even Amazon has won over Nike to sell a limited selection of the latter’s sneakers in its stores for the first time.

The Manhattan Beach, Calif.-based Skechers will announce its second-quarter operating results on Thursday. Looking ahead, company executives said they expect to see net sales increase to $975 million. If the retailer does meet that expectation, it would set a second-quarter sales record.

Equity analysts believe concerns over Skechers’ exposure to its U.S. wholesale channel are declining, according to a news report citing Cowen equity analyst John Kernan. The company’s previous earnings report, from the first quarter of 2017, supports the more positive outlook.

Skechers’ quarterly comp store sales increased by 2.9 percent. In terms of net sales, the company saw an increase of 9.6 percent to $1 billion. That result was attributed to a 16.8 percent increase in its international wholesale business, and a 12.8 percent increase in its company-owned global retail business.

Skechers’ first-quarter results indicate that its international sales are expanding, while domestic business has moved slower.

“They’ve got to differentiate themselves through these stores,” Davidowitz says. “They have to find ways—maybe it’s through food, special vitamins—they have to do a lot to get the customer going to their stores.”

Lifestyle Centers Positioned to Help Landlords Weather Industry Upheavals, Expert Claims

Successful projects like The Grove in Los Angeles or Scottsdale Quarter in Scottsdale can do as much as $800 or $900 in average sales per sq. ft.

The Hanover Mall in Massachusetts represents a Boston retail market enjoying a surge of economic growth. Its owner, PECO Retail Partners, is planning to redevelop a 200,000-sq.-ft. outdoor portion of the mall and turn it into a lifestyle center.

If all goes well with the plan, which calls for tax concessions from the town, PECO could start developing the lifestyle center in three years, according to news reports.

Boston is not the only market that stands to benefit from a new lifestyle center. Earlier this year, Endeavor Retail Group opened The Parke, a 350,000-sq.-ft. property in Cedar Park, Texas.  Nationally, landlords and investors are taking ideas from the lifestyle center to update their properties. Industry experts expect the changes to help landlords’ portfolios withstand the major shifts occurring in the way Americans shop and spend their free time.

“Landlords are being forced to be more creative,” says Michael Nagy, a senior vice president in the Dallas office of real estate services firm CBRE. “You cannot put a center out there to the public and say, ‘Here is my shopping center.’ It has to be experiential.”

That realization is sustaining the resurgence in the lifestyle center sector that began about four years ago. In 2013, industry experts anticipated that investment sales in the lifestyle center sector would reach $1.7 billion, including finalized and pending deals. It would be a record-setting year for deals.

They started from the middle

Poag & McEwen of Memphis was among the landlords that pioneered the format in the late 1980s, characterizing lifestyle centers as outdoor retail centers leased to tenants generally found in enclosed malls. The centers first appeared in small Midwestern towns to offer shoppers more variety than the typical enclosed mall. Now they appear in upscale markets such as Los Angeles and Scottsdale, Ariz.

“It was mall tenants that weren’t in the mall or that wanted to get out of the mall,” Nagy says. “Landlords offered a better mousetrap—an outdoor venue with lower net rents. That is how it got off the ground.”

The lifestyle center count in the U.S. totaled 497 as of year-end 2016, according to data compiled by the ICSC. That represents a slow, but steady increase over the 451 existing lifestyle centers in 2012.

These days, lifestyle centers are as varied in their quality as enclosed malls. Successful projects like The Grove in Los Angeles or Scottsdale Quarter in Scottsdale can do as much as $800 or $900 in average sales per sq. ft., Nagy says. Yet other lifestyle centers manage only $250 or $300 per sq. ft., and the most upscale tenants might include an Ann Taylor.

Much like with other retail properties, the success of these centers depends on their locations. Yet in an era where retailers are announcing thousands of store closings, lifestyle centers offer landlords a better chance of withstanding the shift occurring in retail.

“As a format, it allows landlords to be more creative,” Nagy says, adding that CBRE advises landlords not to turn away lucrative leasing deals from tenants such as nail salons, yoga studios or fitness centers. “[Their] look and feel and the way they are built offer more flexibility.”

That flexibility is critical in today’s retail environment. In a recent look at retail store closings announced for 2017, Fung Global Retail & Technology Weekly Tracker found that about 5,321 retail closings were announced by June 23.

Lifestyle centers afford landlords the flexibility to offer spaces to flea market operators or even use a wing of the center to create incubator shops to local small businesses, as examples. The key for landlords is to offer as many different services and attractions to the local consumer as possible, particularly at a time when American do more and more shopping for apparel and accessories online.

“You have to be as many different things to as many different people to survive,” Nagy says. “It’s about getting people to your [property] every week as many times [as] you can. Lifestyle centers are set up to weather the storm better than a lot of other product types.”

Tom Barrack Juggles Trump Defense and Revamped Property Empire

Barrack’s property empire, Colony NorthStar Inc., has struggled to appeal to investors.

(Bloomberg)—Billionaire Tom Barrack has a lot in common with his longtime friend Donald Trump. He’s a real estate mogul who’s had massive successes and high-profile busts. He projects a wealthy image and rewards loyalists. And in January, he embarked on a new act that has been slow to gain momentum.

Barrack’s property empire has consolidated into Colony NorthStar Inc., a real estate investment trust born near the start of the year from a merger of three companies: his own Colony Capital Inc., NorthStar Asset Management Group Inc. and NorthStar Realty Finance Corp. The new entity is making bets on health-care properties and warehouses, deals that are decidedly less flashy than Barrack’s more famous transactions, such as investing in Nevada casinos and Michael Jackson’s Neverland Ranch.

So far, Colony NorthStar has struggled to appeal to investors. Shares are little changed since the merger’s completion, trailing some rival firms in a year where optimism over the Trump administration’s agenda is helping to fuel a stock rally.

“We’re in a transition,” said Chief Executive Officer Richard Saltzman, who’s worked at Barrack companies for 14 years. “Burden of proof is on us, for sure, but I think people are leaning in. We’ve got a lot more work to do, but we’re quite optimistic about what we are doing and how it’s going to look six months to a year from now.”

Colony NorthStar is now the main investment vehicle for the 70-year-old Barrack, the company’s chairman, marking the latest turn in a more than three-decade career in real estate and private equity. At the same time, he’s becoming more known outside financial circles for his role as a Trump champion, from appearing on television to defend his policies to organizing the inauguration. And while he doesn’t hold an official role in the administration, Barrack says he offers informal advice to the president.

“The best thing I can do is be a friend and be able to tell him when he’s off base without him firing me,” Barrack said in an interview.

Distressed Bets

Barrack built his career from bets on seemingly out-of-favor assets. The son of a Lebanese grocery store owner, he worked as a lawyer in the Middle East and had a stint in the Interior Department of President Ronald Reagan’s administration before joining the investment firm of Texas billionaire Robert Bass in the 1980s. There, he capitalized on the savings and loan crisis by buying distressed assets from failed thrifts, working with the likes of David Bonderman, who went on to co-found TPG Capital. Barrack also helped engineer the sale of New York’s Plaza Hotel to a prominent real estate investor: Donald Trump.

“I learned from him a lot of things about instincts and how he evaluates people,” Barrack said. “We were both contrarians, but he was better, brighter and more aggressive in building his own brand. I had great people around me and the wind at my back a little.”

With money from Bass, Barrack founded Colony Capital in 1991 and built a private equity giant by investing in soured loans and real estate, including celebrity-centric deals such as buying Neverland Ranch and saving photographer Annie Leibovitz from bankruptcy. The company persevered after some missteps in the mid-2000s — including backing the $8.5 billion purchase of Station Casinos, which ended up going bankrupt, and getting crushed on Xanadu, the trouble-plagued $2 billion retail and entertainment complex in New Jersey’s Meadowlands, during the financial crisis — and Barrack now has a personal fortune that’s estimated at $1.3 billion, according to the Bloomberg Billionaires Index.

His collection of residences includes a ranch, polo facility and winery near Santa Ynez, California, and a condo in Manhattan’s Trump Parc East. In Los Angeles’s Bel Air neighborhood, he’s developing a mansion that will be at least 53,000 square feet (4,900 square meters) that a Colony spokesman said it is being built for a friend, whom he declined to identify.

Inner Circle

People close to Colony say Barrack surrounds himself with a tight circle of lieutenants and values loyalty. Senior leaders, who typically number 10 to 15 at a time, stay for an average of 12 years, and many have worked with him since Colony Capital’s inception, according to the company.

He sometimes hires people he knows or as a favor to others. Such employees are known as friends of Tom, or “FOTs,” by Colony workers, according to people close to the firm. Some FOTs lack the necessary business experience or acumen, and often end up having ambiguous roles, said the people, who asked not to be named discussing internal matters. Still, employees are rarely fired, they said.

“I err on the side of loyalty over top performance for sure,” Barrack said. “I’ve hired people from a reservoir of unusual places versus going to Wall Street and saying, ‘I’m going to go steal someone from Goldman Sachs.’”

That’s led to unorthodox hires such as Tommy Davis, a former spokesman and head of external relations for the Church of Scientology. Davis joined Colony in 2012 as a part of the rental-home business before eventually becoming Barrack’s chief of staff, coordinating media-related requests and bookings.

Barrack is the godfather of Davis’s brother, Davis said in a telephone interview. He is no longer employed by the firm but works for Barrack personally as an independent contractor.

Going Public

Barrack took Colony Capital public in 2015, merging it into Colony Financial, a publicly traded REIT, giving the company access to $9 billion in assets and making it less dependent on outside money.

“I was giving back to all the people who had been loyal to me all that time and giving them a currency, a balance sheet, a company and a future,” Barrack said. “And it’s given me space to think about other things.”

The marriage of Colony and the NorthStar companies — one of which focused on commercial-property investments and debt, with the other managing the REIT’s assets — accelerated growth for Colony Capital, which had been slower to raise money from institutional investors after its financial-crisis losses. By 2010, Colony’s flagship private equity fund had lost 60 percent of its value.

NorthStar had the ability to pool money from individual investors through entities like nontraded REITs, which are sold to mom-and-pop investors and aren’t traded on stock exchanges. Colony had already been exploring buying or building such vehicles itself. By merging with Colony, NorthStar had a way to quiet vocal shareholders, who had argued that top managers were collecting millions of dollars in compensation even as the stock was underperforming.

The new company has about $56 billion in assets, compared with about $25 billion for Colony before the merger. Barrack personally owns or controls an almost 5 percent stake, according to public filings.

‘Somewhat Unprecedented’

Property REITs traditionally focus on owning real estate and distribute most of their profits to shareholders in the form of dividends. Colony NorthStar has a more complicated setup in that it also has an asset-management business embedded in the company.

The company has already sold some investments that are no longer central to its strategy of putting money into real estate related to health care, hotels, warehouses or investment-management services.

“What they’ve done is somewhat unprecedented,” said Mitch Germain, a real estate analyst with JMP Securities LLC in New York. “The Colony management team has done a fairly swift job of beginning the process of simplifying what the company is and exiting what they consider to be noncore.”

The stock has likely underperformed because it’s not a traditional REIT that investors can easily compare with others, Germain said. In May, the company reported funds from operations that trailed analysts’ average estimate.

It also has fallen short of fundraising goals. Colony NorthStar closed its latest Global Credit Fund with commitments of $1.2 billion, 20 percent of which was funded by the company itself. Colony had set a pre-merger target of $2.5 billion.

Barrack chalks that up to a shift in the investing landscape, as the traditional model of private equity firms and hedge funds that charge high fees to manage money has become “an antique.”

“Pension funds, family offices and sovereign wealth funds are run by sophisticated investors who aren’t as interested in putting money into a gigantic fund,” he said. “They’d rather pay for each transaction and see the deal. They want to be more involved.”

Warehouses, Nontraded REIT

Colony NorthStar is pushing deeper into investing in industrial properties, according to Saltzman. There’s also a plan in place to tap retail investors by raising $2 billion for a New York-related nontraded REIT, and $4 billion for other funds.


In the meantime, Barrack has made headlines related to Colony’s past deals, including being entangled in a dispute with an Italian prosecutor who has accused him of being involved in a tax scheme related to Colony’s sale of luxury Sardinian properties. Barrack has denied the prosecutor’s allegations.

He’s also selling his stake in house-rental company Colony Starwood Homes, one of the firm’s largest investments over the past several years and an industry he helped pioneer. Another business, lender Colony American Finance LLC, was sold to Fortress Investment Group LLC.

Barrack has become less visible at Colony NorthStar, with Saltzman as the public face of the firm, as it takes shape and finds its place among other REITs. He’s become more visible when it comes to defending Trump. He continues to weigh in, as a friend, but contends the president knows what he’s doing.

“I have given my thoughts on a variety of topics,” Barrack said. “And he has thanked me for my opinion and then said, ‘But if I listened to you I would never be president. I’d still be on ‘The Apprentice.””

To contact the reporter on this story: Heather Perlberg in Washington at hperlberg@bloomberg.net To contact the editors responsible for this story: Daniel Taub at dtaub@bloomberg.net Kara Wetzel


© 2017 Bloomberg L.P

How Mixed Use Structuring Can Help Your Hotel Project Pencil Out

Once the mixed uses for a project have been determined, the next hurdle for a developer is how the different components of the project will be owned.

The nature of the current urban real estate economy is motivating hotel developers to structure large projects in a manner which utilizes every available profitable option. The rising cost of land puts further pressure on developers to maximize economic value and minimize risk. In many cases, especially in urban settings, buildings consisting of a single use are either too difficult to finance, or the economics of the project do not pencil out.

These issues incentivize developers to engage in creative solutions, often leading to the utilization of a mixed-use building structure. Depending on the project’s particular needs, a mixed-use development can combine several different types of uses.Examples include: (1) a hotel building with an apartment component (consisting of both owned and rental apartments); (2) a hotel with a commercial office component; or (3) a hotel with both commercial retail spaces and apartments for sale or for rent. This article will discuss the methods a developer can utilize to structure a mixed-use project, and the practical and legal implications to be considered (including financing benefits).

Once the mixed uses for a project have been determined, the next hurdle for a developer wishing to utilize a mixed-use structure is determining how the different components of the project will be owned. If the developer intends to own the various components after construction of the project is complete, the mixed- use structure is simple as the developer will maintain control over the entire project. However, what happens if the developer does not contemplate retaining all of the components of the mixed-use project following completion of development, or if a developer wants to lower its equity requirements?

Luckily, there are many ways to structure mixed-use projects. Traditionally, the condominium regime is the most recognized method to accomplish the vertical subdivision necessary for a mixed-use project to be owned by multiple owners. However, developers should be wary of condominium laws and the multitude of restrictions and requirements which vary from state to state, as the formation of a condominium requires filing a declaration of condominium and the formation of a condominium association, which must adhere to the laws of the state in which the project is located. The declaration will create a three-dimensional legal description, and through the creation of units, the project can be sold as-is or can be further subdivided. The condominium governing documents will also provide for how the condominium will be operated and managed, and how the expenses associated therewith will be allocated amongst owners.

While the condominium structure is the most common method for creating mixed-use projects, there are many downsides to be considered with utilizing this structure. The primary drawback is associated with the requirement of relinquishing control of the condominium owners’ association and the owner democracy and governance issues that may result. The requirements for turnover of control vary from state to state, and transfer of control of the association from the developer to the non-developer owners may be required regardless of whether the condominium is residential or commercial in nature. Further, state laws typically contain restrictions on how common expenses can be calculated, therefore leaving less room for creativity as to what percentage interest may be assigned to each unit. Some states require that these values be based on square footage, number of units, impact on use, value or a hybrid of these methods. There are also additional expenses to be considered by the developer in creating a condominium; examples include legal fees, obtaining plats and plans, increased insurance costs, regulatory costs, state filing requirements, etc. Given these additional costs and the restrictions imposed by the condominium regulatory scheme, a developer may find that using the condominium regime as the basis for structuring the project is more trouble than it is worth.

An alternative method to the condominium structure is to utilize three-dimensional platting. This method allows for the subdivision of a project into different parcels based on three-dimensional airspace. These parcels are platted on an air space subdivision map and filed with local agencies. This method is ideal as compared to creating a condominium because it allows for the platted parcels to be owned separately, but does not require the formation of an association and the inherent governance issues. Unfortunately, despite the convenience of three-dimensional platting, this method is not accepted in most jurisdictions. Very few cities expressly permit it, and other jurisdictions that have adopted the method generally lack clear codes and regulations.

While the three-dimensional platting method is convenient, it still requires that the developer tie the pieces of the project together. This is where a shared building agreement (sometimes known as a reciprocal easement agreement, or such provisions may be contained in a declaration of covenants, conditions, easements and restrictions) comes into play. A shared building agreement grants easements to the multiple owners of the project, which allow access to the parts of the project that will be used by or serve all parts of the project, often referred to as shared areas. Examples of shared areas include elevators, stairways, roofs, utility systems, parking and other structural components. The shared building agreement may also address limited shared areas, which are shared areas appurtenant to a particular parcel or group of parcels. For example, signage or an elevator serving only the residential portion(s) of the project would be a limited shared area to the particular parcel(s) which it serves. The shared building agreement will provide easements for maintenance of the shared areas and limited shared areas, designate the parties responsible for maintenance of each and how the maintenance costs are allocated amongst the various owners.

Utilizing a shared building agreement requires that the allocation of expenses associated with the shared areas be determined upfront. However, there are many methods to achieve an equitable allocation—certainly one to which all parties can agree. For example, equal costs per unit, pro rata based on square footage, pro rata based on current or projected usage or pro rata based on benefit received or burden created are all methods for allocating shared costs. Oftentimes, there is a blending to achieve the desired result. Further, the governing documents must detail mechanisms to enforce payment of these costs. Obligations to pay shared expenses are usually secured.

Using one of the three-dimensional platting methods identified above can be ideal for a developer from a financing perspective, because it allows a developer to finance the pieces of a mixed-use project without necessarily creating a condominium for the entire project (a developer may still need to create a condominium on those portions that are being conveyed). Should the developer choose to do so, the developer may convey one or more of the components and separately release it from the mortgage. Hotel developers specifically benefit from this arrangement as the ability to take out equity on certain portions of the project helps the project pencil out and offers an improved loan-to-value ratio, making financing or refinancing possible. Consumers also benefit when more parties contribute to the maintenance and replacement of shared areas, as this apportions more funds towards developing and maintaining nicer amenities.

Drafting the legal provisions of the shared building agreement requires a degree of experience and precision to ensure that the document covers all essential elements without unduly burdening owners. Despite the complexities described above, the shared building agreement still provides the greatest degree of flexibility and enables developers to develop a project that will attract purchasers and lenders. All it takes is a little bit of negotiation among the lenders and other future component owners on the front end, as well as the proper legal team to bring it all together.

Dan Bachrach is a partner with Foley & Lardner’s hospitality group. Laura Zampieri is a real estate associate at Foley & Lardner LLP and a member of the firm’s hospitality and leisure industry team.

10 Must Reads for the CRE Industry Today (July 19, 2017)

Cities are considering converting municipal airports into commercial space, reports The New York Times. Treasury yields are rising, according to MarketWatch. These are among today’s must reads from around the commercial real estate industry.

  1. The 30-Year-Old Texas Tycoon Who Is Building a Real Estate Empire “Unlike other successful Millennial entrepreneurs, Nate Paul is not a T-shirt or hoodie kind of guy–his uniform is a suit. He has worn one to work, usually with a vest, every day since he dropped out of college nearly ten years ago. “I always wanted people to take me seriously,” the Texas real estate prodigy says. ‘Part of it is you have to look older.’ At 5’11”, with a stocky build and a two o’clock shadow, Paul certainly looks as though his odometer has long since passed 30 years old. But that’s not why the real estate brokers who clamor to meet him take him seriously.” (Forbes)
  2. Abundance of Office Subleases Available Across Manhattan “Office sublease availability in Manhattan has soared to its highest percentage since 2010 as companies are squeezing into smaller spaces and moving to new buildings before their leases end. A Savills Studley report shows 3.5 million square feet of sublease space has been added since June 2016 — a surge of 44.7 percent year over year. Meanwhile, the firm’s Jeffrey Peck says the new standard for space occupancy has dropped from a range of 200 to 225 square feet per person to just 125 to 135 square feet per person.” (New York Post)
  3. Treasury Yields Tick Higher After Strong Housing Starts Number “Treasury yields rose slightly after a stronger-than-expected housing starts numbers gave investors some reassurance that the economy was still on track after a raft of weaker-than expected data in the last few weeks lowered growth and inflation expectations. The 10-year Treasury yield rose 0.8 basis point to 2.268%. The 2-year note was up 0.8 basis point at 1.356%, the 30-year bond gained 0.6 basis point to 2.854%. Bond prices move inversely to yields.” (MarketWatch)
  4. Factories or Runways? Municipal Airports Face Economic Pressure “Coleman Young International Airport was once one of the nation’s busiest airports and a thriving piece of Detroit’s economy. But like so much else in the city, it festered for decades after the action moved to the suburbs. Now local officials want to reinvigorate the 264-acre plot. The question is whether that means it will survive as an airport or be remade for other purposes. The City Council this month is expected to select a firm to start studying options for the site, including using the land for a half-dozen new factories or other industrial uses.” (The New York Times)
  5. Developer Buys Elk Grove Site Near O’Hare Airport for New Business Park “Chicago O’Hare International Airport is getting some new neighbors. Brennan Investment Group, a private industrial-property developer and investment firm, is planning to develop six parcels of land totaling 85 acres near the airport into a business park, anticipating demand from manufacturing firms and data centers who want to be near the travel hub.” (Wall Street Journal)
  6. Off-Price Giant Details New Store Concept “The TJX Companies will debut a new, off-price home store concept in August. HomeSense will open its initial U.S. location on  August 17, in Framingham, Mass.  Three additional stores are planned by the end of 2017, with locations in East Hanover, N.J., Ocean Township, N.J., and Westwood, Mass. The HomeSense banner is not new for TJX, which operates stores under that name in Europe and Canada. However, the HomeSense U.S. concept will be different from those stores, with a greater depth of merchandise in certain categories.” (Chain Store Age)
  7. The Most Overvalued Housing Markets in America are in Texas “In a city with rising incomes and declining unemployment, it stands to reason that home prices would go up as well. Such is the case in San Antonio. Incomes in the Texas city grew 4.5% between the first quarters of 2016 and 2017, nearly a percentage point more than the national average. The problem is home prices were even hotter. The CoreLogic Case-Shiller Home Price Index for San Antonio gained 7.8% year-over-year, compared to a 3.7% gain nationally. As a result, San Antonio homes are overvalued by 18.6%, the most of any market in America, according to Fitch Ratings.” (Forbes)
  8. Property Developers Push for Open Drinking on City Streets “Property developers trying to create buzz for open-air shopping districts are lobbying regulators to relax rules to allow patrons to walk around streets and parks with alcoholic beverages. As landlords hustle to get customers into their properties, they are looking to tap into demand for food-and-drink experiences. The hope: that lively atmospheres will encourage patrons to linger and shop.” (Wall Street Journal)
  9. Westfield Displays Questionable Sistine Chapel Replica at Oculus “We have no idea, none whatsoever, why Westfield thought it was a great idea to plunk down a tacky ‘UpClose: Michelangelo’s Sistine Chapel’ exhibition on the floor of the World Trade Center Oculus. Described as ‘a way to engage with the master works of art like never before,’ it offers reproductions of 34 of the great Italian painter’s Sistine frescoes, all ‘artfully displayed in near-original size.’ Westfield is presenting the Sistine ceiling images as part of a road show, with stops in other cities including Chicago, Los Angeles and Seattle.” (New York Post)
  10. Good Time to Invest in Boston’s Growth Areas “Boston is turning into the city of tomorrow, with real estate projects built to suit the city’s status as an innovation hub. In addition to the new wave of development, investment is also solid due to diverse asset types with solid rent growth, as illustrated by General Electric’s decision to move its headquarters to Boston’s Seaport District. This is according to Andy Hoar, president & co-managing partner of CBRE/New England, who underlined the main trends and challenges in this northeastern market in an interview with Commercial Property Executive.” (Commercial Property Executive)

CMBS Delinquencies Remain Muted

The CMBS delinquency rate for U.S. commercial real estate loans rose 28 basis points in June to reach 5.75 percent, according to research firm Trepp.

A rise in CMBS delinquencies would not normally be cause for celebration. But with the wall of maturities rapidly diminishing, still low delinquencies at this stage of the game is welcome news for capital markets.

The CMBS delinquency rate for U.S. commercial real estate loans did pop up 28 basis points in June to reach 5.75 percent, according to Trepp’s June CMBS Delinquency Report. Those loans that are 60+ days delinquent, in foreclosure, REO or non-performing balloons have inched steadily higher, rising 115 basis points over the past 12 months. Yet that increase is not unexpected given the wall of maturing legacy loans made in 2006 and 2007 that are still being resolved.

So why the uptick in June? “The main culprit is about $1.6 billion in CMBS that reached maturity without payoff in June. This has been the prevailing trend over the past year,” says Manus Clancy, senior managing director of applied data and research at Trepp.

Delinquencies will likely continue to edge higher in the coming months. Some $17.04 billion of CMBS loans are set to mature in the second half of the year, according to Morningstar’s June CMBS Maturity Report. Successfully refinancing many of these loans will be difficult without sharp improvement in cash flow or an equity infusion as nearly 46 percent of those loans have loan-to-values (LTVs) above 80 percent. Across the five major property types, retail represents the largest property type by balance maturing through year-end, according to Morningstar.

The industry appears to be taking news of higher delinquencies in stride. “There may be a little bit of a blip in delinquencies, because you are dealing with some of the dregs of 2007, but I don’t think that is a meaningful part of the market,” says Thomas Fish, executive managing director and co-lead of the real estate investment banking (REIB) practice in the capital markets group at Jones Lang LaSalle.

“Issuance for new CMBS really kicked into gear in second quarter, and spreads have remained in a non-threatening band since the blowout early last year,” says Clancy. “So it doesn’t appear that this is ruffling many feathers in certain parts of the market.” Delinquencies remain low by recent historical standards. The all-time high was 10.34 percent in July 2012, and 40-basis-point jumps were common in 2010, he adds.

In addition, the most recent data from the Mortgage Bankers Association (MBA) indicates a lower level for CMBS delinquencies and negligible levels of distress among other types of lenders. The MBA reported that first quarter delinquency rates for commercial and multifamily mortgage loans were flat or lower, with delinquencies that remained at or near record lows for most capital sources. The MBA results on first quarter delinquencies include:

  • CMBS at 4.45 percent on loans that are 30 or more days delinquent or in REO;
  • Banks and thrifts at 0.56 percent (90 or more days delinquent or in non-accrual);
  • Fannie Mae at 0.05 percent (60 or more days delinquent);
  • Freddie Mac at 0.03 percent (60 or more days delinquent); and
  • Life company portfolios at 0.02 percent (60 or more days delinquent).

“Those are really fantastic numbers on a historical basis,” says Fish. There is always going to be some level of delinquency in the market. “If you are aggressively making loans, you are going to swing and miss on a few,” he notes. If CMBS has the highest delinquency rate of all the buckets at 4.0 or 5.0 percent, that is a very manageable number, he adds.

Despite the negative headlines about store closures impacting shopping centers, the hardest hit sectors have been office and industrial. Office delinquencies have climbed 191 basis points over the past year to reach 7.67 percent in June, while industrial delinquencies are 162 basis points higher at 7.57 percent, according to Trepp.

The bigger concern for CMBS is not so much delinquencies as it is the subdued activity on the origination side. “That is where we are seeing more of a pullback,” notes Fish. Issuance volume declined to $76 billion in 2016 and the market is on a similar pace for 2017, with issuance volume for the first half of the year at $38.8 billion, according to Commercial Mortgage Alert, an industry newsletter.

The CMBS pie is shrinking due in part to more conservative underwriting and increased competition from other lending sources. There is about $463 billion in U.S. CMBS issuance outstanding, which is down almost $82 billion compared to a year ago, notes Fish. So loans are being paid off or refinanced through other lending options and taken out of the market, and new issuance is not high enough to offset those maturities. “That to me is the bigger concern. How are we going to get our volumes back up to at least year-over-year neutral levels,” he says.