Ripe or Rotten: The Current State of The Major Food Groups

Since the start of the COVID lockdown, Team YazLee has striven to provide constant feedback on the status of CRE and to report on the capital markets. In the past weeks, we have rotated between writing on specific programs (Construction/Perm/Transitioning) and lender types (The “Agencies”, Banks, Debt Funds, CMBS etc.). This week we look to shed light on how specific asset classes have been impacted, which relates to how borrowers will formulate their plans for an opening economy:

Asset Class Updates-

 Multifamily

The Agencies (Fannie Mae and Freddie Mac) have served their purpose, stabilizing the apartment sector. In April, loss of demand for apartments was nominal as rents only fell approximately 1.2% from March according to CoStar. While banks remain active, the Agencies are the de facto source of capital with large loan rates in the low 3s. What has changed are UW requirements: 6-12 month P&l/TI/Reserve holdbacks are now becoming standard. Both agencies are underwriting to a T-3 vacancy but if there is a declining trend in T-3 NRI, there may be a downward adjustment to underwritten income. Obviously both agencies are looking very closely at April collections and will scrutinize May once those come in. 90% for 90 days is still a good rule of thumb. Lease up deals and construction requests are challenging, however multifamily remains the primary asset class capable of obtaining these types of financing.  

Industrial sector

Industrial properties have been mostly resistant to the demand shock of the pandemic. While other assets hope to simply stabilize, there is potential upside to industrial due to growth in online retail sales. Nevertheless, in Los Angeles industrial vacancy has risen from 2.2% to 3.2%. The long-term structural advantages of LA (location of twin ports and LA’s extensive economy) should continue to make it a safe bet for a swift recovery. In summary, low leverage financing requests are commonplace with LTVs in the 60% range, mid to low 3% interest rates, and long-term structures.

Offices

Capital markets are viewing offices with cautious optimism. When the economy reopens in a months’ time, how office space is utilized will be the biggest unknown. There is a fundamental belief that behavioral changes could shift the entire marketplace. The conversation around the bifurcation of suburban and urban office vs “the home office” will only grow as Zoom surpassed 300 million active daily users. Today, offices are viewed favorably with options around 60-65% LTV.

Retail

Since retail tenants —mainly in the restaurant, gyms and theater classes— are not capable of paying rent, it is unclear how many will return. Lenders are still tentative to underwrite retail, including in mixed-use assets, with the exception of essential business (e.g. grocery stores, pharmacies, shipping businesses). Retail with recourse, strong sponsorship, or credit tenants are seeing up to 65% LTV with rates around 3.5% - 4%.

Hotel

Hotels are currently the most difficult asset type to finance. To salvage this industry, an entirely new concept has emerged: nationwide mandates. Mandates include use of temperature checks, improved cleaning regulations, and guests signing liability waivers. At this point, hotels are in a planning phase and the capital markets reflect that. CMBS has indicated the B buyers won’t return for Hotels in 2020. Optimistically, a number of private funds view this as the ideal time to launch new construction projects. Expect 55% LTV or less.  

Land

Land, which encompasses all the above asset classes, warrants its own discussion. The major difficulty with land is determining current value. Pre-COVID valuation metrics included ROC, price/sf, price/acre, and price/door, yet most of these are increasingly problematic to determine. On a nationwide basis, costs continue to increase, entitlement timelines are subject to various review boards, and completed project comps remain in lease up. The consensus from private capital is that urban infill land is an ideal opportunity to obtain a significant discount in a low competition environment. Interest rates and leverage vary from 40%-70% LTV and 8%-12% respectively.

 Specialty Assets (Data Centers, Self-Storage, Medical, Golf Courses, Marinas, Airports)

The separation of specialty assets by capital providers is growing but the fundamental concepts are the same. For example, data centers, which are performing exceptionally in the lockdown (due to the massive uptick/change in online usage), represent an opportunistic asset class. Medical assets and self-storage are also safer in contrast to lifestyle real estate. Still, most capital sources require a high degree of personal experience, a strong balance sheet, and underlying fundamentals.

Global points:

With about two weeks left before California begins re-opening (unless the ordinance is extended), there are a few essential events we are watching.

•  Unemployment claims have begun to trend downwards, likely due to PPP funding. Still, over 26 million jobs were lost since March 15th.
• Oil prices went negative for the first time; historically oil price volatility has not been shown to have a strong correlation to CRE. During previous periods of oil pricing fluctuations — 2008 (increases), 2009 (lows), and 2015 (lows)— market rents remained stable.
•  Congress has passed 4th major relief package, including $320B in PPP, but lenders are saying the fund will need even more money
•  1-MO LIBOR is forecasted to match near the Federal Funds Rate of 25 basis points by July