Commercial Real Estate’s Troubles Offer Opportunities for Investors: Panelists
Meet a very optimistic bunch at Commercial Observer’s latest forum
It’s no secret that the commercial real estate industry is struggling.
The Federal Reserve has hiked interest rates to their highest levels since 2007. The collapse of First Republic Bank last week represented the second-largest commercial bank failure in American history.
But, through all the tumult, there may be opportunities for investors looking to take advantage of the distress, panelists said at Commercial Observer’s State of Commercial Real Estate forum, hosted in partnership with L&L Holding Company.
JPMorgan Chase’s decision to buy First Republic, at the behest of federal regulators, certainly weighed on the minds of the public and private sector experts gathered at 222 Broadway the morning of May 2. But not so for Andrew Farkas, CEO of Island Capital Group.
“Now that you’re all distressed investors, this is good,” Farkas said during a fireside chat. “Don’t be afraid of defaulting loans. Don’t be afraid of down markets.”
While “a recession is never really good for anything,” Farkas said that tough markets like today’s are when “fortunes are made,” because investors can buy on the cheap. A slowdown in the debt markets also could encourage sellers to provide financing for acquisitions themselves, he added.
Still, the turbulence in the banking sector is another concern in a long list of problems facing New York City’s office market. A “wave of defaults” looms for office property debt, Richard Barkham, CBRE (CBRE)’s global chief economist, said in the opening panel, titled “2023 Economic Outlook: Analyzing Key Stats & Data,” where he was interviewed by Kramer Levin’s Jay Neveloff.
Office property values have dropped roughly 30 percent since the pre-pandemic peak of the market, and those buildings are unlikely to recover all of their value in the next five years, Barkham added.
But not every office building is in trouble. High-end, trophy properties are still seeing strong attendance, Jamil Lacourt, director of construction at L&L Holding, said in the “Office 2023: Where Occupier Innovations & Workplace Demand Meet” panel that was moderated by Kurt Koegl, a partner at Marcum LLP. Buildings that offer tenants data on their carbon footprint are more attractive to firms that are required to track their sustainability commitments, said Linda Foggie, CitiGroup’s global head of real estate operations.
Landlords can also use data to measure how tenants use amenities and what types of benefits keep renters coming back to their buildings, said Chase Garbarino, founder of workplace experience software company HqO. Panelists were joined by Colliers’ Michael Cohen and the Rockefeller Group’s Bill Edwards.
“The market environment today is creating a really good opportunity for the larger commercial real estate market to be more data-driven,” Garbarino said. “Commercial real estate does a better job than any industry in assessing the financial viability of their customers. And they probably have the least understanding of how people use their product.”
Buildings that can’t survive as offices could be converted into housing, if the property is the right size, zoned properly and empty of tenants, said Michael Pestronk, co-founder of real estate development firm Post Brothers.
”That process might be aided by some additional cash from the state,” said Shimon Shkury, president and founder of Ariel Property Advisors.
“You need a lot of stars to be aligned in order to convert an office building,” Shkury said in the “Investment Sales, Conversions & The Rise of the Rental Market” panel moderated by David Szeker of Kasowitz Benson Torres LLP. “The city and state, if possible, have to think about subsidies and help people that want to come here and convert office buildings.”
Gov. Kathy Hochul proposed a tax incentive to turn office space into housing in her initial budget in February, though most of the governor’s housing agenda was cut during budget negotiations. But Melissa Román Burch, CEO of the New York City Economic Development Corporation, said legislation to support conversions could be passed before the legislative session ends in June.
“We think there is an opportunity to absorb some of that excess [office] supply through conversion,” Burch said in the Szeker-moderated panel that also included Brooke Richartz of JPMorgan Chase. “There is still work that is happening with the legislature to try to push for conversions.”
Transforming offices into apartments or condominiums is also a more sustainable practice because it recycles an existing structure, Jake Elghanayan, a principal at TF Cornerstone, said.
“The cleanest new building is the one you didn’t build,” Hilary Spann, executive vice president of Boston Properties (BXP)’ New York region, added, referring to green construction.
Not all commercial real estate properties need a complete redesign. Multifamily properties remain a strong asset class as rising rents outpace the impact of higher interest rates on owners’ bottom lines. (Farkas said he was “all-in” on single-family rentals. “Single-family home rental has been unbelievable,” Farkas said. “And 10 years ago, I told everybody they were going to lose their ask. Wrong!”)
Life sciences space and data centers are also still in demand, particularly thanks to the exponential growth in the amount of data collected by companies that utilize artificial intelligence technology, Rob Harper, head of real estate asset management in the Americas at Blackstone (BX), said in the panel “A Deep Dive Into the State of CRE Market: Paving the Road to Stabilization.” Michael Werner of Fried Frank moderated the discussion, which also featured Spann and Elghanayan.
Last, it was on to retail.
Retail leasing activity has started to trend up slightly, said Fred Posniak, senior vice president of leasing at Empire State Realty Trust. That could be because the retailers that survived the pandemic represent a stronger crop of businesses, Andrew Mandell, vice chairman at Ripco Real Estate, said in the “What’s Next for Retail: The Innovative Strategies Driving the Retail Revival” panel that featured RXR’s Whitney Arcaro and The Canvas’s Devin Gilmartin.
Still, retail is far from immune to inflation and the higher cost of debt, which can make it more difficult for retailers to raise funds to expand to new locations, Posniak said.
“Debt is a critical part of how retailers run their businesses,” Posniak said. “Where now the cost of funds are more expensive, it really restricts your maneuverability.”
Celia Young can be reached at email@example.com.