CCIM Commercial Real Estate Forecast Competition 2023

BY RAY HANKAMER

The 2023 Competition held at Houston's Briar Club was attended by over 450 real estate professionals. The meeting was opened by CCIM Institute President David Schnitzer, and the winners of the 2022 Competition were announced: Multi-Family: Swapnil AgarwalNitya Capital; Industrial: Walter Menuet-Colliers International; Brandi Bellow Sikes-SVN; Retail: Michelle Johnson-George E. Johnson Properties.

Keynote Speaker: Ted Jones, Chief EconomistStewart Title Company

Takeaway: We are operating in a climate of historically low unemployment, high mortgage rates, and high inflation. Efforts by the Federal Reserve Bank to curb inflation may result in lost jobs and a recession. Efforts to convert the economy to renewable energy will involve disruptions to existing energy sources.

• Rising wages fuel inflation

• Household debt is soaring

• Credit card interest rates are the highest ever

• Savings rate lowest in 20 years

• Recession almost guaranteed according to Bloomberg News; Goldman Sachs on the other hand predicts a 'soft landing'

• Rents and home values are receding somewhat

• Population growth in Texas will continue, benefitting CRE; December 2022 in Texas and Houston marked the highest level of employment in history

• Texas boasts no state income tax but this is in part balanced out by our high property taxes

• Texas has 5.7% more jobs than before the pandemic

• Houston home sales down 17%

• Apartment rents due to ease somewhat

• 2022 saw record CRE investment sales; real estate is doing very well in this inflationary atmosphere

• Due to high interest rates there is a glut of unsold new homes, the most since 2008; investors are buying homes, not families; many used and new homes fall out of contract before closing due to inability to secure acceptable financing

• Where local governments legislate rent control, 86% of builders cease to build there, adding to the problem; mandated regulations to homebuilders such as impact fees drive up costs for home buyers but can improve neighborhoods

• Brick and mortar retail sales are at highest level in history and e-Commerce (at 15% of total retail sales) has not dimmed brick and mortar prospects

• Industrial is very sound in Texas, while Office is still reorganizing as the battle over work-from-home continues; we are seeing office buildings being converted to housing and hospitality and other uses

• We have the lowest spread between cap rates and ten year treasurys in history

• Total lending is way down for CRE developers due to unclear vision of future demand in some CRE sectors

• "Creativity" is the big issue in tough times; there will be buying opportunities for those with 'dry powder'

• The insurance market is going through turmoil and some CRE owners are forming insurance pools to self-insure

Multi-Family Moderator: Carra Chrzan Panelists: Blake WillefordGreystone; Jeffrey Ketron-Northmarq; Dillon Mills-Newmark

Takeaway: Houston is an attractive market for M-F developers and investors alike, as our population continues to grow and our local economy continues to diversify. The financing costs of single family homes is resulting in people remaining in apartments as they wait for lending rates to subside.

• Cap rates are projected to range from 4.5 to 5.75 with Class A on the lower side and Class C on the higher side

• New construction for this year is projected from 14,000-17,500 new units and absorption from 5-6,000 units

• Katy, Cinco Ranch, River Oaks, and Richmond-Rosenberg are projected to have the strongest absorption

• Market rent averages projected to be in the $1,250-1,340 range

• Investors are looking to an average hold of 7-10 years, and insurance costs and other variables are a big question mark as investors calculate their operating expenses going forward

• Houston is now (finally) thought of as a "Gateway" top-tier market by U.S. and international investors

• There is a land buying spree and developers are holding sites at the ready to see what the economy will do; land sellers are usually well-heeled and can wait till they get their selling price

• Developers and investors are getting creative with lenders, who have their own issues; bridge loans, shorter term fixed loans, and creative equity sourcing are the rule of the day

• Government backed loans are closing only ten percent of loans quoted... this has to change with more creativity in the structuring of the financing

• 2021 was a record year for M-F investment transactions

• The industry wants flexibility to come into to the lending marketplace to stave off vulture lenders coming in, which could cause problems for owners and ultimately tenants...which could be politically uncomfortable

• Lots of creative equity packaging is taking place as developers are unable to find formerly available sources

• The Houston population growth and diverse work force is a good base for supplying tenants to M-F; we have a market here where people want to live and work, so outside investment should continue to flow in

Office Moderator: Brandi Sykes-SVN/J.Beard Panelists: Marty HoganJLL; Eric Siegrist-Parkway Property Investments

Takeaway: City jobs continue to grow. The horizon in this sector has been dark but the sun is beginning to shine, and there is a belief that Houston will continue to recover and grow. Buildings built after 2014 are mostly 100% occupied. Return to normal in office? Every year since 2020 has improved, so things are heading in the right direction. Houston is a super-resilient market.

• There are investors in this sector and they are looking for either stabilized quality in full new buildings or for steals in older ones

• A big emphasis by tenants now is 'what is the commute time' for the bulk of a company's employees? The CBD and the Galleria markets are losing out to Westchase and The Energy Corridor

• There is a flight to new and experimental buildings and interior layouts

• Rental rates downtown Class A are projected in the $25-26 range and Class B $17; Suburban rates Class A $20-21.50 and Class B $16.50-17.00; Overall occupancy both classes 75-81%

• The Energy Corridor, once distressed, now does not have a wide range of space options for larger tenants

• There are conversion opportunities for older buildings which no longer measure up to today's tenant needs

• Low availability of lender financing for some investor sales is leading to seller financing arrangements; a leased and stabilized building can attract a 6-6.5% loan while one leased at only 50-70% can only attract a loan at 10% interest

• Older offices are trying to renovate

• The creative new Environment, Social, and Governance considerations (ESG) are driving up development costs somewhat but are also attractive to quality tenants and to office lenders and to Wall Street in general

• New tenants shopping for space include technology companies, medical, and returning oil & gas firms; the emergence of tech firms in many industries is exciting to office building owners and their leasing brokers

• Last year there were 50 office investment transactions at a value of $2 billion

• Old outdated office buildings will be 'flushed' out of the system by special servicers and by the marketplace in general; many occupy infill sites which are attractive for redevelopment

• This year will see both big new leases AND downsizing by tenants

• A very large number of workers are still working from home, but the trend seems to be to return to the office environment; the majority of company layoffs have been to those insisting on working from home

• Some companies are rethinking their downsizing and are considering readding space

• By 2024 there will be definite positive absorption

Specialty Development Moderator: Barrett Von Blon-JLL Panelists: Richard Buxbaum-Radius Development; Ting Qiao-Wan Bridge; Brett Walker-Parkside Capital

Takeaway: Build-to-rent single family homes with more than two bedrooms are an exciting new concept and large master planned developments of them are on the ground and leasing up fast. Now the communities are including some 2 BR units to go head to head with M-F.

• Like any new concept, build-to-rent faces some pushback from permitting entities and neighbors, and they have to be educated about the new concept

• These communities provide top level 'concierge 5-star services' to their tenants

• The first reaction is that the tenants will be 'low-rent' but this is not the case, and often the tenants of these communities are more upscale incomewise than the neighborhoods they are adjacent to

• Calculating annual rental escalations is a challenge in this current economic environment

• Finding large sites for these communities is tricky

• These communities provide single-family benefits to those unable to purchase a home in the current interest rate environment

• Materials and labor costs have also driven up costs of single family homes, so build-to-rent is an attractive alternative

Retail Moderator: Lacee Jacobs-Midway Panelists: Tenel Tayar-Fifth Corner; Jason Baker-Katz

Takeaway: Fear of e-Commerce and the uncertainties of the pandemic stunted brick and mortar retail development while at the same time the sector was booming-and continues to boom. The result: severe shortage of space available to today's tenants. Houston has more retail space per our population of almost any other U.S. city. Tenants are having record sales. New construction is coming at a higher cost, with longer move-in times due to permitting delays and shortages of key items required for specialty fit and finish buildouts.

• Cap rate on investment sales: 6.4%; market rent growth: 5.5%; absorption forecast: 4,250,000 SF; new SF delivered next 12 mos.: 3,500,000 SF; vacancy rate: 4.5%

• Tenant improvement (TI) issues very big now as specialty floor plans and overall buildout requirements become more complex, especially with franchised tenants

• Many coffee shop tenants in the market, and there will be a fallout of some of them

• There is increasing demand for endcap drive-through spaces with no sit-down interior service

• Houston is now a 'flagship' retail market and demands attention from all national and local brands in other cities, and they are flocking here

• Houston retail sales are exceptional and this is not lost on national retailers

• More and more tenants are 'entertainment tenants' and restaurants, catering to people out to have fun

• Investors are now chasing Houston retail, which are considered to be a great value; sales are at mid-six to mid-seven cap rates

• Overall there will be demand for high-end Houston CRE product for years to come

• Texas is a non-disclosure state so it is difficult to know at what price CRE transactions take place

• Due to frenzied demand, some landlords are auditing their tenants and waiting them out so they can be replaced with tenants with higher sales volumes...and higher percentage rents-40-50% percent of deals now being negotiated are on space occupied by low-performing tenants

Industrial Moderator: Christen Vestal-Provident Panelists: Travis Land-Partners; Rob Stillwell-Newmark; Keith Edwards-Caldwell Companies

Takeaway: Activity still good, land prices up, close-in land availability down. Building and build-out materials are now stabilizing and costs are moderating some. Capital markets are challenging, in spite of the overall health of this sector. International firms are now wanting to come in because of our port, and this drives asset values.

• Wall Street is getting into the lending and equity industry now, competing with traditional lenders, who are being somewhat constrained by market factors. Local banks are overweight in industrial/warehouse loans, so there is a sort of bottleneck when it comes to availability of equity and development loans

• Some lenders are requiring 40-50% equity

• Construction and entitlement costs continue to rise, although at a little slower rate that last two years

• Somewhat lower construction costs are not enough to offset higher capital costs

• "A" development sites are available less often, so developers are having to make less desirable tracts work; it is better to pay top dollar for an "A" site than less for a less desirable tract

• Investment buyers are not seeing sellers coming down in prices; most sellers will wait it out to get 'their price'

• Regardless of our 'high' local site prices they are still low when compared to industrial tract prices in other cities

• When a warehouse is under construction, the developers are waiting as long as possible before quoting rates, since construction costs are a moving target

• Leasing rates are more are less similar in all of Houston's industrial submarkets

• Rates for the smaller 25-30,000 SF tenant are up and spaces are hard to find, since big box developers are refusing to subdivide their large buildings when they can rent it all to one large tenant

• National tenants are used to paying higher rents than are local Houston tenants

• The far-out sub-markets service more remote markets...Katy warehouses can service San Antonio; NW, Austin; North, Dallas; East, Beaumont and Western Louisiana. Incoming goods from the Port go out in all directions from Houston

• Warehouses are being built in Brenham, Dayton, Tomball, and all around the Grand Parkway...i.e. farther and farther out

• The ESG trend toward sustainable and environmentally conscious buildings is increasingly demanded by national tenants and national lenders

• Many tenants are asking for alternative energy sources on their buildings like solar

• Europe is further ahead on ESG that the US, but we are catching up

• With regard to attracting manufacturing to our warehouse industry in Houston, we have a broad labor pool of both blue collar and skilled labor

• The infrastructure at our port gives Houston's industrial sector a powerful backup

• Some big box users such as Amazon 'got ahead of their skis' during the pandemic and are downsizing now, but are only moving out of the older and less functional buildings