Matthews™ Winter 2023/2024 Publication

WINTER 2023/2024 TM

UNDERSTANDING APARTMENT FINANCING

THE OPTIONS AVAILABLE FOR BORROWERS IN THE CURRENT MARKET

MULTIFAMILY MARKET REPORT EXPLORE CRE FUNDAMENTALS IN 20+ MARKETS

A BALANCING ACT

THE ONGOING CHALLENGES FACING MULTIFAMILY SUPPLY

NAVIGATING

THE WALL OF DEBT 1

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W W W. M AT T H E W S . C O M

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featured articles 12 A BALANCING ACT THE ONGOING CHALLENGES FACING MULTIFAMILY SUPPLY

29 MULTIFAMILY MARKET REPORT EXPLORE CRE FUNDAMENTALS IN 20+ MARKETS

86 UNDERSTANDING APARTMENT FINANCING THE OPTIONS AVAILABLE FOR BORROWERS IN THE CURRENT MARKET

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table of contents

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thgirWNAVIGATING selrahC . A .J THE STORM

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06 Unraveling the Complex Web

67 The Key to Apartment Investment

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BALANCING ACT 12 gnAThe 73 THE BOND BULL MARKET azleg oV kirE Challenges Facing ssorG werdnA Is it Over After 40 Years? y cnalC nae S Ongoing Multifamily Supply

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nepraC eitaK THE IMPACT 16retUNPACKING How Economic Conditions Shape

Self-Storage

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79

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86

TOP TRENDS TO WATCH IN INDUSTRIAL FOR 2024

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UNDERSTANDING APARTMENT FINANCING The Options Available for Borrowers in the Current Market

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29 Explore CRE Fundamentals in se hg u H nola M 20+ Markets kre B t ta M

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107

been Impacted by Interest Rates

Expansion Plans

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contributors Executives Kyle Matthews

Daniel Withers

J. A. Charles Wright

David Harrington

Maxx Bauman

Patrick Graham

Raddie Zlatkov

Hutt Cooke

Brian Streilein

Duerk Brewer

Chuck Evans

Cory Rosenthal

Sean Clancy

Andrew Gross

Erik Vogelzang

Paul Mudrich

Keegan Mulcahy

Nicole Capobianco

Matt Fitzgerald

Bob Osbrink

Lori Valencia

Bill Pedersen

Kurt Sauer

Katie Carpenter

Cliff Carnes

L.B. Sierra

Michael Pakravan

Matthew Wallace

Featured Agents Austin Graham

DJ Johnston

Kyle Inman

Austin McLeod

Drew Cerny

Liam Skelly

Brian Brady

Finley Askin

Malon Hughes

Brock Emmetsberger

Gabriel Peña

Matt Berk

Caleb Frizzell

Gene Mello

Michael Kasser

Cameron Hooper

Geoffrey Arrobio

Nabil Awada

Catherine Lueckel

Jared Rice

Sam Jackson

Connor Kerns

Joanna Rotondo Manfro

Tim VanWingerden

Corey Russell

John Solari

Tyler Marshall

Daniel Grays-Yang

John Stroud

Daniel Thompson

Josh Ein

David Ferber

Kayden Birney

Publications

Design

Leanne Jenkins

Marina Rubio

Lauren Huling

Brooke Farris

Kaylee Stock

Maddi Raccine

Lori Valencia

Alfonso Lomeli

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T H E U N R AV E L I N G T H E C O M P L E X W E B O F C R E C A P I TA L M A R K E T S

BY COREY RUSSELL

In a complex interplay of factors, commercial real estate’s capital markets significantly shifted in 2023 compared to the year prior. As interest rates surge, property lending plummets, and a conspicuous disparity emerges in price discovery, the industry finds itself navigating a challenging terrain.

Transactions are experiencing a notable downturn, reflecting the cautious approach of lenders.

Notably, Q3 2023 witnessed a substantial decline in lending activities compared to the preceding year, with a 7% decrease in bank lending from Q2 to Q3 2023. The total volume of loans during this period dropped by a staggering 49% compared to Q2 2022, and year-to-date borrowing, as of November 2023, registered a 44% decrease. An in-depth examination of statistics from the Mortgage Bankers Association’s (MBA) recent report further underscores the challenging environment, revealing a 26% decline in total lending, down from $816 billion in 2022 to $442 billion in 2023. Multifamily lending, a significant component of the market, is anticipated to experience a substantial 41% drop to $285 billion. Despite these challenges, the industry persists, and deals are still being executed, driven by a combination of creativity and effective communication. In this dynamic environment, stakeholders must adapt and innovate to navigate the evolving landscape successfully.

INDUSTRY TRENDS

The Federal Reserve’s influence on the current state of commercial real estate lending is palpable, with a vigilant eye on potential credit deterioration in the sector. The November 2023 Supervision and Regulation Report provides a comprehensive overview of the regulatory landscape, revealing increased pressure on lenders to curtail activity for economic cooling. The report highlights credit rating downgrades for banks, attributing them to elevated interest rates and substantial exposure.

Larger banks are strategically bolstering their cash-to-asset rations, while smaller banks, although actively lending, face vulnerabilities.

To navigate these challenges, the commercial real estate market is utilizing creative lending strategies, including the growing popularity of owner financing. These nonbank lenders are stepping in to fill the void left by traditional banks, with private investors and funds injecting capital into the market. However, concerns have been raised by the Federal Reserve regarding a lack of transparency in these financial maneuvers.

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COMMERCIAL MORTGAGE DEBT OUTSTANDING Over the past two quarters, there has been a significant surge in U.S. Treasury debt issuance — $1.9 trillion, triple the 10-year average.

Simultaneously, there has been a reduction in demand for U.S. Treasuries as China downsizes its holdings and the Federal Reserve tightens its holdings by $843 billion. Amidst this, the potential impact of a federal budget resolution on interest rates looms, underscoring the intricate web of financial dynamics shaping commercial real estate lending.

COMMERCIAL & MULTIFAMILY MORTGAGE DELIQUENCY RATES Fannie Mae & Freddie Mac Source: MBA

8% 7% 6% 5% 4% 3% 2% 1% 0% ’90 ’93 ’96 ’99 ’02 ’05 ’08 ’11 ’14 ’17 ’20 ’23 ■ Fannie Mae ■ Freddie Mac

Of the $4.6 trillion of commercial mortgage debt outstanding, roughly $2 trillion is backed by multifamily, $750 billion by office, $420 billion by retail, $360 billion by industrial, and $300 billion by hospitality, with the remainder in healthcare, self-storage, mixed-use, and other CRE properties, according to MBA.

Banks & Thrifts Source: MBA

7% 6% 5% 4% 3% 2% 1% 0% ’90 ’93 ’96 ’99 ’02 ’05 ’08 ’11 ’14 ’17 ’20 ’23

GROW TH IN DELINQUENCY R ATES Examining delinquency rates reveals a concerning trajectory, with rates for CRE loans hitting a decade high. This surge in delinquencies, particularly in the office space, raises apprehensions regarding property valuations and the stability of existing loans. Compounding these challenges is the looming “wall of maturities,” encompassing a staggering $1.4 trillion in commercial loans set to mature. The consequence of this influx is a logjam characterized by banks hesitant to write off loans and a potential reluctance to acknowledge losses.

This dilemma contributes to declining demand for new mortgages and challenges establishing accurate property prices. As the industry grapples with these intricacies, the impact on property values and the overall help of the market remains a critical focal point for stakeholders navigating the complex landscape.

Life Companies (60+ Days) Source: MBA

8% 7% 6% 5% 4% 3% 2% 1% 0% ’90 ’93 ’96 ’99 ’02 ’05 ’08 ’11 ’14 ’17 ’20 ’23

CMBS (30+ Days & REO) Source: MBA

12% 10% 8% 6% 4% 2% 0% ’90 ’93 ’96 ’99 ’02 ’05 ’08 ’11 ’14 ’17 ’20 ’23

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SHORT-TERM FINANCING DOMINATES THE MARKET Short-term financing dominates the current scene, with strong indications that rates may decrease in the near future, though the potential for volatility necessitates a nuanced consideration of each client’s risk tolerance. Approximately 75% of the commercial real estate pipeline comprises bridgeto-bridge finance requests, with limited partner (LP) equity in short supply, posing challenges in meeting capital calls. Notably, clauses such as “no prepay” are merging as crucial tools for borrowers, offering resilience in harsh economic conditions and providing flexibility to refinance or sell properties when market conditions become more favorable. These adaptive strategies underscore the industry’s resilience in the face of evolving financial landscapes and highlight the importance of tailored approaches to mitigate risk.

PLUMMETING PROPERT Y SALES Commercial property sales have witnessed a sharp decline in 2023, with transactions plummeting by 68% compared to a year ago. This downturn is not confined to specific property types, as retail property sales are down 48%, industrial down 73%, office down 55%, and apartments down 72%. The reduced transaction activity has created challenges in assessing property values, with various indexes providing conflicting narratives.

BREAKDOWN OF LENDING BY PROPERTY TYPE

Looking back to 2022, loans were made by just looking at the deal size. For example, in 2022, more than one-third of the multifamily loans made last year were $1 million or less. The average size of multifamily loans made for a bank portfolio was $3.9 million in 2022, compared to averages of $38 million for life companies and CMBS, $19 million for FHA, and $18 million for Fannie Mae or Freddie Mac. According to MBA, bank lending accounted for 77% of the loans but 42% of the dollar volume in 2022. In 2023, each loan is driven by the property’s subtype, market, age, deal age, size, income, and more.

Cap rates, a key measure of investment yield, have seen marginal adjustments despite the changing market conditions. According to MBA, retail cap rates rose by 20 basis points, multifamily rose by 30 basis points, industrial rose by 40 basis points, and office by 50 basis points. These adjustments occurred against risk-free yields, which increased by 350 basis points over the last three years. The implication is that property value metrics may lag behind actual market dynamics, and a more accurate picture will emerge as transaction activity resumes and is recorded.

Navigating the diverse landscape of commercial lending involves a meticulous breakdown of lending practices across various property types.

In this market, relationships are paramount, and aligning the right lenders with borrowers is crucial.

Recognizing the unique approval processes and understanding the credit boxes of different institutions is fundamental, with the upfront due diligence process playing a pivotal role in setting realistic expectations, whether dealing with a seasoned investor or a first-time participant, challenges abound.

However, it is crucial to point out that these changes in property values are occurring after a period of remarkable growth and a good majority of properties exchanging hands in 2022. The accumulated equity in many parts of the market, especially with longer hold periods, serves as a buffer against potential price declines, providing resilience in the face of current market conditions, according to MBA.

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Office Mortgage Originations

Retail Mortgage Originations

$400B $350B $300B $250B $200B $150B $100B $50B $0

$400B $350B $300B $250B $200B $150B $100B $50B $0

Source: MBA

■ 2019

Q1 ■ 2020

Q2 ■ 2021

Q3 ■ 2022

Source: MBA

Q4 ■ 2023

■ 2019

OFFICE Office properties are undergoing the most intense scrutiny as the landscape of office work undergoes significant changes, prompted by the adoption of flexible work schedules and questions surrounding how companies will navigate work-from-home and hybrid models. According to CoStar Group, the overall U.S. office vacancy rate has reached a 30-year high at 13.5% and reports a negative net absorption of 7.3 million square feet, accompanied by a 1% decrease in rental rates. However, trophy properties with the finest amenities in some of the nation’s central business districts have experienced an 11.6% increase in rental growth. With these challenges lenders have been reluctant to lend on this property type.

Q1 ■ 2020

Q2 ■ 2021

Q3 ■ 2022

Q4 ■ 2023

RETAIL Three years ago, retail properties faced significant challenges and were widely perceived as one of the most vulnerable CRE sectors. Since then, investors and lenders have been drawn to the sector. According to Moody’s Analytics, there has been a positive trend in retail property performance, with vacancies decreasing from 10.4% at the beginning of 2022 to 10.2%. Average asking rents have experienced a 0.7% increase over the last year. These numbers indicate a nuanced landscape within the retail sector, where certain subtypes demonstrate resilience and even growth, reflecting a more refined understanding among industry participants regarding the dynamics of retail properties in the current market.

As such, credit unions addressing the gaps left by traditional banks, offering advantages such as the absence of prepayment penalties. Examining lending terms reveals nuances in secondary and tertiary markets, including interest rates and amortization periods, as well as major markets featuring five-year deals, spreads, and amortization periods. Notably, non-recourse financing dominates in this space, with CMBS taking precedence, characterized by interestonly payments and sizing based on property income.

Meanwhile, life insurance companies contribute to the landscape with desirable features such as tighter spread and higher amortization rates.

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Industrial Mortgage Originations Source: MBA

$400B $350B $300B $250B $200B $150B $100B $50B $0 ■ 2019

Q1 ■ 2020

Q2 ■ 2021

Q3 ■ 2022

Q4 ■ 2023

INDUSTRIAL Industrial property performance has been remarkably strong lately – with high demand driving vacancies lower and rents higher. The slowdown highlights the lingering impacts of rising interest rates and the commensurate uncertainty around asset pricing. However, private capital remains at the forefront of buying actively, and institutional and public REIT investors persist in their pace of acquisitions, homing in on first-class developments and prime locations. For industrial, the preference leans towards agency financing, driven by factors like predictability and bridging the leverage gap.

Multifamily Mortgage Originations Source: MBA

$400B $350B $300B $250B $200B $150B $100B $50B $0 ■ 2019

Q1 ■ 2020

Q2 ■ 2021

Q3 ■ 2022

Q4 ■ 2023

MULTIFAMILY Multifamily has been defined by a significant mismatch between supply and demand of space. This imbalance resulted in record-low vacancy rates and rapid rent increases, defining the landscape of the multifamily sector for over a year. In response to this demand, developers increased the issuance of permits, initiating new construction projects. The consequence of these efforts has resulted in nearly one million multifamily units currently in the development pipeline, an uptick in vacancy rates, and moderation in rent growth.

ECONOMIC OUTLOOK & RISKS

The economic outlook for commercial real estate is at a critical juncture, marked by considerations of the potential impact of sustained 5% or higher 10-year Treasury yields on cap rates and capital values. The prospect of such yields has raised questions about the resilience of commercial real estate in the face of increased borrowing costs. BlackRock’s prediction of a long-term borrowing cost of 5.5% further adds to the cautious sentiment, hinting at challenges in the financing landscape. This economic landscape is compounded by lowered growth expectations for investment rate volumes in 2024, suggesting a need for stakeholders to recalibrate strategies in response to evolving market conditions. On the lending front, projections indicate that commercial real estate lending is set to reach $559 billion in 2024, with multifamily lending anticipated to constitute a significant portion, projected at $339 billion. These forecasts underscore the dynamic nature of the commercial real estate market, prompting industry participants to carefully navigate the economic landscape, adapting strategies to mitigate potential risks and capitalize on emerging opportunities.

Corey Russell

corey.russell@matthews.com +1 (817) 932-4333

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W W W. M AT T H E W S . C O M

A balanci ng act A balanci ng act A balanci ng act A balanci ng act A balanci ng act A balanci ng act A balanci ng act

A balanci ng act A balanci ng act A balanci ng act A balanci ng act T h e O n g o i n g C hal l e n g e s Fac i n g M u lt i fam i ly S u p p ly b y d av i d f e r b e r , C PA Multifamily development continues to make headlines, with over 900,000 units underway across the U.S. as of Q3 2023. Apartment demand weakened in late 2022 and continued into 2023, and although the trend is reversing, is it reversing fast enough? Many markets are reporting a supply pipeline that outpaces demand. In addition, most deliveries are projected to be Class A properties when the need for affordable housing is ever-growing. Add a slowing economy, insurance concerns, and declining construction lending to the mounting challenges the sector faces — How do these deliveries affect the overall market, and what challenges are slated for 2024?

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94.5%

Record De live ri es M e et Wan i ng De man d The imbalance between multifamily supply and development has existed for decades. It took a sharp turn in 2022 as the post-pandemic boom wore off, and demand declined while construction remained bullish. In Q3 2023, the sector hit a positive note, reporting the highest absorption rate in two years. However, the increase in absorption was met by 140,000 delivered units, making Q3 the eighth straight quarter of supply excess.

occupancy

is just 20 basis poi nts be low th e 2010 ave rage, wh ich suggests furth e r market normalization.

Not onlyREALPAGE is there an imbalance of supply and SOURCE: demand, but there is an imbalance within the supply pipeline. There are more Class A apartments under construction than any other multifamily property type, contradictory to the affordable housing crisis in major U.S. markets. The average vacancy rate of Class C apartments is 6.6%, while Class B and Class A apartments average 9.7%, according to CoStar Group.

This imbalance hurt rent growth throughout 2023, but Q2 and Q3 were relatively steady compared to previous decreases. From Q3 to Q4, monthly rent rates fell $8, while year-over-year rent growth grew from 0.8% to 0.9%. Although the ongoing supply and demand challenges are hindering rent growth, there are several other factors in play. This year brought historically high interest rates and inflation, rising energy prices, and weakened consumer spending.

With that said, rent growth is by far the most affected by the robust pipeline of supply applying pressure to rent rates.

Th e re is a shortage of 7.3 m i llion affordable an d avai lable re ntal hom es for re nte rs with extre m e ly low

up 8% from 6.8 m i llion i n 2019. i ncom es i n th e U.S.,

Occupancy among primary and secondary markets is balanced due to solid job growth. RealPage stated occupancy rate stabilized at 94.5% in September, marking the third consecutive month that rates have held constant. Although occupancy rates are steady, an influx in supply over the next few quarters could encourage rates to fall. The Federal Reserve expects job growth to slow in the first half of 2024, which could also strain occupancy rates.

SOURCE: URBAN INSTITUTE 12-MONTH A B S O R PT I O N

325,634

VACA N CY R AT E

7.6%

12-MONTH O C C UPA N CY @ DEL I V ERY

-6.8% YOY

SOURCE: COSTAR GROUP *As of December 2023 va c a n c y r at e SOURCE: COSTAR GROUP

12% 11% 10% 9% 8% 7% 6% 5% 4%

f o r e cas t

3% ‘13

‘14

‘15

‘16

‘17

‘18

Class B United States

‘19

‘20

‘21

‘22

Class A United States

13

‘23

‘24

‘25

United States

‘26

‘27

‘28

Th e Markets Outperforming Although the U.S. multifamily market is experiencing challenges across the board, including rent growth, supply, operational costs, etc., specific markets are outperforming the averages.

leading the pack. According to Yardi Matrix, New York City and New Jersey averaged 5.6% and 5.2% annual rent growth, respectively. These regions are the most stable in terms of supply and demand issues. Midwest and Northeast metros lack oversupply and feature resilient economies, helping the markets stay balanced.

Multifamily performance is strongest in the Midwest and Northeast, with New York and New Jersey

Q3 '22 - Q3 '23 YOY Re nt Growth Re nt Growth SOURCE: YARDI MATRIX 0.0% n ew york city n ew je rsey ch icago i n dianapolis kansas city boston colum bus ph i lade lph ia san di ego m iam i

5.0%

I n th e curre nt marketplace, th e reason why som e m etros are un de rpe rform i ng is ofte n on e of two issues:

th e hangove r e ffect of post-pan de m ic growth or regulatory restrictions. unlike most of the country, the supply and demand imbalance isn’t the primary issue. For landlords in the western U.S., it’s less about supply and demand and more about process delays and the regulatory environment. Although the region is in dire need of housing, specifically affordable housing units and the absorption rates are positive, development in the West slowed starting in 2022. This is because investors have to work harder to earn a profit on their properties. Rent control, environmental restrictions, and various renter-friendly government regulations discourage multifamily development. The regulatory environment, coupled with rising operating costs, greatly hinders development activity, in turn hurting the supply pipeline.

Secondary markets experienced extraordinary growth post-COVID-19 as migration from densely populated cities heightened. But, as the pace of migration slowed and renters returned to urban environments, renter demand decreased, and the units desperately needed in 2021 were now coming to market after the urgent need had passed. Industry outlets have referred to this outcome as the “hangover effect” from the explosive post-pandemic growth.

Essentially, the growth after COVID-19 was so strong and critical that the markets were likely to see fundamentals decline as the figures were unstainable.

Some primary markets experiencing hangover imbalance are Phoenix, Tampa, and Nashville.

The West is another region facing obstacles, but

th e hangove r e ffect Th e excess of growth i n on e pe riod of ti m e causes a slum p of th e sam e proportion th e reafte r.

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Another challenge causing owners and operators to pivot is rising insurance costs. Insurance costs are not a new issue in the multifamily sector, but over the last year, conditions have worsened, and multifamily owners are feeling the heat. Due to industry consolidation, companies exiting certain markets, increasing claims, and the ongoing climate crisis, insurance companies are rising their costs drastically. In order to combat the increased costs, developers look to construct buildings that sustain extreme weather and are up to code. At the same time, owners are more proactive with property upkeep, hoping to decrease the cost of their policies.

How Deve lope rs an d Own e rs are Pivoti ng During difficult markets, investors and developers need to get creative with how to turn a profit.

Renters in today’s markets are much more demanding than previous generations, knowing what they want for housing and expecting topof-the-line amenities for the current rent rates.

Mixed-use development grew widely popular and is in high demand as they combine modern living with accessible retail and office space. In addition, developers facing a lack of available land are repurposing established buildings and converting them to multifamily. Office-to-apartment conversions are a leading trend in primary markets. Investors must also research and ensure they understand their target audience, aligning their property to the community’s demographics and needs.

I nsurance pre m iums have

rise n more

than 100% i n so m e i n stan c e s i n F L an d TX. SOURCE: MULTIFAMILY DIVE

What to Expect i n 2024 Interest rates are expected to start decreasing in mid-2024 as the Fed’s inflation target of 2.0% is expected to be met over the next few months. Until the interest rates fall, commercial real estate will stay in a down market, multifamily included. However, the market as a whole is healthy, and much of the decline is being caused by outside factors that will eventually turn back positive. In early 2024, markets will see their supply pipeline decrease, helping the sector regain balance. The current lending environment makes it more difficult to close deals, but several primary and tertiary markets offer opportunities. The multifamily sector is historically resilient, and this downturn is no different.

davi d fe rbe r, cpa dav i d. f e r b e r @m at t h e ws . c o m +1 (551) 888-0042

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UNPACKING THE IMPACT HOW ECONOMIC CONDITIONS SHAPE SELF-STORAGE

BY AUSTIN MCLEOD In the face of a challenging market, investors remain optimistic regarding the self-storage sector thanks to its inherent resilience. However, it is undeniable that the self-storage industry is feeling the effects of the broader economy. Over the past several quarters, both rent growth and occupancy rates have steadily declined, primarily due to reduced demand resulting from rising interest rates, sluggish home sales, and shifting migration patterns.

Those owners with the ability to adapt to this economic climate not only secure their survival but also position themselves for thriving in an industry where adaptability is a crucial factor for long-term success.

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INDUSTRY OVERVIEW The number of people utilizing self-storage increased to 14.5 million in 2022, up by 970,000 since 2020, according to Yardi Matrix. Additionally, over a recent nine-year span, selfstorage facility owners across the U.S. saw an annual return on their investments of almost 17%, according to Real Estate Daily News.

2020 - 2021 — The Height of the COVID-19 Pandemic Americans became increasingly more comfortable with relocating across the country, resulting in demand for additional storage space. Sales volume for self-storage assets increased 180% from $8.4 billion in 2020 to $23.9 billion in 2021, according to Real Capital Analytics.

2022 — Moderation Across the Sector A decrease in home sales and consumers holding back on spending for non-essential items/services caused a slowdown in self-storage usage. The average rate per unit decreased marginally year-over-year (YOY). In November 2022, the street rate for nonclimate-controlled units was $128 (a 2% decrease YOY), while climate-controlled units averaged $144 (a 0.8% decrease YOY). Sales volume dropped to $14 billion in 2022.

2023 — The Market Downturned After a long string of Fed rate hikes and high inflation, the self-storage sector witnessed softened occupancy rates. Q1 through Q3 2023 saw a combined sales volume of $14.2 billion, but most sales occurred in Q3 with over $11 billion sold, primarily due to the Extra Space/Life Storage merger, as well as Public Storage’s acquisition of Simply Self-Storage.

SELF-STORAGE SALES VOLUME Source: Real Capital Analytics

Sales Volume ($M)

$30,000

$20,000

$10,000

$0

Q1 ’13

Q1 ’14

Q1 ’15

Q1 ’16

Q1 ’17

Q1 ’18

Rolling 4-Quarters

Q1 ’19

Q1 ’20

Q1 ’21

Q1 ’22

Quarterly Volume

*Q3 ’23 is so high because of the $11.7B Extra Space and Life Storage merger, as well as Public Storage buying Simply Self-Storage.

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Q1 ’23

STREET RATES AFFECTED BY A TOUGH LEASING ENVIRONMENT

NOVEMBER 2023 YOY RENT CHANGE FOR MAIN UNIT SIZES* Source: Yardi Matrix National

Interest rate volatility has created significant changes in financial markets. In particular, rising short-term rates have impacted self-storage developers and owners seeking construction and similar loans. Due to these interest rate increases, the self-storage industry is now navigating the broader economic landscape, marked by almost a year of negative YOY street rate trends and an increased vacancy rate to 7.0% as of Q4 2023, up by 4.6% YOY. The influx of new supply in lease-up has also hampered street rate growth, particularly in markets with the highest overall supply volume and recent deliveries.

New York Denver Nashville Columbus San Diego Washington D.C. DallasFort Worth

In November, street rate growth continued to be negative YOY in the majority of Yardi Matrix’s top metros. Combined same-store rates for nonclimate-controlled (NCC) units fell in all but one of the top metros on an annual basis, while asking rates for same-store climate-controlled (CC) units decreased in all of the top metros.

Los Angeles Austin Atlanta Tampa -10%

THE GROWTH IN STREET RATES IS EXPECTED TO STAY SLUGGISH IN THE COMING MONTHS DUE TO THE HOUSING MARKET’S INFLUENCE ON REDUCED DEMAND.

-8%

-6%

-4%

Non-Climate-Controlled

-2%

-0%

2%

Climate-Controlled

*The main unit sizes and types include the 5x5, 5x10, 10x5, 5x15, 15x5, 10x10, 10x20, 20x10, 10x30 and 30x10 climate-controlled and non-climate controlled units.

18

CONSTRUCTION & SUPPLY UPDATE

UNDER CONSTRUCTION SUPPLY BY PERCENTAGE OF EXISTING INVENTORY Source: Yardi Matrix DEC-23 3.8% 6.7% 5.6% 4.2% 3.1% 5.4% 3.8% 2.8% 3.1% 3.9% 2.0% 1.0%

CHANG E

^ ^ ^ ^

^

H1 2023 saw a pullback in self-storage construction projects, which allotted more time for the existing supply to be absorbed. This trend is expected to continue in the coming years, with deliveries projected to dip below the long-term average. This shift is anticipated to reduce operator competition, fostering a more favorable market environment.

NOV-23 3.8% 6.7% 5.5% 4.3% 3.0% 5.2% 3.8% 3.1% 3.0% 5.0% 1.9% 1.0%

^

M ETRO National Columbus Tampa Los Angeles Austin Atlanta San Diego Washington D.C. Dallas-Fort Worth New York Denver Nashville

^

Despite continuous drops in street rates, the industry maintains a positive outlook. While the lack of home sales has caused new rental activity to dampen, both occupancy and rental rates are coming out of a period of all-time highs, with current levels remaining above 2019 rates. Although there is a degree of uncertainty regarding the performance of these metrics, numerous operators maintain a guarded sense of optimism.

^ -

National Columbus Tampa Atlanta Los Angeles

As of November 2023, construction activity remains stable, but the number of abandoned projects continues to rise. The duration it takes for a project to progress from the planning to the under-construction phase has consistently increased, more than doubling in the past few years.

This trend implies that projects are becoming less viable and are decreasing in the likelihood of being constructed. Consequently, the number of project completions is expected to gradually decline.

New York San Diego DallasFort Worth Austin Washington D.C. Denver Nashville 0%

1%

2%

3%

4%

5%

6%

7%

Under Construction % of Completed

MAJOR SELF-STORAGE ACQUISITIONS

The self-storage industry has changed tremendously in the past five years, with an increasing consolidation trend taking center stage. In March 2023, Extra Space Storage completed the largest self-storage transaction in history by acquiring Life Storage for $12.7 billion. As a result of the merger, the combined company became the biggest self-storage operator in the nation in terms of facility count, boasting more than 3,500 locations.

The merger between Extra Space and Life Storage is anticipated to bring substantial strategic, operational, and financial advantages to Extra Space moving forward.

Another prominent merger in the self-storage industry in 2023 was the recent acquisition by Public Storage, as they purchased Simply Self Storage from Blackstone Real Estate Income Trust for $2.2 billion.

The transformation of the self-storage industry into a consolidation hotspot exemplifies the operational efficiencies accelerated by achieving significant scale in the marketplace.

19

THE IMPACT OF RISING RATES ON SELFSTORAGE ASSETS As anticipated, rising interest rates have impacted the commercial real estate market. The number of sales in the U.S. self-storage sector decreased by 40% in 2023 compared to 2021, which is primarily due to the rising cost of borrowing and a general shortage of available funds in the market. This decline has created a multifaceted environment, presenting challenges for facility owners with high levels of debt while at the same time opening doors for well-financed investors.

THE DYNAMICS OF THE RENTAL HOUSING MARKET ARE CLOSELY INTERTWINED WITH SELF-STORAGE DEMAND. AREAS WITH A HIGH PERCENTAGE OF RENTERS, 60% OR MORE, TEND TO EXHIBIT A MORE CONSISTENT DEMAND FOR STORAGE SOLUTIONS, AS RENTERS NORMALLY MOVE MORE FREQUENTLY THAN HOMEOWNERS.

HOUSING MARKET'S EFFECT

The constant fluctuations in mortgage rates have created volatility within the housing market, influencing the self-storage industry, which relies on people moving and needing storage. The national average 30-year mortgage rate ended 2023 at 6.61%. This surge in mortgage rates has resulted in YOY existing home sales declining since the beginning of August, dropping by 0.7% across all four major U.S. regions, according to the National Association of Realtors.

In addition to rising mortgage rates, the housing market is grappling with elevated home prices and limited housing inventory, all contributing to the decline in self-storage demand and street rates. Homebuyers may have to allocate more of their income towards mortgage payments or rents, leaving them with less disposable income.

30-YEAR FIXED RATE MORTGAGE Source: Freddie Mac 20.0% 17.5% 15.0% 12.5% 10.0% 7.5% 5.0% 2.5%

1975

1980

1985

1990 1995 2000 2005 2010 *Shaded areas indicate U.S. recessions

2015

2020

SEASONAL FLUCTUATIONS IN THE HOUSING MARKET CAN ALSO AFFECT THE SELF-STORAGE INDUSTRY. THE HOUSING MARKET TENDS TO BE MORE ACTIVE DURING THE SPRING AND SUMMER MONTHS, RESULTING IN HIGHER OCCUPANCY AND DEMAND FOR SELF-STORAGE.

20

LOOKING FORWARD There’s an expectation of the typical February low point for the self-storage industry, with rental rates anticipated to increase from March through August. This could result in 2024 following a more conventional pattern in the operational landscape.

Additionally, Yardi Matrix’s Q3 self-storage supply forecast shows an increase in projected deliveries for 2024 by 4.4%.

In 2024, the housing market is expected to stabilize after a long period of uncertainty. Mortgage rates are expected to drop, while home prices are likely to stay relatively stable throughout the year. The U.S. News Housing Market Index indicates that a national housing shortage will persist into the late 2020s, creating a seller’s market in many areas. The National Association of Home Builders also predicts this housing shortage will endure. This means that the self-storage industry can expect more stable occupancy rates and rental incomes for this year.

The state of the overall economy and geopolitical conditions can significantly impact self-storage owners by influencing customers’ demand for their services, the competitive landscape for acquisitions, pricing power, and the financial stability of their customer base.

Remember, although self-storage assets have historically been resilient during recessionary periods, data has proven that this industry is not immune to the realities of the current economic environment. With this in mind, self-storage owners should pay close attention to the trends in their specific trade area and how the overall economy fairs in the coming months, potentially shifting how one operates their business.

AUSTIN MCLEOD

austin.mcleod@matthews.com +1 (404) 445-1093

21

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22

W W W. M AT T H E W S . C O M

TOP TRENDS

TO WATCH IN

INDUSTRIAL FOR 2024

BY JOHN STROUD Over the last few years, the U.S. industrial segment has become one of investors’ most sought-after product types. However, given the current economic climate, the market is settling into what could be one of the sector’s more challenging times as interest rates are to remain ‘higher for longer’ and absorption decelerates. Despite this, vacancy rates are below the 20-year average, and rent growth is positive. With this in mind, there are a few trends industrial owners and tenants should keep an eye on in 2024.

23

PERFORMANCE AND OUTLOOK Source: Yardi Matrix December National Industrial Report

The average rental rate for industrial space nationally stood at $7.60 per square foot in November 2023. This reflects a slight uptick of four cents compared to October and a notable year-over-year (YOY) increase of 7.7%.

Southern California continued to outpace the rest of the nation for in-place rent growth, with the only three markets where rents grew by double digits in the last 12 months. In the Inland Empire, rents increased by 15.2%, 12.7% in Los Angeles, and 11.6% in Orange County.

The average rate for new leases signed in the past 12 months climbed to $10.26 per square foot, surpassing the overall average for all leases by $2.66. Premiums for new leases were most significant in port markets like the Inland Empire ($9.77 more per foot), Los Angeles ($6.46), and the Bay Area ($5.73). In contrast, midwestern markets such as Detroit, the Twin Cities, and Kansas City showed little to no premiums for new leases.

THE INLAND EMPIRE MAINTAINED ITS POSITION AS THE FRONTRUNNER IN RENTAL GROWTH,

industrial`

EXPERIENCING AN AVERAGE YOY INCREASE OF 15.2% IN NOVEMBER

AVERAGE RENT BY METRO Source: Yardi Matrix M ETRO

NOV ’23

National Inland Empire Los Angeles Orange County New Jersey Phoenix Atlanta Bay Area Nashville Columbus Dallas Tampa St. Louis Kansas City Indianapolis Detroit Cincinnati Chicago Denver

12- M ONTH CHANG E

AVG R ATE S IG N E D I N L A ST 12 M ONTH S

VACANCY R ATE

$7.60 $9.48 $13.69 $14.58 $10.06 $8.48 $5.51 $12.83 $6.04 $4.64 $5.67 $7.22 $4.59 $4.73 $4.53 $6.66 $4.76 $5.83 $8.24

7.7% 15.2% 12.7% 11.6% 9.1% 7.8% 7.2% 7.7% 7.3% 6.2% 7.0% 4.6% 5.3% 4.6% 5.6% 3.6% 4.2% 3.7% 4.3%

$10.26 $19.25 $20.15 $19.58 $14.21 $10.63 $8.34 $18.56 $8.83 $5.96 $7.38 $9.20 $4.38 $5.22 $5.33 $6.71 $5.77 $7.21 $9.30

4.6% 4.9% 6.3% 4.7% 5.1% 4.2% 3.6% 4.2% 2.4% 1.6% 4.3% 6.7% 6.7% 3.7% 3.2% 5.5% 6.6% 3.4% 5.8%

24

TOP TRENDS 1.

Moderating E-commerce

The surge in e-commerce during the early stages of the pandemic that elevated demand for industrial real estate to unprecedented levels stabilized in 2023.

Dallas and Phoenix have maintained their positions as leaders in new industrial development nationwide. Together, these two markets contribute to over 17% of all industrial starts nationwide, with Dallas initiating 26 million square feet of new projects and Phoenix starting 22.6 million.

However, it’s important to note that even in these markets, the number of starts has significantly decreased compared to last year, where Dallas started at 49 million square feet and Phoenix at 41.3 million.

Since Q1 2021, e-commerce sales volume has risen by 74%, with almost half of the increase occurring in the initial spike of Q2 2021. In Q2 2023, total e-commerce sales reached $277.6 billion, a 2.1% rise from Q1 and a 7.5% increase YOY. Although these figures appear to be robust, the full story paints a different picture. From 2010 to Q1 2020, e-commerce sales grew at an average quarterly rate of 3.6%. Following the initial COVID-19induced spike, the average rate dropped to 2.2%.

Additionally, the figures are not inflation-adjusted, with rising prices contributing to the growth.

As of November 2023, the national vacancy rate was 4.6%, unchanged from the prior month. Record levels of new supply in recent years have helped alleviate the scarcity of available space for occupiers.

There are currently 505.2 million square feet of industrial supply under construction.

INDUSTRIAL PIPELINES IN MOST MARKETS CONTINUE TO BE HISTORICALLY SIGNIFICANT,

industrial`

BUT THERE WAS A NOTABLE REDUCTION IN THEIR SIZE IN 2023.

NATIONAL NEW SUPPLY FORECAST

Sq Ft

Source: Yardi Matrix 600M 500M 450M 400M 350M 300M 250M 200M 150M 100M 50M 0M

THIS REDUCTION IS ATTRIBUTED TO A SUBSTANTIAL DECLINE IN PROJECT STARTS, DRIVEN BY THE ADJUSTMENT TO NORMALIZED E-COMMERCE DEMAND AND THE INCREASED COST OF CAPITAL. While online sales growth has normalized, it continues to drive substantial demand for industrial space. The expectation is that e-commerce will remain a significant driver of industrial sector growth. Retailers will need both large-scale facilities and small-scale infill centers to ensure a quick and efficient omnichannel experience for customers.

This trend will likely lead many existing retailers to consolidate brick-and-mortar operations, further fueling the demand for industrial space.

’17 ’18 ’19 ’20 ’21 ’22 ’23 ’24 ’25 ’26 ’27 ’28 Completed

Forecasted

Industrial sales totaled $48.6 billion through the end of November, with an average sale price of $130 per square foot. Denver experienced the most significant drop in average sale price, with a 24% decline in 2023.

25

2.

% OF SUPPLY CHAIN LEADERS SHIFTING TO NEARSHORE PRODUCTION

NEARSHORING

COVID-19 spurred a need for closer-to-home manufacturing, also referred to as nearshoring, and it will ultimately influence the industrial market in the upcoming years. Specifically for the U.S., the breakdown in the global supply chain encouraged supply chain companies to look at moving or expanding their manufacturing and distribution plants in North America instead of Asia. Empowered by the United States-Mexico-Canada Agreement (USMCA), these companies aim to enhance their oversight of production, facilities, labor expenses, transportation, and energy planning.

Source: McKinsey 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%

2022

2023

As nearshoring becomes more of a priority, industrial investors can expect to see an increased demand for industrial real estate as companies seek larger spaces for their operations within the U.S.

THEIR SUPPLY CHAINS TRIPLED IN 2023.

OFFICE TO INDUSTRIAL

2021

*Annual Surveys of between 60 and 113 Supply Chain Leaders; 2020 to 2023

ACCORDING TO A RECENT SURVEY CONDUCTED BY MCKINSEY, THE SHARE OF COMPANIES NEARSHORING

3.

2020

industrial`

According to an article released earlier in 2023 by Commercial Observer, over 15.2 million square feet of office space nationwide had been converted to industrial use, a 33.7% increase in only two years.

Additionally, the U.S. vacancy average for industrial properties is 4.6%, compared to 13.5% for office properties, further emphasizing the amount of unused office space.

There has been an increasing trend of converting underused office space to different commercial real estate asset types nationwide. According to GlobeSt., 100 office conversions were completed in 2023, more than double the annual average of 41 properties between 2016 and 2022.

As developers face increased development regulations and markets lack land availability, investors are finding creative ways to repurpose current spaces to fit their industrial needs. The newest trend is converting old office buildings into industrial spaces. There are specific needs for this type of rehab, including proximity to major highways, expansive acreage, and single-tenant occupancy.

Still, if the property fits the requirements, it can present an excellent opportunity as an adaptive reuse project.

In general, converting to industrial use typically comes at a lower cost per square foot compared to residential conversions. This is because industrial spaces, often referred to as a “giant box,” have simpler designs without the additional expenses associated with features like multiple bathrooms and other components found in residential properties.

26

4.

DECELERATING RENT GROWTH

The growth in industrial rents in the U.S. has significantly slowed from the peak levels seen during the pandemic and is at risk of dropping below levels even seen before the pandemic in the coming months.

Although the YOY national rent growth remains at a healthy 6.8% as of Q4 2023, it’s important to note that most of these gains occurred in early 2023, when the U.S. industrial vacancy rate was increasing at a much slower pace than it is currently. In Q3 2023 alone, rents increased by just under 1.1%, indicating an annualized growth rate of 4.6%.

MARKET RENT GROWTH (YOY) Source: CoStar Group 14%

FORECAST

12% 10% 8% 6% 4% 2% 0%

2018

2019

2020

Specialized

2021

2022

2023

Logistics

Flex

2024

2025

2026

2027

United States

Despite the current 10-year low in industrial construction starts and the U.S. industrial vacancy rates staying near pre-pandemic historic lows, CoStar Group suggests there’s a chance the national vacancy rate could peak at a relatively low level. This scenario could pave the way for a rapid increase in rent growth once the availability of space begins to tighten again.

27

5.

to freeways, railways, and ports. With their strategic location, these assets play a vital role in the last-mile supply chain, providing essential resources and facilitating efficient transportation to consumers, ports, and other hubs. The pandemic has further emphasized the critical nature of these assets, highlighting their significance in maintaining the speed and effectiveness of the global supply chain.

INDUSTRIAL OUTDOOR STORAGE

Despite the recent freight recession, the industrial outdoor storage sector is anticipated to sustain vigorous activity, gradually transitioning from the rapid growth seen in the past. With its resilient nature and favorable supply conditions, the industrial outdoor storage industry is poised to continue offering attractive investment opportunities and meeting the evolving needs of industrial users.

Formerly recognized as a subset within the broader industrial market, industrial outdoor storage has expanded over the past few years to become a market valued at least $200 billion. This growth has led to rising interest from institutional investors nationwide.

Industrial outdoor storage encompasses a wide range of functions and serves as a versatile solution for various industries. These storage facilities cater to diverse needs, including the maintenance and storage of rigs, trailers, containers, chassis, and the housing of bulk materials like roofing supplies, stone, and construction materials. Companies with extensive fleets, such as utility providers and field technician-based firms, often utilize these sites.

INDUSTRIAL OUTDOOR STORAGE RENTS HAVE INCREASED BY NEARLY 30% ON AVERAGE SINCE THE END OF 2019 AND HAVE SUPERIOR SUPPLY-DEMAND FUNDAMENTALS.

Typically occupying 5% to 20% of the land, industrial outdoor storage facilities are commonly situated in infill industrial areas near urban centers, ensuring convenient storage and access through proximity

Source: Commercial Search

While facing potential challenges in the current economic climate with higher interest rates and a deceleration in absorption, the U.S. industrial sector continues to exhibit resilience. The sector remains attractive, with vacancy rates below the 20-year average and positive rent growth. As the industrial landscape continues to evolve through moderating e-commerce, office conversions, nearshoring, and more, these trends will shape the sector’s overall trajectory in the coming years.

JOHN STROUD

john.stroud@matthews.com +1 (602) 975-0807

28

SOUTHEAST • GULF MARKETS • MIDWEST • SOUTHWEST • NORTHEAST • TEXAS • CALIFORNIA

29

G A

Atlanta

Experiencing recent relief, Atlanta closed Q3 2023 with the strongest positive absorption in nearly two years. The positive absorption was accounted for by high-end properties (Class A), while there was negative absorption for low-to-moderate income properties (Class C). Atlanta has 32,000 units under construction, where nearly three-quarters of the construction is Class A. The properties under construction represent 6.5% of the current multifamily inventory in Atlanta, a significant jump from the average of 14,000 units delivered annually since 2019. Two years ago, Atlanta was experiencing a record-low vacancy rate of 5%, but with the amount of new construction coming to market, vacancy rates have climbed to 11.3%. Rents are down 3% across the market, and submarkets such as Buckhead, Midtown, and West Midtown are seeing even steeper declines.

Absorption, Net Deliveries, & Vacancy Rate

9K

13%

8K

12%

7K

11%

6K

10%

5K

9%

4K

8%

3K

7%

2K

6%

1K

5%

0K

4%

-1K

3%

-2K

2017

2018 2019 ■ Absorption

2020 2021 2022 ■ Net Deliveries ■ Vacancy

30

2023

2%

Vacancy Rate

Absorption & Net Delivered Units

Source: CoStar Group

SOUTHEAST K Y

Lexington’s multifamily market is healthy heading into 2024. Ahead of the historical average, annual net absorption totaled 1,000 units, while demand remains steady. An influx of Class A apartments is pushing Lexington’s vacancy rates up, however, the affordability of Lexington’s Class C properties is keeping absorption high. In addition, the Lexington submarket, Jessamine County, represented 14% of market-wide net absorption in 2023. Vacancy rates in Lexington are at 6.2%, compared to the national average of 7.1%. Also, rent growth in Lexington is at 5.2%, compared to the 10-year Lexington average of 4.1%. This outperforms the National Index of 0.7%, which can be attributed to limited deliveries and balanced population growth. As high-interest rates widen, the gap between buyer and seller expectations on property valuations has increased and as such, Lexington will continue to see low investment activity. Most of the existing investment activity in Lexington is trending towards Class B/C assets of less than 10 units.

Nashville

Nashville’s multifamily market is amid a recordbreaking era, with 13,000 units anticipated to be delivered by 2024. In the previous 15 years, the highest number of units delivered never topped 10,000. Demand in Nashville is segmented as 85% of the overwhelming demand falls within the Class A cohort. Since the beginning of 2020, more than 20,000 units have been absorbed on a net basis within the luxury asset class. Despite the increased absorption of higher-rate units, asking rents declined in 2023 for the first time since 2010. In fact, during Q3 2023, asking rents declined by 2%, and they are expected to continue to fall in early 2024.

Vacancy rates are at 20-year highs at 10.9% and are expected to grow in the coming quarters. However, 40% of Nashville’s existing inventory has been delivered since the beginning of 2020 alone.

Sales Volume & Price/Unit

Sales Volume

Source: CoStar Group

Deliveries, Demolished, & Net Deliveries Source: CoStar Group

5K

Units

4K

$250M

$150K

$200M

$130K

$150M

$110K

$100M

$90K

$50M

$70K

3K 2K 1K 0 -1K

$0

2017 2018 2019 2020 2021 2022 2023 ■ Deliveries ■ Demolished ■ Net Deliveries

31

’17 ’18 ’19 ’20 ’21 ’22 ’23 ■ Sales Volume ■ Price/Unit

$50K

Market Sale Price/Unit

T N

Lexington

GULF MARKETS A L

Birmingham

F L

A decline in demand and above-average deliveries have resulted in below-average performance for the Birmingham market. In 2023, Birmingham delivered over 1,600 units, slightly above the 10-year annual average. New inventory was primarily delivered to Downtown Birmingham, the Lakeshore submarket, and Shelby County. Due to the dip in demand and higher deliveries, Birmingham is experiencing increased average vacancy rates of 10.6%. Still in the pipeline, the market has 2,700 units under construction, which will likely lead to continued upward pressure on Birmingham’s vacancy rate in the coming quarters. Rents in Birmingham have increased 1.2% since Q3 2023, a pace below the national average. Birmingham’s average asking rent is $1,200 per month, which is on par with those in Huntsville, while rents remain lower in the Mobile and Montgomery markets. In addition, multifamily sales in Birmingham totaled $139 million 2023, far below the market’s historical annual average.

While the decline in sales is in line with national trends, the market price per unit ($120,000/unit) has declined, and cap rates have increased by about 1% on average.

Jacksonville

Jacksonville’s multifamily market has felt the impact of delivering over 8,000 units in 2023 as developers have slowed breaking ground on construction projects. There are 10,000 units under construction at the moment, which is an inventory expansion of 9.0%. Comparing the number of new units to overall inventory, Jacksonville ranked second in 2022 among the top 10 U.S. markets for deliveries, causing vacancies to rise to 13% in 2023, a 4% increase from the previous year. This shortterm oversupply is expected to resolve itself as Jacksonville is one of the fastest growing markets in the U.S., growing at 1.2% in the last 12 months.

Investment sales in Jacksonville have declined recently due to a heavy amount of deliveries and negative rent growth mixed with a high interest rates environment. Total transaction volume is down over the last year totaling $813 million, compared to the prior year of $2.7 million. We see this trend resolving itself by Q2 2025 due to the resilient growth of the market and the market moving more towards an equilibrium.

Sales Volume Source: RCA

$4B

Market Fundamentals Source: CoStar Group

$3.5B

10.60% YOY Vacancy Change 1.20% Asking Rent $1,191 YOY Rent Change 0.59% Units Under Construction 2,691 Percent of Inventory 4.68% Sales Volume $95.2M YOY Volume Change -90.74% Vacancy Rate

$3B $2.5B $2B $1.5B $1B $0.5M $0

’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23 ■ Rolling 4 Quarters ■ Quarterly Volume

32

GULF MARKETS

F L

Fort Lauderdale

Fort Lauderdale's multifamily market is currently under pressure due to slow population growth and a high supply pipeline. While annual apartment absorption reached 2,000 units by early Q4 2023, this is below the five-year average of 3,300 units.

Despite outperforming the U.S. average in demand growth from Q4 2019 to Q1 2022, the pace has slowed since mid-2022 and continued in 2023. A record 6,700 units began construction in 2022, but only 1,600 units were started in 2023. Over 5,000 units are expected to be completed in the next two years, significantly exceeding the historical average.

Despite these developments, vacancy rates should stay below the U.S. average until later this year, driven by new, higher-income renters and those moving from the single-family market. However, the growth in luxury apartment inventory will likely suppress rent growth, with vacancies expected to rise above 9% by 2025. Fort Lauderdale ranks fifth in Florida for its apartment inventory pipeline, at 7.6%.

Fort Lauderdale Multifamily Rent Growth Year-Over-Year Source: CoStar Group

30% 28% 26% 24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2%

2019

2020 ■ Fort Lauderdale

2021 ■ Miami

33

2022 ■ Palm Beach

2023

GULF MARKETS F L

Tampa

With over 215,000 total units, Tampa is Florida’s largest multifamily market. Tampa’s construction pipeline is significant, with 17,995 units under construction. These units are expected to increase the market’s inventory by 8.3%, which is significantly higher than the national average growth rate of 5.1%. Cap rates have been steadily rising, averaging 5.1%, and are expected to continue to increase through the end of 2024.

Tampa is experiencing a supply and demand imbalance, which has caused an incline in vacancy rates, reaching an average of 8.2%. The market has not seen this high of a vacancy rate in over a decade. Tampa has delivered 7,032 units since Q3 2022, but has only recorded 4,621 units of absorption. The majority of absorption occurred in 2023, with 3,800 units absorbed through the end of Q3 2023. Since more units have come online over the past year, the market has witnessed a slowdown in asking rent growth. Asking rent losses have been most apparent in submarkets like Southeast Tampa and Pasco County, where these areas also lead in the new multifamily construction and consistent inflow of new units. Numerically, asking rents have changed -0.7% year-over-year. Investment sales of multifamily assets in Tampa have been muted in 2023. In total, $1 billion was traded in 2023, down significantly from 2022, where nearly $4.5 billion was recorded. Selling multifamily properties in Tampa has been challenging as buyers are underwriting lower rent growth assumptions and dealing with significantly higher debt costs. Despite market obstacles, investment activity quickly picked up in Q3 2023 with $850 million in total sales volume, fueled by several transactions over $50 million, split between institutional and private buyers.

Tampa's Investment Volume Holds Steady on Solid Multifamily Performance Source: RCA

$5B $4B $3B $2B $1B $0

2018 ■ Office

34

2019 2020 2021 ■ Industrial ■ Retail

2022 2023 ■ Multifamily

MIDWEST O H

Cleveland

An elevated level of deliveries and deceleration of demand is weighing the Cleveland multifamily market down. A total of 2,174 units have been delivered within 2023, and only 692 units have been absorbed. Downtown Cleveland accounted for 60% of deliveries in the market in 2023. There is an influx of Class A properties, but demand resides in Class B & C assets due to their affordability and national economic challenges. Rent in Cleveland is 34% below the national average at about $1,130 per month. The Cleveland market is parallel to what the country is seeing in terms of low investment activity.

By midyear of 2023, Cleveland had traded only 40 assets ($110 million), 38% below the average number of mid-year deals over the past five years.

I L

Market Fundamentals Source: CoStar Group

2022

2023 YOY Change

Vacancy Rate

6.16%

7.12%

0.96%

Asking Rent

$1,105

$1,134

2.57%

Units Under Construction

4,158

3,738

-10.10%

Sales $295M Volume

$88M

-70.20%

8.50%

0.87%

Cap Rate

Chicago

7.63%

Sales Volume Source: RCA

$7B

Chicago’s multifamily market is stable, with a positive outlook for the near future. Since Q3 2022, approximately 7,300 units were absorbed, well over the annual net absorption average of 4,200. The two strongest submarkets, Downtown Chicago and North Lakefront, accounted for more than 40% of Chicago’s year-over-year absorption gains. In total, Chicago delivered 9,200 units throughout 2023, and one of the largest multifamily projects contained over 800 units. Chicago has an astounding 5.5% vacancy rate, which is below average for the market, and above average rent growth at 2.8%. Out of the top 45 markets in size (over 100,000 units), Chicago’s rent growth was only outpaced by Cincinnati and Northern New Jersey, each posting 3.5% rent growth year-over-year at the beginning of Q4 2023. Investors choose Chicago due to its overall stability as one of the largest metros in the nation. Over the last 12 months, sales volume in Chicago was $4.2 billion, almost double the historical average of $2.8 billion.

$6B $5B $4B $3B $2B $1B $0

35

’16

’17

’18

’19

’20

’21

’22

’23

MIDWEST M N

Minneapolis

The Minneapolis multifamily market recorded its third-strongest quarter of net absorption in Q2 2023 and tripled the three-year pre-pandemic average. High absorption rates have occurred in Minneapolis due to its flourishing labor market and nation-leading market-rate apartment affordability despite rising interest rates and recession fears around the country. In the previous twelve months, Minneapolis delivered 8,917 units and saw 8,207 units absorbed. Most of the demand for multifamily housing originates from the suburbs, but Minneapolis continues to post record-setting years of net deliveries that include the eighth-highest cumulative three-year inventory expansion nationally. Roughly 13,000 units are currently underway in Minneapolis, accounting for 4.9% of the market’s existing inventory. However, the Twin Cities entered the second half of 2023 with the seventh-highest vacancy rate expansion relative to its 2017 to 2019 average. In addition, Minneapolis’ supply and demand imbalance has weighed on landlords’ ability to push rents, leading to annual rent growth of 1.5%.

Absorption Units & Annual Rent Growth

5K

5%

4.5K

4.5%

4K

4%

3.5K

3.5%

3K

3%

2.5K

2.5%

2K

2%

1.5K

1.5%

1K

1%

500

0.5%

0

’17 ’18 ’19 ■ Absorption Units

36

’20 ’21 ’22 ■ Annual Rent Growth

’23

0%

Annual Rent Growth

Absorption Units

Source: CoStar Group

SOUTHWEST C O

Denver

The Denver multifamily market continues to experience a downshift in apartment activity, quite the turn of events after the explosive growth over the past two years. During the first half of 2023, absorption registered about 3,400 units, down significantly from the 6,500 units absorbed in the first half of 2022 and the 8,300 units absorbed in the first half of 2021. In 2023, Denver delivered 10,845 units, and there are roughly 31,000 units still under construction, a record high. Denver’s multifamily construction is one of the most aggressive supply lines in the country. About 25% of Denver’s construction is located in Downtown Denver, and 70% of said construction will be within the luxury category. Downtown Denver’s inventory will grow by 10.7% when all construction is complete. Despite the rising construction of Class A properties, demand in Denver is seen from lower- to middle-income households as they seek more affordable housing options. In the past year, vacancy rates have increased by 1.2% to 7.9%. Multifamily sales in Denver have been impacted negatively due to higher interest rates, discouraging both buyers and sellers from executing deals. In 2023, Denver had a total sales volume of $2.7 billion, lagging behind the market’s annual five-year average of $5.9 billion.

Units Under Construction

40K

16%

35K

14%

30K

12%

25K

10%

20K

8%

15K

6%

10K

4%

5K

2%

0

’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23 ■ Under Construction Units ■ Under Construction Percent of Inventory

37

0%

Percent of Inventory

Units Under Construction

Source: CoStar Group

SOUTHWEST A Z

Phoenix

Phoenix’s multifamily demand is moderating as high inflation and economic uncertainty stall the launch of new renter households.

Like the majority of the country, there is an imbalance of supply and demand, and Phoenix’s overwhelming construction pipeline is no different. Phoenix looks to expand inventory by 8.6%, with an estimated 33,000 units underway. Downtown Phoenix accounts for 15% of inventory, where dramatic revitalization is occurring and attracting young professionals and students. The Phoenix skyline is being reshaped with the emergence of new luxury highrise apartments. Another Phoenix submarket, Tempe, has the potential to attract new renters due to the presence of Arizona State University and its 57,000+ students. Sales in the Phoenix multifamily market are modest at best. The market saw its weakest sales quarter in Q2 2023 since 2016 from the $1.2 billion traded properties. Cap rates climbed 125 to 150 basis points since bottoming out in early 2022, and property values have no sign of strengthening in the next 6 to 12 months. Despite an uncertain economy, buyers are still optimistic in Phoenix as they look to the long-term outlook of robust demographics coupled with strong expansion fundamentals.

Unit Deliveries vs Inventory Change Source: CoStar Group

22.5K

4.5%

20K

4%

8,365

8,909

8,897 6,180

4,883

6,427

6,685 147

250

2,886

4,587

3,279

3,997

2,823

-108

2.5K

2,506

5K

7,111

7.5K

8,147

10K

7,065

12.5K

3% 2.5% 2% 1.5% 1% 0.5% 0%

0 -2.5K

3.5%

’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23 ■ Number of Units Added ■ Inventory Change (%)

38

-0.5%

Inventory Change (%)

11,554

15K

6,522

Units Added

17.5K

16,447

5%

16,320

25K

NORTHEAST N J

New Jersey

Northern New Jersey is breaking historical averages as hundreds of new luxury units flood the market, and the metro sees elevated demand. The market continues to have long-term demographic trends in place to support the eventual absorption of new stock. Specifically, Northern New Jersey's construction pipeline is within the country’s top 20 largest metros (100,000+ units), reporting 14,000 units underway or 8.9% of existing inventory. However, Northern New Jersey is prepared for stability with vacancy of 4.6% and annual rent growth at almost 4%. In addition, local operators have commented that the market remains bullish on the metro due to high population density and above-average incomes. The first three quarters of 2023 unveiled a significant slowdown for multifamily sales in Northern New Jersey, with just $266 million traded.

Comparatively, $1.3 billion was traded in 2022, representing a 73% year-over-year drop. In addition, prices have dropped 24% year-over-year as the average price paid per unit as of Q4 2023 stands at $166,000.

Northern New Jersey Multifamily Market is Saturated with Luxury Apartments

Luxury Units Built in 2020 vs. Units Under Construction in 2023 9K

180%

8K

160%

7K

140%

6K

120%

5K

100%

4K

80%

3K

60%

2K

40%

1K

20%

0

0% Essex Union Morris Somerset ■ Under Construction ■ Built Since 2020 ■ Growth

39

Growth

Units

Source: CoStar Group

NORTHEAST N Y

New York

New York’s multifamily market remains one of the tightest U.S. markets, with at least 100,000 units. Many renters are competing for a limited number of units, and vacancy rates are at a historic low of 2.5%. There are about 67,000 units under construction, representing 4.3% of New York’s existing inventory, a percentage that is below the national average of 5.1%. The construction is taking place in neighborhoods that have been steadily adding new units over the past five years, such as Long Island City and Brooklyn. However, there has also been recent construction activity in the Bronx and Westchester County due to rising construction costs and increased competition, as these neighborhoods have needed meaningful inventory additions over the past decade. Due to tight vacancy levels, owners continue to push rents upward, averaging a 2.1% rent growth throughout 2023. New York multifamily sales were well above annual long-term historical averages of $11.7 billion in 2022 as more than $14 billion traded. However, in 2023, New York’s sales volume was among the lowest over the past decade despite Brooklyn and Manhattan neighborhoods' consistent demand. New York City’s retail, dining, and hospitality sectors improved through 2023 as visitor foot traffic trended upward. Still, the market remains elevated compared to national averages of unemployment rates, sitting at 5.4%.

Multifamily Real Estate Timeline

$20B

500

$18B

450

$16B

400

$14B

350

$12B

300

$10B

250

$8B

200

$6B

150

$4B

100

$2B

50

$0

’13

’14 ’15 ’16 ’17 ■ Sales Volume

40

’18 ’19 ’20 ’21 ’22 ■ Transaction Volume

’23

0

Transacion Volume

Sales Volume

Source: RCA

TEXAS Austin

Sales Volume & Transaction Volume Source: RCA

Sales Volume

Although the Austin multifamily market sees rebounding numbers in terms of renter demand, the influx of new completions is creating an imbalance and disrupting market fundamentals. Austin is set to deliver the highest number of multifamily units ever recorded in a single year, with 20,000 units in 2023. The anticipated net absorption for 2023 was 12,500 units, but the market saw a slightly lower net absorption of 9,213 units. This has caused Austin’s vacancy rates to climb to the fourth highest among major U.S. markets, currently sitting at 11.7%. The gap between the units absorbed and delivered is disrupting the Austin multifamily market. Despite this imbalance, Austin exceeds the absorption numbers of pre-pandemic averages of 8,400 units and has outpaced the 10-year average. This growth can be accounted for by the affordability, accessibility, employment opportunities, and increasing amenities of Austin’s suburban areas, where populations are rising. Between mid-2021 and 2022, Williamson and Hays County, the two largest suburban counties, saw their populations grow by 4% and 5%, respectively.

$4.5B

90

$4B

80

$3.5B

70

$3B

60

$2.5B

50

$2B

40

$1.5B

30

$1B

20

$0.5B

10

$0

’13 ’15 ■ Sales Volume

41

’17

0 ’19 ’21 ’23 ■ Transaction Volume

Transaction Volume

T X

TEXAS T X

Dallas-Fort Worth

The Dallas-Fort Worth multifamily market is recovering from elevated economic uncertainty caused by inflation, but demand remains present. During the first half of 2023, net absorption recorded 9,040 units, on par with average levels from 2016 and 2017 but below levels reported in 2018 and 2019 when the market experienced net absorption above 20,000 units. In hopes that net absorption will pick up, vacancy rates are expected to decrease. In 2023, vacancy rates increased to 9.4%, much higher than the 5.9% vacancy rate in mid2021. Dallas-Fort Worth expects that demand from highquality suburban submarkets such as Frisco/Prosper, Denton, and Allen/McKinney will continue to remain positive from the strong population growth. Dallas-Fort Worth has about 57,000 units underway, accounting for 6.8% of inventory. However, inflation stress for many mid and lower-income households has been in effect as occupancy decreases in Class B properties and below.

About 40% of the market’s inventory is labeled as a Class B property, negatively affecting the market due to shedding occupancy.

Dallas Ranks as Most Active Market in 2023

■ Individual

Source: RCA

2021 2022 YTD 2023

Market

Sales Volume ($M)

■ Portfolio/Entity YOY Change

1

1

1

Dallas

2

2

2

Atlanta

6

5

3

Los Angeles

16

11

4

Chicago

2,830

3

4

5

Phoenix

2,792

-75%

21

7

6

Manhattan

2,760

-59%

7

6

7

Austin

2,756

-62%

25

16

8

Boston

2,724

4

3

9

Houston

5

14

10

Denver

6,837 -64% 3,738 3,361

2,374 1,976

42

-68% -59% -30%

-32% -81% -56%

TEXAS T X

Houston

In the past quarters, Houston has experienced supply outpacing demand in the multifamily market, and 2023 continues to be a promising year for the market.

About 13,000 units were absorbed during the first three quarters of 2023, more than five times the number of units absorbed during the same period last year and about 20% more than the average amount absorbed annually between 2017 and 2019. CoStar anticipates that this growth will continue to achieve the prediction of 20,000+ new units set to open in 2023, a three-year high for the market. The forefront of the construction velocity is within the north and west suburban areas, where population growth is also the driving force. Due to the high number of delivered units, rent growth has slowed, and vacancy rates have ticked higher to 10.3%. Class B-priced units have emerged for the first time since 2021, and inflation in the area has decreased significantly over the past year after reaching double digits last summer. Houston’s multifamily market sales have slowed considerably in 2023. As of Q4 2023, the makeup of the buyer pool has shifted, with institutional capital and private equity accounting for more than 60% of buyer volume over the past four quarters. Although economic uncertainty in Houston remains uniform with the rest of the country, the Houston market remains positive on its long-term potential for job growth, population growth, and ensuing multifamily demand.

Percent of Units Occupied Source: MRI

Overall

Class A

90.8% 89.2% 86.4% 84.9%

Class B

93.0%

Class C

91.7%

91.7%

89.9% Class D

90.3% 89.6%

80%

82% 84% 86% 88% 90% ■ September 2022 ■ September 2023

43

92%

94%

CALIFORNIA C A

Los Angeles

In 2023, 4,800 units were absorbed, below the 8,000 units absorbed annually on average over the past decade. Furthermore, 12,248 units were delivered in 2023, and as a result, vacancy rates increased from 4.4% one year ago to 4.8%. In addition, Los Angeles rental rate movements have fallen short of national averages for years. Average asking rents in the market increased by 11.6% during the past five years, while the national average increased by 20.3%. This underperformance is attributed to the steep rise in vacancy the market faced in 2020 during the early stages of the pandemic. Development levels have stayed consistent in Los Angeles for the past five years, with around 9,000 to 12,000 units added annually since 2018. Los Angeles saw 12,000 net new market-rate units complete since Q3 2022, representing inventory growth of around 1.2%. Most of the construction is located in Downtown Los Angeles and Koreatown, with just under 2,800 units and 2,000 units, respectively. In Downtown Los Angeles and Koreatown, about 85% is ground-up Class A development and the remaining is conversion of older office buildings into multifamily. The increase in debt costs has led to declining sales volumes in 2023. Sales are well below the $2.2 billion average in multifamily sales that trade quarterly compared to the $864 million in assets traded in Q3 2023.

Market Fundamentals Source: CoStar Group

44

2022

2023

YOY Change

Vacancy Rate

4.22%

4.90%

0.68%

Asking Rent

$2,219

$2,222

0.10%

Units Under Construction

27,618

23,624

-14.46%

Sales Volume

$13.6B

$5.4B

-60.27%

Cap Rate

4.10%

4.60%

0.51%

CALIFORNIA

Sacramento

C A

Sacramento’s residents have become price-sensitive due to increasing interest rates, years of record rent growth, and high inflation. While the demand for one- and two-bedroom units has returned since the large move-outs seen in 2022, the wave of inventory delivered in Sacramento increased the vacancy rate to 6.6%. Most of the demand in Sacramento comes from residents moving to the city from the Bay Area, where rents are significantly higher. Sacramento offers the cheapest large California city monthly rent, for an average of $1,780 per month, a discount of more than 40% compared to San Francisco, just 90 miles away. Sacramento’s monthly average rent is still higher than the national average of $1,660. In total, 2,400 units have been delivered in the past twelve months, while 1,280 units have been absorbed. Construction continues to outweigh demand in Sacramento as 3,900 units are currently in the pipeline, accounting for 2.8% of inventory. Sales in Sacramento, like most of the country, are very weak. In 2023, sales reached only $313 million from 82 transactions, compared to the past five-year average of $1.3 billion. This can be linked to slowing rent growth, rising vacancy, and a disconnect between seller expectations and buyer pricing. With the prediction of increased cap rates, a quick turnaround for sales in Sacramento is unlikely.

Leasing in Walnut Creek remains a popular option for residents looking to move out of expensive California cities such as San Francisco, Oakland, and San Jose. In mid-2022, Walnut Creek saw a decadelow vacancy rate of 3.8%. Recently, vacancy rates have crept up to 6.8% due to recent large deliveries that have slightly overwhelmed the downshift in space signings. Despite growing population totals over the past decade, Walnut Creek is still experiencing demand weaknesses and slight supply imbalances attributed to the 0.7% increase in vacancy rates in the past twelve months. However, Walnut Creek offers a high quality of life, community amenities, and solid school ratings, helping set Walnut Creek up as a strong multifamily demand driver. In addition, the overwhelming majority of more than 2,200 units added over the past decade were built in the submarkets of Lafayette and Pleasant Hill, where developers are putting effort into capitalizing on transit options. In 2023, six properties traded, totaling $44.3 million in record volume. Many of Walnut Creek’s transactions have been on the smaller side, pricing from $5 million to $12 million.

Vacancy Rate, Absorption Units, & Net Deliveries Source: CoStar Group

Sales Activity a Small Fraction of Recent Years

Absorption & Net Delivered Units

Source: CoStar Group

$2B $1.8B

Sales Volume

$1.6B $1.4B $1.2B $1B $0.8B $0.6B $0.4B $0.2B $0

’16

’17

’18

’19

’20

’21

Walnut Creek

600 550 500 450 400 350 300 250 200 150 100 50 0 -50 -100

12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2%

Vacancy Rate

C A

2018 2019 2020 2021 2022 2023 ■ Absorption ■ Net Deliveries ■ Vacancy Rate

’22 ’23

45

CALIFORNIA C A

Orange County However, this downturn is more moderate than the national fall of 63% in sales. Job growth in Orange County has been limited due to the lack of available workers. During the pandemic, many residents fled to cities outside of California, which disturbed job growth potential. However, in Q3 2023, Orange County saw a jump in total nonfarm employment, measuring 1.4% above pre-pandemic levels. Orange County also remains tight in unemployment rates compared to surrounding California cities despite a 0.4% jump over the two years ending in June 2023, which sets the market up for a 3.9% unemployment rate.

Compared to the nation’s largest 50 multifamily markets, Orange County continues to stand out positively. The market ranks third lowest for apartment vacancy compared to the national average at just 3.9% versus 7.1%. Affordability is a strong testament to the low vacancy as incomes catch up to higher rental rates. In addition, job growth remains positive, and population outflows have subsided with the end of the pandemic. Net absorption nearly matched supply growth in Q2 and Q3 2023, leading to a more stable market vacancy rate. Rents increased by 1.3% by year-end 2023 due to high-quality apartment rents growing and lowquality apartment rents moderating. Nevertheless, Class C apartment buildings still have the strongest rent growth of an average of 2.6%. Orange County ranks among the lowest markets with construction projects, where most development is concentrated in Irvine. The market broke ground with less than 1,000 apartment units in 2023, compared to the five-year average of over 2,700 units. This is predominately due to construction financing becoming increasingly challenging to source.

Orange County is on pace for a 35% shortfall as sales volume in 2023 totaled $1 billion, compared to the five-year average of $1.8 billion.

Market Fundamentals Source: CoStar Group

46

Vacancy Rate

3.90%

YOY Change

0.40%

Asking Rent

$2,641

YOY Change

2.90%

Units Under Construction

5,570

% of Inventory

2.20%

Sales Volume

$1.2B

YOY Change

-63.93%

CALIFORNIA C A

San Diego

Throughout 2023, San Diego’s multifamily sector saw mixed results. In neighborhoods of Chula Vista, Balboa Park, and the South I-15 Corridor, demand was on par with what was typical between 2015 and 2019. In addition, these neighborhoods saw new supply, outpacing historical norms.

Demand in these submarkets is primarily driven by Class A buildings.

Construction continues to be heavy in these submarkets, leading to increased demand among high-net households. In total, San Diego has 8,300 units under construction, and the region has added a net of about 19,000 new units in the past five years. In Q3 2023, rent growth fell, which has not happened in the past 10 years. This lack of performance can be blamed on San Diego’s most expensive coastal areas, such as UTC and the North Shore Cities, where rents have fallen year-over-year. The number of transactions during Q3 2023 was more than 50% below the quarterly average between 2015 and 2019. In addition, investment volume has fallen to historically low levels, and sales volume was roughly one-third of the Q3 2021 peak. The average transactional price recorded $390,000 per unit in 2023, compared with $400,000 per unit in 2022. Cap rates have also increased from an average of 4.2% to between 4.3% and 5% in 2023.

Urban & Downtown Apartment Demand in San Diego Source: CoStar Group

Balboa Park Central Coast Chula Vista/Imperial Beach Downtown San Diego East San Diego/El Cajon La Jolla/UTC Mission Valley/North Central National City/South Central North County North I-15 Corridor North Shore Cities Poway/Santee/Ramona South I-15 Corridor 0 500 ■ Absorption

1K

1.5K 2K ■ New Units

47

2.5K

3K

3.5K

CONTRIBUTING AGENTS SOUTHEAST

MIDWEST

TEXAS

■ Atlanta

■ Chicago

■ Austin

CONNOR KERNS connor.kerns@matthews.com +1 (404) 445-1090

FINLE Y ASKIN finley.askin@matthews.com +1 (773) 446-7634

AUSTIN GR AHAM austin.graham@matthews.com +1 (404) 445-1091

JOHN SOL ARI john.solari@matthews.com +1 (773) 446-7692

■ Nashville

SAM JACKSON sam.jackson@matthews.com +1 (615) 667-0126 ■ Lexington

TIM VANWINGERDEN

tim.vanwingerden@matthews.com

+1 (502) 804-4608

■ Minneapolis

KURT SAUER kurt.sauer@matthews.com +1 (612) 605-8156 ■ Cleveland

DREW CERNE Y drew.cerney@matthews.com +1 (216) 260-0711

T YLER MARSHALL tyler.marshall@matthews.com +1 (512) 361-1305 ■ Dallas

JARED RICE jared.rice@matthews.com +1 (214) 295-5080 ■ Houston

PATRICK GR AHAM patrick.graham@matthews.com +1 (281) 645-6151

CALIFORNIA ■ Sacramento

GULF MARKETS

SOUTHWEST

■ Birmingham

■ Denver

CALEB FRIZZELL caleb.frizzell@matthews.com +1 (205) 216-1403 ■ Fort Lauderdale

GABRIEL PENA gabriel.pena@matthews.com +1 (954) 204-0115 ■ Jacksonville

MATT BERK matt.berk@matthews.com +1 (720) 800-9761

K YLE INMAN kyle.inman@matthews.com +1 (602) 975-0805

NORTHEAST

+1 (904) 322-7738

■ New Jersey

■ Tampa

K AYDEN BIRNE Y kayden.birney@matthews.com +1 (813) 774-8645

■ Walnut Creek

DANIEL GR AYS-YANG

daniel.graysyang@matthews.com

+1 (925) 215-8643

■ Phoenix

CAMERON HOOPER

cameron.hooper@matthews.com

MALON HUGHES malon.hughes@matthews.com +1 (916) 518-9998

DAVID FERBER, CPA david.ferber@matthews.com +1 (551) 888-0042

■ Los Angeles

NABIL AWADA nabil.awada@matthews.com +1 (310) 844-9362 ■ Orange County

LIAM SKELLY liam.skelly@matthews.com +1 (949) 200-7168 ■ San Diego

■ New York

DJ JOHNSTON dj.johnston@matthews.com +1 (718) 701-5367 BROCK EMMETSBERGER

brock.emmetsberger@matthews.com

+1 (646) 868-0013

48

MICHAEL K ASSER michael.kasser@matthews.com +1 (619) 382 3750

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NYC

YORK NEW YORK’S NEW YORK NEW Rebound from the Pandemic &

T H E I M PA C T O N A PA R T M E N T S

MHTN

BKLYN

BY B RO C K E M M ETS B E RG E R & DJ J O H N STO N

It was previously predicted that New York City wouldn’t recover from the COVID-19 pandemic until 2025. Ahead of schedule, the city has seen a swift rebound with job levels, population recovery, and an across-the-board increase in demand for quality commercial real estate.

51

GOOD UNDERLYING FUNDAMENTALS, MEET DISTRESS AND OPPORTUNITY Between April 2020 and July 2022, New York City’s population decreased from 8.80 million to 8.34 million, a 5.4% decline, mainly occurring in 2020 and 2021. Despite initial setbacks during the pandemic, the city managed to recover, regaining all lost private-sector jobs by October 2023, with the unemployment rate dropping to 5.3% in September 2023. Office space vacancies remain New York’s biggest Achilles’ heel, at a high of 40%. Still, retail, dining, and hospitality sectors have shown improvement, with Midtown and Lower Manhattan witnessing a recovery of 74% compared to 2019 levels. New York City’s apartments remain in high demand, with a tight vacancy rate of 2.5% and record-high apartment sales over the past two years, reflecting a strong desire among people to live in the city permanently.

NYC HAS ENDURED PREVIOUS CRISES LIKE 9/11, THE ’08 RECESSION, S U P E R S T O R M S A N DY, A N D S U R V I V E D T H E W O R S T O F C O V I D - 1 9 . T H E R OA D T O R E C O V E R Y H A S B E E N R O C K Y, B U T T H E C O M E B AC K I S O F F I C I A L , A N D S AV V Y INVESTORS KNOW THERE’S A REASON NEW YORK COMES BACK EVERY TIME.

Other areas like the Civic Center and Lower East Side Manhattan, as well as Brooklyn’s popular neighborhoods like Brooklyn Heights and Williamsburg, have seen significant population growth, fueled partly by their proximity to Manhattan and attractive amenities. Meanwhile, quieter, lower-cost areas in South Brooklyn, such as Coney Island and Spring Creek, have also experienced resurgence due to their waterfront appeal and more affordable real estate options. However, not all areas have rebounded equally; some inner neighborhoods of Brooklyn continue to face population declines.

Furthermore, the state as a whole experienced a population decline of 2.6% between 2020 and 2023, according to the Moving Migration Report from North America Moving Services. Nonetheless, there is optimism for the city’s future. While the post-COVID-19 urban revival varies across neighborhoods, neighborhoods with unique offerings are likely to thrive, indicating continued demand for urban living despite the challenges posted during the pandemic.

THE METRICS THAT TRACE THE TENUOUS PATH FORWARD FOR NYC P O P U L AT I O N R E C OV E RY

In the aftermath of the lockdowns, people initially left New York City; however, they were swiftly replaced by newcomers seeking opportunities. By 2022, with the lifting of lockdowns and the return-to-office life, the city experienced a resurgence as those who first moved away returned to the city. Interestingly, Manhattan saw a notable increase in population.

New York County, encompassing Manhattan, welcomed over 17,000 new residents by 2022, marking a positive turnaround.

M A N H AT TA N E X P E R I E N C E D A N 8 .1 % P O P U L AT I O N D E C L I N E D U R I N G T H E E A R LY M O N T H S O F T H E P A N D E M I C , BUT BY OCTOBER 2022, IT HAD F U L LY R E C O V E R E D , W I T H A N E A R LY 4% INCREASE IN RESIDENTS SINCE JANUARY 2018.

52

POPULATION USA PROJECTS NEW YORK CITY’S POPULATION TO REACH 8.90 MILLION BY THE END OF 2023, UNDERSCORING THE CITY’S RESILIENCE AND POTENTIAL FOR GROWTH. POPULATION SHIFTS IN NEW YORK BOROUGHS M O N T H LY P O P U L A T I O N C H A N G E C O M P A R E D T O J A N U A R Y 2 0 1 8 B A S E L I N E SOURCE: PLACER.AI

4% 2% 0 -2% -4% -6% -8% -10%

20

O

ct ob er

ne

20

22

22

22 Ju

ar y br u Fe

O

20

20

21

21

ct ob er

ne Ju

ar y br u

20

21 20

20 20

ct ob er

20 ne Ju

O

Fe

20

20 ar y

br u Fe

O

20

20

19

19 Ju

ct ob er

ne

20 ar y br u

Fe

O

20

19

18 20

20

ct ob er

ne Ju

Fe

br u

ar y

20

18

18

-12%

• Kings County (Brooklyn) • Bronx County • Queens County • New York County (Manhattan) • Richmond County (Staten Island) MANHATTAN DOMESTIC NET MIGRATION October 2019 to September 2022 SOURCE: PLACER.AI

TO P D E ST I N AT I O N Z I P C O D E S I N M A N H AT TA N 10069 (Upper West Side)

NET M I G R AT I O N

BY ZIP CODE

10003 (East Village/Gramercy) 10038 (City Hall/Civic Center) 10014 (Meatpacking District) 10044 (Roosevelt Island) 10001 (Chelsea) 0

5%

10%

15%

20%

25%

30%

-14%

35%

-10%

-6%

-2%

2%

6%

10%

14%

-2%

2%

6%

10%

14%

BROOKLYN DOMESTIC NET MIGRATION October 2019 to September 2022 SOURCE: PLACER.AI

T O P D E S T I N A T I O N Z I P C O D E S I N B R O O K LY N 11224 (Coney Island)

NET M I G R AT I O N

BY ZIP CODE

11201 (Downtown Brooklyn) 11211 (Williamsburg) 11239 (Spring Creek) 11238 (Prospect Heights) 11216 (Bedford-Struyvesant) 0

1%

2%

3%

4%

5%

6%

-14%

53

-10%

-6%

RETAIL CHAINS FOOT TRAFFIC RECOVERY BY CATEGORY

UNEMPLOYMENT & JOB RECOVERY

SOURCE: PLACER.AI

Within the early weeks of the pandemic, the city lost nearly one million jobs, and the unemployment rate skyrocketed to 21% in May 2020. However, in October 2023, it was announced that New York City had regained all private sector jobs lost, and the seasonally adjusted unemployment rate was down to 5.3% in November 2023. The city currently has more total jobs than ever before, totaling 4.7 million.

The Urban Displacement Project tracked cellphone data which shows Midtown and Lower Manhattan as two employment centers that have seen increased visitation in offices, shops, and public transit.

CAT E G O RY

RECOVERY

A P PA R E L

66%

DINING

90%

FITNESS

107%

GROCERIES

92%

HOME IMPROVEMENT

76%

HOTEL/CASINOS

89%

LEISURE

77%

M E D I C A L & H E A LT H

87%

SHOP & SERVICE

89%

S PA & B E A U T Y

91%

SUPERSTORES

As the job market has improved, retail, dining, and hospitality have all witnessed increased foot traffic trends. Midtown and Lower Manhattan have seen a recovery level of 74% in comparison to 2019 levels, foot traffic has increased to 80%, and more businesses opened in 2022 than in 2019. New York is a city that is constantly reinventing itself. Once plagued by an oversupply of retail, the pandemic shook out the retailers that weren’t going to survive and/or adapt to new consumer shopping habits, opening the market up to more opportunities.

95%

OFFICE SUPPLIES

56%

ELECTRONICS

59%

RETAIL CHAINS RECOVERY

88%

- 1 2 % C O M PA R E D T O S E P. 2 0 1 9 SOURCE: PLACER.AI

VISITS TO TRIBECA AND THE FINANCIAL DISTRICT PEAK MID-WEEK, WHILE OTHER NEIGHBORHOODS DRAW THEIR LARGEST CROWDS ON SATURDAYS S H A R E O F D A I LY V I S I T S T O S E L E C T M A N H A T T A N N E I G H B O R H O O D S , Q 3 2 0 2 3 SOURCE: PLACER.AI FINANCIAL DISTRICT

13.7%

14.3%

15.5%

TRIBECA

13.5%

15.7%

16.6%

C H I N AT O W N

12.5%

12.2%

GREENWICH VILLAGE

12.4%

13.5%

EAST VILLAGE

11.0%

11.6%

12.3%

13%

LOWER EAST SIDE

10.9%

11.5%

12.1%

13.1%

WEST VILLAGE

10.8%

12.2%

• MONDAY

• TUESDAY

12.4%

14.1%

• THURSDAY 54

14.8%

14.7%

15.5%

14.7%

13.5%

14.7%

16.8%

12.9%

14.3%

• WEDNESDAY

15.6%

13.3%

19.4%

15.2%

16.6%

16.6%

16.4%

• FRIDAY

11.5%

9.5%

15.2%

17.5%

12.4%

20.7%

14.9%

21%

14.8%

19.8%

13.2%

• SATURDAY

• SUNDAY

attendance for workers returning to New York, and the Real Estate Board of New York reported a visitation rate of 61% of pre-pandemic baselines across 250 office buildings in Manhattan in Q1 2023.

Although this marked a 10-point increase from Q1 2022, it falls short of the 65% peak in Q1 2021. In Q3 2023, there was a nine-point increase in workers returning to the office, reaching 58% between August 23 and September 15, compared to 49% during the same period in 2022. Despite this, mobile device activity in the city’s central office districts, primarily in Midtown but also in the Financial District and Brooklyn, remains 26% lower than pre-pandemic levels. However, this decline is comparatively less than in cities like Miami and Austin.

RETURN-TO-OFFICE While the end of lockdowns and the return-to-office seems to have lured people back to the city, the office sector still has a challenging year ahead as office utilization has yet to fully recover. The returnto-office movement in New York City has been marked by fluctuations in employee attendance, with the number of employees reporting to their offices on a given day stuck at less than half of prepandemic levels, as tracked by keycard swipes. The Kastle Barometer for office card swipes indicated that in Q1 2023, the rate went above 50% compared to pre-pandemic levels but dropped below 50%

by Q2 2023. At the same time, data from the partnership of New York City shows an average

M A N H AT TA N

LOW E R M A N H AT TA N 0%

-17.9%

-21.1%

-13.2%

SOURCE: PLACER.AI

-24.7%

Q U A R T E R LY V I S I T S , Q 3 2 0 2 3 C O M PA R E D TO Q 3 2 0 1 9

-26.1%

WHEN ANALYZING NYC POST-PANDEMIC VISIT RECOVERY, THE DEVIL IS IN THE DETAILS

• MONDAY - THURSDAY VISITS • FRIDAY VISITS • WEEKEND VISITS

O N LY 4 0 % O F T O T A L O F F I C E S P A C E I S C U R R E N T LY O C C U P I E D, O N E O F T H E LOW E ST P E R C E N TAG E S AC R O S S T H E C O U N T R Y. I T I S C R U C I A L T O H I G H L I G H T T H AT 6 0 % O F T H E AVA I L A B L E O F F I C E S PAC E I S LO C AT E D I N B U I L D I N G S T H AT H AV E N OT B E E N R E N OVAT E D I N OV E R A D E CA D E .

SOURCE: KASTLE

mere 2% vacancy rate, and broke records in 2023, with 6,400 people visiting The Summit, an art, technology, and architecture-focused observation deck, in a single day. While this concept isn’t new, it’s a promising sign for the New York office market. The market has become increasingly bifurcated as these quality buildings benefit from significantly lower vacancy rates and rental premiums. The flight to quality is most observable in Manhattan, where the net effective rent for trophy office space averaged approximately $100 per square foot in Q1 2022 and jumped to $112 per square foot in Q1 2023. This trend is here to stay as hybrid work drives employers to create a more inviting and fulfilling working culture that supports the return-to-office movement.

A recent Bloomberg News analysis estimated that office workers are spending $12.4 billion less annually in Manhattan due to the rise of hybrid work.

Still, the possibility of more return-to-office mandates could prompt a significant return of workers to their office space. In the tech sector, there’s a notable growth in office presence, with companies like Apple focusing on expansion plans concentrated in Manhattan’s thriving West Side. Additionally, Amazon has become New York’s second-largest private employer, employing approximately 20,000 workers, despite canceling plans for a second headquarter.

Despite the office occupancy numbers, the flight to quality is evident in specific locations throughout New York. For example, One Vanderbilt generated approximately $25 million in NOI in 2023, boasts a 55

T H E M O S T S O U G H T- A F T E R F E AT U R E S I N H I G H - Q U A L I T Y O F F I C E S PA C E S T O D AY A R E T H E B U I L D I N G A M E N I T I E S A N D P R OX I M I T Y T O P U B L I C T R A N S P O R TAT I O N .

TOP AMENITIES

•- World-Class Restaurants •- Rooftop Bars •- Gyms & Fitness Studios •- State-of-the-Art Conference Centers

•- Messenger Center •- Speedy Elevators •- Valet Parking •- Transportation Access •- Floor-to-Ceiling Windows

While Manhattan has not seen major companies relocating elsewhere, there are approximately 10 million square feet of new office space to be delivered. This indicates that developers remain optimistic about the Manhattan office space market despite the rising concerns that these deliveries will contribute to the increasing vacancy rate.

•- Outdoor Areas •- Lounge/Recreational Space

INCREASED SUBWAY RIDERSHIP A substantial investment of $171 million has been made in the Subway Safety Plan, aimed at benefiting working individuals by restoring confidence in the transit system and facilitating their return to work.

Alongside these initiatives, significant infrastructure enhancements, such as the new Grand Central Madison, have been implemented to enhance accessibility for employees in the city.

With several surveys and reports providing insight into the evolving office landscape, there are notable infrastructure changes, such as those around Grand Central Madison, that have made living and working in the city more accessible, reflecting the ongoing efforts to adapt to the changing dynamics of office attendance and urban life.

Remarkably, the MTA achieved a milestone by accommodating over four million riders in a single day on May 17, marking the first instance within a month. This achievement is particularly noteworthy as it signifies a recovery from the early days of the pandemic when subway ridership plummeted by more than 90%. Ridership has rebounded to approximately 68% to 72% of its pre-pandemic levels, reflecting a resilient and evolving public transportation system.

NEW YORK SUBWAY RIDERSHIP

N E W YO R K S U B WAY

SOURCE: U.K. DEPARTMENT FOR TRANSPORT, NEW YORK METROPOLITAN TRANSPORTATION AUTHORITY 100%

N E W Y O R K S T A Y- A T - H O M E O R D E R

75% 50% 25% 0%

• MONDAY

AUGUST 2020

• TUESDAY

• WEDNESDAY

DECEMBER 2021

• THURSDAY 56

• FRIDAY

• SATURDAY

• SUNDAY

AUGUST 2023

TOURISM

THE IMPACT ON APARTMENTS

New York City’s tourism industry is experiencing a surge, with significant developments on the horizon.

In the next three years, the city plans to add 11,000 hotel rooms, building upon the 10,000 rooms that were added or renovated in 2022. In 2023, tourism surpassed 61 million visitors, an increase from 22 million in 2021 and 56 million in 2022, inching closer to the pre-pandemic mark of 70 million tourists in 2019. The city’s infrastructure has also received upgrades, with new terminals at LaGuardia Airport, Newark, and JFK, enhancing the overall travel experience. Additionally, the Moynihan Train Hall, a new 17-track expansion of Penn Station, has been introduced, improving transit facilities for commuters and tourists.

Properties Under Construction

Units Under Construction

% of Inventory

Avg. No. Units Per Property

408

65,511

4.2%

161

12 Mo. Delivered Units

12 Mo. Absorption Units

Vacancy Rate

12 Mo. Asking Rent Growth

21,493

19,053

2.5%

2.0%

12 Mo. Sales Comparables

Avg. Price

Avg. Price/Unit

Avg. Vacancy at Sale

1,212

$7.2M

$329K

2.7%

New York City’s housing market has experienced an unprecedented boom in recent months, driven by a rapid influx of returning residents who are all competing for a limited number of units. As a result, the vacancy rate plummeted to 2.5%, a near-historic low and making it the tightest among major U.S. markets. This surge propelled rent prices to record highs, reaching an astounding $5,100 per month in Manhattan alone. Over the past 12 months, rents have steadily grown by 2.0%, particularly in Manhattan and Brooklyn. However, landlords of recently delivered buildings are now offering concessions, a signal that owners are witnessing moderation.

Furthermore, Broadway, a quintessential part of New York’s cultural appeal, has made a triumphant comeback. The current season has witnessed a remarkable surge in ticket sales, totaling over $1.3 billion, doubling the figures from the previous year.

These developments signify the city’s resilience and appeal as a premier global tourist destination.

DOMESTIC TOURISIM RECOVERY + 2 9 % C O M PA R E D T O S E P, 2 0 1 9

While rents have soared and vacancies remain scarce, there was a slight moderation in quarterly absorption totals in 2023 compared to the levels observed in 2022.

This shift has led to a delicate balance where supply slightly outpaces demand, with 22,000 units delivered against 19,000 units absorbed in the last 12 months.

Currently, 65,000 units are under construction, 4.2% of the existing inventory, primarily in areas like Jersey City, Long Island City, and Brooklyn.

129%

However, with rising construction costs and the expiration of the 421A Tax Abatement program, filings for multifamily construction plunged in 2023. This tax incentive allowed developers to forego paying property taxes on new construction projects for a decade or more if they offered rental units at affordable prices for low- to middle-income families. The program required developers to rent out 25% to 30% of a project’s units at below market rents.

Critics argued that the program enabled the construction of luxury rental apartments, where some affordable units were priced as high as 130% of a household’s area median income (AMI), far beyond what an average family could afford. The City’s Controller Brad Lander estimated that the city gave up collecting $1.77 billion in property taxes in the past fiscal year due to this program.

Developers contended that this figure was purely theoretical, as they claimed these properties wouldn’t have been built without the incentive.

SOURCE: PLACER.AI

VISITS BY LOCAL AND NATIONAL TOURISTS SOURCE: PLACER.AI 250%

RECOVERY %

200% 150% 100% 50% 0% MAY 2020

DEC 2021

SEP 2023

• LOCAL TOURISTS (51-150 MILES) • NATIONAL TOURISTS (>150 MILES) 57

O V E R T H E P A S T D E C A D E , A P P R O X I M A T E LY 3 , 0 0 0 P R O P E R T I E S I N T H E C I T Y, T O TA L I N G A R O U N D 1 1 7, 0 0 0 U N I T S , UTILIZED THE 421A PROGRAM, AS REPORTED BY A STUDY FROM NEW YORK UNIVERSITY’S FURMAN CENTER.

AC C O R D I N G TO A ST U DY BY T H E R E A L E STAT E B OA R D O F N E W YO R K , M O R E T H A N H A L F, O R 56% O F A L L M U LT I FA M I LY U N I TS C O N ST R U CT E D I N T H E L AST E I G H T Y E A R S TO O K A DVA N TAG E O F T H I S TA X P R O G RA M .

However, challenges loom on the horizon, including rising borrowing costs, moderating rent growth, and the potential for a near-term recession, all of which could contribute to a slowdown. In this evolving market, lenders will drive the trajectory of the real estate sector. CoStar Group highlights the need for careful consideration, suggesting that unless buyers focus on specific buildings or locations with substantial rent growth potential, advertised cap rate projects on multifamily properties may require upward adjustments. Navigating these complexities will require adaptability, strategic planning, and a keen understanding of market dynamics, ensuring that stakeholders remain agile in the face of changing trends and seize opportunities for growth and development in the landscape of New York City’s real estate market.

Addressing these rent laws could alleviate some of the market distress, as 900,000+ units in New York are rent-regulated, and nearly half of the city’s residential buildings fall under this category, all experiencing significant challenges.

The market has witnessed substantial transactions, with approximately $7.2 billion changing hands in the past year, predominantly in Brooklyn and Manhattan, including several deals above $100 million. Notably, Manhattan has experienced a three-decade high in sales, indicating that more apartments have been sold in the city between 2021 and 2022 than in the past 30 years combined. Still, investment volume slowed down tremendously in 2023. The amount traded is on pace to lag behind 2022’s total of $1.4 billion and the long-term annual average of $11.7 billion.

BROCK EMMETSBERGER LOOKING AHEAD TO 2024

brock.e@mat thews.com +1 (6 4 6) 868 - 0 0 13

In 2024, the New York City real estate landscape is poised for innovative transformations. Creative solutions will be pivotal in reimagining and rezoning areas into more mixed-use spaces, revitalizing business districts, and enhancing urban living experiences.

DJ JOHNSTON dj.johnston@mat thews.com +1 ( 7 1 8) 70 1 - 5367

58

59

COMPARING ERAS H OW M U LT I -T E N A N T V E L O C I T Y H A S B E E N I M PA C T E D B Y I N T E R E S T R A T E S

BY MATTHEW WALLACE + JOANNA R. MANFRO

INTRODUCTION In the ever-evolving landscape of multi-tenant retail, transaction velocity has seen highs and lows over the past 20 years. Despite the fluctuations, the sector has exhibited resilience, finding solid ground with sustained strength in retail sales, responding positively with investors. This article highlights the intriguing trajectory of multi-tenant velocity by exploring transaction patterns and contextualizing them with economic and industry shifts, unraveling the relationship between multi-tenant transactions and the fluctuations in the 10-year Treasury.

Stock – Existing number of assets in the market Velocity – Turnover of the stock The data highlighted includes centers classified as anchored, unanchored, and grocery-anchored over 10K square feet, priced at $2.5 million and above.

60

THE PAST 5 YEARS

Over the past five years, transaction velocity for multi-tenant retail has been on a rollercoaster of a ride, but the reality is year-over-year retail sales have continued to get stronger with the sector finding its footing with investors, tenants, and developers.

2018

6.86% West 4.84% California 6.38% Southwest 6.16% Texas 4.18% Northeast 5.27% Midwest

6.56% West 4.44% California 5.76% Southwest 5.84% Texas 4.03% Northeast 6.13% Midwest

3.32% West 2.97% California 3.55% Southwest 3.68% Texas 2.09% Northeast 3.21% Midwest

5.71% Florida 5.28% Southeast 3.85% Mid Atlantic

2.91% Average Interest Rate | 5.32% Average Velocity In 2018, there were 2,403 transactions with an average price of approximately $9.1 million, averaging $144 per square foot and a cap rate of 7.5%. This year saw the highest sales volume in a single quarter despite the “noise” around the demise of brick-and-mortar retail. It all centered around the concept that underlying economic fundamentals had placed the consumer in a position of strength that they hadn’t seen for some time. Headwinds were minimal – consumer spending hit a sixyear high, and the savings rate dropped to a 12-year low.

2019

5.71% Florida 5.40% Southeast 4.42% Mid Atlantic

2.14% Average Interest Rate | 5.35% Average Velocity In 2019, transactions were on par with 2018. The average sale price and price per square foot increased to $9.9 million and $158, respectively.

Where things get interesting is cap rates went up by a slim margin to 7.7% for an approximate 2% increase. During this time, economic expansion tightened core markets, and secondary or tertiary markets began to gain more investor traction. While consumer confidence and spending remained elevated and property fundamentals were strong, the retail industry began seeing more vacant big-box space, with large retailers shuttering locations and announcing closures. Brands such as Sears, Macy’s, and JCPenney declared bankruptcy.

2020

3.32% Florida 3.49% Southeast 2.82% Mid Atlantic

0.89% Average Interest Rate | 3.18% Average Velocity While the decline in physical retail stores began before the arrival of the pandemic, the pandemic served as the final nail in the coffin for struggling retailers. Chains falling behind on consumer trends and preferences, like online shopping, saw depleting sales during nationwide lockdowns. But it wasn’t all bad news; 2020 was the year when retail was forced to transform and pivot business models to meet modern consumer needs. The multi-tenant retail space changed as the vacancies were filled with more appropriate tenants, and the pandemic or recessionresilient anchors (such are grocers) took center stage as the darling asset for investors. While 2020 doesn’t accurately represent the market, here’s what center fundamentals looked like that year – the average sale price was $8.5 million, the sale price per square foot was $143, and the average cap rate was 7.4%.

61

2021

6.56% West 4.62% California 7.68% Southwest 7.87% Texas 4.45% Northeast 5.94% Midwest

6.79% Florida 7.28% Southeast 5.20% Mid Atlantic

1.45% Average Interest Rate | 6.22% Average Velocity In 2021, the market correction began, and 2,812 transactions occurred.

The average asset price jumped back to pre-pandemic levels at $9.9 million and $156 per square foot, but cap rates decreased to 7.3%.

Shopping center owners began to implement and upgrade centers to accommodate curbside pickup centers, and more centers began to see a healthier tenant mix that complemented instead of competed.

2022 2.95% Average Interest Rate | 7.12% Average Velocity Compared to the last 10 years, 2022 saw record-breaking transactions, and a large portion of the nation’s multi-tenant retail exchanged hands.

Approximately 3,216 total sales were recorded, the average sale price increased to $10.4 million, the sale price per square foot jumped to $169, and cap rates declined to 6.9%.

2023 7.73% West 5.98% California 7.57% Southwest 8.21% Texas 6.88% Northeast 7.41% Midwest

7.24% Florida 5.30% Southeast 5.30% Mid Atlantic

2.92% West 2.21% California 3.01% Southwest 3.34% Texas 3.78% Northeast 3.47% Midwest

7.24% Florida 5.30% Southeast 5.30% Mid Atlantic

3.86% Average Interest Rate | 3.15% Average Velocity As of October 2023, commercial real estate transaction volume across all sectors was down 68% to $19.3 billion. While still negative compared to a year ago, retail saw more favorable transaction velocity, down 48% with $2.9 billion in transaction volume. At the heart of the problem is the dramatic rate increases by the Fed that began in Spring 2022, and despite the two pauses in September and November of 2023, there’s no guarantee that the hoped-for decreases will materialize in 2024. This has made returns to investors more challenging and debt more expensive, further compounding the problem, widening the bid-ask spread, and elevating valuations of assets. With debt leverage down and interest rates up, achieving accretive returns is challenging, pushing investors to the sidelines and transaction velocity down. Approximately only 1,422 transactions have taken place, the average sale price declined to $9.1 million, the sale price per square foot declined to $154, and cap rates jumped to 7.3%.

So, what does all that mean, and why are we looking at the past? These numbers show that sales are still robust for the asset class despite the challenging economic environment. There remains and will always remain a steadfast level of interest in this type of investment.

62

HOW ARE TRANSACTIONS TIED TO THE INTEREST RATE ENVIRONMENT?

THE CORRELATION TO THE 10-YEAR TREASURY Over the last 21 years, the 10-year Treasury has ranged from 1.45% to 4.80%. The lowest 10-year Treasury rate was in 2021 when the Fed decreased the Federal Funds Rate to boost economic activity after COVID-19. The highest was in 2006 at 4.80%.

During this time, the Fed raised short-term interest rates in response to overheating equity, real estate, and mortgage markets. On average, the 10-year Treasury is 3.14%. Looking at the regional breakdown, the Midwest has the highest number of centers and, unsurprisingly, in 2022, experienced the highest number of transactions. The West (excluding CA) has the lowest number of centers and thus experienced the lowest number of transactions, recording only 26 in 2009. The Southwest (excluding TX) has the highest average velocity over the 21 years, and Mid Atlantic has the lowest.

Since the start of 2022, the Federal Reserve has implemented seven rate hikes to combat high inflation in the U.S. economy, making lending more expensive for businesses and consumers. These rate hikes have ranged from 25 up to 75 basis points. Federal Reserve Chair Jerome Powell has stated that interest rates will continue to climb until inflation reverts to the annual 2% target. As a result of these rate increases, the cost of debt has gone up nearly 300 basis points over the past year, and the higher cost of debt is putting increased pressure on building valuations, thus affecting velocity. Furthermore, when interest rates are high, cap rates tend to increase. This is because higher interest rates lead to higher borrowing costs, meaning investors will require a higher return on their investment to compensate for the increased costs.

AVERAGE VELOCITY OVER THE YEARS Source: RCA

10%

7.5%

5%

2.5%

0% '06

'07

Northeast

'08

'09

Mid Atlantic

'10

'11

'12

South East Ex. FL

'13 Florida

'14

'15 Midwest

63

'16

'17

'18

SouthWest Ex. TX

'19 Texas

'20

'21

West Ex. CA

'22

'23

California

U.S. VELOCITY CORRELATION TO 10-YEAR TREASURY Source: RCA 8%

6%

4%

2%

0% '02

'03

'04

'05

'06

'07

'08

'09

'10

Minimum U.S. Velocity

'11

'12

'13

'14

'15

'16

Maximum U.S. Velocity

'17

'18

'19

'20

'21

'22

'23

10-year Treasury

CORRE L ATION TO 1 0 -YE AR TRE A SURY 20 YE ARS

1 0 YE ARS

Northeast

0.16

-0.04

5 YE ARS 0.01

Mid Atlantic

-0.30

-0.64

-0.73

Southeast Ex FL

-0.32

-0.55

-0.63

Florida

-0.07

-0.56

-0.68

Midwest

-0.44

-0.49

-0.53

Southwest Ex Tx

-0.20

-0.70

-0.72

Texas

-0.50

-0.49

-0.66

West Ex. CA

-0.33

-0.52

-0.59

California

-0.09

-0.54

-0.47

Average

-0.28

-0.55

-0.59

This table shows the correlation coefficients between the velocity of different regions over 20, 10, and five years.

The positive values indicate a positive correlation between the region’s velocity and the 10-year Treasury. In simple terms, as the 10-year Treasury increases, velocity increases as well. Conversely, negative values indicate an inverse relationship. Most notably, in the Northeast, there is a positive correlation between the region’s velocity and the 10-year Treasury, the strongest being over the past 20 years.

64

THE NORTHEAST The Northeast stands out as a unique real estate market for several reasons. First, there’s a notable “flight to safety” phenomenon, where investors perceive the region as secure. This perception is bolstered by a combination of factors, including high barriers to entry, limited development, and constrained supply. The stability in rents further enhances the attractiveness of the Northeast as an investment destination. The region’s resilience during economic downturns is attributed to its density and wealth, providing insulation against recessionary pressures. Notably, the historical ownership pattern reveals that assets in the Northeast are often generationally owned, although a recent trend shows these assets increasingly being traded to REITs. This shift contributes to a decrease in transaction frequency as institutions tend to hold onto their assets for more extended periods of time. There is a growing trend of generational owners collaborating with institutions, adding a layer of complexity to market dynamics. Despite this, the market remains fragmented, with a significant portion of properties owned by high-networth individuals.

Joint venture partnerships, partial interest sales, and UPREITs provide alternative options for owners today to explore.

MATTHEW WALLACE matthew.wallace@matthews.com (216) 220-8860

JOANNA R. MANFRO

joanna.manfro@matthews.com (203) 253 8827

65

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66

The Key to Location, Location, Location

Apartment Investment Success

by Daniel Withers In this economy, investing in apartments might as well be considered a science. There is a myriad of factors that go into selecting the right investment to plant capital and receive the highest return. One of the most critical factors that can ultimately determine an investment’s success, profitability, or even failure is location. The asset’s location plays a substantial role in establishing its worth, demand, value increase potential, investment performance, and more.

THE PHRASE "LOCATION, LOCATION, LOCATION" IS A FREQUENT SAYING IN THE REAL ESTATE INDUSTRY, AND IT'S VALUABLE ADVICE, ESPECIALLY WHEN INVESTING IN APARTMENT PROPERTIES.

67

LOCATION FACTORS TO CONSIDER

HOW LOCATION AFFECTS VALUE AND RETURNS

Investors should prioritize increasing the demand for their investment property – high demand leads to higher occupancy rates, rental rate growth, and increased monthly rental income, making properties in desirable areas especially valuable. The location also influences rental prices, with high-demand areas in sought-out neighborhoods commanding higher rents, resulting in higher net operating income (NOI) and greater returns. Additionally, properties in highly coveted locations tend to appreciate faster, offering investors the potential for building equity and long-term value growth.

However, it’s crucial to note that location choice can introduce risks, as properties in less desirable areas are more susceptible to market fluctuations and tenant demand, increasing the chances of delinquency or vacancy and negatively impacting investor returns.

Proximity to Economic Hubs/CBDs

Economic Growth Potential & Demographic Trends

Nearby Amenities, including Grocery Stores, Schools, Parks, and Quality Infrastructure

Access to Nearby Public Transportation

AN IDEAL OCCUPANCY RATE AGAINST THE NATIONAL AVERAGE IS 96% OR MORE, BUT THIS WILL VARY BASED ON LOCALITY.

Low Crime Rates & Robust Sense of Community

68

BEST CITIES FOR RENTERS

The list prominently features three metro areas in warmer climates. Chandler and Gilbert, AZ, secure the first and second positions on the ranking, with two other cities in Phoenix ranking in the top 25.

Additionally, the study identified two cities in Las Vegas and two more in Washington D.C.

Forbes Advisor recently surveyed the 96 mostpopulated U.S. cities to find the top areas for apartment renters. The study assessed the best cities for renting by examining factors such as typical rental costs and the dimensions of one and two-bedroom rental units, the annual percentage shift in mean rental rates, the proportion of renters facing affordability challenges, levels of crime, the availability of pet-friendly rentals, the range of amenities, and various other metrics.

Most of the cities listed among the top 15 for ideal renting conditions are accommodating to pets. For instance, Plano, TX, boasts the greatest number of pet-friendly rental options, while Boise, ID, offers the most dog parks.

The average cost of renting a one-bedroom apartment in the 96 most densely populated U.S. cities stands at $1,301, while a two-bedroom apartment averages $1,590. In terms of size, a typical one-bedroom apartment spans 688 square feet, whereas a two-bedroom apartment covers an average of 979 square feet.

CHANDLER, AZ’S TOP POSITION IS ATTRIBUTED TO THE SUBSTANTIAL DECREASE IN YEAR-OVER-YEAR AVERAGE RENT PRICES (A 4.77% DEDUCTION) AND ITS HIGHER-THAN-AVERAGE MEDIAN HOUSEHOLD INCOME OF $91,299.

TOP 10 BEST CITIES FOR RENTERS, RANKED Source: Forbes Advisor CIT Y

STATE

OVE R ALL SCORE

AVG. RE NT 1-BED

AVG. RE NT 2- B E D

YOY RE NT % CHANG E

* % OF RE NT BU RDE N E D H OUS E H OLDS

Chandler

AZ

100.00

$1,394

Gilbert

AZ

99.37

$1,464

$1,053

-4.77%

44.89%

$1,064

-5.79%

Henderson

NV

96.06

$1,321

$1,086

37.26%

-6.77%

49.20%

Plano

TX

93.48

$1,495

$1,085

-1.43%

41.47%

Austin

TX

92.73

$1,461

$1,058

-3.93%

46.19%

Minneapolis

MN

84.74

$993

$1,017

-1.36%

48.28% 46.15%

Lincoln

NE

84.03

$886

$1,037

1.03%

Washington D.C.

-

81.70

$1,811

$988

0.08%

45.14%

Denver

CO

81.04

$1,423

$1,031

-0.73%

45.64%

Las Vegas

NV

79.80

$1,071

$1,020

-4.84%

54.66%

*Renters who spend more than 30% of their income on rent are classified as "rent-burdened" by the federal government.

69

HOTBEDS OF MULTIFAMILY DEVELOPMENT: TOP ZIP CODES IN CONSTRUCTION

In central business districts (CBDs), there has been an influx of new multifamily construction within the last few years. An analysis by RentCafe reveals that approximately 1.2 million new rental units have been delivered since 2018, with specific zip codes showing remarkable growth. The zip codes with a higher percentage of a younger population and above-average incomes are at the top of this multifamily construction list.

THE RENTCAFE REPORT REVEALED THAT MANY RENTERS PRIORITIZE NEWLY BUILT APARTMENTS WITH EASY ACCESS TO URBAN AMENITIES WHEN CHOOSING THEIR NEXT PLACE TO LIVE. TOP 15 ZIP CODES BY APARTMENTS COMPLETED IN THE LAST 6 YEARS Source: CoStar Group, RentCafe

R AN K

CIT Y/STATE

ZI P CODE

TOTAL I NVE NTORY (UN ITS) 2022

20 1 8 -2022 UN ITS

20 1 8 -2022 COM PLETE D PROPE RTI E S

TOTAL I NVE NTORY (UN ITS) 20 17

I NVE NTORY CHANG E 2022 VS 20 17

1

Washington D.C.

20002

17,476

7,378

25

10,098

73.10%

2

Washington D.C.

20003

13,137

7,225

24

5,912

122.20%

3

Queens, NY

11101

16,712

7,081

16

9,631

73.50%

4

Nashville, TN

37203

13,852

6,806

25

7,046

96.60%

5

Frisco, TX

75034

14,315

5,872

19

8,443

69.50%

6

Tempe, AZ

85281

20,263

5,667

23

14,596

38.80%

7

Atlanta, GA

30309

13,691

5,397

17

8,294

65.10%

8

San Diego, CA

92101

16,868

5,346

22

11,522

46.40%

9

Jersey City, NJ

07302

18,144

5,289

18

12,855

41.10%

10

Redmond, WA

98052

15,011

5,121

21

9,890

51.80%

11

Houston, TX

77007

13,641

5,014

18

8,627

58.10%

12

Seattle, WA

98109

14,118

4,780

24

9,338

51.20%

13

Chicago, IL

60607

7,555

4,547

19

3,008

151.20%

14

Fort Lauderdale, FL

33301

7,061

4,481

12

2,580

173.70%

15

San Francisco, CA

94103

11,009

4,379

18

6,630

66.00%

A SIGNIFICANT NUMBER OF NEIGHBORHOODS THAT EXPERIENCED A SURGE IN CONSTRUCTION ACTIVITY OVER THE PAST FIVE YEARS ARE SITUATED EITHER WITHIN CITY CENTERS OR IN THEIR VICINITY. The Washington D.C. zip code 20002, encompassing the U.S. Capitol and the H Street Corridor, leads the nation in construction, combined with a median income of $79,460 and a median age of 33.5. A notable feature of the 20002 zip code is its abundance of available land, making it an ideal choice for developers. This zip code has transformed into a top choice for city residents in search of a harmonious mix of historical significance and modern living. The neighboring zip code 20003, covering Capitol Hill and Capitol Riverfront,

ranks second nationally with a median household income of $116,000 and a median age of 34.5.

Combined, these two zip codes have witnessed over 14,000 new units added over the last five years.

Washington D.C., has made quite the comeback since the COVID-19 pandemic after losing a significant percentage of residents. The state has welcomed over 3,000 new residents in the last two years and is expected to continue growing, thus the need for more apartments.

70

New York’s zip code 11101 in Queens comes in third place, with 7,000 new apartments added in five years. The neighborhood’s easy access to Manhattan, several luxury and affordable housing options, as well as its strategic location along the East River have made it an excellent place for developers to build new apartment buildings.

Nashville’s Gulch/West End zip code 37203 ranks fourth, with 6,806 new apartments added. Frisco, TX, zip code 75034 secures the fifth spot, with a solid corporate presence and highly-rated schools attracting young professionals and families. This Frisco zip code added 5,872 units over the last five years, the majority being high-end rentals.

WHILE ALL 50 ANALYZED ZIP CODES MORE THAN DOUBLED THEIR MULTIFAMILY INVENTORIES, NOTABLE PERCENTAGE INCREASES WERE SEEN IN MIAMI, FL’S 33132 (354%), MAITLAND, FL’S 32751 (274%), PANAMA CITY, FL’S 32405 (190%), VIRGINIA’S 23230 (235%), AND FUQUAY VARINA, NC’S 27526 (216%).

Despite the strain on rents nationwide caused by the robust delivery pipeline, the positive demand and absorption persist. Occupancy rates have stabilized, and the market remains relatively steady. The rise in construction activities not only enhances property values but also has the potential to result in higher rental rates, thereby increasing the overall value of investments. Moreover, an uptick in construction can foster economic growth in the area, drawing in more potential tenants and reducing vacancy rates, further emphasizing the importance of location when choosing an apartment investment.

Daniel Withers daniel.withers@matthews.com +1 (818) 923-6107

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IsBy itCameron Over Hooper After 40 Years?

73

In the world of commercial real estate, the age-old Wall Street adage about bull and bear markets still holds true – bull markets take the stairs up, and bear markets take the elevator down. Unlike the dramatic crash of Black Monday (where, in one single day, the Dow Jones fell over 22%), the current market decline is unfolding subtly, and real estate isn’t the leading cause, like in other recessions. Investors and developers in the commercial real estate market have seen a seepage of difficulty in the sector, but there’s one market that is never really considered in the realm of commercial real estate – the bond market.

Navigating the Unpredictable

The outlook for commercial real estate indicates there may be challenges ahead. Advancements in financial markets have simplified the process of assessing investments for individuals and corporations, helping to understand the exact value of most investments. However, commercial real estate presents complexities that technology struggles to capture in real-time market corrections. If the real estate market was more like the stock market, there might have been coined days, much like the historic Black Monday, describing and predicting the unprecedented asset value drop in 2023. Typically, bear markets stem from a distinct catalyst or black swan event that investors can pinpoint, a trend mirrored today as the Federal Reserve works to tame inflation caused by significant government spending from the pandemic. Though reasons for the spending might be different, the pattern is familiar. History does, in fact, repeat itself as market cycles are cyclical and human behavior remains predictable.

As creatures of habit, people seek safety in times of fear and acquire more risk when they are carefree. For investors, this means they often turn to bonds for safety, a secure, long-term investment funnel, valuing its stability.

Change in effective federal funds rate Percentage Points

6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0%

0

■ 2022-2023 Taming Inflation

10 20 30 M O N T H S S I N C E H I K I N G C YC L E S TA R T E D ■ 2015-2018 Returning to Normalcy

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■ 2005-2006 The Housing Market Boom

■ 1999-2000 The Dot-Com Boom

■ 1994-1995 A Soft Landing

The Bond Market’s Impact on CRE The 10-year U.S. Treasury yield is a crucial benchmark for the commercial real estate industry.

During the COVID-19 pandemic, there was a flight to quality and perceived safer assets, such as bonds, which led to record low yields. However, volatility created by the hawkish tone of the Federal Reserve made lenders apply more cautious underwriting measures and reduce the leverage provided to developers. From the lender’s perspective, as rates started to rise in conjunction with runaway inflation, this created a need to shift strategies.

Banks and institutions are afforded the ability to make more money from their deposits and the rising overnight rate. Rising rates created more options of investment and steered banks away from making loans on commercial real estate deals that only had marginally better returns, with significantly more risk.

This has lead to a major drop in deal flow as banks have pulled back.

The average price of the bonds dropped to around 75 cents on the dollar from roughly 89 cents a year ago.

For more than a year, a specific segment of the U.S. bond market, CMBS, has been facing significant challenges. Investors should closely monitor CMBS pricing because it provides insight into a broader view of commercial real estate loans and the true value of assets. Economists have warned that challenges at regional banks are likely to reduce overall lending and drag on economic growth. What most investors don't realize is that as interest rates go up, the price of the underlying bond goes down.

It's an inverse relationship that can be costly if the bondholder is exposed to long durations. As an example, the price of a single bond will typically fluctuate by the interest rate increase multiplied by the duration. If market rates go up 1% and you're holding a bond that has a 20-year duration, the price of your bond is down 20%. In all, bond markets and interest rates are intricately connected, and as bond yields fluctuate, mortgage rates follow suit and it trickles down throughout commercial real estate.

The Simplest Investment Advice Isn’t Always the Easiest

Buy low and sell high – the investment strategy that’s often repeated as a rule of thumb but is hard to predict. It would be simple if economists could predict where the market peaks or how to identify rock-bottom prices.

To formulate a strategy for the next couple of years, a three-step approach is necessary. Investors must ask:

» Why are rates rising? » What is the timeline of impact? » How should I position myself for the best opportunity to survive & thrive?

75

Deep Dive: Why Are Rates Rising?

The Federal Reserve has raised rates in one of the steepest climbs in history, aiming to counter the adverse effects of rampant inflation. Despite the positive momentum in the U.S. economy brought on by the resilient consumer base, the prolonged COVID-19 shutdowns led to widespread ripple effects. The government’s mass injection of government spending created an unprecedented situation – people kept their jobs when historically they would have been lost, and people were able to save disposable income because many retailers and restaurants were closed. The mix of pent-up disposable income, and the convenience of Amazon delivery created an avenue that accelerated inflation beyond anyone’s prediction.

What is the Timeline of Impact?

The work-from-home movement shifted focus to moving where climates are warmer and more time could be spent outside. It also put a major focus on the home as more time was spent there, escalating housing prices and related costs. The measure of CPI (inflation) is made up of almost 40% housingrelated items. In addition to a strong consumer, supply chain disruptions and increased demand further elevated prices, which was exacerbated by historically low interest rates. As a result, investors found themselves in an unsustainable growth pattern. This prompted Jerome Powell to adopt a reactive approach, taking a page out of Volcker’s book and aiming to reset the market by applying hawkish and tough strategies. While this might have caused short-term challenges, historical patterns indicate economic resilience and eventual recovery.

Once again, revisiting the COVID-19 pandemic – the pivotal factor that reshaped daily lifestyles and work dynamics. The office sector has borne the brunt, a trend likely to persist as the return-to-office movement is slow. Other sectors, such as buildto-rent (BTR) and multifamily, saw a massive initial surge, only to be met with steepening construction costs, borrowing costs, leverage reductions, and cap rate expansions that followed the 10-year Treasury yield increase. Sales within the retail and single-family sector have thrived due to a robust consumer, pent-up demand, and the implications of interest rates rising, turning a large percentage of homeowners into landlords. Mortgages sub 3% to 4% remain attractive, especially when the alternative is doubled interest rates and reduced purchasing power.

Volcker created short-term pain that reset the market and set the stage for one of the greatest periods of a bond bull market for forty years.

There have been short times of fluctuation, such as 1994, where it can be costly in the short term, but the economy has historically bounced back.

Office and rental markets are starting to find stability due to shifting consumer demands and needs.

However, the U.S. faces a shortage of approximately two million homes. As such, investors and developers must remain vigilant and cautious and not try to “catch the falling knife.” Chasing drastically reduced prices might not yield profits, akin to the misconception following the 2009 recession where every investment seemed profitable.

76

How should I position myself for the best opportunity to survive & thrive?

The 40-year drop in rates is resetting, moving toward the average. If rates continue to rise, it’s expected that a generational shift will occur. The baby boomers will see a risk-free rate of return higher than it’s been for years and start to move large amounts of investable dollars into treasuries and securities with high coupons. Meanwhile, millennials, facing increased mortgage rates, are likely to lend another shift into rental housing, given their inclination toward experiences and rental-based lifestyles. This trend indicates a growing demand for multifamily and built-to-rent (BTR) properties.

By taking the lessons learned in the past and plotting the path for the future, developers and investors in this bearish market must strategize for survival and growth. Remember the saying – bull markets take the stairs up, and bear markets ride the elevator down – investors are riding the elevator down, and what does a person do in an elevator?

They stand still and let it carry them.

In this market pause, crafting a buying strategy is crucial. However, investors can’t buy if they don’t have cash or access to capital. Unless the Federal Reserve changes its targeted inflation number, it’s hard to suggest they will start cutting rates.

Plotting plans of investments and creating an “if/ then” scenario is paramount. For example, ask what you would do if residential mortgages become assumable like they were in the past, or what will you do if rates go up another 100 basis points?

Crafting this "if/then" investment strategy will help when the market is at a tipping point, whether to the upside or downside.

The bond bull run has come to an end, but that doesn’t mean investment returns are going to decline. Remaining vigilant and consistent with allocations in sectors and focusing on strategies that have historically performed well during rate accelerations enables investors to capitalize on the current resilient economy and the short-term opportunities presented during this period of market fluctuation.

Cameron Hooper

cameron.hooper@matthews.com +1 (904) 322-7738

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W W W. M AT T H E W S . C O M

IN CRE BRIGHT SPOT

HOW RETAIL CONTINUES TO ROLL WITH THE PUNCHES

BY JOSH EIN

79

Retail’s transaction volume declined 41% in 2023 from 2022 as macroeconomic pressures have thrown water on the previously scorching market, but it has retracted less than any other sector. This relative outperformance resulted from boosted deal activity at the entity level in Q3 2023, the second strongest year ever recorded for entity-level sales at $5.3 billion and a dedicated private buyer pool.

Despite transactions declining, pricing adjusting, and cap rates increasing, investors consider the sector a safe haven. This report dives into why retail is in high demand.

RETAIL MARKET PERFORMANCE

IN 2023, THE MERGER OF GLOBAL NET LEASE AND THE NECESSITY RETAIL REIT

Since the pandemic, retail has demonstrated notable growth, attributed to consistent demand, adaptive strategies, a notable reduction in store closures, and limited new supply. With the current market conditions, few retail opportunities are available for buyers, and pricing is stabilizing quicker than the broader commercial real estate market due to the sector’s low-risk profile.

(464 RETAIL ASSETS) AND THE ACQUISITION OF URSTADT BIBBLE PROPERTIES BY REGENCY PARTNERS

(66 RETAIL ASSETS) OCCURRED. SALE S VOLUM E ACROSS TH E BOARD Source: RCA

While pricing is adjusting, it’s insufficient to push investors’ aggressive investment strategies like in 2022. The spread between borrowing costs and cap rates is impacting transaction volume. On the private client side, cap rates have adjusted 50 to 100 basis points higher. Well-located assets boast longer lease terms and great credit tenants can find cap rates in the 6.00% range.

VOL ($B) JAN - NOV 2023

YOY 2023

Retail

52.1

-41%

Industrial

76.0

-50%

Hotel

21.7

-52%

Office

43.4

-61%

Apartment

105.5

-64%

CAP RATES Source: RCA 7.5%

7.0%

6.5%

6.0%

5.5% ’02

’03

’04

’05

’06

’07

’08

’09

’10

’11

All Retail

’12

’13

Centers

80

’14

’15 Shops

’16

’17

’18

’19

’20

’21

’22

’23

This volatile climate has paved a path of robust growth and recovery for the sector. Shopping center vacancy rates have been the lowest in decades, retail rents have increased, and with over three-quarters of new development having a tenant in place at delivery, the retail market has faced little to no threat from new supply.

NET LEASE DEMAND A tight labor market, expectations for a pause in rate hikes, and historically low single-tenant vacancy continue to attract active buyers to the retail market. Private buyers have been the largest group of investors and remain active in the sector, but institutional investors also eye the sector as they have dry powder to deploy. Investors like the stability, steadiness, and ability to increase cash flow and pass-through tax benefits.

RETAIL BY THE NUMBERS

While there was a definite slowdown in transactions in 2023, the market is coming off all-time highs.

Single-tenant net lease transaction volume for 2021 surpassed $5.4 billion, and 2022 rounded out at $6.3 billion. As of November 2023, transaction volume recorded $2.8 billion, which is still in line with pre-pandemic levels, noting that retail will remain resilient moving forward. According to GlobeSt., investment in retail properties nationwide increased to $11.86 billion in Q3 2023, 34% higher than the $8.84 billion recorded in Q2 2023.

2023

DELIVERIES IN SF

50.4M

VACANCY RATE

4.1%

NET ABSORPTION IN SF

51.7M

In Q3 2023, the Southeast led in investment sales volume, recording $3.04 billion, followed by the Northeast ($2.87 billion), West ($2 billion), Midwest ($1.8 billion), Southwest ($1.65 billion), and Mid-Atlantic ($1.01 billion).

RENT GROWTH

3.4%

Source: CoStar Group

MONTHLY TRANSACTIONS VOLUME AND PRICING Source: RCA $25B

100

$20B

80

$15B

60

$10B

40

$5B

20

$0B

’18

’19 ’20 ’21 ’22 ’23 Individual Portfolio Entity Commercial Property Price Index (RCA)

0

81

LOW VACANCY RATES The anticipated risk of new supply will remain low for the foreseeable future. As of Q4 2023, about 58.2 million square feet of retail space is in progress nationwide. Additionally, new construction projects have declined across the U.S. due to rising construction financing costs and record-high land and labor costs. New retail space is expected to be limited over the next year, keeping prices high in primary locations for the foreseeable future.

In Q3 2023, demand for space grew by almost 12 million square feet, the 11th consecutive quarter of rising demand and minimal new supply, according to CoStar Group. This has contributed to an unprecedented decline in shopping center vacancy rates. Asking rents have increased 3.4% over the last 12 months to a new record high of $25 per square foot. Sunbelt markets have experienced the most extensive rent growth, attributed to the region’s substantial population and buying power. Once rents stabilize, the market is expected to revert to normal transaction levels.

DESPITE SEVERAL PROMINENT RETAILERS FILING FOR BANKRUPTCY OVER THE PAST YEAR, THERE IS STILL

RENT COLLECTION TRENDS FOR THE FIRST THREE QUARTERS OF

HEALTHY DEMAND,

AND LANDLORDS REMAIN OPTIMISTIC THEY CAN FILL VACANCIES QUICKLY AND PUSH RENTS HIGHER.

2023 OUTPACED 2022 NUMBERS IN THE SAME PERIOD. Source: CoStar Group

Source: Deloitte

After nearly reaching a balance in 2021, net store openings reached their highest point in nine years in 2022, and this positive trend persisted through 2023. The prevalence of store openings surpassing closures in 2022 and 2023 underscores the robust demand for retail space.

According to Mark Sigal, CEO of Datex Property Solutions, the lack of new retail inventory, amplified by a repositioning of enclosed malls that are no longer economically viable, has created increased demand for open-air retal.

WHILE ECONOMIC FORECASTS HAVE INDICATED A MINOR RECESSION IN THE COMING MONTHS, INEVITABLY RESULTING IN A MINOR SLOWDOWN IN CONSUMPTION,

Retail tenants leased just under 59 million square feet in Q2, the lowest amount of space signed in a quarter in over two years. Just 4.9% of total retail space is available for lease as of September 2023, a more than 1.5% decline from the pandemic-era peak and the prior 10-year average for retail availability, according to CoStar Group.

RETAIL FUNDAMENTALS ARE EXPECTED TO REMAIN BALANCED.

THE 10 CONSECUTIVE QUARTERS OF DEMAND GROWTH HAVE PUSHED THE RETAIL MARKET INTO ITS

TIGHTEST POSITION IN NEARLY 20 YEARS, THERE IS LESS SPACE AVAILABLE FOR LEASE NOW THAN AT ANY POINT SINCE NATIONAL TRACKING BEGAN IN 2006.

Source: CoStar Group

82

1031 EXCHANGE INVESTORS Many investors in the net lease retail segment are 1031 exchange buyers who want to get out of managementintensive assets like multifamily or office. Net lease investments are attractive because they provide long-term structures, steady cash flow, and depreciation benefits. Currently, there is a lack of 1031 exchange buyers, creating a void in the market, especially for products in the $2 to $10 million range. However, there has been an uptick in the $10 to $30 million range, sometimes as high as $50 million.

SEGMENTATION IN RETAIL

Retail has undergone several strenuous periods, from an abrupt shutdown of physical stores in 2020, supply chain issues, increasing operating costs, constantly evolving consumer preferences, an insufficient workforce, and constant rate hikes. As such, the net lease retail market has become very segmented. While cap rates have increased, certain property types remain in high demand.

These property types include but are not limited to:

• Gas and Convenience Stores • Dollar Stores • Grocery Stores • QSR • Healthcare

A strong flow of capital has poured into these net-lease spaces, primarily through 1031 exchanges. There are various reasons this influx of capital continues; most specifically, net-lease properties offer limited owner responsibilities, long-term leases, strong credit, and attractive rental increases.

SPOTLIGHT ON DISCOUNT STORES

The recent success of the retail sector can be heavily attributed to the rise of discount retailers, including Family Dollar, Dollar Tree, and Dollar General. These three stores alone account for a third of openings in 2023, adding over 16 million square feet of occupied retail space. The sector’s ability to sustain its visit gains from the pandemic period is a clear indication that discount stores have become a crucial part of the regular shopping habits of many consumers.

NATIONWIDE VISITS | 2023 Source: Placer.ai

DOLLAR TREE

DOLLAR GENERAL

FAMILY DOLLAR

1.12B

993.84M

323.18M

83

RETAIL STORES AND SHOPPING CENTERS ARE EVOLVING TO CATER TO THE CONSUMER PREFERENCE FOR

MULTI-TENANT RETAIL SALES SKYROCKET| INVESTOR’S CHOICE Overall, the outlook continues to look promising for commercial real estate investors. Several junior and big-box anchor stores and grocery operators have disclosed their intentions for expansion. Owners of current multi-tenant retail properties can capitalize on the chance to attract these brands and elevate the value of their centers. Well-situated properties, whether unanchored strip centers or open-air power centers featuring national anchor tenants are expected to remain appealing investments.

A SEAMLESS EXPERIENCE, WHETHER THEY ARE SHOPPING ONLINE OR IN PHYSICAL STORES.

THE RESURGENCE OF RETAIL | IMPACT OF CONSUMER SPENDING

Most recently, there has been a strong push for shopping center owners to unlock hidden value by monetizing outparcels. This is possible by subdividing outparcels on existing shopping centers, which tend to be net lease and trade at a premium. This can occur by signing new outparcel leases or utilizing parking lot space for pickup/ delivery in larger parking lots where parking ratios are still compliant with existing tenant leases and municipal codes.

The vitality of the retail market hinges on consumers’ capacity to spend money and shop at physical retail stores. Once viewed as the cause of retail’s inevitable downfall, e-commerce may be the key to keeping up with rising demand and evolving consumer preferences. Physical retail stores can utilize the benefits of both online and offline channels by effectively incorporating e-commerce into their business models, resulting in a more dynamic and resilient retail environment.

RETAIL OUTLOOK Retail real estate has become a focal point for investors seeking opportunities during retail’s transitional phase. The stabilization of interest rates is a crucial factor that will pave the way for enhanced deal flow in 2024. The shift in the financial environment has the potential to shape a new normal in the minds of investors, fostering a climate of increased confidence in asset pricing and yields. Lastly, as retailers continue to evolve with consumers and find new ways to connect, the retail sector is poised for further expansion and success.

A report from Coresight Research revealed that over 75% of American consumers engage in both online and in-person shopping within two weeks.

This percentage is notably higher among individuals under the age of 45 and those with an annual income exceeding $100,000. In the context of discretionary spending, a mere 7.7% of consumers limit their purchases exclusively to online platforms, highlighting the essential role of physical retail stores in the overall consumer experience. The findings further reinforce the notion that brickand-mortar stores and shopping centers are more effective in encouraging larger shopping cart sizes compared to online marketplaces.

JOSH EIN

josh.ein@matthews.com +1 (301) 971-0207

84

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U N D E R STA N D I N G A PA RT M E N T F I N A N C I N G T H E O PT I O N S AVA I L A B L E FO R B O R R OW E R S I N T H E CU R R E N T M A R K E T

BY G EO F F R EY A R R O B I O The good news is that there remains plenty of liquidity in the market (although at lower leverage points) as market bid-ask spreads continue to be defined.

DEFINING THE MARKET

Over the past couple months, higher market interest rates have affected the multifamily market with several negative outcomes. The increased cost of capital has inhibited multifamily sales as sellers and buyers find risk-adjusted return price discovery due to increasing leverage costs. Buyers are much more reluctant to acquire assets (unless in a 1031 exchange) below borrowing financing costs or negative leverage. For example, buying at a 5.50% cap rate and borrowing at a 6.75% to 7.00%+ interest rate, thus creating negative leverage. As rates stay higher, asset price discovery continues to be reached, although at a slow pace, as sellers and buyers meet at common price offers. On average, multifamily cap rates have increased 60 to 100 basis points since Q3 2022 as buyers adjust their leveraged rate of return thresholds. Cap rate expansion has directly affected asset sales as the industry works through buyers and sellers settling on executable pricing (price discovery).

H I G H E R FO R LO N G E R

As this market cycle evolves, investors await stabilization within the capital markets. Although the Fed has kept rates higher, they announced in the December meeting that interest rate cuts are likely in 2024. However, that’s not to say there may be another 25 basis point hike at the next Fed meeting.

Regardless, pricing for multifamily debt is directly indexed to either Treasury yields, Treasury swaps, and/or SOFR for floating rate loans, plus a spread premium. These indexes are “influenced” by Fed policy but not necessarily directly correlated.

What we do see from investors is patience.

Market uncertainty has led to a “risk off” investor mindset as they wait to see where rates and pricing stabilize, thus affecting transaction values across all asset classes.

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S E L ECT IVI TY I N T H E D E BT M A R K E T

Due to financing economics, borrowers who have loans coming up for refinancing have had to solve for several issues, including lower available loan proceeds, higher rates, and less mainstream capital market players offering financing options (mainly local, regional, and money center banks). Borrowers have found it more challenging to locate lending sources who can offer terms that make sense, thus approaching alternative financing strategies to achieve higher debt leverage, including but not limited to short-term bridge financing structures, mezzanine financing, and/or preferred equity capital sources. All three options have various capital structures, time frames, requirements, and investment hurdles. Borrowers are engaging with these private capital sources rather than adding additional capital to the investment to pay down the loan amount coming due. There remains a bevy of private capital sources within the bridge, mezzanine, and preferred equity capital for multifamily as a wave of loan maturities hit the market over the next 12 to 18 months. New capital sources seem to be entering the market weekly as demand far outweighs supply.

In addition to many market participants waiting on the sidelines, investment capital is being highly selective, not only for debt transactions but for equity investments. The new development segment has seen the greatest impact.

Equity investors have been reluctant to deploy development capital due to several factors:

Rising construction costs

High cost of construction financing Achieving the appropriate risk-adjusted returns over a 3, 5, or 7-year hold period

Debt financing for existing cash-flowing assets has tightened considerably due to increasing rates.

As lenders solve for a 1.25x or better debt service coverage ratio, higher rates have diluted the calculus. This has resulted in the loan constant to calculate the final loan amount to increase by 150 to 200 basis points over the past nine months. A loan that originated in the 5% range over the past two years would have garnered 20% in loan proceeds over a loan originated today in the 7% range, using a 1.25x debt service coverage ratio. As leverage decreases with increasing rates, investment economics have become more difficult to pencil.

We have also seen borrowers utilize “rate buydowns” to achieve higher leverage to refinance their fixed or floating rate loans. Rate buys-downs range between 1% to 4% of the loan amount, allowing the borrower to lower the spread premium with the lender, thus increasing loan proceeds for loan pay off. Most agencies (Freddie Mac and Fannie Mae), life insurance companies, and CMBS lenders will allow for rate buy-downs and have used them frequently over the past couple months. Additionally, borrowers are more apt to secure a shorter-term loan in the hopes of refinancing if and when rates subside. A large majority of borrowers are securing two- to five-year loan terms for this purpose.

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M AC R O F U N DA M E N TA LS O F M U LT I FA M I LY R E M A I N ST R O N G

There is no denying the persistent housing shortage in the country, affecting not only the availability of affordable housing units but also those multifamily renters entering the homeownership marketplace.

Families transitioning from multifamily into single-family are finding it incredibly costly. With interest rates at decade highs, would-be homeowners simply cannot afford the monthly debt service payments and have delayed purchases. Single-family sales have dropped precipitously as those sellers, who locked in long-term interest rates in the 2% to 4% ranges, are reluctant to sell and take on new mortgage debt in the 8% range, thus creating a substantive lack of singlefamily supply in many markets. The single-family home has become more unaffordable today than at any time in recent history, delaying renters’ ambitions of homeownership. Due to these factors, existing multifamily housing, including build-to-rent (BTR) communities, will continue to enjoy solid lease-up, occupancy, and moderate rent growth. However, the velocity of rent growth has subsided in many major markets recently compared to the past 36 months. Some of this is directly attributed to the implementation of municipal rent control in many markets, as renters and politicians lobby for stricter caps on rental housing increases. These measures will eventually lead to less housing; as units become more functionally obsolescent, landlords will have less capital to re-invest in property and unit improvements.

Even with the new inventory coming online in many markets, demand will ultimately outstrip supply. This adds more pressure to the supply side of the equation as many new multifamily projects on the drawing board have been delayed or mothballed due to rising construction costs, available construction financing, and available equity investment in many markets.

WH AT PR OJ ECTS A R E G E T T I N G D O N E TO DAY ?

This leads to the question of what is really getting financed in today’s multifamily markets and at what levels of leverage and cost.

These segments can be broken down into several categories: Stabilized Assets Acquisition/Rehab Bridge Financing Construction Financing

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rents to market upon lease-up. These loans are underwritten to a stabilized net operating income for agency or CMBS take out. However, current market dynamics have prevented most “value-add” deals from penciling as the gap between seller and buyer valuations, cap rates, and high renovation costs remain a challenge. For those projects that pencil, typical underwriting structures can include debt service coverages below 1.0x with a built-in interest reserve for capital improvements, loan-to-costs of approximately 70% and short-term interest rates in the 7% to 9% range. Most lending sources will underwrite to an exit debt yield of 9%, assuring the rehab loan can be refinanced upon stabilization. Due to the inverted yield curve, short-term rates remain 100 to 200 basis points higher than fixed-rate options, including spread premium.

Stabilized Assets

Stabilized cash-flowing multifamily assets continue to be an attractive asset class for most lending sources. Liquidity is readily available via agencies, life insurance companies, banks (even though many have shut down origination departments), CMBS, credit unions, and private debt funds. Underwriting for stabilized multifamily projects within primary and secondary MSA locations are typically underwritten to a 1.25x debt-service coverage ratio (DSCR), 30year amortization (based on asset age and quality), with debt yield metrics between 8.00% to 9.50%, with all in rates between 6.40% to 7.50%. However, due to rate increases that affect higher debt constants and adjusted cap rates, as mentioned above, actual loan to values have dropped as a result. We are seeing actual loan-to-costs come in between 55% to 70% due to the current underwriting calculus. Pending the lending source and sponsor credit quality (global cash flow analysis and sponsor liquidity), loans are either non-recourse with carveout guarantees or come with some form of recourse provisions based on loan risk and sponsor credit.

Within the stabilized cash-flowing asset class, affordable or “mission-based” multifamily assets can achieve much lower interest rates from the agencies (by 15 to 40 basis points) and longer amortization schedules (35 to 40 years) pending the level of rents to area median income (AMI) levels within the submarket. The agencies have large affordable housing mandates to achieve annually, which do not affect their overall market rate lending caps.

Bridge Financing

Bridge financing for multifamily has been highly sought after for assets that either need more time for stabilization or cannot underwrite to a conventional fixed rate option; either the property has not obtained stabilization post construction (remains within the lease-up phase) or the property has a high variable rate loan coming due, and the borrower needs more time to either stabilized the asset or is anticipating rates to come down over time. There are many “bridge-to-bridge” financing structures for existing assets today. The typical bridge structure consists of short-term 12- to 36-month loan terms, typically priced as a variable rate product (although there are some fixed options in the marketplace), between 8% to 10%, interest only, with some form of recourse guarantees. Bridge lenders will typically underwrite to a 9% exit debt yield. Depending on the lending source, borrowers can purchase a rate cap if desired, while some sources do not require caps. Most bridge financing comes with some form of recourse guarantee unless the sponsor has a substantial equity position in the asset.

Acquisition/Rehab

Capital for the multifamily acquisition/rehab segment of the market remains robust, with private debt funds, banks, agencies (pending if the project falls into the affordable category), and certain CMBS shops. Private debt funds and CMBS shops who have the capacity to lend “on book” can underwrite “acquisition with light rehab” loans for borrowers whose business plan is to renovate units and mark

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starter, with loan-to-costs ranging between 55% to 65%, variable rate pricing (either prime or SOFR indices) in the 8.50% to 10% ranges, plus personal or corporate recourse to the sponsor/developer.

Many banks are also requiring GMAX contracts from the general contractor as the cost for lumber, labor, concrete, steel, glass, and fixtures remain volatile. Construction lenders have been caught with insufficient contingency reserves over the past 36 months, as input cost inflation has led to major cost overruns and construction delays. Construction lenders are underwriting to a 9% to 10% exit debt yield upon stabilization, which in turn impedes the overall loan to cost in many instances, forcing many developers to increase their equity requirement for the project.

Construction Financing

Construction financing has been extremely difficult to obtain within this market cycle. Local and regional banks are typically the “go-to” lending sources for multifamily construction needs. Federal regulators have approached most local and regional banks over the past nine months, requiring them to “scale back” on credit, short up deposits, and ensure that sponsors with outstanding current loans have solid global cash flow, stable credit, and ample liquidity. The absence of construction credit has led many developers to approach “private” capital sources. For those construction lenders who remain in the marketplace, underwriting has certainly been constrained for market-rate multifamily projects. Most banks require 10% to 15% of the construction loan amount in deposits as a Commercial/Multifamily Mortgage Bankers Originations Index Source: Mortgage Bankers Association 600 500 400 300 200 100 0

Q1 ’19

Q2 ’19

Q3 ’19

Q4 ’19

Q1 ’20

Q2 ’20

Q3 ’20

Q4 ’20

Q1 ’21

Q2 ’21

Q3 ’21

Q4 ’21

Q1 ’22

Q2 ’22

Q3 ’22

Q4 ’22

Q1 ’23

Q2 ’23

Q3 ’23

*2001 quarterly average = 100

Looking forward, there is a sizable volume of loan maturities coming due within an interest rate environment that is much higher than the past five to 10 years (assuming average loan terms). Below are the actual statistics over the next 48 months.

WH AT WE FAC E I N 2024 — T H E LOA N M ATU R I T I E S WA L L A N D AVA I L A B L E O PT I O N S

Over the past eight to 10 years, available commercial and multifamily real estate debt has been cheap, relative to historical standards, as the Federal Reserve kept the overnight lending rate to a minimum, artificially keeping interest rates low for an extended period of time. Lower debt costs allowed investors to borrow at very low rates and acquire assets with positive leverage (borrowing costs below the purchase price cap rate). During this period, apartments experienced increasing rent growth and new development, as strong demand fundamentals outweighed oversupply in most markets.

Between 2023 and 2027, $980.7 billion in multifamily debt is coming due.

Approximately $1.99 trillion of multifamily mortgage debt outstanding through 2028.

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These loan maturities consist of a mixed bag of short-term variable rate debt (construction financing/bridge loans) that tend to carry two- to three-year terms, in addition to five- to 10-year fixed-rate loans coming up for maturity. For those borrowers who cannot find adequate refinancing proceeds, existing lenders are offering short-term loan extensions to many borrowers; however, these extensions typically include some form of loan paydown if the minimum debt service coverage ratio is not met at the new higher market rates.

Delinquent CRE Loans Hit Highest Level in a Decade CRE Delinquencies of Non-Owner Occupied Property Loans Source: BankRegData $30

$ in Billions

$25 $20 $15 $10 $5 $0

’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23

Borrowers are facing difficult decisions as they must decide how to handle heavier, unforeseen monthly debt service payments due to increased rates. In addition, borrowers with variable rate loans are required to replace their interest rate caps, adding additional cash flow constraints. Borrowers have had to run the math calculations between paying down the loan to refinance with a fixed rate lender or finding a suitable bridge lender that will provide enough proceeds to cover the refinance and allow the borrower more time to execute their business plans at higher interest rates. So, in this context, below are some creative approaches available in the market today.

Rescue Capital Some investors have turned to the preferred equity segment of the market, allowing the property owner to inject new capital via equity recapitalization.

A preferred equity investor can pay down the outstanding debt amount and at the same time buy additional terms without the borrower investing outof-pocket capital.

Extensions By utilizing extension options, borrowers can extend their loan for a year or two. However, this approach comes with risks, including the assumption that interest rates will decrease in the near future, the need for additional equity injection to reduce the lenders’ loan exposure, and efforts to align the loan with the loan-to-value or debt service coverage requirements, potentially requiring additional loan guarantees.

These are structured as a secured interest of the borrowing entity and include a preferred return of 8% to 10% with an overall return between 13% to 18%, depending on the project metrics. Investment terms vary from 24 to 60 months. The exit (preferred equity payoff) is typically a sale unless the property can be refinanced at a future date to generate the preferred equity partner returns.

Refinance Refinancing at current rates with the most competitive financing available is certainly the best option; however, property cash flows (not necessarily value) are the determining factor here.

The unfortunate reality is that rates are higher and property values are lower, so either borrowers are adding additional equity or utilizing rate buy-downs to cover maturing debt.

Full/Partial Sale For borrowers facing an insurmountable debt with impending maturities, selling the asset (even at a loss) can be the best option.

Loan Restructuring This includes modifying loan terms, extending maturities, or temporarily reducing rates, but only if the property is performing and the sponsor maintains creditworthiness by its lender’s loan document standards.

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Upcoming Apartment CMBS Loan Maturities; Maturing Loan Amount, Month by Month Source: CoStar Group

$ in Billions

$5 $4 $3 $2 $1 $0

July ’23

January ’24

July ’24

January ’25

July ’25

January ’26

July ’26

January ’27

July ’27

January ’28

375 - 40 0

40 0 - 425

425 - 450

450 - 475

475 - 50 0

50 0 - 525

525 - 550

550 - 575 0.2%

Rate Cut Probabilities for 2024

Source: CMEGroup FedWatch Tool M E ETI NG DATE

350 -375

1/31/2024

0.0%

0.0%

0.0%

0.0%

0.0%

0.0%

2.1%

97.8%

3/20/2024

0.0%

0.0%

0.0%

0.0%

0.0%

0.7%

32.7%

66.5%

0.1%

5/1/2024

0.0%

0.0%

0.0%

0.0%

0.3%

17.4%

50.3%

31.9%

0.1%

6/12/2024

0.0%

0.0%

0.0%

0.2%

11.9%

39.7%

37.9%

10.4%

0.0% 0.0%

7/31/2024

0.0%

0.0%

0.2%

8.2%

30.8%

38.4%

19.1%

3.3%

9/18/2024

0.0%

0.1%

5.5%

23.3%

35.9%

25.5%

8.5%

1.1%

0.0%

11/7/2024

0.1%

3.0%

15.1%

30.1%

30.3%

16.4%

4.5%

0.5%

0.0%

12/18/2024

2.1%

11.4%

25.5%

30.3%

20.7%

8.2%

1.7%

0.2%

0.0%

The timing of these sales will likely occur at the beginning of Q1 2024. Market volatility often brings opportunity for the opportunistic investor with a three- to 10-year investment horizon. Accumulating assets over the next 12 to 24 months could end up being excellent timing for long-term cash flow and appreciation.

O UT LO O K

In conclusion, the long-term viability of multifamily and the build-to-rent sector as an asset class remains very positive, as the demand for housing will continue unabated for years to come. Assets in strong primary and secondary locations should retain considerable value compared to other asset classes with moderate rent growth, pending submarket fundamentals. Liquidity will be readily available, although less robust than in the past, and at higher rates than most investors have had experience with over the recent past. However, moving forward, the market should see rates stabilize (with the Federal Reserve slowing or ceasing to raise rates further), allowing for price discovery, cap rate adjustment, and fresh capital to enter the market.

Volume of Maturing CRE Debt by Lender Type Source: RCA $500

$ in Billions

$400 $300 $200 $100 $0

There are silver linings that come with all real estate cycles. For those who are entering the multifamily market for the first time, have a contrarian investment outlook, or are simply redeploying fresh capital, there should be plenty of investment opportunities over the next 12 to 24 months where investors are able to acquire assets at much lower basis levels, as banks and bridge lending sources start to unload non-performing assets.

’23

’24

’25

’26

’27

’28

’29

’30

CLO CMBS Investor-Driven Private Insurance International Bank Government Agency National Bank Regional/Local Bank

G EO F F R EY A R R O B I O

geoffrey.arrobio@matthews.com +1 (310) 308-4116

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Listen Now on 93

The Repurposing of the

American Mall

By Daniel Thompson

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First introduced in 1956 in Edina, MN, the shopping mall became a cornerstone of the American retail experience. Malls captivated shoppers, offering a vast array of goods in a centralized location and cultivating a cultural phenomenon. Over the years, changing consumer preferences and the strength of e-commerce pivoted shoppers away from traditional malls, leaving owners and developers with empty square footage. However, malls are making a comeback, but not in the traditional sense. Owners and developers are getting creative, redefining a mall’s purpose through strategic repositioning.

Occupancy Rate of U.S. Malls

Source: Coresight Research & Statista

98% 95.2% 95.5% 95.1% 96% 91.6% 92.8% 94% 94% 92% Estimated 90% 88% 92.7% 91.6% 86% 87.3% 89.6% 89.1% 84% FY18 FY19 FY20 FY21 FY22 FY23 ■ Top-Tier Malls ■ Non-Top-Tier Malls

The Fall from Grace

Shopping mall fundamentals were declining pre-pandemic, and the onslaught of COVID-19 exacerbated the sector’s challenges even further.

Vacancy rates rose throughout the mall sector, and anchor tenants, once considered “safe,” began shutting their doors. Nordstrom, Macy’s, and JCPenney closed a large number of their stores, while other well-known anchors such as Barney’s and Lord & Taylor shut down operations entirely. The empty anchor spaces’ enormity didn’t fit modern retailers' needs or vision, leaving thousands of square feet bare, burning a hole in the owner’s pocket.

Once quintessential to a mall’s foot traffic,



Top-Tier Malls feature luxury retailers and newer direct-to-consumer (DTC) brands; often located in more affluent areas where a typical shopper has an annual income of over $200,000.



Mid-Tier Malls have anchor retailers and fewer vacancies; located in moderately affluent neighborhoods where a typical shopper has an annual income of around $100,000.



Low-Tier Malls have at least one, and sometimes two or more empty anchors, declining sales, and a less-affluent customer demographic.

anchor tenants are exiting the market rapidly.

Although all malls saw a decline in performance in 2020, there has been a significant variation in performance throughout the sector since then.

Class A malls rebounded quickly post-pandemic and continue to report relatively strong rent growth and lower vacancy rates compared to Class B and Class C malls. On average, U.S. malls reported a lower rate of 3.1% annual rent growth in Q4 2023, according to CoStar Group. Top-tier malls are seeing more positive rates in terms of occupancy as they attract and retain profitable tenants. Due to low foot traffic or a less desirable location, mid to low-tier malls often cannot attract newer brands that bring in either higher-end or a younger customer base, increasing their vacancy rates.

The average vacancy rate for all U.S. malls in Q4 was 8.5% , although malls with one or two anchor vacancies reported a much higher rate.

While shopping malls face challenges, there are several positive attributes to the industry. According to ICSC, retail expenditure at malls grew 11.2% from 2021 to 2022, and 12.9% of U.S. consumer spending went through malls in Q1 2023, helping indoor malls achieve higher sales productivity compared to more modern, open-air complexes. In addition, retail development is limited, so new deliveries are not a threat to the sector. The dominance of e-commerce is weakening as consumers return to in-person shopping. E-commerce only accounted for 15.6% of total retail sales in Q3 2023, reported by the U.S. Census Bureau, meaning there is plenty of capital for malls to capture.

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Live.Work.Play The modern renter is looking beyond an apartment’s location or square footage, instead focusing on the lifestyle an apartment can offer.

Mall developers and owners have taken advantage of this trend by repurposing older malls into mixeduse developments that feature multifamily, retail, office space, and entertainment in one location.

These models cater to a larger audience, providing an experience rather than just a place to shop.

Often, live.work.play centers offer social gathering areas in beautiful courtyards, local’s favorite eateries, and an entertainment-focused tenant.

Trampoline parks, go-karting raceways, interactive museums, luxury bowling alleys, etc. are popping up in mixed-used complexes, as they successfully bring Gen Zers to the property and encourage consumers to stay longer. The ability for renters to eliminate their commute to work, and the city’s best restaurants, shops, and activities creates a mix of leisure and business that is highly desirable to the modern consumer.

Pivoting with Purpose

The headlines spuing that the traditional mall is dying aren’t necessarily accurate. Not all shopping malls are dying; many are adapting and innovating to move into the next era of retail. Owners and developers are listening to consumers and pivoting the aged idea of what a mall looks like and what a mall offers through strategic redevelopment and repurposing.

Nearly 2 in 3 (61%) Americans want to see a revival of the shopping malls.

Source: IPX 1030

Medtail There is a consistent increase in the amount of retail space being leased to healthcare tenants. To combat vacancies, owners are opening spaces to brands outside of traditional retail, such as urgent cares, med spas, clinics, and more. Typically, healthcare tenants take up smaller tenant space as a compliment to an anchor, but some companies found success by replacing anchor tenants to accommodate larger facilities. For example, Novant Health acquired the former Sears building at HanesMall in Winston-Salem, MA, opening an 18,600-square-foot freestanding orthopedic clinic in its place. Co-locating healthcare and retail brings in an additional customer base, increases accessibility to healthcare, and strengthens food services within the mall. To note, the cost of repurposing into healthcare is often higher at $200 to $300 per square foot as they require more specialties than retail buildings, according to a report by ICSC.

Almost two-thirds of Gen Z consumers say

they go to malls for the social aspect, not for any specific product.

Source: ICSC

20% of leased medical space was in retail in 2022, compared to 16% in 2010.

Source: RealDeal

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Boxing Small Shop Space Another successful approach to repurposing underutilized space is boxing, a strategy where owners create larger spaces within the mall by combining small shop space that is harder to fill.

Typically, malls have a combined small shop space of 250,000 to 300,000 square feet, but fewer small shop space tenants are looking to lease within traditional malls. So, by sectioning off the square footage into a larger format, the owner now has less small shop space for lease and can attract large shop space tenants who may not typically consider leasing in a mall, diversifying the portfolio.

Replacing Anchors The massive space left behind by former anchors created a severe issue for mall owners. Over the last few years, owners have found repurposing the anchor buildings for multifamily or hospitality use a successful approach. Converting big box stores into apartments or hotels is a sustainable solution to the large quantity of square footage and attracting new generations of shoppers. Hotels bring in additional revenue from tourists, and multifamily brings a builtin customer base. It’s important to note that when replacing anchors, owners must research to ensure the current tenants match the demographics of the desired renters or tourists.

What the Future Holds

A 200-room hotel with an average 70% occupancy rate and an average stay of 2 nights per guest and 1.25 guests per room will

With the current economy suggesting a softening in consumer spending, mall fundamentals will likely tighten next year. Class B and Class C will struggle most to attract and retain profitable tenants, whereas Class A malls will remain resilient. In-person shopping is predicted to stay as consumers practice the “halo effect,” where they research their favorite items online but visit a physical store to purchase said items. Brands are seeing the benefits of having both an online and physical presence, helping malls stay relevant and competitive within the retail space.

This year will be difficult as interest rates remain elevated, but there are opportunities for owners and developers to continue to innovate. Overall, the great American shopping mall is undergoing metamorphosis, transforming its exterior and proclaiming a new purpose.

generate approximately 32,000 potential unique visitors to the mall.

Source: Intalytics

If an owner is unable to replace anchors with viable tenants, converting the space for a different use is a good alternative. Many older malls have been redeveloped into warehouse space, helping the community add industrial space without the negative environmental effects new construction can have.

Daniel Thompson

daniel.thompson@matthews.com +1 (813) 358-3420

97

EXPLORING TOP TRENDS & TENANT EXPANSION PLANS

BY G E N E M E L L O , C A T H E R I N E L U E C KE L , & M I C H A E L P A K R A VA N The U.S. retail real estate market proved its resilience in 2023 despite persistent worries of an economic slowdown, staffing hurdles, and the influence of increasing interest rates. Retailers have seized opportunities to broaden their presence, embrace inventive tactics, and harness shifting consumer trends to distinguish themselves from the competition. This resilience can be attributed to the retail sector’s flexibility and adaptability. As the retail landscape continues to transform and consumer purchasing behaviors evolve, tenants are competing to secure their spot on investor and developer rosters. This article delves into top retail trends, spotlighting certain tenants and their expansion plans.

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R E TA I L TR E N D S T O W A T C H I N 2 0 2 4 LIVESTREAM SHOPPING Brands have begun utilizing livestream shopping to promote and sell products via digital channels. This is usually done by partnering with popular influencers. Services such as TikTok and Amazon are spearheading the introduction of livestream shopping, offering a new way for retailers to connect with their customer base. This highly interactive shopping experience facilitates tailored suggestions, culminating in a distinctive and captivating shopping atmosphere.

In 2024, the retail sector will be defined by greater digitization, customization, and efficiency. As these trends progress, they will unquestionably offer both prospects and hurdles for retailers across the globe.

CYBER SHOPPING SURGE The ongoing surge in online shopping is a pivotal trend that is set to shape the retail environment in 2024. With a substantial rise in the number of individuals leveraging online shopping, retailers are investing in their e-commerce systems. This expansion represents a fundamental transformation in how consumers make purchases, propelled by online vendors’ convenience and diverse choices.

SELF-CHECK OUT As a result of staffing shortages and evolving customer preferences, the retail industry is experiencing a technological revolution. A recent Forbes survey indicates that 66% of in-store shoppers prefer non-conventional checkout experiences that allow them to shop at their own speed. The self-service trend initially gained momentum during the pandemic, and now, amid a persistent labor shortage, numerous retailers are enhancing their capacity to deliver self-service experiences.

Despite e-commerce becoming more prevalent, brick-and-mortar stores are here to stay and are utilizing online shopping to their advantage.

Through curbside or in-store pickup, retail stores can speed up online shopping by allowing the customer to obtain their purchase much quicker than waiting for it to arrive through the mail. This process enables retailers to leverage e-commerce while achieving product delivery speeds that surpass what’s achievable for businesses solely focused on e-commerce.

Some self-service examples in retail include:

OMNICHANNEL RETAILING Prominent retail entities such as Walmart and Target have been pioneers in omnichannel retailing, providing patrons with a unified shopping experience whether they are physically in a store, using a mobile application, or navigating a website. This tactic elevates customer satisfaction and loyalty. According to data from Marketing Dive, 82% of purchasing decisions are made while in-store, and 62% of shoppers make an impulse buy while shopping.

Retailers adept at targeting consumers through digital channels can anticipate significant sales growth. Their proficiency extends beyond boosting e-commerce sales; it enables them to drive consumers to their physical stores as well.

SELF-SERVICE KIOSKS

SCAN-AND-GO TECHNOLOGY

AUTONOMOUS STORES

SHRINK-TAIL Despite observing more store openings (approximately 3,300) than closures (around 2,600) up to August 2023, numerous retailers are progressively reducing the square footage of their store footprint, resulting in a net

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decrease in overall space. Pharmacies are an example of this trend. Although the sector has experienced favorable sales volume over the last 12 months, smaller format stores started becoming the preference among consumers, landlords, and tenants. In addition, some retailers are capitalizing on in-store collaborations, reducing the tenant’s available space to accommodate an in-store partner. Instore collaborations can attract more customers into the retailer’s space by bringing together various customer bases.

R E S TA U R A N T S The restaurant industry faced severe challenges during the COVID-19 pandemic, and its recovery was further hindered by the onset of inflationary pressures in 2022. However, in 2023, there was a noticeable turnaround, as foot traffic gradually returned to pre-pandemic levels, with a significant uptick in Q2 2023. This resurgence was particularly evident in the growing demand for sit-down dining and quick service restaurants (QSRs).

A notable development within the QSR space is the emergence of digital-only restaurants. These establishments have made technology a focal point of their operations, introducing self-service kiosks and food-preparation robots in back-of-house operations. Similarly, casual dining restaurants are embracing technology by enhancing operations and client experience through mobile apps and loyalty programs. They are also offering more self-serve options, incorporating tabletop tablets while still maintaining the presence of waitstaff.

AVERAGE SIZE OF NEW RETAIL LEASE IN SF Source: CoStar Group 4,500 4,000 3,500 3,000

2 ’2

’2 0

’18

’16

’ 14

’ 12

8 ’0

’10

6

2,500

’0

Square Feet

5,000

Fast-casual restaurants are rising nationwide, attracting consumers with their efficient dining experiences. A notable addition to this trend is the emergence of to-go-only storefronts. For instance, Buffalo Wild Wings introduced “BWW GO – Wings On The Go,” which provides customers with three ordering options: online, through the app, or at the counter.

Data from Placer.ai has shown Taco Bell is the most visited restaurant in the nation, closely followed by Chipotle and Texas Roadhouse. With the brand’s continuous expansion plans across the Sunbelt, Whataburger also captured industry attention.

RANKED RESTAURANT CHAINS BY TOTAL VISITS Source: Placer.ai

100

NAME

TOTA L V I S IT S I N 2 02 3

U. S . LO C ATI O N S A S O F Q 4 2 02 3

Taco Bell Chipotle Texas Roadhouse Olive Garden Applebee’s Chili’s Buffalo Wild Wings Cracker Barrel Waffle House Denny’s

506.63M 295.35M 291.92M 280.22M 276.12M 244.02M 225.74M 217.02M 172.69M 169.91M

6,702 2,836 621 889 1,527 1,189 1,112 662 1,943 1,367

TACO BELL In a recent press release, the QSR chain declared its ambition to operate a total of 10,000 stores across the U.S. in the upcoming years. This strategic vision encompasses restaurant concepts that prioritize digital integration and prioritize consumer experiences. In March 2023, the company also launched its “Go Mobile” concept: small, digital-first locations. According to the Taco Bell press release, “This concept was created to provide solutions for an industry-wide problem – drive-thru bottlenecks – by eliminating the indoor dining area and adding dedicated parking for mobile and delivery orders with an outdoor pickup window and grab-andgo shelves. The newest addition just opened in Columbus, Georgia, and elements of this restaurant will be incorporated into future builds.”

CHIPOTLE In Q1 2023, Chipotle opened 41 new restaurants, with 34 locations including a Chipotlane. The company also has plans to open new 100% sustainably-powered restaurants, decarbonizing its supply chain and investing more resources into local and organic produce. The program’s primary goal is to help the company cut both direct and indirect greenhouse gas emissions by 50% from 2019 to 2030.

Chipotle properties are usually close to large shopping malls, university and college campuses, and business districts. The restaurants typically have a 2,000 - 3,500 square foot facility and are located on 0.50 - 1.00 acres of land. Depending on the location, some Chioptlanes have no dining room, while others are the same size and layout as the original restaurant. Chipotle net lease properties are long-term investments that require no property management. The lease period is typically a 15-year NNN ground lease with four, five-year options with 7% - 12% increases every five years. Chipotle leases are also corporately guaranteed.

In addition to increasing its digital presence, Taco Bell continues to enrich its customers’ experiences by extending the reach of its Cantina restaurants.

Each Cantina is thoughtfully designed to harmonize with its surroundings, featuring contemporary urban aesthetics, open kitchen layouts, and a selection of alcoholic beverages. The latest Cantina locations are equipped with state-of-the-art technology to ensure that both customers and employees enjoy the best possible experience. Taco Bell plans to introduce the Cantina concept in Indianapolis and Downtown Los Angeles.

CHIPOTLE VISITS (YOY)

TACO BELL VISITS (YOY) 10%

40M

5%

30M

0%

20M

-5%

10M

-10%

0

-15%

YOY Change

2023 Number of Visits

40%

25M

30%

20M

20%

15M

10%

10M

0%

5M

-10%

0

-20%

Ja n.

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23

50M

% Change (YOY)

15%

YOY Change

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23

60M

Ja

Visits

Source: Placer.ai

30M

% Change (YOY)

Visits

Source: Placer.ai

2023 Number of Visits

+5.96% VISITS

2022 Number of Visits

December 2023: 23.79M December 2022: 22.45M

-2.17% VISITS

December 2023: 41.37M December 2022: 42.29M

101

2022 Number of Visits

CO F F E E S H O P S Large coffee chains and established brands have traditionally dominated the market, making it challenging for new entrants to prove themselves.

However, the emergence of small coffee shops with smaller square footage, around 800 square feet compared to the traditional 2,000 square feet, has disrupted the industry by offering a distinct value proposition that sets them apart from the competition. These new coffee shops are centered around convenience, with drive-thrus and mobile orders taking the spotlight.

TEXAS ROADHOUSE According to the Dallas Morning News, Texas Roadhouse is the world’s fastest-growing restaurant brand, worth more than $2.3 billion, an increase of 56% in 2023. This unprecedented growth comes as a result of the company’s extensive expansion strategy. Currently, the chain includes about 700 establishments and intends to reach 900 locations in the upcoming years. Texas Roadhouse’s expansion strategy focuses on smaller markets with populations of 40,000 - 60,000 people and has seen more pronounced success in these smaller markets with more receptive consumers.

Starbucks is following this same trajectory of downsizing its stores’ footprints to cover approximately 900 square feet. These compact stores have demonstrated impressive results, attracting around 15% more visitors per square meter than their larger counterparts, typically 2,500 square feet. Similarly, Dunkin’ stores average about 750 to 3,100 square feet, while Dutch Bros. coffee locations, known for their compact size, have an average footprint of 950 square feet.

Texas Roadhouse’s success can be attributed to its investment in technology, which has significantly attracted and retained customers. In most of its locations, the chain offers Roadhouse Pay, allowing guests to pay their bills at their own speed. The restaurant also allows guests to place themselves on a waitlist prior to going to the restaurant, significantly reducing in-restaurant wait times.

Starbucks’s anticipated global store expansion rate is around 7% annually from 2023 - 2025, with a projected 10% increase in revenue during the same timeframe. The corporation indicated that its expansion efforts will be primarily focused within the U.S., where the chain is currently established with 15,650 stores. Starbucks also mentioned that specialized store formats, like drive-thru and curbside pickup, are projected to contribute to an annual net increase in store count of 3% - 4% within the country, equating to roughly 2,000 new stores in the U.S. by 2025. Starbucks plans to open these new locations in growth markets, including cities experiencing population growth or up-andcoming neighborhoods.

TEXAS ROADHOUSE VISITS (YOY) 20%

25M

16%

20M

12%

15M

8%

10M

4%

5M

0%

0

-4%

% Change (YOY)

30M

Ja n.

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23

Visits

Source: Placer.ai

YOY Change

2023 Number of Visits

2022 Number of Visits

+9.83% VISITS

December 2023: 26.86M December 2022: 24.45M

102

According to Placer.ai, the Starbucks locations with the highest amount of total visits in 2023 include:

H O M E I M P R O VE M E N T According to Yahoo Finance, in 2020, the U.S. home improvement market was valued at $419.8 billion and is anticipated to grow at a compound annual growth rate (CAGR) of 4.47% from 2022 - 2026 to achieve a market value of $537.47 billion by 2026.

SAN DIEGO, CA (433K VISITS)

The expansion of the home improvement market can be linked to an increasing inclination towards renovating and enhancing both the interiors and exteriors of homes. During the COVID-19 pandemic, several people began making home improvements to pass the time, significantly benefiting home improvement stores nationwide. Furthermore, the recent change in consumer preferences towards energy-efficient and luxurious residences is anticipated to provide additional momentum to the growth of the market over the next five years.

Although this trend has slowed since 2020, home improvement stores will remain stable investments, given the countless at-home projects people take on daily.

MAKAWAO, HI (441.1K VISITS)

WAIPAHU, HI (429.7K VISITS)

STARBUCKS VISITS (YOY)

80M

15%

60M

10%

40M

5%

20M

0%

0

-5%

-20M

-10%

RANKED HOME IMPROVEMENT CHAINS

BY TOTAL VISITS Source: Placer.ai

Ja

n.

F e ’ 23 b.

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23

20%

Visits

100M

% Change (YOY)

Source: Placer.ai

YOY Change

2023 Number of Visits 2022 Number of Visits

-4.71% VISITS

December 2023: 83.91M December 2022: 88.05M

NAME

TOTA L V I S IT S I N 2 02 3

The Home Depot Lowe’s Menards Tractor Supply Co. HomeGoods Ace Hardware Harbor Freight Tools IKEA At Home

1.38B 1.01B 256.85M 213.57M 198.16M 184.17M 152.23M 69.18M 64.03M

According to Placer.ai, the top three most visited chains include The Home Depot, Lowe’s, and Menards. Harbor Freight, a company listed in the top 10 of this list, was also named one of the fastestgrowing retailers on the National Retail Federation’s “Hot 25 Retailers List.” In 2022, Harbor Freight Tools expanded by opening 122 new stores, resulting in a total of over 1,400 locations across the nation.

The company plans to continue their store expansion in 2024.

103

KROGER Kroger intends to introduce its new and innovative concept, The Marketplace, in Clarksville, TN, representing a significantly larger grocery store designed to compete with retail giants like Target and Walmart. The Marketplace is set to encompass 123,000 square feet, which is 50,000 square feet larger than a standard Kroger grocery store and roughly three-quarters the size of a Walmart Supercenter. The Kroger Marketplace will have expanded offerings, including clothing, appliances, home goods, furniture, electronics, toys, and jewelry.

The new concept will also include in-store dining and coffee shops. If everything goes according to plan, Kroger envisions the start of construction in early 2024, and the grand opening is projected for sometime in 2025.

GROCERY-ANCHORED Despite today’s challenging market for deals and financing, grocery-anchored shopping centers have found their place with investors. The industry is bullish on grocery-anchored centers and views them as a buffer from economic headwinds due to the necessity of goods they provide – food. This has translated to frequent, consistent visits, higher foot traffic, and immunity from disruptors and market headwinds.

Grocery-anchored centers have joined the darling asset classes of industrial and multifamily as a favored place to plant capital. Investors are targeting these properties as traffic to grocery stores has increased, and shoppers walk through the door’s week-after-week. For example, some of Westwood’s largest centers have clocked six million visits a year.

New investments in grab-and-go food options have generated more traffic and returning shoppers.

ALDI ALDI, the discount grocer, has announced its plans to acquire the Winn-Dixie and Harveys Supermarket chains from Southeastern Grocers, a significant move that has caught the industry’s attention. This acquisition, which encompasses around 400 grocery stores across five Southeastern states, marks a bold step in ALDI’s aggressive growth strategy. In addition to this acquisition, ALDI also plans to have 2,400 operating stores by the end of 2024.

RANKED GROCERY CHAINS BY TOTAL VISITS Source: Placer.ai

NAME

TOTA L V I S IT S I N 2 02 3

Kroger Publix Safeway ALDI H-E-B Walmart Meijer Food Lion Grocery Trader Joe’s Shop Rite

1.05B 956.09M 591.40M 529.75M 487.68M 458.46M 433.78M 418.41M 363.21M 319.78M

104

ULTA BEAUTY Ulta Beauty has dedicated substantial efforts to augmenting its beauty and skincare offerings through the introduction of GLAMlab. This innovative feature serves as a means for prospective customers to sample products virtually before making a purchase, aiming to engage and convert potential customers by offering a virtual beauty shopping experience. Ulta’s CEO, Dave Kimbell, has stated that the company plans to focus on growth through multiple channels, digital platforms with virtual try-on makeup and hairstyles, supported by digital stores to fill orders anywhere.

BEAUTY & SPA After a strong rebound following the COVID-19 pandemic, the beauty and spa industry is projected to reach $580 billion by 2027, with an anticipated annual retail sales growth of 6.0%, according to the Global Cosmetic Industry.

Top beauty and spa tenants, according to Placer.Ai, include Ulta Beauty, Great Clips, and Bath & Body Works. It’s worth highlighting Sephora as well, given the significant expansion plans the company has enacted over the last couple of years.

Ulta’s most visited locations, in 2023, according to Placer.ai, include:

RANKED BEAUTY & SPA CHAINS

BY TOTAL VISITS Source: Placer.ai

NAME

TOTA L V I S IT S I N 2 02 3

Ulta Beauty Great Clips Bath & Body Works Sports Clips Super Cuts Sephora Sally Beauty Supply Massage Envy Sola Salon Studios European Wax Center

179.46M 108.81M 107.64M 43.03M 37.16M 35.50M 35.29M 26.67M 22.34M 21.87M

PENSACOLA, FL (468.8K VISITS)

MAYWOOD, NJ (433.9K VISITS)

SOUTH PORTLAND, ME (427.8K VISITS)

105

SEPHORA The introduction of Sephora at Kohl’s took place in 2021, and as of Q4 2023, there are more than 850 Kohl’s stores with a Sephora. In the autumn of 2021, Kohl’s launched 200 stores, and this was followed by an additional expansion of 400 more locations during the summer.

Sephora also stepped up its digitization strategy with the launch of SEPHORiA: House of Beauty in September 2023. The event took place through virtual reality and allowed visitors to create their own avatars to experience new social touchpoints, chat live with Sephora Beauty Advisors, and play games.

WHAT DOES THIS ALL M E A N F O R CR E ?

Consumer preferences are going to continue to change. Right now, optimizing the consumer experience is the name of the game. Retailers and landlords who understand how to create environments with amenities that focus on immediacy and convenience will be the most successful. Whether this is done through increased digitization, personal shopping, or updated layouts, these trends all have one thing in common – they focus on the consumer experience. Consumers want options in this modern world, and they are going to be attracted to the tenants that provide the most convenient and efficient ones. The retailers mentioned are essential for landlords to know as they are doing well with consumers and will be excellent additions to tenant line-ups. For fellow retailers, knowing what tenants are doing well can serve as a reference point as to which strategies consumers are drawn to.

GENE MELLO

gene.mello@matthews.com +1 (619) 270-1173

C A T H E R I N E L U E C KE L catherine.lueckel@matthews.com +1 (216) 503-3596

M I C H A E L P A K R A VA N michael.pakravan@matthews.com +1 (310) 919-5737

106

Navigating the Inflation Landscape KEY METRICS FOR CONSIDERATION

by B r ian B r ady

Inflation is the topic of discussion as a historic series of rate hikes by the Federal Reserve Open Market Committee (FOMC) have produced economic stagnation. Commercial real estate is heavily dependent on leverage and is negatively impacted during stagnant economic periods — property values decrease, and debt becomes increasingly expensive. Today’s landscape has investors trying to navigate this uncertain market and understanding inflation is critical.

What trends or data should investors focus on when it appears that prices of consumer goods are rising and show no signs of slowing down? The three inflationary measures that accurately depict the market include the Consumer Price Index (CPI), Core CPI, and Shelter Costs. When investors dig into the data, they will see that there is light at the end of the tunnel.

107

CPI vs. Core CPI CPI is used to identify periods of inflation and deflation. Significant rises in CPI within a short time frame may suggest a period of inflation, whereas rapid declines in CPI may indicate a period of deflation. However, since CPI incorporates variable food and oil costs, it may not be the most accurate measure of inflationary and deflationary times.

Consumer Price Index

Source: U.S. Bureau of Labor Statistics

9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2%

Consumer Price Index (CPI)

Goods & Services by Relative Importance Source: U.S. Bureau of Labor Statistics

Housing (42.6%) Shelter, utilities, heating fuel, furniture, appliances, household supplies, trash collection, repairs, etc.

Transportation (15.3%) Cars, fuel, public transit

Recently released data from the BLS has shown that while CPI has significantly moderated, Core CPI has not. As of December 2023, CPI stands at 3.1%, down from 9.1% in July 2022. Core CPI is 3.99%, down from 5.9% in June 2022. The stubborn, largest weighted component of Core CPI is “shelter.” While all other commodities of Core CPI have significantly moderated, shelter costs are the reason why CPI has not dropped to the FOMC’s targeted inflation rate of 2.0%. This inflation target acknowledges the challenge of accurately measuring inflation, as there is often an inherent upward bias in inflation calculations. Having a slightly positive inflation target allows central banks like the Fed to lower interest rates to stimulate the economy during recessions and acts as a safeguard against harmful deflation.

Food & Beverage (14.6%)

Education & Communications (7.0%) Computers, college tuition, cell phones, internet Recreation (5.7%)

Medical Care (8.6%)

’00 ’02 ’04 ’06 ’08 ’10 ’12 ’14 ’16 ’18 ’20 ’22 ’23 ■ All Items ■ All Items Less Food & Energy

Apparel (3.0%)

Other Goods & Services (3.2%) Including legal services Core CPI is frequently utilized for a more accurate identification. Core CPI excludes volatile items such as food and energy prices, focusing on an economy's underlying and more stable inflation trends.

Why do multifamily owners need to pay attention to these numbers & their impact on CRE? Rent and Lease Agreements: Commercial leases often include provisions for rent adjustments based on changes in the CPI. Understanding CPI fluctuations is crucial for property owners as it can impact their rental income.

Financial Planning: Commercial property owners use CPI data to assess their financial planning.

Understanding the rate of inflation, especially core CPI, can help owners make more accurate projections for their expenses and revenues.

Market Conditions: This information is valuable for commercial property owners as it can help them anticipate significant market shifts such as rising cost of capital and cap rates. Understanding the complete picture and what to do when rising interest rates make borrowing more expensive helps investors make informed decisions regarding property management, leasing, and investment.

Investment Decisions: Commercial real estate owners often invest in various financial instruments, including bonds and securities. CPI and Core CPI can impact the performance of these investments, so staying informed is essential for optimizing investment strategies.

108

Shelter

Inflation

Shelter Inflation

The intricate economic landscape hinges on the trajectory of shelter inflation, which influences...

Shelter, which accounts for roughly one-third of CPI, is calculated by the BLS by examining changes in actual rents and owners' equivalent rent. Owners’ equivalent rent is a survey-based estimate of how much homeowners believe they could earn by renting out their homes. The surge in shelter costs, encompassing housing and rental rates, significantly contributed to the rapid escalation of property values and rents from the start of the pandemic in 2020 to the present day. This has led to a notable increase in net operating income (NOI).

over all inflation, overall inflation, interest ates, interestrrates, and financing financing dynamics. dynamics.

The BLS September CPI summary states that the index for shelter was the largest contributor to the monthly all-items increase (CPI), accounting for over half of the increase. Shelter was also the largest factor in the index for all items, less food, and energy. The shelter index increased 0.4% in November, after rising 0.3% the previous month.

Though increasing NOI can be highly beneficial to multifamily owners, the surge in shelter costs has been a prime contributor to the inflation that prompted the Federal Reserve to raise interest rates to cool the economy. The sequence of interest rate increases elevated mortgage rates to nearly 8.0%, abruptly halting the previously booming pandemicdriven housing market. Consequently, commercial real estate financing rates have climbed, making refinancing exceedingly tricky for many.

109

The researchers' models provide a broad spectrum of potential changes, predicting that YOY shelter inflation in late 2024 could range from -9.0% to the targeted 2.0% in their baseline model. It's worth noting that even the highest estimate represents a deceleration of inflation. Keep in mind these projections assume that there won’t be any additional unexpected disruptions to the system.

A Light at the End of the Tunnel Several experts have predicted that the U.S. could experience the most severe reduction in housing inflation since the Global Financial Crisis of 2007 to 2009, according to a recent report by researchers at the San Francisco Fed. The report suggested that the shelter cost inflation peaked in April 2023 at around 10% on a year-over-year (YOY) basis. Though still high compared to historical norms, shelter costs are expected to decline at the beginning of 2024, and there's a chance it could even dip into negative territory by mid-2024, positively impacting Core CPI. Such a development would signify a dramatic reversal in shelter inflation trends, with significant implications for the overall inflation landscape.

With projections of lowering shelter costs to the target 2.0% by mid-2024 and may even go negative

by Q3 2024, the Fed will likely refrain from an additional rate hike, and the burden of shelter inflation will soon be significantly alleviated.

Overall, CPI and its components can notably impact commercial real estate by influencing inflation rates, loan rates, building prices, and a region's general economic health.

Shelter Inflation & Market Indexes Source: Federal Reserve Bank of San Francisco

The Federal Reserve Bank of San Francisco forecasts that shelter inflation in 2024 can fall anywhere

150 130 110

between -9% to about 2%

90

Regardless, shelter inflation is expected to experience a notable slowdown this year.

80

’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23 ■ Case-Shiller HPI ■ CoreLogic SFRI ■ Zillow ORI ■ Apartment List RI ■ CPI Shelter Inflation

110

Considerations for CRE In certain commercial real estate leases, CPI serves as a mechanism to reasonably adjust a tenant's rent by linking their base or additional rent to fluctuations in the national or regional CPI, effectively connecting rent to the corresponding inflation rates at national or regional levels. Although this practice is uncommon, it does occur, particularly in government leases. It's important to note that not all leases with CPI adjustments experience an annual increase. Some leases may feature adjustments on a calendar year basis or at specified mid-term intervals, while others may include limits or minimum thresholds for CPI increases. The uncertainty surrounding the exact CPI adjustment at the beginning of the lease will often lead to it being overlooked in calculating leasing commissions.

Commercial real estate investors rely heavily on debt to purchase properties. High-interest rates are making it harder to acquire or maintain properties at current prices. Recently, Guggenheim Investments, a global investment advisory firm, believes the FOMC could cut rates as much as 1.5% in 2024, with more cuts coming in 2025. If the San Francisco Fed and Guggenheim are correct in their predictions, debt rates could drop from the current 7s to somewhere in the 5s again.

While ambitious, any relief would be welcome to lubricate this clogged market.

Brian Brady

brian.brady@matthews.com +1 (813) 489-6197

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