Ackman-Ziff Mid-Year Market Update

Market Color

In the first half of 2023, capital markets and consumer sentiment were affected by high inflation, interest rate increases, and a series of challenges in the banking industry.

This market turbulence reduced commercial real estate transaction activity. There have been limited opportunities for price discovery to validate potential distress.

Many experienced sponsors will need to move beyond their traditional relationship-driven financing sources (banks) this year to find the best solution for their financing needs in the broader markets. Here’s a high-level on what to expect from the different lender classes as we move into the year ahead.

Insurance Companies Stay Active: Insurance company lenders are advantageously positioned to be a stable and consistent source of commercial mortgage debt for a broad range of assets and markets. With no required deposits to make new loans, insurance companies have filled some of the void created by the banking industry’s contraction in commercial lending. Though not known to lend the last dollar of leverage, this conservative approach has allowed insurance company lenders to remain in the market while other lender segments pause and pull back.

Debt Funds Get Conservative: Debt funds remain an active source of capital, although they are tightening their underwriting criteria to define a more conservative exit strategy for their capital. They are, however, more likely to push leverage higher than insurance companies and banks, but with an elevated cost of capital. Debt funds are also picking up market share in the construction space as banks retreat from exposure.

Banks Are Selective: Banks have experienced significant headline media scrutiny. However, not all banks are created equal. Now more than ever, substantial bifurcation exists in the banking sector. Many banks are out of the market, while others have implemented floor rates and underwriting criteria that push good deals out of reach. With less banks in the market, the division in the sector has cleared a path for the remaining banks to win business. Depository requirements, tighter underwriting, less leverage and shorter fixed-rate loan segments will continue in prevalence as the year plays out.

CMBS Quieting Down: CMBS originations have dropped to historic lows. Rate volatility, pricing/bond pricing and a general market sentiment that rates will be lower in the coming years, have all impacted conduit originations. CMBS is the remaining alternative for sponsors requiring full term I/O on assets not attracting quotes from insurance companies, agencies and banks. When stability reemerges in debt pricing, we anticipate conduit lenders to regain their active position in the market.

• Retailer demand pretty much remains extremely high, from local mom & pop and national retailers alike. This feedback came from landlords across the country.

• Occupancy levels are near, or at, all-time highs. More so in suburban markets; urban retail varies and is struggling to gain momentum due to the impact of office worker occupancy levels in some CBD's.

• New ground-up development remains in check as it has been for the past 10+ years coming out of the GFC; with retailers remaining vigilant in their growth focused on existing/2^nd generation spaces and redevelopment opportunities, allowing for cheaper than development rents.

• Even with the increase in rental rates, new development is scarce because of high construction costs and higher interest rates for construction financing. Mixed-use, with a large MF component, is the exception.

• Retailers with strong balance sheets and continued growth in store sales like Five Below, Burlington, Ulta, TJX, etc are competing for bankrupt retailers’ locations, along with Landlords, both seeing opportunities. Landlords are very optimistic about re-tenanting BBB stores (and possibly Party City) with higher rent paying retailers.

• Permitting and City delays are a huge problem for retailers and Landlords when filing for tenants’ buildouts. Many cities remain short staffed, and many are still virtual, contributing to the delays. This is especially true in Florida, where building codes and inspections have been very stringent following the apartment building collapse and more frequent and more powerful storms.

• Pricing/Cap rates both continue to move through traditional market forces, slowly bridging the gap between Sellers and Buyers, reducing the “price dislocation” that has persisted in tandem with the amount of and timing of the rise of interest rates. Seller financing is being offered when necessary.

• Most sellers are still reluctant to bring assets to market and most selling is happening by forced sellers. Therefore, indicative cap rates reflect distressed or opportunistic pricing, and discretionary sellers are staying on the sidelines. Thus, price discovery is slow and BOV's are of little value.

• Grocery-anchored is still considered best-in-class investment format. Unanchored strip retail centers, which have come more into favor, continue to show strength and strong demand, from both private and institutional investors.

• Institutional investors are showing very little conviction to step into the value-add space.

• There is a market for B / B+ malls at 10-12% caps. A small handful of private buyers are acquiring these with no redevelopment plans - the strategy is low-basis and high current CoC returns.

• Proliferation of use of Social Media channels, primarily LinkedIn and Twitter, is generating both engagement and networking, along with true new business opportunities, if done correctly. 

• A number of the traditional equity sources have a new preference for preferred equity; trading a capped upside for more downside protection. This leaves a large equity check that the sponsor needs to find. Preferred equity will go up to 80% to 90% LTC. There’s no shortage of capital looking to deploy capital into this space.

• What LP Equity Is Targeting Today:

  • Multifamily: Deals with a somewhat newer vintage and deals in growth markets throughout the sunbelt are still in demand. For development, institutions are generally looking to see a return on cost number north of 6.25% in infill locations and 6.5% in suburban locations.

  • Industrial: Ground up spec development has become significantly harder to raise equity for. Size is also important. It'll be harder to pitch a spec project of 1M SF than a spec project of 250K SF. For value-add acquisitions, the main goal going in is to be positively levered on top of your amortizing debt.

  • Retail: If you’re buying a shopping center, you’re going to want to be able to create value at the property. Having strong tenant relationships is key, and if you could extend an important lease prior to closing, that’s an interesting story to an LP.

In A Down Economy, Ground Leases Are An Underutilized Development Solution: Ground lease transactions don’t account for a large percentage of commercial real estate transactions, but they have significant value. In a down market, there is less capital supply available, and the ground lease can act as a financing vehicle for the owner when other financing is either unavailable or cost prohibitive. As a result, developers and investors often look for alternative ways to control their assets that give high returns. Ground leases are a great solution that allows owners to maintain that control, while offering flexibility for all parties involved. Owners can retain their assets and developers can minimize costly land expenses and reduce expensive debt.

Author: Jordan Brustein

Email: [email protected]

Mobile: (516) 996-7722