ConradsNotes On the Economy and CRE Market (June 6th, 2023)

ConradsNotes On the Economy and CRE Market (June 6th, 2023) “The only person you are destined to become is the person you decide to be.” – Ralph Waldo Emerson

By Conrad Madsen, SIOR

Co-Founder & Partner

Paladin Partners

Dallas, TX

[email protected]

The following is an overview of my notes from my recent conversations with commercial real estate professionals, speaking engagements, industry events, earnings calls, and research & economic reports.

MacroEconomic:

• Slowing economy, real GDP growth of 1.1% last quarter
• Consumer spending and sentiment is down and will trend in that direction through 23’.
• 3 of the 4 largest bank failures in US history took place over the last couple months.
• Regional banks have massive exposure to loan maturities of office and retail properties, this will fuel continued bank failures.?
• Job growth continued in April, unemployment now at 3.4%
• Vs. 2001 & 2009 Recessions, this one is taking a long time to play out.
• Construction Costs are down 5-15%
• Container Shipping Costs are down from $11k per container in Fall of 21’ to $1500 per container now.?

Banks/Interest Rates/Debt:

• CRE accounts for 23% of ALL bank loans - $2.8 Trillion
• CRE Loans account for 44% of all loans at smaller regional banks.
• Big 4 Bank – 90% of real estate loans will not get paid back this year.?REALLY HIGH NUMBER
• The Banking Crisis is just beginning.
• Might have 1 more rate hike this year.
• Fed could then begin lowering rates in late 2023 to restart economy. The more bank failures that occur in 23’ could push up timelines on rate drops. ?
• Fed Funds rate is now at 5-5.25%, has increased by 500 basis points in little over a year.
• No debt available for speculative construction.
• Long term Debt is in Mid 5’s, short term debt in 7-8% range.
• Regional banks pulling back lending to small businesses, which is the main economic driver of economy.
• Greater amount of Debt & Equity will open back up sometime in 24’.??Capital can’t sit idle forever.

Cap Rates:

• Now at +/- 4.5 - 6% for Class A/B institutional Industrial product.??This was at +/- 3% just over a year ago in DFW and many other major markets.?Lots of equity wiped out.

Commercial Real Estate:

Industrial:

• DFW – was the largest commercial property sales and investment market in the entire US (22’)
• Some Industrial portfolios are currently trading to provide cash for their office assets with debt maturing in 23’-24’
• Tenant demand for industrial space is now back at pre-covid levels.??Still relatively healthy. ?
• Vacancy Rates are still extremely low for industrial, nationally many markets below 2% vacant. ?
• Industrial rental rates are still climbing, especially for infield locations.?Many base rental rates are increasing by over 50% on lease renewals for leases signed in 18’/19’.??Painful for tenants, great for Landlords.
• Lack of new development of industrial in 23’-24’ due to the debt freeze will push vacancy rates lower and fuel continued rental growth, especially in Infield locations.
• Infield vacancy rate in DFW is +/- 3.5%
• Yearly base rental escalations in DFW are now over 4%.??
• 70% of spec industrial development is in the Outfield areas of DFW. ?(44M SF)
• Softening in the rental rates for 500k+ spaces in some areas of DFW (South Dallas, Forney/Mesquite, North FW, Denton)
• Only 6% of the total US industrial inventory has been built over the last 10 years.??Going to be some functional obsolescence.?Tenants want higher clear heights, parking, trailer storage, etc.
• Sellers have begun to realize in the last 90-120 days that 2021 pricing is no longer happening.
• Land prices have fallen by 20-30% off peak pricing from 2021.
• Yield on Cost for New Construction development is not achievable unless land prices decrease.?
• 700M SF of industrial spec development in the US pipeline.
• INFIELD & OUTFIELD (sounds much better than Infill/Outfill/Perimeter/Tertiary areas) Your property is now Infield or Outfield. :)

Office:

• Class A office buildings in well located areas (Uptown, Preston Center, Galleria, Legacy) are still doing strong in DFW.??Lease rates are pushing over $80/SF Gross on new construction in Uptown.
• San Francisco, LA, NYC, etc. office/retail are getting crushed due to WFH and crime that is killing return to office and destruction of ground floor retail in mixed use complexes.?????
• Class B/C office sector will be destroyed in the coming years.??Manhattan is on brink of converting vacant office space in functionally obsolete office buildings to hydroponic grow farms (think weed & organic vegetables)
• Only 20-30% of functionally obsolete office buildings make financial or functional sense to convert to condos/apartments. ?Think too deep on functionality. No windows for apartments
• In many markets less than 10% of office buildings have equity left in them.
• WFH in Asia has fully recovered to pre-Covid levels, IE-office workers are back in the office.????

Etc:

• Retail is healthy in DFW due to lack of new construction over last decade as e-commerce growth slowed construction of power centers and net migration gains.
• Now that the market has slowed, brokers are making career changes and switching shops, many of them for the first time.
• Multi-family rent growth is slowing and or declining.

DFW/Texas Facts:

• Texas was #1 in more residents added than any other state.
• 17.9% Projected population growth for DFW (2020-29)
• 42% population growth since 2000 in DFW.?
• DFW will surpass Chicago as the 3rd largest MSA in US within the next decade.
• DFW is the #3 MSA for added Tech Jobs (22’)
• Texas – 9th largest economy on Planet Earth
• Texas – leads the U.S. in Exports (19th consecutive year)
• DFW had the largest year over year employment increase in U.S.
• DFW Airport – 2nd busiest airport in the World.?

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About the Author:

Conrad’s mantra is “Make an Impact”.?Over his career, he has been very blessed to advise some of the largest corporations and institutions on earth.?His true passion is to use Paladin as the vehicle to impact others’ lives and the communities around us through the Paladin Partners Foundation and their industry-first “Give-Back” business model.

Recently, he was identified as one of the Top 5 Commercial Real Estate Influencers in the world and was also inducted as a Texas Icon in Commercial Real Estate by REDNEWS. ?He is a regular speaker at industry and business events, podcasts, and is routinely quoted by the media in their video, digital, and print publications.

Consistently recognized by the Dallas Business Journal and D CEO Magazine as one of the “Heavy Hitters/Power Brokers” in commercial real estate, Conrad specializes in industrial tenant representation, development & project leasing, land and building sales, investment property sales, and corporate services consulting for clients, where he has transacted over 60 Million SF in over 150 cities across the globe.

Conrad walked on at Texas Tech University under legendary coach Spike Dykes before graduating with a Bachelor of Science from Texas State University. Conrad is extremely involved with the Paladin Partners Foundation and their annual Give Back Gala, which supports Team Luke Hope for Minds (where he is a Board Member) and other charities that enrich the homeless, less fortunate, cancer research and the true heroes of our country, the United States Veteran.

He is very active on LinkedIn and Twitter (please connect with him) and a huge follower of college football and basketball. ??When he’s not in the office, you can most likely find him in the great outdoors or hunting rare whiskeys and collectible wines from Bordeaux, Napa Valley, and Pouilly Fume.??Be on the lookout for his upcoming Podcast.?

www.paladin-partners.com