Q3-2024
Executive Summary
THIRD QUARTER �� � 4
The US economy is oscillating between an upper boundary imposed by high real interest rates and the support provided by a resilient consumer. Overall trends reflect modest cooling of economic activity and declining inflation. The financial media refers to this benign construct as a “soft landing”, which is historically difficult to achieve. Analysis of fundamental signals leads to the conclusion that this unique economic resilience we enjoy is the result of normalizing supply chains, technological innovation, accumulated consumer and corporate wealth. This prosperity stems from the Pandemic and the ongoing stimulus of government spending in strategic initiatives, (infrastructure and processing chips). The confluence of these factors have allowed the US economy to maintain a positive momentum in the face of high real interest rates and a darkening global geopolitical landscape. In sum, the US resembles a “safe haven” for investors.
Following several years of strong inflows of debt and equity, Commercial Real Estate (CRE) assets lost investor attention as the interest rate hiking cycle gained steam. Risk aversion toward CRE investments brought about a steep decline in investment sales and difficult price discovery, which we are still experiencing. The loss of capital and confidence, with a backdrop of high borrowing rates, pushed capitalization rates higher and depressed values. According to Green Street Advisors, overall property values declined approximately 17% peak to through, with the lowest values recorded early 2024. This is a useful reference point, however, there are marked differences between geographies and market segments.
The start of the easing cycle, marked by the recent 50 bps decline in Federal Funds rate, is helping CRE re-capture investor attention. Capital that had been on the sidelines is now searching for value plays in commercial real estate, principally in distressed debt or loan-to-own situations. Financing real estate deals is still difficult, and investment sales remain subdued. A continuation of the easing cycle would revive the dormant transaction market. Green Street Advisors’ property price index suggests that the initial drop-in short-term rates, adjustments in the yield curve across maturities, and renewed investor confidence on the US economic resilience have already helped CRE prices recover approximately 3% from the through.
Rising oil prices -due to confrontations in the Middle East- have created fears that inflation may rekindle, and the easing cycle could be derailed. Over the next several weeks, evidence will transpire about further progress on inflation, the easing cycle, CRE borrowing availability and financing costs. However, even if the easing cycle continues, CRE assets with excessive debt and poor cash flows are likely to fall in distress.
CMBS data published by Trepp give us a window into delinquency trends and loan modifications. Overall, 30 Day delinquencies have now risen 1.31% over the last year driven principally by office, lodging and multifamily. Office delinquencies have steadily trended upwards. Poor cash flows persist in this market segment as occupancy has not recovered and work from home protocols remain well entrenched. Multifamily, on the other hand, has been a victim of its own success. Oversupply in some geographies has caused new and older product to suffer, and in supply-constrained geographies, owners are realizing that rent affordability has become an issue for many households. Over the last 12-months multifamily delinquency increased 1.48%. On a positive note, over the last two months, multifamily delinquency trends appear to have stabilized.
Executive Summary
Loans that have been transferred to special servicing, for modification or liquidation, have also been increasing. Of the total CMBS outstanding, special servicing rate has increased close to 2% over the last twelve months. Office, mixed use and residential loans are driving this increase. In summary, the message from CMBS statistics is that the performance of CRE assets is under stress and high debt levels are a key contributor to such stress.
Westchester Offices – Not Yet Light at the end of the Tunnel
An apparent paradox has developed in the national office markets which we have observed in Westchester for some time. Despite weak supply-demand fundamentals, statistics show rising aggregate office rents. The explanation is that at a national level and in local markets (Westchester), Class A assets are capturing the bulk of the leasing activity. Tenant Improvement (TI’s) costs are on the rise due to still escalating construction costs. The combination of higher TI’s (for which landlords try to get reimbursed in rents) and the concentration of leasing activity in high-amenity offices commanding higher rents, explains the aggregate office statistics showing advancing rents despite high vacancies.
Westchester office properties had an unfavorable supply-demand balance during the quarter and very subdued leasing activity. Activity was concentrated on sub-let tenants, in contrast to last quarter. Direct tenants returned space to Landlords, detracting from supply-demand dynamics. Lease prices increased, driven by activity in the Class-A space, a trend that has persisted for several quarters. Direct rents reported by Costar increased 2% versus prior quarter and sub-let rents increased by a similar amount.
Westchester Retail – Retail Evolution Ongoing
Retail space demand in Westchester continues to evolve rapidly, a result of a well informed and dynamic consumer with healthy purchasing power. Westchester consumers are selective, look for convenience, performance and value. Food concepts have proliferated after COVID but only those with strong management and superior quality and service are gaining traction. Older chains that have over-expanded are retrenching or closing, Walgreens and Stop and Shop are examples of well-know retailers that are consolidating stores to improve profitability in the face of new competition and changing consumer demand.
Westchester retail had a positive supply-demand balance during the quarter. Both, direct and sublet space performed well. Retail lease price has been improving and increased 2% from last quarter according to Costar. The volume of leasing activity during the quarter was average but lower tenant departures helped to improve the fundamental picture.
Westchester Residential Apartments – Demand Falls Slightly Short of new Deliveries
During the quarter, deliveries of new apartments amounted to approximately 1.7% of stock. This was a strong quarter of deliveries following the second quarter, which also saw a similar number of new deliveries. Demand was robust and seasonality helped with absorption throughout this last two quarters. Yet occupancy has weakened slightly and conversion rates- from visits to leases – has now declined significantly. Under construction inventory has declined but is still over 7%
Executive Summary
of stock. As a result, the next few quarters may be challenging for Westchester multifamily projects. Modest fundamental challenges are likely to put a temporary cap on rental pricing gains. However, employment trends in the region are strong and Westchester competitiveness intact, therefore, these headwinds are likely transitory.
Westchester Industrial and Flex- A Modest Decline in Rents
Industrial space demand has cooled in response to a modest retreat in economic activity, particularly in the manufacturing sectors. However, in the third quarter, supply and demand were in close balance. Deal activity was subdued but tenants remained in place, contributing to a better balance. Lease pricing declined slightly, and we would expect some further weakening during the winter months. Occupancy rates have trended downwards but still healthy with vacancy around 6%.
Westchester Transactions Remain Subdued
Transaction volumes declined further during the quarter as financing is still scarce and investor capital remains on the sidelines for acquisitions. Median transaction prices per square foot were stable suggesting that we are not seeing deep value transactions in the data. The start of the easing cycle may encourage some activity in the last quarter of 2024 which is typically and active quarter for CRE. We eagerly wait for increased transaction volume and price discovery activity as liquidity slowly returns to the CRE investment sales space.
About this Commercial Real Estate Report
This report was researched and written by Teresa Marziano. Please contact Teresa at: M 914.441.2254 | TMarziano@HoulihanLawrence.com for questions, comments or feedback about the contents of this report.
HOULIHAN LAWRENCE COMMERCIAL TEAM
Commercial real estate is entering a challenging period as low-interest rate maturities start to come due. Interesting commercial real estate investment opportunities will likely become available, but investors must be prepared to evaluate and make decisions expediently. Given consumer and market changes brought about by the intense period of change we have experienced after Covid, it is very important to correctly assess the numerous market and economic risks that add to the complexities of acquiring commercial real estate. Understanding the market forces that are shaping the fundamentals for each property requires a deep knowledge of the property, local and regional insights, and close contacts with the right financial partners. Our Team is highly skilled in all these areas.
Reach out to HOULIHAN LAWRENCE COMMERCIAL for a complementary assessment of your real estate, an evaluation of a purchase target, and to receive an in-depth perspective on the ever-changing Westchester commercial real estate market.
Unemployment Rate in Westchester – Remains in line with pre-Pandemic levels
Westchester’s unemployment rate remains low. Job openings are still plentiful. Participation rate is increasing as wages and salaries become attractive enough to entice individuals not currently in the labor force. Overall, a larger labor force is positive for consumption and for the County’s economic fundamentals.
Sources: COSTAR, Trepp, US. Bureau of Labor Statistics, Unemployment Westchester County (Not Seasonally Adjusted) , NY. Real Estate Employees Data is Seasonally Adjusted. All data retrieved from FRED, Federal Reserve Bank of St. Louis; October 2024
Westchester County Unemployment Statistics- Not Seasonally Adjusted
Multifamily Projects Experience Softness
WESTCHESTER, SOUTH OF I- ���
Multifamily rent growth and occupancy has weakened as significant number of new units are delivered to the market.
Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; October 2024
Westchester Office and Retail – Office Departures
Continue but Prices Hold, Retail Fundamentals Stabilize
WESTCHESTER, SOUTH OF I- ���
Office rental pricing has been stable despite still poor demand. Leasing transactions are concentrated in more costly, Class A offices. Also, higher costs for new Tenant Improvements (TI’s) encourage landlords to be disciplined in price. Retail shop fundamentals are stable. Retail rental prices have gained ground on a nominal basis and vacancy has hovered under 8%.
Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; October 2024
Industrial/Flex Properties – Slow re-adjustment
SOUTH OF I- ���
Industrial fundamentals, just like the economy, have cooled over the last quarter. Older product is harder to lease while new product, with access to highways and allowing larger trucks, is still in high demand.
Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; October 2024
Investment Activity Begins to Rebound Price Discovery Starts
SOUTH OF I- ���
Investment sales transaction prices weakened modestly but remained within the band established over the last few quarters. The volume of transactions is very low underscoring the uncertainties faced in financing CRE transactions.
Sources: COSTAR, Trepp, US Bureau of Labor Statistics, Data Reflects Fundamentals for Westchester County Area South of I-287. Price Index for Westchester retrieved from FRED, Federal Reserve Bank of St. Louis; October 2024