Some might think that the upcoming election in 2024 will influence the Fed’s rate policy – leaning toward lowering those rates. Don’t count on it.

Speaking on a news video produced by Marcus & Millichap, John Chang, its Senior Vice President and National Director of Research and Advisory Services, said that while he can’t definitively say what the Fed’s policy will be in 2024, historically speaking, interest rate movements during election years have not been measurably different from non-election years.

Looking all the way back to 1955, the federal funds rate has gone up in election years 10 times by an average of about 135 basis points and the overnight rate has gone down seven times by an average of about 140 basis points.

Naturally, some people may ask if there’s a bias based on which party is in power at the time of the election, but Chang couldn’t find any political bias driving rate decisions in election years.

He also didn’t see any irregular rate movements in September or October of election years just before the vote.

The 10-year treasury, Chang said, “is far more important to commercial real estate lending rates and much more difficult to potentially manipulate, and there was almost no difference between election years and non-election years.”

Chang also addressed the question of when interest rates might get back to normal. But first, he tried to define what is normal. That opinion, he said, is based on when the person asking got into the real estate market.

“Investors who became active in real estate after the global financial crisis have been operating in a very unique interest rate climate,” Chang said.

From 2009 to 2021, the average 10-year treasury rate was 2.3%.

Investors who were in the business between 2001 and 2008 were operating in a climate with a 4.4% average 10-year treasury.

The average 10-year treasury over the long term is 5.6%. And today the 10-year treasury is well below that in the 4.25% range, he said.

In fact, prior to the second half of 2002, the last time the 10-year treasury was at 4.25% was in 1965.

“So, from a historical perspective, the current interest rate climate is actually quite low,” he said.

“Yes, interest rates are higher than they were through much of the last 15 years, but since the financial crisis, the Fed has wanted to raise rates and create some dry powder to use in the event of a recession.”

Chang said that given rates are a bit higher today, he believes the Fed will try to stabilize at this level, which is about on par with where rates were in the early 2000s, prior to the global financial crisis.

“That may become the new normal going forward,” he said.

Of course, no one can predict what interest rates will do as there are a lot of forces affecting rates, Chang added.

“Assuming we are in the new normal, the commercial real estate market will take some time to recalibrate to the current interest rate climate,” he said.

“We’re navigating the recalibration process right now and cap rates have been migrating higher as investors adjust their expectations.

“However, I wouldn’t expect cap rates to move up too dramatically because commercial real estate has become a more mainstream investment class that’s drawing from a broader range of capital.”

As a result, the amount of money waiting for commercial real estate opportunities has grown significantly, according to Marcus & Millichap, and that wall of capital will restrain the upward movement of cap rates.

“Where cap rates ultimately stabilize will depend on the property type, the asset quality, the location, and a variety of other factors,” Chang said. “But I do expect the market to find its footing pretty soon. We’re already seeing the market navigate the price discovery process and the expectation gap has begun to narrow.”

The head of one of the leading firms in commercial real estate investment sales thinks we’ll be seeing distressed buying, but not at the volume that would shape the market as it did in the early 1990s or following the Global Financial Crisis. 

“Is that going to be the catalyst to move the market? I don’t think so,” Marcus & Millichap president and CEO Hessam Nadji said earlier this month in a conversation with Connect Media CEO Daniel Ceniceros. “We’ve now gone through a couple of cycles where the expectation of the fire-sale, bargain pricing hasn’t come to fruition. And if you look at the financial system, the messaging from the Fed and the Treasury, it wouldn’t support a fire sale in commercial real estate.” 

He acknowledged a bifurcation in the office market compared to all other asset classes “in terms of loan performance and actual fundamentals, where you have more performance issues with older or obsolete office space than anything else.”  

Yet Nadji added, “A lot of the Class A office spaces that are attracting whatever tenant demand there is in the market are doing fine. It’s not that all office is non-performing. Certain metros are hit a lot harder than others.”  

Marcus & Millichap is gearing up to handle distressed transactions. For example, Nadji said, the company’s acquisition of Mission Capital Advisors positions it to be in the forefront of note sales.  There will also be auctions, and some of the company’s agent listings are now being handled through its auction division, which it established in the spring of 2022.  

“So there are alternate channels for marketing real estate or loan portfolios, but is that going to redefine the entire marketplace?” Nadji asked. “I don’t think so. I think what redefines the marketplace is a realignment of price expectations, is a continuation of a decent economy—where you either have flat growth or maybe a mild recession somewhere along the way, but not a huge recession—that supports the occupancies and rents. and you have an entire reset in the marketplace.”  

The pricing reset will take time, said Nadji. “Everyone who’s been through cycles knows that it’s not a quick fix when there’s a profound change in the marketplace. What we just experienced was profound because of the curve of interest rate shock, really taking the industry by surprise.  

“Going back to normal interest rates should not be this disruptive. But if you’re going to five and a quarter on the federal funds rate from zero in 15 months or so, that is, of course, going to be disruptive to valuation. Everyone is still trying to figure it out. And the right price depends on the right asset and the right motivations of the seller.” 

The impact of the Federal Reserve’s rate hikes hasn’t been felt as deeply as expected just yet. “Give it another 12 months; we’re going to see more of the effects of high interest rates really ripple through the economy,” Nadji said. “We would have expected to see more of it by now. But the economy has proven to be very resilient.”

Luxury apartment assets have proved resilient, due largely to rising housing prices and mortgage rates — and despite market pressures confronting the overall multifamily sector.

Vacancy rates for Class A rentals jumped 30 basis points (bps) from the end of 2022 through the midpoint of 2023, compared with a jump of 40 to 80 bps for Class B and C apartments,  according to a new report from Marcus & Millichap (MMI)’s Institutional Property Advisors (IPA)  division, released Monday morning. 

The durability of higher-end apartments is occurring despite the “record construction” of nearly 200,000 units delivered in the first half of 2023, which surpassed the previous record for the first six months of a year by 25,000 rentals, the report shows.

“Today’s high barriers to homeownership are helping support demand for high-end apartments, particularly among the millennial demographic,” John Sebree, senior vice president and national director of IPA’s multihousing division, said in a statement. 

Sebree, who authored the IPA multifamily outlook report, noted that a series of aggressive interest rate hikes that began in early 2022 cooled housing demand and normalized price growth. This dynamic locked many current owners into lower-rate mortgages, limiting the amount of residential real estate listings on the sales market and causing “an increasing share” of millennial renters to abandon homeownership plans. 

An added barrier to homeownership this year was the sharp rise of about $660 a month in the second quarter in the difference between a Class A apartment rental and a typical monthly mortgage payment on a median priced U.S. house, Sebree wote. One of the key challenges millennials, in particular, confront is saving for a down payment — an obstacle that might only grow, as student loan payments resume in the fall, according to Sebree.

Class A vacancy has been far more stable this year in gateway metro markets with dense populations and “extreme homeownership barriers,” the IPA report outlines. The Boston, Chicago, New York City, Seattle-Tacoma and Washington, D.C. areas each recorded luxury rental vacancy changes of 120 bps or less over the past 12 months, according to the IPA research. 

Other metros with similar vacancy trends that were aided by discounted rents included Northern New Jersey, West Palm Beach, Fl., Reno, Nev. and Sacramento, Calif. Sebree wrote. 

In May, the average length of time that a rental unit sat empty fell to 26 days, the shortest duration since August 2022, according to a Marcus & Millichap report. It also noted that new lease applications per unit increased in the last two months, and the velocity of lease renewals per unit also grew. 

Demand was never a significant problem for multifamily and new signs are emerging that this trend continues to move in landlords’ favor.

Certainly many apartment residents know multifamily housing these days can be very enticing with the continued onslaught of amenities, indoors and outdoors, some new to the category to compete—organic gardening and beekeeping, anyone? Also, most new buildings offer the popular open-plan layouts with big windows in apartment units, and a strong Wi-Fi bandwidth is essential. Many buildings also deliver the space residents crave since the pandemic for their pets, to work from home and for their own leisure activities.

Another factor that is propelling interest by renters is an unfortunate housing market for buyers where supply is scarce and mortgage rates are high.

Also, the expected major valuation adjustments haven’t transpired, according to Marcus & Millichap. As an example, it reported that the median sale price of an existing home has now climbed for a third straight month this past May to $389,000.

Until the pandemic, the number of existing homes for sale was typically above 1 million. Now, that can’t be said in 18 of the last 28 months. And the stalemate of getting sellers to list continues.

As a result of these trends, many first-time potential buyers continue to remain renters, including many with all-time high incomes. The median income of a renter household has climbed to a record high of about $47,600 in this year’s second quarter.

The rising cost of capital has stalled most commercial real estate development in 2023. Unless projects were already underway or financing had been secured, there will be few projects started, according to John Chang, senior vice president of research services, Marcus & Millichap.

In the firm’s 2023 Construction Trends Report video, Chang said that otherwise, “builders are being pushed to the sideline.”

The cost of capital is rising due to the Federal Reserve’s decisions to raise rates considerably, “making it difficult to get a construction loan, and if you do, it’s rather expensive,” Chang said.

Loans are running 350 to 400 basis points over the Secured Overnight Financing Rate (SOFR) of 4.5%.

Alternative debt financing is running between 8.75% and 10.5%.

Forecasting Growth for Key Asset Classes

Forecasting for what’s coming online in 2023, Chang said apartments are forecasted to complete 400,000 new units in 2023, growing the overall inventory by about 2.1%. Some 43% of that will be in just 10 metros.

Industrial will see 400 million square feet in 2023 for an inventory gain of 2.3%. Half of that construction will be in eight metros.

Marcus & Millichap expects 42 million square feet of retail to be completed, a “meager” half-percent of growth, Chang said, and two-thirds of that will be single tenant. Office will see 86 million square feet or growth of 1 percent and two-thirds of that will be situated in the suburbs.

Self storage should see 2.5% inventory growth – or 47 million square feet, which is well below the 73 million square feet completed in 2019. Self storage is a rare asset class where completions possibly will also grow in 2024.

Chang said demand drivers should begin to strengthen by early 2024 for most property types.

He added that there has been relative relief in materials costs for lumber (currently 38% above pre-pandemic rates) and cement (28% above).

Supply chain issues are now mostly under control, Chang said.

One executive panelist pretty much nailed it (pardon the pun) about the apartment development “oversupply” on the way for 2023 when speaking at this month’s National Multifamily Housing Council’s Apartment Strategies Conference.

“Unless there’s an outside force to stop us, we’re going to keep on building,” Cortland CEO Steven DeFrancis said.

“There’s no one in this conference today that if they were able to get the financing they need to develop, wouldn’t be ready to run home and start it.”

The industry lately has pointed to a lack of housing in nearly all forms.

DeFrancis said that in whatever economic environment 2023 turns out to be (a soft landing, a recession) “there’s definitely going to be some pain because we have a lot of product coming and not a lot of people to put in there.”

Greg Willett, First Vice President, National Director of Research, Institutional Property Advisors (IPA) Division of Marcus & Millichap, has taken in the many forecasts for new apartment development for this year and offers his realistic calculation of 2023’s likely rental apartment completions.

“Given the run-up in the total volume underway and the pattern of building delays seen in recent years, the number is perhaps harder to determine than you might expect,” Willett said, in a post on LinkedIn.

“Looking at info from various sources, there’s basic agreement on how much product is physically under construction right now: It’s between 900,000 and a million units, up by more than a third from the pre-pandemic building pace seen in late 2019 to early 2020.”

It’s More Like 400,000

Some apartment industry data providers have 2023’s scheduled deliveries coming in at well more than 500,000 units, Willett said, with that volume based on the timelines provided by developers of individual properties.

“But that’s probably more product than can actually make it across the finish line this year,” Willett said, based on IPA analysis. “We think the actual new supply figure will come in closer to 400,000 units.

“Influencing that expected completion volume, developers already have been using available resources to build as fast as possible, and 2020-2022 annual deliveries held steady right around the 350,000-unit mark. Completing another 150,000 to 200,000 units on an annual basis without a sizable expansion of the labor pool seems like it simply can’t happen.”

Digging deeper, Willett said the comparison of actual completions to scheduled completions in recent years shows that it’s become routine for at least 15 percent of the targeted new supply to get pushed into the next year’s delivery tally.

“Holding 2023’s completion total below the scheduled volume will yield slightly better results for vacancy stats as well as pricing power,” he said. “Still, in many instances, it’s going to be tough to get the new projects through the initial lease-up process.

The disruptive force that was the 2020 pandemic found Marcus & Millichap continuing to innovate in ways to serve its clients better, even as other real estate services firms focused simply on riding out the storm. However, building on its history of staying a few steps ahead, the company had been gathering momentum for lasting change since 2016, when Hessam Nadji assumed the role of CEO. 

“Periodically, there is a need to refresh the vision, culture, and leadership thrust to make the company stronger with a sharpened focus on the future,” Nadji says. “This was an important period in our evolution, so we took a holistic look at the market, our position, strengths and weaknesses, and evolving client needs with a fresh eye.”   

Nadji and the company’s senior leadership saw this as an especially opportune time to conduct surveys and focus groups internally and externally, to secure input from its sales force and clients. Through this process, the team refreshed the company’s long-term strategy, which is built on four key charters: further building the company’s leadership in the private client segment; increasing its penetration in larger, institutional transactions; significantly expanding its financing service capabilities in both the private client and institutional segments and market coverage; and further expanding the advisory, research, and consultative foundation of providing client services. 

“In any given year, there are between 40,000 and 50,000 commercial real estate transactions in the U.S., of which on average 84% are between $1 million to $10 million,” says Nadji. “This micro-cap base is predominantly made up of private investors, many of which are passive individual high-net-worth investors and small partnerships as well as professional traders and private fund managers.” 

Within this universe of micro-cap transactions, the top 10 brokerage firms — including Marcus & Millichap, the front-runner in this space — represent “just 25% of total transactions, with the rest brokered by small local and regional firms, individual brokers, and many principal-to-principal transactions.” 

Given the size and fragmentation of the private client segment, “even in apartments and retail, which have been the company’s leading market segments throughout our history, there is still significant room for growth,” says Nadji. At the same time, there is also an opportunity to expand the company’s presence in other major property types, especially office, industrial, hospitality, and self-storage.

George Marcus founded the company by recognizing a major gap in service for private investors and the absence of any organized system for matching buyers and sellers. “There were no investment specialists at the time, mostly generalists,” says Marcus. “We saw the disservice to sellers who were not getting the asset exposure they deserved to maximize value, especially the private investor most ignored by major service firms.  So we created an entire company based on professional, training-based investment specialization and developed a marketing system to reach the broadest buyer pool,” he adds.  

Fifty-plus years later, the company’s signature training program, proprietary marketing system (Mnet), and a culture of collaboration have evolved to make it a highly effective platform for capturing repeat business and dominating the private capital space while creating a career track for its salesforce.

Increasing Marcus & Millichap’s presence in the institutional sector was a natural expansion strategy, Nadji explains. “About 10 years ago, we anticipated that many private investors, particularly aging Baby Boomers with significant long-term real estate equity, would seek larger, institutional quality properties as a path to consolidate their portfolios. At the same time we also expected that institutional allocations to commercial real estate would continue to grow in search of yield and alternative investment option, which has also materialized.“ 

The result of this projection was the establishment of the Institutional Property Advisors (IPA) division within Marcus & Millichap. IPA is designed to service the unique needs of institutions in terms of underwriting, account management, and multi-market service delivery while creating a channel of equity deployment into larger assets for the firm’s private clients. By 2016, says Nadji, “the initial success of IPA gave us confidence that we were on the right track and should get more aggressive about this growth strategy as we began to prove our ability to bridge the private and institutional segments and add value for clients across the board.” 

To expand the company’s financing service capabilities and market coverage, Marcus & Millichap Capital Corporation (MMCC) was created as a financing intermediary to help borrowers secure the most competitive rates and terms. “The integration of this critical service with our sales force to provide a more holistic value proposition has been and remains a clear opportunity to build stronger client relationships, capture more repeat business, and grow revenues as a result,” Nadji says.  

In growing the MMCC platform, two key strategies became clear: growing capacity by adding experienced, accomplished financing professionals and teams and acquiring complementary financing firms; and building out service capabilities, notably agency lending for multifamily and loan sales, which are complementary to the company’s existing financing activities. Investments in marketing, technology, and widening the lender network were additional strategies to bolster the company’s private client financing capabilities and to better support its organically grown financing professionals.

Behind Marcus & Millichap’s high transaction velocity — averaging 50 per business day in the first nine months of 2022 — is “an extraordinary amount of research, market and financial analysis, performance benchmarking, and data on pricing and buyer demand that our nearly 2,000 professionals provide to owners and investors daily,” Nadji says.

These factors go back to the reason Nadji joined the firm in 1996: “to help set up a unique, research and advisory service-based connectivity between our sales force, owners, and investors while shifting the brand to a leading source of market intelligence and research. We have come a long way toward accomplishing this goal, but given the rapidly increasing sophistication of the client base and the opportunity to position every one of our professionals as a long-term, trusted advisor, there are many ways we can further build on this concept.”  

“An increasing number of investors are also coming directly to the company for research, consulting, and analytical work as they look to develop strategy before executing transactions,” he continues. “We see this trend as another growth opportunity.”  

Once the business strategy was refreshed, it became critical to design the right execution strategy and priorities for getting there. “We had, and still have, the same fantastic foundation in our unique business model, culture, and personality of the firm,” says Nadji.  “But everything else was in need of a major push out of the comfort zone. “ 

This push required refreshing the company itself and updating plans, resources, and, most importantly, priorities, Nadji says. The process entailed the following strategies: 

• Reshaping and expanding the leadership and management teams. 

• Re-energizing the collaborative culture of the firm and pride of association. 

• Increasing productivity and ease of doing business for the sales force by significantly increasing investment in technology, innovation, support personnel, and systems. 

• Advancing the firm’s market-facing technology to enable investors’ connectivity to our industry leading inventory, sales force, and research content.  

• Elevating direct client content, information flow, and knowledge-based brand awareness.  

• Complementing the company’s traditional organic growth model with select, targeted acquisitions as well as recruiting experienced professionals and teams without disrupting the highly valued and respected existing sales force the company is built on. 

• Enhancing sales force training, internal communication, and best-practices forums.  

• Attracting and retaining the most talented sales and support professionals by making the company a great place to work through individual care, development, and diversity and inclusiveness initiatives that expand the talent pool. 

“My first order of business was to reshape the leadership team,” Nadji says. “We retired a number of legacy partners with honor, opening the field up for the next generation of in-house best of class leaders and bringing in outside talent to supplement our thought leadership and benefit from executive expertise from other industries. Our leadership team today reflects this massive reshaping.”

The reshaping in turn facilitated the execution of the other seven strategies. “This set the foundation of how we navigated the pandemic in 2020, achieved record results in 2021 and 2022 and are now navigating the current challenge of the market disruption caused by the Fed’s extreme measures to fight inflation,” says Nadji.   

In 2020, Nadji says, the company made four key acquisitions and achieved healthy earnings despite a major market disruption as transaction volumes collapsed in the early part of the pandemic and moderately grew its cash reserves. “We went completely virtual within three business days amid the economic shutdown and did not lose or delay a single transaction,” he says. “Our team across the organization really pulled together, and the interconnectivity empowered our sales force to stay focused on solving problems for clients and helping them navigate the shock of an economic shutdown. The pandemic was a real test of our technological advancements and cohesive leadership execution. We simply focused on the client, supported our sales force, pumped best practices and idea sharing at extreme levels, helped our staff operate virtually, and stayed on the offense by acquiring and adding talent.”  

In 2021, the company achieved records “by helping investors move a record volume of capital across markets and product types, take advantage of record-low interest rates and put capital to work,” says Nadji. “The company set milestones in revenue, earnings, productivity, and the introduction of new tools. These achievements further boosted our fortress balance sheet, which positioned the company to continue with key acquisitions and initiate a dividend policy in 2022.“  

One of the drivers of growth and change has been a series of key promotions and hires. These include naming Richard Matricaria and J.D. Parker as co-COOs and Greg LaBerge as chief administrative officer. Both Matricaria and Parker “started as investment brokers, became managers, and grew to oversee multiple offices,” Nadji says. “They lead seven outstanding division managers who have extensive tenure at the firm successfully running major offices, and who now oversee over 80 brokerage offices.”  

“This generation of sales leadership is highly in tune with our sales force’s needs, understands technology and branding, and passionately advocates change,” he continues. “The COOs also oversee our specialty directors, who are veterans within each property type and bring technical expertise and client relationships to our sales force. This integration has been instrumental in bringing out the best of coordinated support and management to our sales force.” 

As CAO, LaBerge oversees the company’s infrastructure, technology initiatives (in partnership with CIO Ken Sayward), administrative support, and research. A company veteran with roles as an agent, manager, and specialty director, LaBerge came to Marcus & Millichap with an extensive consulting background.  

The company further appointed Evan Denner, an industry veteran with 30-plus years of real estate capital markets experience, as head of capital markets last year. “Our new CFO, Steve DeGennaro, is a veteran Silicon Valley technology executive with extensive M&A experience,” says Nadji. “Our chief legal officer, Mark Cortell, comes from the private equity world and also has significant M&A experience. To round out the leadership team, we added chief marketing officer Andrew Strockis, a high-ranking marketing executive at Schwab and a strategy consultant with Accenture before that.  

“The combination of in-house tenure, cultural knowledge, and fresh thinking is helping us take the entire growth vision and its execution to the next level in a relatively short amount of time,” he continues. “For me, it’s great to watch the dynamic among these thought leaders as we foster a culture of consensus and free thinking to explore ideas and encourage debate but execute with a high level of alignment.“ 

Among the firm’s key advantages, and the foundation that enables it to be nimble and innovative, is “the structure of our local management,” says Matricaria, COO of the Western Division. “Our regional managers are all former investment sales professionals and understand the brokerage business exceptionally well.”  

The company has also grown through a series of initiatives: adding many experienced investment brokerage and financing teams and individuals, establishing an auction platform in 2022, and developing a loan sales platform and alliances, such as the relationship with M&T Bank that was announced in 2021. Parker, COO of the Eastern Division, says the initiatives have been very successful “because they fit well with our core business. They came about as the result of a deliberate and specific strategy to augment and supplement our core brokerage and financing service, not overlap with them.”  

The auction platform, he says, adds another marketing channel suited for particular situations and assets. “It functions as another layer or extension of our traditional marketing system, which effectively exposes each exclusive listing to the largest and most qualified buyer pool selected for that particular property.”   

Denner says, “The loan sale platform enables the firm to widen the breadth of business opportunity with major lenders. As we drive volume to many lenders as an intermediary, we can help the same lenders buy and sell loans or pools to fit their strategy and portfolio needs.”  

Denner calls the partnership with M&T “truly groundbreaking on the agency lending side. One of the best lending platforms in the multifamily business is now our partner in helping major multifamily owners and buyers access the agencies seamlessly and competitively with no added cost to the client. The partnership works because as the leading broker of multifamily assets, Marcus & Millichap and our IPA division generate a tremendous volume of sales each year and a high level of interaction with major owners regarding capital needs, refinancing, and recapitalization. Our loan originators can now bring M&T’s agency licenses, expertise, and execution to these clients, which they could not do before our partnership was set up.”   

Nadji adds, “We are just getting started on these supplementary growth initiatives, their scaling, and expansion. It’s really exciting to see the possibilities and that they are working as envisioned.”  

Within commercial real estate, the pandemic accelerated the adoption of technology at many companies. Marcus & Millichap, though, has always been there. “Technology is in our DNA,” says Nadji, pointing out that the most basic founding principle of the platform — exposing each exclusive listing to the largest pool of qualified buyers — was “ripe for automation, technology, and efficiency” from the start. 

“Our late co-chairman Bill Millichap was a major advocate for real estate technology from the beginning,” says LaBerge. “By the late 1970s, the company already had a central electronic inventory system and databases that tracked properties, sellers, and buyers. Our proprietary internal inventory and buyer-seller matching system, Mnet, is rooted in that original application with countless upgrades and replacements. We were the first firm to embrace the Internet. Our website went live in 1994 displaying inventory online, and we even invested in new platforms such as LoopNet and several other real estate startups.”

“Over the past five years we have quadrupled technology investments and introduced an array of automation tools internally and for our clients,” he continues. “The latest examples are major website upgrades during the pandemic that made it much easier for investors to access our inventory, which were then followed up last year by a new tool called My MMI. This is a client application that allows each investor to have saved, custom searches for inventory that continually look for listing matches with automatic alerts and access to our research content. We are already working on the next series of upgrades to this and many other tools.”    

Marcus & Millichap started the first large-scale apartment rental directory in 1996 and named it “AllApartments,” which was renamed “SpringStreet” and eventually became part of Realtor.com. “In addition, we were the first firm to introduce an automated internal system for preparing market analysis and opinion of value as listing proposals and marketing packages for clients called Mnet-Offering,” LaBerge says. “This automation empowered our sales force to offer more relevant information produced more quickly to each client than ever before. It, too, is constantly undergoing refinement, upgrades, and replacements.”  

Nadji says, “The key to success is having a highly focused management team that listens to client and sales force needs and a technology development group that partners with management on priority-setting instead of making decisions in a vacuum.” 

Just as a tech-forward approach has been in Marcus & Millichap’s platform from the beginning, so has a client-first approach. “Creating a client-centric business model was George Marcus’ founding vision for the firm,” Nadji says. “This meant doing something that had never been done in starting a company that specialized in investment brokerage, financing, research, and advisory services.  

“The real estate investment specialization cornerstone has morphed over the past five decades by organizing the sales force by product type and market area specialization,” he continues. “The premise of this is the belief that a dedicated specialist will accumulate a higher level of expertise and seller, buyer, and lender relationships, all of which result in doing a better job for the client. This is how Marcus & Millichap has earned the top investment broker slot for many years and is top brokerage firm in apartments, retail, self-storage, and hospitality and is among the top in office by transaction count. This market leadership creates an advantage for our clients because they benefit from the depth of information and relationships we bring to them.”   

On the financing front, “the same dedication to specialization empowers our loan originators to craft capital markets solutions covering all property types, price points, and client groups,” Nadji says. “MMCC has evolved into a top financing intermediary as a result and predominantly serves our private investor clients in the $1-$20 million price point, a growing portion of which is being executed in partnership with our investment sales force.” 

“IPA capital markets is growing rapidly within the higher price points and targeting larger private investors and institutional clients,” he continues. “The key is collaboration across these divisions and parts of the company that happens real time in the way our sales force connects buyers and sellers, borrowers, and lenders and provides a steady flow of research and content to the marketplace.”  

In terms of the transaction volume this client-centric model generates, the numbers speak for themselves. “In the 12 months ending September 2022, the company closed a record 14,000 transactions and over $100 billion in volume,” says Nadji. “Over 47% of best and final buyers came from out of market as illustration of our ability to ‘make a market.’ MMCC closed over 2,400 financing transactions totaling $14.2 billion in financing volume, which were executed through 460 separate lenders.”   

Specialization by both product type and service is a concept that Marcus & Millichap references frequently. That specialization operates in tandem with “the entire company’s resources and scale of relationships across an entire platform that is harnessed one transaction at a time,” Nadji says. “Value is created through not just exposure, but by strategic exposure to the right buyers or by going to the right lenders in the case of securing financing. Our interconnectivity, technology, and real-time communication means our clients are as close to the real market as they can possibly get.”  

“Our mantra has always been to create the most value and certainty of execution through a great experience that makes our clients want to continue doing business with us,” he continues. “We value the long-term relationship above all, and that means advising clients not to execute a transaction if the time is wrong for the asset or due to market factors. The fact that we can offer the most comprehensive and effective marketing machine to sell investment real estate, an auction platform for the right situation, competitive financing, and a refinancing or recapitalization path if a sale is not the right strategy brings the best of all worlds to our clients.”

Starting in the third quarter of 2022, “we began to see the impact of the Fed’s most dramatic and steep financial tightening since 1980,” says Nadji. “The steep curve of successive rate hikes broke down real estate valuations, dried up financing options and caused transaction activity to fall dramatically as bid/ask spreads widened. Our industry faces a new challenge given the disruption and uncertainty in the market place. Our playbook is stronger than ever, and we are approaching this chapter with the same formula of a client-focused, advisory approach to help solve problems for investors and continuing to enhance our platform and market position.”    

The year 2021 saw Marcus & Millichap not only reaching record levels of transactions, but also celebrating its 50th anniversary. Over the half-century of the firm’s history, the commercial real estate market has gone through numerous cycles and hence has offered ample opportunity to prove out the firm’s ability to “make a market in any market.”   

Nadji provides insight into how that concept plays out. “Making a market in any market means that no matter what the market conditions may be at a given time, the goal is to achieve the best possible results for the client,” he says. “For example, in a disrupted market, when buyers are harder to secure, knowing who the real buyers are, how to increase the probability of a successful close, and who the most likely lenders are makes all the difference. You can’t throw an asset to the marketplace and hope it generates offers.  

“Market conditions going into 2023 will once again put a spotlight on our ability to get deals done in a very tough environment,” he continues. “Pricing, financing, and bringing buyers and sellers together face a lot of headwinds because of the interest rate shock imposed by the Fed, and it will take time for pricing to adjust. Until then, sales and financing volumes will be hampered. We are starting to see easing in the inflation rate, and the Fed should be getting closer to the end of its tightening cycle in the first half of 2023. At the same time, I anticipate evidence will be pointing to moderate job losses and not to a major recession. The combination of these factors should result in an improving capital markets environment in the second half of the year.”  

For Marcus & Millichap, it’s about building for the long term. While the firm takes pride in its longevity, it’s also continuing to look ahead. “Our 50th anniversary was a fantastic milestone in celebrating how we have differentiated our client services and results,” says Nadji. “It was also a key point of recognizing and protecting the best of the company’s history, culture, and achievements but mostly importantly, of knowing where we need to improve, modernize, and perpetually innovate. We are also excited to evaluate other business lines that are complementary to our business and further deliver a value proposition to our clients and salesforce. We are constantly thinking ahead.” 

Over the past couple of weeks, we took some time to reflect on some of L.A.'s biggest real estate, architecture, and urban planning stories of 2022. But with the calendar flip to January, it's time to look forward. Here's a preview of some projects that could be making headlines during 2023.

A block north of Expo/Bundy Station, Hines is putting the finishing the West Edge, a mixed-use office and housing complex on the former site of Martin Cadillac.

Located at the northwest corner of Bundy Drive and Olympic Boulevard, the project includes two buildings featuring a total of 600 apartments, including 120 units of workforce and very low-income affordable housing, accompanied by 200,000 square feet of office space and 90,000 square feet of ground-floor retail.

While the housing will await tenants over a lease-up period, we already know who is coming to the West Edge's commercial space. League of Legends maker Riot Games, which is headquartered out of a neighboring campus to the north, agreed to take all 200,000 square feet of office space in 2021. Meanwhile, Gelson's will anchor the ground floor of the property, with 36,000 square feet of space.

Completion is expected soon.

While the project may be the first big development to sprout next to Expo/Bundy Station, it will not be the last. Carmel Partners has plans to redevelop single-family homes to the south of the elevated station with more than 600 apartments.

It's been a few years since a new residential high-rise opened its doors in Downtown Los Angeles, but 2023 should see the debut of two of them.

Brookfield Properties is wrapping up work on Beaudry, a roughly 60-story tower next to the Figat7th shopping mall, which will bring 785 studio, one-, two-, and three-bedroom apartments to the neighborhood. The tower is billed as the final component of a master-planned development first conceived by the late developer Robert Maguire in the 1980s, following the neighboring shopping center and the 777 Figueroa and EY Center office towers.

Just east across Figueroa Street from Beaudry, developer Mitsui Fudosan America is also scheduled to complete work on its 8th and Figueroa tower this year. The 42-story building will feature 438 studio, one-, and two-bedroom apartments above a glass-clad podium containing parking and street-level retail.

Both projects will serve as a test for Downtown's apartment market, which has taken a beating from the pandemic. A continued recovery is a must for Brookfield and Mitsui Fudosan, as both have additional projects in the entitlement phase nearby.

A groundbreaking ceremony that doubled as a send-off for departing Metro Board members occurred last year, but it is in 2023 that work should truly commence for the East San Fernando Valley line, which will bring 6.7 miles of at-grade rail to Van Nuys Boulevard. Plans call for 11 stops, as well as connections to Metrolink and the G Line busway, with service to begin sometime between 2028 and 2030.

It also sets the table for additional Metro projects coming to the Valley in the near future (including upgrades to the G Line and a new bus rapid transit line) and the distant future (a Sepulveda Pass rail line and a conversion of the G Line to rail).

In mid-2023, Trammell Crow Residential is set to break ground on the first components of the West Gateway development, which would replace the parking lot just north of the Long Beach World Trade Center. Plans call for a total of six buildings featuring 756 residential units, 1,500 parking stalls, and a small ground-floor retail component fronting Broadway.

While originally slated to include two high-rise buildings, including a 40-story tower which would have ranked as the tallest in the city, a revised plan which emerged last year includes just one 31-story tower. It seems that Shoreline Gateway's time at the top of the Long Beach skyline will continue.

The project is slated for completion by 2025.

Last year, real estate and construction giant Lendlease scored approvals to redevelop a public storage facility just south of Metro's La Cienega/Jefferson Station with a combination of commercial and residential uses. Plans call for the construction of two mid-rise buildings featuring 260 residential units, approximately 227,000 square feet of offices, and 2,869 square feet of ground-floor retail space.

Lendlease has previously indicated its intent to break ground on the project in 2023.

The project at 3401 S. La Cienega Boulevard is part of a boom in development surrounding the E Line's Culver City and La Cienega/Jefferson Stations, following the completion of the Cumulus District and the Eric Owen Moss-designed Wrapper office tower.

In late 2021, Apple announced plans to redevelop a series of commercial buildings near Culver City Station with a nearly 550,000-square-foot office campus. The project, which would double the Cupertino-based tech giant's presence in the region in a single stroke, is slated for a site at the southeast corner of Venice and National Boulevards.

While an environmental report has previously pointed to a groundbreaking in 2023, the development is complicated by its location directly on the boundary between L.A. and Culver City, meaning that both jurisdictions will have to provide sign offs. The project has yet to go before the L.A. City Planning Commission for its approval.

While the City of L.A.'s permitting process may be arduous, if there's any company in the world with the resources and political heft to get it done quickly, it's Apple.

Take this news well salted, but troubled developer Oceanwide Holdings began sending signals last year that construction may finally resume at the long-stalled Oceanwide Plaza complex in Downtown in 2023 - if money can be secured. Mostly finished, but stalled since 2019, the three-tower complex is slated to bring 504 condominiums, a 184-room Park Hyatt hotel, and approximately 150,000 square feet of retail space to the city block bounded by Figueroa, Flower, 11th, and 12th Streets.

Then, just a few weeks ago, the Chinese developer announced that it had entered into a non-binding letter of intent with an unnamed potential buyer for the property. Will this finally be the year that Oceanwide gets back on track? Or will the husk remain a husk for the foreseeable future?

Commercial real estate financiers and borrowers alike remain in flux after the Federal Reserve closed its 2022 calendar with the year’s seventh interest rate hike, and no clear sign of the hikes letting up in early 2023.

The central bank announced a 50 basis point (bp) hike Wednesday afternoon, placing the federal funds rate between 4.25 percent to 4.5 percent — its highest level since December 2007 and a stark contrast to near-zero short-term borrowing conditions that existed in early 2022. While the Fed ended its streak of four consecutive 75 bp increases, it indicated in its statement following the meeting that rates will continue to climb into 2023 in an effort to combat inflationary pressures.

“This continues to exert headwinds to transaction activity well into 2023,” Sam Chandan, director of New York University’s Chen Institute for Global Real Estate Finance, told Commercial Observer. “We are early in the cycle of price adjustments, and for some property types the bid-ask spread between buyers and sellers, the data suggests, is still significant, and so I think we’ll continue to see subdued activity or drags on investment sales.”

The rising interest rate environment has been a reality for CRE since the Fed implemented its first jumbo rate hike since 1994 on June 15. Since then, market participants have been working overtime to bring deals across the finish line.

Chandan noted that — based on past cycles with inflationary pressure —  investment sales activity could bounce back under new price adjustments by mid-2023. Yet he cautioned that debt scheduled to mature next year will remain a major concern for the CRE market since it will have to be refinanced at significantly higher rates. Chandan does not see the levels of distress that occurred during the 2008 Great Financial Crisis, however, and expects market participants to seek out flexible terms on deals to avoid defaults instead. 

Evan Denner, executive vice president and head of business at Marcus & Millichap Capital Corporation, said he has held numerous meetings on weekends on individual transactions to help bring them to a close. A number of “outside the box” approaches have been implemented by his team to execute deals, such as raising additional equity or going with partial recourse on certain loans. 

“It’s a conversation we’re having multiple times a week right now with lenders,” Denner said. “We’re communicating with our clients not only around their transaction, but also what’s happening in the market, and we’re going through a lot of what-if scenarios.” 

The Fed’s rate 50 bp rate hike came a day after the consumer price index reading for November came in at 0.1 percent, a sign that perhaps inflation may have peaked. Fed Chair Jerome Powell stressed at his press conference Wednesday afternoon though that recent inflation strides are not sufficient enough to discontinue rate hikes in the near future saying “it will take substantially more evidence to give confidence that inflation is on a sustained downward path” and estimates it to be 5.1 percent in late 2023.

Kelly Kulak, a partner in the real estate department of law firm at Schwartz Sladkus Reich Greenberg Atlas in Manhattan, said she has helped facilitate multiple deals since the summer where borrowers sought loan modifications in which the loan’s term would be extended two years with their existing lender instead of eyeing a new refinance. She is currently working on another refinancing, slated to close by the end of 2022, for a Manhattan office property where the borrower is securing a two-year, fixed-rate loan to account for the possibility of rates continuing to spike.

Kulak stressed that to get any deal closed these days requires some giveback from sponsors. 

“Everybody likes nonrecourse loans, but sometimes you do have to give a little bit of a guarantee, especially if it’s a construction loan,” Kulak said. “You’re definitely going to have to give a completion guarantee and maybe sometimes even a small payment guarantee to get the loan to the finish line and make it attractive to the credit committee at the bank because they’re not going to approve it if there’s too much risk involved.” 

The three-month/10-Year Treasury yield curve has inverted, with the three-month Treasury closing last Tuesday at 4.14% and the 10-year closing at 4.10%. So does that mean a recession is imminent? And if so, will it be worse than expected?

Maybe, and it depends, says Marcus & Millichap’s John Chang.

“There may be another shoe to drop,” he said in a new research video. “A lot will depend on the Federal Reserve,” which is meeting this week to discuss further hikes to the overnight rate.

A yield curve inversion happens when short-term Treasury rates pay a higher interest rate than long-term Treasuries. Other economists, like JLL’s Ryan Severino, has said that such an inversion “has typically preceded economic downturns and therefore is taken as a warning sign.”

“Some economists think the 3 month-10 year is the gold standard [as an inflation sign],” Severino told GlobeSt in late October. “Other economists look at other inversions. Some look at multiple. But none will take this as a positive sign.”

Other experts warn that valuations could take a hit.

“Cost of debt for real estate has gone from the mid-3% level at the beginning of the year to more like 5.5% to 6% today and there’s capital rationing happening across the debt markets,” Uma Moriarity, senior investment strategy analyst and global ESG lead of CenterSquare Investment Management, told GlobeSt in a preview interview. “REITs have effectively already priced in the impact of the changing reality of debt costs. That price correction has not happened in the private markets yet, and we anticipate that is coming in the next 12 months.”

But despite that, Chang says opportunity abounds for commercial real estate investors.

“I want to encourage investors to not get too focused on the inverted yield curve or the recession risk that may be out there,” Chang says. “If the recession is as mild as most economists think it will be…then commercial real estate will be a very well-positioned asset to weather the brief, mild storm. Don’t forget, after every recession there’s a recovery cycle and a growth cycle. and when there’s growth, CRE tends to do very well.”

Chang says “the real focus shouldn’t be on the next few quarters,” adding that “investors should be thinking about what the recovery and growth cycles following the next few quarters could look like.”

LOS ANGELES—“Our markets are so dynamic, it is hard to pinpoint what to do at any particular time.” That is according to Hessam Nadji, president and CEO of Marcus & Millichap, who led an economic overview at Monday’s GlobeSt. Multifamily conference here at the JW Marriott LA LIVE.

Nadji began his macro and micro trend overview forecast by “getting the good news out of the way” because “we are going to hit some challenges ahead.”

THE POSITIVES FROM 2012 to NOW

From 2012 to today, there are 18.5 million more people in terms of population. There is a 2.6 million increase in young adult population and roughly 9.8 million more households, Nadji said. In addition, there are 18.5 million more jobs, and 6.2 million more job openings than in 2012. “Our GDP as a country has grown by $8.6 trillion. There are 10,000 people per day who are turning 65 in the US and unlike any other developed economy on the planet, we also have 12,000 people turning 21 today every single day,” he said. 

“That dichotomy gives us an underlying strength that no other country can point to,” Nadji said. And with all of those factors in mind, 10 years from now, he said, “Whether it is me or someone else on the stage, they will be telling you something similar to this because the next 10 years are going to be great… The next 10 months, not so much.”

PUMPED LIQUIDITY, CONSUMPTION

Interest rates have been increasing and the problem is due to the global pandemic, he explained. “During that time, the central banks around the world pumped more liquidity into the global economy than it has ever experienced… It was unprecedented to have $5 trillion plus pumped into the economy.”

Not only was it unprecedented, but it was shocking and injecting that much into the system will do things to an economy, he explained. “We will never look at toilet paper and hand sanitizer the same… Things did change and there were ramifications. Look at what it did to the economy.”

He continued that we lost 20 million plus jobs in two months and then “had a rapid recovery from that within 2 months or so to full employment and then some. That happened because of the stimulus that was pumped into the system.”

Switching gears, Nadji talked a bit about retail sales growing and consumption still on the rise. “Consumption also has changed dramatically,” he said. “We are over-consuming because it is so easy to consume.”

All of these things, he explained, ended up with an inflation rate near a 40-year high and it is a major challenge, but it is better than the alternative. “Had the government not acted the way they did, it would have been worse.”

Where things stand now, he said, is that median home prices have increased nationally (up 37.3% over the past two years). “Is that going to come back down to earth? Absolutely… Prices will adjust. This was dramatic. The inflation and deflation.”

WHO IS TO BLAME?

Everyone who studies economics knew that the Fed wasn’t acting as it should have, Nadji explained. Rates stayed way too low for too long, he said, and that delay contributed to the pressure that shocked the system. “It was a missed opportunity by about a year and here we are having to deal with this missed opportunity to synchronize sweeping up the excess liquidity.”

The Fed is having to declare war on the economy, he said. “They are walking a tightrope.”

He continued that commercial real estate was in a good spot. “it wasn’t being overbuilt or overleveraged and presented all sorts of opportunities… The beauty of our business is that we have risk reward opportunities that match pretty much every investment.”

BEHAVIOR TRANSFORMATION, LENDER COMPOSITION

Behavior transformation has also invigorated space demand, he explained. Look at the metros that benefited from the natural migration out of urban areas. “The pandemic drove young adults back to their parents and pent-up households will be a positive force for future demand,” Nadji said. “These are future renters and demand creators… Yes, it hurts in the short turn, but we are building demand.” 

As for US apartment rent, there is still strong momentum. Class A apartments faced the biggest initial impact and are experiencing rising vacancy rates but Nadji expects that pricing power there will be taken back. The dynamic between urban and suburban markets also changed dramatically with suburbs outperforming across all market types, he explained.

In terms of lender composition, agencies are no longer priced out of the market, Nadji said. “They become the solution in a market like we experienced in 2020 and are coming back as a solution with the challenges we are facing now.” Short term debt solutions in this market are also a key tool. He added that “creativity is another key tool in solving whatever it is that you are facing or wanting to execute on a property that is available that wasn’t available before. For everything that needs to get done, there is a solution. I would not exit this market and miss out on opportunities.”

After nearly three years of COVID-19 emergency restrictions, landlords will once again be allowed to evict tenants who have fallen behind on their rent, the L.A. City Council decided Tuesday.

The unanimous vote allows the eviction protections, some of the longest-lasting in the country, to end starting Feb. 1.

The restrictions have prohibited landlords from evicting renters affected by COVID-19 since the beginning of the pandemic in March 2020. At the time, the fear was that the widespread economic damage caused by the virus could cause a tsunami of evictions that would send homeless rates soaring as well as further fuel COVID-19’s spread.

“This policy that was put into place two years ago was intended solely to keep people housed and keep them off the streets,” City Council President Nury Martinez said before the vote. “Now is time that we not only keep people off the streets but also protect people’s housing and preserve their financial well-being.”

L.A.’s eviction protections were part of a robust set of policies advanced by federal, state and local officials during the pandemic. Tenants in the city of Los Angeles received $1.5 billion in rental assistance, according to L.A. housing officials, in an effort to keep renters in their homes while also paying landlords’ bills. About 70% of tenants receiving the money were residents classified as “extremely low-income,” such as families of four making less than $35,340 a year.

But that money hasn’t been enough to cover all outstanding debts, according to landlords and tenants who spoke during more than an hour of public testimony at the meeting.

Wayne Harris, 65, a landlord who owns small properties in South L.A., told the council that some of his tenants haven’t paid rent since near the start of the pandemic, but government assistance programs have covered only half what he is owed.

“I worked hard all my life to purchase my building, not to house people rent-free,” Harris said. “If the government wants to implement something where people don’t have to pay rent, implement something where we get paid and made whole.”

The city’s eviction protections have not waived past due rent, but landlord groups said it was unrealistic to expect tenants would ultimately repay large sums and unfair for landlords to have to go years without payment. Under the plan approved Tuesday, tenants have at least until August to repay rent debt accrued during the pandemic.

Councilmember John Lee, who represents eastern San Fernando Valley neighborhoods, said that small landlords had borne too much burden from the eviction protections as the economy stabilized and vaccines became widely available.

“We are learning to live in this new normal,” Lee said. “The moratorium has served its purpose, and now it is time to move on.”

Tenants told council members that the city’s policies had been a lifeline keeping them and their neighbors from losing their homes while dealing with the economic and health ravages of COVID-19.

Teresa Roman, 50, a tenant who lives in Cypress Park, told the council that renters had struggled working minimum-wage jobs while facing continued pressure from their landlords. She said she and others feared their families would become homeless.

“We want our children to be safe,” Roman said. “We don’t want them to be on the streets.”

The council’s actions Tuesday begin to unwind a series of other protections put in place at the pandemic’s start. In February 2024, a year after being allowed to resume evictions against tenants who are behind on their rent, landlords will be able to evict tenants for unauthorized pets or residents who aren’t listed on leases. In rent-controlled apartments — about three-quarters of the city’s apartment stock — rent increases will also be allowed to resume in February 2024.

But council members agreed to move forward a permanent expansion of other eviction protections. Currently, tenants in rent-controlled apartments cannot be evicted without documented lease violations or receiving relocation assistance for owner move-ins and other “no-fault” reasons. The council voted to explore expanding those protections to tenants living in newer apartments not covered by rent control.

Many other cities across California and the United States adopted eviction protections for renters at the start of the pandemic. But they have since expired or were repealed — in some cases more than a year before L.A.’s will. L.A. County supervisors recently voted to sunset county eviction protections by the end of the year.

Some council members credited the city’s emergency eviction protections with slowing the growth in L.A.'s homeless population. Last month, officials revealed that city homelessness increased by less than 2% since 2020 to just under 42,000 people, according to the regionwide homeless count, despite the dramatic effects of the pandemic.

“The protections that the city put in place to keep renters in their homes during this time of great turbulence and uncertainty did just that,” said Councilmember Nithya Raman, who represents neighborhoods stretching from Silver Lake to Encino. “It kept people in their homes, people who might have otherwise ended up on the streets.”

Councilman Bob Blumenfield, who represents communities in the western San Fernando Valley, noted that tenants who spoke Tuesday rarely mentioned ongoing hardships due to the pandemic, but rather broader difficulties in L.A.'s expensive housing market.

He said that showed the council needed to turn its attention away from emergency regulations and instead toward more comprehensive policies.

“It’s no longer the COVID question,” Blumenfield said. “It’s the bigger question of housing equity.”

During the meeting, tenants also decried what they called holes in the net of eviction protections. Landlords have still been allowed to file eviction lawsuits, pulling tenants into a complicated court process, most often without a lawyer. Although the pandemic protections provided them a defense in court, tenants could lose their cases by default if their filings weren’t done properly and on time.

Cases are once again on the rise. Residential eviction filings across L.A. County in June totaled nearly 3,400, according to L.A. County Superior Court records compiled by Kyle Nelson, a postdoctoral researcher at UCLA who has tracked them during the pandemic. Despite the ongoing city and county eviction protections, that monthly figure for the first time eclipsed the number of filings that occurred before the pandemic in February 2020.

The Fed’s most recent rate hike has widened the emerging “expectation gap” between buyers and sellers of commercial real estate, according to one industry watcher.

“Sellers tend to be slow to adapt to a cooling market,” says Marcus & Millichap’s John Chang in a new research video. ”Many continue to shoot for top dollar when they sell, and often end up chasing market prices down. But buyers are completely changing their underwriting assumptions…as a result, the buyer-seller disconnect has widened and commercial real estate activity activity has begun to slow.”

Motivated sellers should recalibrate pricing to meet the market, Chang says — and buyers should seize the opportunity to target strategic acquisitions to position for the next growth cycle.

“Any Fed-induced downturn should be mild compared to the last two recessions, but considering the stock market is down more than 20% so far this year, commercial real estate may be one of the best investment options as the Fed grapples with inflation and creates some economic turbulence,” Chang says. “Now is when investors should be thinking longer term, where they want their portfolio to be in three to five years.”

Chang says the recent 75 bps hike by the Fed was “telegraphed and wasn’t any surprise,” but there are still no signs that inflation is coming down yet. As of a few weeks ago, the headline rate of inflation was pegged at 8.2% and core inflation rate stood at 6.3%

On the supply side, Chang says, the war in Ukraine has cut the availability of oil, natural gas, and food. China’s COVID zero-tolerance policy continues to stay manufacturing and shipping, and ongoing transportation challenges have hampered the movement of goods. And “the strength of the US economy is on the other side of the equation,” he says, noting that unemployment is 3.7% and there are 5.2 million more job openings than people looking for work. Wage growth has been above 5% for the last eight months, and households have amassed $23 trillion in savings, a major upswing from pre-pandemic numbers. Meanwhile, inflation-adjusted retail sales are 20% higher than pre-COVID figures.

“Manufacturing, shipping, and logistics systems simply cannot keep up with consumption,” Chang notes. “The Fed’s answer to this is to try to cut demand and get it back into alignment with supply by raising interest rates. Unfortunately this will cause some pain…in a nutshell, the Fed’s basically suggesting the economy may need to go into recession to get inflation under control.”

On a day when a stubbornly high inflation rate threw cold water on everyone’s hope for a soft landing for the US economy, former US Treasury Secretary Lawrence Summers assured CRE executives that “if the car’s going faster, we need a stronger brake, but that doesn’t mean we’ll hit the wall before the car stops.”

In a wide-ranging online discussion hosted by Marcus & Millichap CEO Hessam Nadji on Tuesday, Summers predicted that continued rate increases by the Fed soon will create a “recession of choice” that will bring the unprecedented job growth of the past year to a halt.

“We have incessant inflation due to a collision between demand and supply, and the Fed intends to contain it by restricting demand by raising rates,” Summers said. “My best guess is that the economy will go into recession and we’ll have a year of contraction of job growth.”

But the former Treasury chief said the economy—and the CRE sector in particular—is in much better shape to weather an economic downturn than it was in 2008 when the housing market collapsed.

“We won’t see something like 2008 again,” Summers said, noting that homeowners are much less leveraged, inventory is not overbuilt and lenders are stronger and much more careful in underwriting mortgages than they were during the sub-prime crisis.

Summers signaled that it may take a few months for the recession to materialize because fundamentals like consumer spending remain robust—and still have some room to grow.

“It’s important to remember that there’s still a big savings overhang. The amount of money that people couldn’t spend during the pandemic is $2 trillion,” Summers said.

“Only $300 billion of that has been spent, and more than half of it is [still] in checking accounts. That tells me that consumers will keep going. I don’t think they’ll run out of room to spend because of devalued paychecks,” he said.

Summers counseled CRE players not to assume that “structural” trends that have been unleashed by the pandemic—including the rise of remote work and the surge in e-commerce—will impact negatively on the demand for CRE.

“There will be substantial ferment and opportunity in CRE markets, even in a year—or two—when you won’t see job growth,” Summers said.

“Many people think it will be bad if people work from home. That’s wrong. When people go to different places, their migration becomes a source of real estate demand,” he said, adding that the rapid expansion of e-commerce during the pandemic created an exponential demand for warehouses.

Regarding the office sector, Summers thinks hybrid work is here to stay, but he does not believe it will have as much of an impact on office footprints as some may be projecting.

“A lot of people will go substantially remote. Employers are going to get better at monitoring remote work and they’ll become a bit more accepting of work at home,” he said.

“But if people come to the office three days a week, the employers will want everyone to come in on the same three days, so that will have less impact on office footprints,” Summers said.

In a prediction that is sweet music to the ears of the commercial real estate sector, the former Treasury Secretary said CRE—with cap rates currently averaging 5.7% across asset classes—remains a compelling investment opportunity compared to stocks and bonds.

“The role of CRE in portfolios is likely to be greater” in the months and years to come, Summers said.

“For a large number of portfolios, there should be a larger place for commercial real estate,” Summers said. “It’s substantially tax advantaged, and on an after-tax basis, it looks even better.”

“A bond is 3.3 percent and that’s all it’s going to be at the end of ten years. The value of property is vastly more likely to appreciate [over ten years]. It will go up, not down,” he added.

Los Angeles may wind down many of its COVID-19 protections against evictions and rent increases by January, ending what has become some of the nation’s strongest and longest-lasting tenant safeguards during the pandemic.

Starting in 2023, landlords will once again be allowed to evict tenants for not paying their rent even if they’ve fallen behind for COVID-19-related circumstances, under a proposal released by the city housing department last week. The plan also calls for tenants living in rent-controlled apartments in the city — about three-quarters of the apartment stock — to once again face rent increases the following year, in January 2024.

“As we recover to a new normal, the city must provide clarity to both landlords and renters on the timeline when current and past-due rent must be repaid and temporary eviction restrictions lifted,” the report reads.

If passed by the City Council, the proposal would put L.A. back in line with many cities in California and across the country that have repealed or let expire renter protections enacted when the pandemic began in spring 2020. At the time, citing the risk of widespread homelessness because of COVID-19’s economic damage, local, state and federal leaders passed a battery of rules against evictions and rent hikes.

But Los Angeles’ rules are rare both for their strictness and how long they’ve lasted. If the proposal advances, tenants in rent-controlled apartments will have had no rent increase for almost four years by the time they’re allowed again in 2024. And tenants who fell behind on rent during the pandemic will have at least until August 2023 to repay what’s owed.

Dan Yukelson, head of the Apartment Assn. of Los Angeles, said that the city’s rules have been “far worse than any others” in the region. Many landlords, he said, don’t expect to recover past-due rent debts, and have been struggling to keep up with rising city fees and inflationary-driven maintenance costs in recent years.

“It’s very easy for the city to push this on the backs of landlords and have them suffer longer and be responsible for the entire support system for these renters,” Yukelson said. “It’s not fair.”

He said he was relieved that the city was moving to end its restrictions.

“Any kind of finality, we’ll be doing the happy dance,” he said.

Still, the pandemic has further exposed the precariousness of housing for renters in the region.

Tenants in the city of Los Angeles alone received $1.5 billion in local and state rental assistance during the pandemic, the housing department report said. About 70% of those receiving the money were extremely low-income residents, such as families of four making less than $35,340 a year or an equivalent amount.

Los Angeles tenants are generally covered by the city’s rent-control rules if they live in apartments built before October 1978. But those in newer apartments can now receive as much as a 10% rent increase under a state law designed to cap larger rent hikes.

And after a sharp downturn at the beginning of the pandemic, rents for newly leased apartments in the city have roared back. The median two-bedroom now goes for $2,225 a month, a 9.5% increase since March 2020, according to data from real estate firm Apartment List.

The rising costs have prompted at least four cities in Southern California to implement rent-control rules over the past year with multiple others considering new or tightened policies on the ballot in November.

As part of its report, the city housing department also is recommending new permanent eviction protections for rental properties currently not covered by the city’s rent-control regulations as well as studying whether to make it more difficult to evict tenants behind on their rent.

Tenant advocates say that the combination of eviction protections, financial assistance and other policies dramatically decreased the number of evictions filed in L.A. county courts, showing that governments can prevent them from occurring.

They want more robust permanent renter protection policies implemented prior to the expiration of the COVID-19 rules so that there’s no gap for affected renters, said Faizah Malik, a senior staff attorney with Public Counsel, a pro bono law firm that assists low-income renters.

“Even we have to acknowledge the emergency protections can’t go on forever,” Malik said. “But we can’t go back to what it was pre-pandemic because in some ways things are worse now.”

After soaring throughout the first half of 2022, inflation is beginning to flatten, prompting speculation as to how the Fed will react at their September meeting. Headline inflation came in at 8.5%, down from last month’s 9.1%, while core inflation numbers, which omits the oil, gas, and food sectors, held steady at 5.9% on a downswing from 6.4% in March.  

And “that’s good news,” says Marcus & Millichap’s John Chang. “Basically, things aren’t getting worse.”

Chang says he expects inflation to slowly come down over the next several months but doesn’t think the improvements are tied to the Federal Reserve’s rate hikes. He notes that supply chains are finally beginning to even out and the average length of time to ship goods from China is declining.

“The Fed’s trying to force the market back into alignment by reducing demand and they’re doing that by raising borrowing costs,” he says. “It’s basically the only tool they have.”

But because household savings and balance sheets are so strong, Americans aren’t borrowing as much to cover higher costs – so raising rates doesn’t have as much as an impact. Retail sales are still climbing, though home sales have slumped.

The most recent inflation numbers were “pretty much what I hoped would come out,” Chang says, and he predicts the Fed will again raise rates in September, likely by 50 basis points. The Fed is also scheduled to double their quantitative tightening program in September, raising their monthly balance sheet reduction to $95 billion per month. That will put upward pressure on the 10-year Treasury.

“That’s the not-so-good news for investors.  Inflation will likely remain stubbornly high, and interest rates will likely continue to climb,” Chang says.  But elevated inflation will likely also have minimal impact on space demand for commercial real estate: while apartment vacancy ticked up a tad in the third quarter, Chang says the increase is a “normalization of the market” post-COVID.  And demand for retail, industrial, and hotels should remain relatively strong. Office space demand will be stable, but at a high vacancy rate of around 16% nationally.

“The more important aspect will be how rising interest rates affect commercial real estate investor activity through the remainder of this year and into 2023. The market has already begun to recalibrate,” he says. “Some sellers are reducing prices to meet the market, while some buyers are reducing their leverage to meet their yield hurdles. Overall, the CRE market remains liquid with strong investor activity.”

Housing, particularly multifamily, saw big jumps—and cap rate crushing—during the pandemic. Now? The Mortgage Bankers Association says the brakes are about to hit.

The organization released a new baseline forecast that projected a much slower second half of the year, with total commercial and multifamily financing to fall by 18% from $891 billion in 2021 to $733 billion in 2022.

Separate out multifamily and there’s a 10% drop from 2021’s record $487 billion to an expected $436 billion by the end of this year.

But the MBA expects this will be a hiccough, with borrowing and lending to rebound in 2023, hitting $454 billion in multifamily and $872 billion overall. Still not what we saw in 2021, but strong.

“The rapid changes taking place across space, equity, and debt markets are having a significant effect on commercial and multifamily real estate transaction volumes,” MBA vice president for commercial real estate research Jamie Woodwell said in prepared remarks. “After a record start to the year, we expect that the rise in rates, ongoing uncertainty about supply and demand balances among some property types, and concerns about the direction of the economy will suppress new loan originations in the second half of the year.”

But as the expectations for 2023 demonstrate, the group sees most CRE activity as strong, “with significant increases in the incomes and values of many properties in recent years. These factors are why MBA expects loan demand to begin to bounce back in 2023 and 2024.”

And that may be. But it’s also not the only concern on the horizon, though that may be putting it too strongly. For example, during the company’s recent quarterly earnings call, Prologis CEO Hamid Moghadam called the last couple of quarters for the logistics and warehousing company as a 12 or 13 out of 10. “And I think this quarter, there may be 9.5 to 10,” he said. Great performance, but when markets have been experiencing extraordinary, unusually good can seem tame by comparison.

As Woodwell also said, the real gating factor and test will be the economy. “Should the economy enter a recession, which—if it were to happen—would most likely come in the first half of 2023, commercial and multifamily borrowing and lending would likely be further constrained,” he said.

That’s unless there’s already a recession, as nearly real-time analysis from the Federal Reserve Bank of Atlanta has suggested, with a GDP slowdown in the first quarter of 2022 followed by what seems to be another drop in the second quarter. Two consecutive quarters of negative GDP growth isn’t the definition of a recession, but it’s considered a rough rule of thumb.

Apartment List put together an explainer on how housing costs factor into inflation and where housing inflation might be heading. But the topic is even a bit more elusive than the explanation.

Inflation—commonly measured by the Consumer Price Index, or CPI—is a complex topic. The government measures the ongoing costs of a “market basket of consumer goods and services,” according to the Bureau of Labor Statistics. The collection can change over time and prices are checked in many different geographic locations. The single number is an average, so not necessarily the real experience of any one household. 

Also, the impact of inflation depends on your personal circumstances, because things in the market basket change at different rates. Typically, housing, school and childcare, and healthcare all rise significantly faster than per capita disposable income, which is the money left over after paying personal taxes. If you are paying for college or a significant illness, chances are that you feel the effects or rising prices more than someone who isn’t.

As Apartment List notes, the shelter portion of CPI is an estimate based on actual market rents but also a market rent equivalent for people who own their homes. That shelter component is up 5.5% year over year, versus so-called topline 8.6% CPI, which is the official overall number. 

But that’s differentiated from “core” inflation—that’s inflation with food and energy costs taken out. The rates of inflation for those two categories are 10.1% and 34.6%. So, in one sense, Apartment List is correct that shelter is not the main driver of inflation at the moment.

“The reason that the shelter component of CPI shows housing costs rising more modestly than our index [of rent changes] is that the two measures are actually answering different questions,” the company explains. Apartment List’s rent index tracks rent changes for new leases, while the CPI tracks ongoing changes in price. But people will tend to sign a new lease once a year, not once a month. They don’t feel the constant increase, but it hits the pocket in a noticeable way annually.

Also, while shelter is not the fastest growing part of inflation, it is the largest single component of CPI, and it is one that is more difficult to mitigate. When food becomes very expensive, people substitute, like buying ground beef instead of steak or a cheaper brand of coffee. When energy grows rapidly, people can travel less or swap out incandescent bulbs for other technologies that use much less power. For housing, making short-term swaps or changes in utilization isn’t possible. So, while housing technically isn’t the biggest component of inflation, it’s growth, at least for those renting or buying a new place, is more inexorable.

One thing that Apartment List mentioned was that its data shows a likely cooling of rents. “Year-over-year growth in our rent index peaked at 17.8 percent this January and has since fallen to 14.1 percent as of June,” they wrote. “Assuming a seven-to-eight-month lag [that analysis suggests exists], we would expect that year-over-year growth in the rent CPI will begin to decline in the data for September or October.”

Fed executes steepest rate hike in decades. At its June 15 meeting, the Federal Open Market Committee (FOMC) raised the federal funds rate 75 basis points to a target range of 1.50 percent to 1.75 percent. This was the largest single increase since November 1994 and brings the total year-to-date advancement to 150 basis points. Additional rate hikes are anticipated through the rest of the year, likely lifting the year-end target range into the 3.50 percent zone for the first time since before the Global Financial Crisis. These actions are applying substantial upward pressure to short-term interest rates. To lift longer-term rates, the Fed has also initiated quantitative tightening. The central bank is reducing its balance sheet at a measured pace of $47.5 billion per month from June to August, before accelerating to $95 billion beginning in September. The plan could adjust if economic risks shift. Causes of inflation outside of central bank’s control. Previous guidance from Chairman Jerome Powell had prompted the market to anticipate a 50-basis-point increase in June. The FOMC’s decision to accelerate that pace was driven by decades-high inflation in May when headline CPI grew 8.6 percent year-over-year, due largely to factors outside of the Fed’s control. Global supply chains remain beleaguered by COVID-19 lockdowns in China and the war in Ukraine. This is leading to a shortage of goods globally and at home, lifting prices. The conflict in Eastern Europe is also disrupting food and energy markets. Nearly half of last month’s multidecade-high jump in inflation was driven by greater food and energy costs. Removing those two categories, core CPI advanced 6.0 percent year-over-year in May, a slight deceleration from recent months. Nevertheless, several domestic factors continue to apply upward pressure to a range of prices

Lack of sufficient homes and labor lifting prices. The nation’s growing housing shortage was exacerbated by the health crisis. Pandemic-influenced lifestyle changes and low interest rates pushed the demand for single-family homes well ahead of supply, resulting in sales prices climbing more than 36 percent since 2019. The Fed’s actions are now aimed at curbing that demand by substantially raising borrowing costs. The average 30-year fixed rate mortgage surpassed 5.7 percent in mid-June, its highest level since 2008. New home costs are also continuing to advance, due to shortages of raw materials from abroad and labor at home. The workforce shortfall is not unique to the construction sector either. Across most industries, job openings well exceed the number of people looking for work, applying upward pressure to wages, another source of inflation. Powell sets price stability ahead of labor market. Given the multiple forces driving inflation, the Fed has embarked on this path to curb consumer demand until supply can catch up. Chairman Powell has identified achieving price stability as the first goal, even at the cost of full employment. The Fed believes the labor market is so tight that some hiring demand can be siphoned off. Even if unemployment climbs modestly to around 4 percent, the measure is still tight by historical standards. Positive momentum in other aspects of the economy, including strong levels of household and business spending, could also help support the jobs market while interest rates climb. Nevertheless, the Fed has acknowledged that bringing inflation back near the 2 percent target could require slowing the economy more than they initially hoped, with the Federal Reserve’s GDP growth expectations for the year now falling under 2 percent.

Impact of Tighter Monetary Policy on Commercial Assets

Fed rate hikes have notable repercussions for capital markets. The higher-than-anticipated 75 basis point June bump in the federal funds rate, and guidance of a similar move in July, have financiers re-evaluating their offerings. Lenders that benchmark to credit markets, including CMBS and life insurance companies, may begin to push their spreads and their quoted rates higher. Banks and other balance sheet lenders may hold the line a bit longer, especially for borrowers they have a strong relationship with. Forward-looking momentum is nevertheless moving toward higher lending rates. This will create both short- and long-term headwinds for investors. Buyers making near-term adjustments as spreads likely to rise in summer. Over the short term, some borrowers may face adjustments to quoted rates on transactions they have in process. In some instances buyers will absorb the rate increase, and in others they may reduce their leverage. The Fed move could also spawn a round of re-trades with sellers, as buyers attempt to renegotiate pricing based on the rapid rise in the cost of capital. Depending on the pool of investors pursuing each asset, this could begin to weigh on market pricing for commercial properties. Over the longer term, lenders may begin to widen their spreads to mitigate interest rate risk, particularly through the summer. Historically, many lenders have widened spreads a bit in the summer months before tightening them again in the fall. Given the increased uncertainty created by the Fed’s accelerated rate hike plan, however, more lenders may bake-in higher interest rates. Impact to sales varies at property level, widespread correction unlikely. Higher lending rates have the potential to restrain some buyers, reducing the competition for assets and potentially softening the market for select properties in some markets. The impact of rising rates will depend on a variety of factors. The type of lender the buyer is using, and the buyer’s relationship with that lender, will have a notable influence on terms. The forward-looking supply and demand metrics for each property is also critical, as is whether there is a value-add component. Properties with inflation resistance integrated into the future cash stream, as well as that asset’s prospects for rent growth, will play large roles as well. The range of variance across the commercial real estate spectrum could be substantial as each investor sharpens their pencil and recalibrates their underwriting. A tremendous volume of capital continues to pursue commercial real estate investments, so even though interest rates went up more than many expected and the expectation gap between buyers and sellers may widen, a broad-based pricing correction remains improbable.

Single-family construction in large metro urban areas fell while multifamily construction there spiked, according to the National Association of Home Builders (NAHB) Home Building Geography Index (HBGI) issued this week.

The rate of year-over-year single-family construction growth in small metro urban, suburban and rural regional submarkets also slowed in the first quarter. 

Large metro suburban counties fell from 18.7% in Q1 2021 to 5.2% in Q1 2022.

The only region to post an increase in growth was micro counties (small towns) – a 3.9 percentage point increase to 16.7%.

John Hunt, senior analyst, Founder & President, MarketNsight, tells GlobeSt.com “There’s no inventory, especially for homes under $300,000 which means people are moving to second tier suburbs because of price. This is happening in every market.”

NAHB Chairman Jerry Konter, a home builder and developer from Savannah, Ga., said in prepared remarks, “Ongoing building material production bottlenecks have delayed or stalled home building projects, construction labor shortages are running near an all-time high of 400,000 workers and more recently the rapid runup in mortgage rates have all combined to exacerbate the housing affordability crisis.”

NAHB Chief Economist Robert Dietz said that the more pronounced drop in growth for the large suburban markets “is due to the easing of the rapid shift of home buyer preferences for the suburbs in the aftermath of the COVID-19 pandemic.”

MF Growth Found in Large Population Centers

Multifamily growth in large population centers posted sharp gains during the same time period, rebounding from negative growth rates.

Dietz noted that apartment construction growth is far outpacing single-family building in all regional geographies. “Low rental vacancy rates and rising rents give multifamily developers confidence to continue building despite rising costs for land, labor and materials,” he said.

Key findings from the first quarter HBGI show that four-quarter moving average single-family growth rates in:

Large metro suburban counties fell the sharpest, from 18.7% in the first quarter of 2021 to 5.2% in the first quarter of 2022.

Large metro core counties very marginally slowed down from 9.5% in the first quarter of 2021 to 8.8% in Q1 2022.