Sunday Summary: McKinsey’s $800 Billion Bombshell
By The Editors July 16, 2023 9:00 am
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Real estate was delivered a punch squarely to the gut last week.
McKinsey & Company — the largest, oldest and arguably most respected of the big three consulting firms — issued a report carrying a message that landlords had been dreading for the past three years:
Hybrid is here to stay. As much as 40 percent of the core of retail and office corridors in the nation’s cities could be rendered obsolete. An estimated $800 billion worth of real estate could be wiped out.
“There was this notion in 2020 or early 2021, where the idea was people left the city but they would come back. There’s a lot of evidence they won’t come back,” said Brian Vickery, one of the authors of the report. “Our survey populations said they’re not planning to move back to where they once were. They’re OK with longer commute times because they have to go in less often.”
The report exploded not just in the trades, but also crossed over into the mainstream media. (See here, here and here.)
And almost immediately real estate executives began dissecting what this would mean.
“The projections into the future don’t represent a preordained destiny,” argued Brookfield (BN)’s Stuart Mercier at a forum organized by McKinsey that included RXR’s Scott Rechler, Gensler’s Diane Hoskins and KKR (KKR)’s Ralph Rosenberg. “This is an opportunity for us to think about how we adapt to the urban core and urban environment and the working experience to earn the commute.”
And, even though there was a sober willingness to look at McKinsey’s findings, Rechler defended the importance and prospects of cities.
“[There are] cities like New York, where you have 8 million people in New York City, but if you think of the greater New York region, there are 22 million people connected by public transit,” Rechler said. “You’re starting to see that in places like Miami, Florida, and places like Phoenix, where that outer region is growing, and you have leadership investing in that infrastructure, so it’s connected as a superstar region and thought of as one.”
Rosenberg was unconvinced by the report’s conclusions.
“I do not believe, from a human nature perspective, that my 28-, 26-, 25- and 22-year-old children are going to raise their hand and move to Greenwich, Conn., anytime soon,” Rosenberg said. “If you took this report at face value, you might not have concluded that the four of them ended up back in New York City.”
We hope you’re right, Ralph.
If not for this report, it would have been a pretty good week!
Hopefully this didn’t put too much of a damper on news that CRE professionals had been impatiently waiting on for a long time. Inflation numbers came out and they were … actually pretty good!
Inflation came way down and the consumer price index rose just 3 percent — the lowest figure since March of 2021 — leading some to believe that the Federal Reserve would ease off on raising interest rates.
“One couldn’t ask for a better report on consumer price inflation,” tweeted Moody’s chief economist Mark Zandi. “Inflation is definitively throttling back, and while today’s report overstates the case, there is a strong case that inflation is headed in the right direction. The Fed should rethink the need for more rate hikes.”
Indeed, money is still changing hands. Be it MaryAnne Gilmartin’s MAG Partners, which scored a $196 million refinancing from Elliott Investment Management for its project in West Chelsea, or UP Province Holding shelling out $125 million to Chateau Group USA for the not-yet-finished Province in San Gabriel, Calif., or a former meatpacking plant in Los Angeles selling for $206 million, or Beach Point Capital peeling off $120 million to Flintlock Construction and Atlas Capital to finish the Voco hotel in Times Square.
Plus, there were some significant leases — like, say, a modest 1.42 million-square-foot industrial lease for Bodega Latina (the company behind El Super and Fiesta Marts) in Rancho Cucamonga, Calif. (Cue Bart Simpson.) But, even if we hadn’t seen that jaw-dropper, there were some pretty impressive office leases (well, renewals) like the 183,000 square feet that the Department of Citywide Administrative Services took to house three city agencies at 255 Greenwich Street.
And, while the deal did not wrap last week, Camber Property Group CEO Rick Gropper last week did break down the massive $783 million in public and private financing he got for New York City Housing Authority’s Edenwald Houses in the Bronx in late June.
Remember 421a!
One other reason why last week didn’t suck as much as it might have? 421a (long thought dead and gone) might be back.
According to reports, Gov. Kathy Hochul is toying with the idea of reinstating the tax break (or a close substitute) by executive order. Not that everyone is happy about this. (“I don’t think one can deal with a housing crisis truly behind the scenes without the legislature as a partner. That’s the wrong way to get something done,” said Linda Rosenthal, the chair of the state Assembly’s Housing Committee.) But this is nevertheless a very interesting development given that only a month ago 421a had been written off as over.
Now let’s see what happens with the new LLC Transparency Act.
Of course, good inflation news aside, it remains a tough landscape out there. Even fabled veterans of CRE like Steve Witkoff and Ian Schrager are feeling the heat. (Their Public Hotel on the Lower East Side is looking like it might go into foreclosure.)
So one should expect that there will be a lot more foreclosures to go before CRE gets out of this.
“Larger institutions have already run the calculus on whether or not to hold, and many are handing back the keys,” Nitin Chexal, CEO of Palladius Capital Management, recently told CO. “It clears the way for smaller firms to follow suit.”
For this reason we’d recommend looking over our nifty primer on handing back the keys.
See you next week.
