The holiday season is supposed to be a joyful time. Beginning at the start of November, as thoughts turn towards Thanksgiving turkey, cooler temperatures, family gatherings, Christmas, Chanukah, New Years and shopping, a certain contentment begins to settle in all around.  Or does it?

Certainly not in offices where real estate closings take place. Holiday season brings panic.  As year end approaches, the calendar is the enemy.  Everybody wants to close and everything is a rush.  A feeding frenzy has begun.

Why does this happen? I remember when I first began practicing, we always had to get 1 or 2 last big deals finished before the end of the year.  My senior partners always told me we had to do this for “tax reasons”.  The first couple of years, I assumed that this was because the client had tax planning reasons for closing by December 31.  I then came to realize that it was really for the firm’s cash flow needs that December 31 was critical.  Close the deals, collect large fees, partners get bonuses, don’t close, no fee, partners don’t get bonus.  Simple economics!

Later, when I started practicing on my own and money in the bank on 12/31 vs. 1/1 made no difference to me, we still had surges in November and December. But, if deals weren’t closed by the middle of December, many clients began to close up shop for the holidays, deciding to carry over the gain or loss until the next tax year.  Thus, 12/31 became an artificial deadline.  Sometime before 12/20 was the new deadline only for my own peace of mind.

Today, the feeding frenzy is as real as ever. It is true for residential and commercial closings.  Some of it might have to do with Trump tax reform.  But there are other factors.  First, we continue to ride a long, strong economy.  The real estate market remains strong and interest rates remain low.  With so many deals out there, clients want to close quickly to take advantage of the economic climate and interest rates before this changes.

Second, contracts signed early in the year, after everything closed at year end, run their course and have year end closing dates. There are 2 factors driving this.   Commercial deals are longer term.  Once the due diligence period has run its course and approval and other contingencies have been satisfied, closing must occur.  In a typical commercial contract, this can take 6-12 months, sometimes longer.  But when the date comes up, there is a rush to close.  Though you can’t predict when a contract will be signed, it does seem that many projects start at the beginning of the year which often times out the closing date for the end of the year.  As to residential contracts, many people put their homes up for sale in the summer, after the school year.  Consequently, contracts are often signed at the end of summer and early fall.  Closings usually take 60-90 days, which puts the closing right in the middle of the holiday period.

Third, cash deals are very common in both residential and small commercial contracts. Take a lender out of the picture and the process to close gets shorter.  Sellers like to accept cash contracts as it takes a major contingency out of the picture, further shortening the closing.  Sellers will accept lower purchase prices to get to closing faster.  If the expectation is a faster closing, a closing scheduled for the holiday time period will not likely carry over to the new year.

How do we cope with the frenzy and avoid becoming shark chum? Clients, brokers and other attorneys can sense stress immediately and when they do, they do what they can to add to it.  It is important to remain organized and up to date on every transaction, no matter the size, so that you never let the sharks smell the blood in the water.  If we do this, we will make it from Thanksgiving to New Years in one piece.

Perhaps I haven’t been paying attention but sometime over the last, oh I don’t know how many years, local, and some national stores, have become highly specialized. Maybe not so much here in South Florida, but certainly in New York, Washington and other big cities.  Yes, the trend eventually hits Miami and elsewhere.  I am talking about stores that sell things like just cupcakes instead of a general bakery or coffee shop.  I hadn’t paid much attention to this until recently when my wife had 3 or more choices of cupcake stores in Washington from which to send cupcakes to our son for his recent birthday.  Here, in our Ft. Lauderdale suburb, we would have just gone to Publix.

Maybe it is a food trend. We were in New York last year with our daughter lining up at Momofuku Milk Bar for cereal milk ice cream, the ONLY flavor on the menu.  Momofuku only sells this interesting ice cream as well as cookies and other baked goods that center around the cake, cereal and truffle theme.  Not a place to go if you are watching your weight.

Starbucks originally was just a coffee shop. But it has expanded to way beyond coffee.  Today, there are many niche coffee shops which are going back to the coffee roots.  Just coffee.  The list of specialty shops is by no means just food – bags/purses, containers, phones, soap, bath items – to name just a few.  But food is certainly a leader and there are numerous different single item food stores.

But the kicker, to me, in this trend, occurred on May 31 in Chicago when the 1st all-Nutella café opened. This is a stand alone restaurant dedicated to serving Nutella filled crepes, pastries, gelato, pancakes, waffles and other items.  Seriously?  1 or 2 spoonfuls of Nutella is great, but an entire restaurant’s worth is really…. I don’t have the words to finish this thought.

00180370

        During the past three meetings, the Alliance of Corporate Real Estate Executives and Specialists (ACRES) presented some of the top real estate economists and prognosticators. Brad Hunter, Jack McCabe and Eric Fixler expressed fairly similar views on the state of the South Florida real estate market for the next few years. What follows is an amalgam of their opinions and is not intended to be a restatement of the position of each expert. Each may disagree with some of the positions taken by the other two. The over-arching message of all three of our group’s speakers is that the presidential elections, world events, and exchange rates may create disruption to any of their predictions or the trends currently being seen. These predictions are their opinions of market trends and are not guaranties of future performance.

Market categories:

  • Luxury condo towers – The high-end luxury condo market on Brickell, South Beach and Sunny Isles is pretty much dead. If a project is not out of the ground, there will likely be a wait of 3 to 5 years before the next cycle. Their comments were mirrored by a recent Wall Street Journal article entitled “Another Condo Bust Looms in Miami”. The Journal, quoting a Miller Samuel, Inc. report, stated that  “In the fourth quarter of 2015, the number of Miami Beach condo transactions declined nearly 20% from a year earlier, while inventory jumped by nearly a third…” The Journal went on to note that the median sales price for luxury condo units dropped 6.6%. With exchange rates flipping in favor of the US dollar, some South American buyers may choose to abandon even 50% deposits, as that may be a “less worse” choice than closing. The silver lining for investors is that, as in past condo cycles, units will likely sell for far less than today’s sales prices.
  • Other residential – For entry-level, mid-market, and senior housing, demand has outstripped supply and will likely continue even in the face of a new recession.
  • Retail – Despite the loss of big box stores, like Office Depot and Sports Authority, core retail sales development will likely continue at an average pace. The projected average increase is 4.2% in project starts annually over the next few years.  The cautionary trend is that the cap rate spread between primary and tertiary markets is now dropping from 2012 levels. This means that there is more cash chasing investments and willing to pay more for third tier market properties.
  • Industrial – cap rates are down and rents are up. The cap rate spread between primary and tertiary markets has closed but not to the same degree as retail.
  • Office – cap rate spread has been fairly steady since 2012.
  • Multi-family – cap rates generally between 5% and 6%, although primary markets (South Florida included) have seen as low as 4 caps. New product being delivered is not substantially affecting existing inventory.

 

Financing:

  • CMBS – still most readily available source for long-term fixed, non-recourse lending. Currently between 270 to 290 basis points above 10-year T-bills.  From a real estate litigation/real estate acquisition play, between 2016 and 2012 $1.7 trillion in CMBS loans will mature. Most are in office, hotel and some retail product. As most were made in boom times, the LTVs are high and will be difficult to refinance at same percentages. Of the $1.7 trillion, $390 billion will come due in 2017. In addition, Dodd-Frank will place pressure on the B tranche of new CMBS loans. The B holder must retain ownership in that tranche for at least 5 years. Under the new Reg AB, the CEO of the fund will be personally liable for false information in the issue.
  • Life Companies – almost 2/3rd of 2016 allocations already funded. Additional funding will be limited to Class A properties in primary markets.
  • Private Funds –  demand is increasing. Pricing still high (loans $3mm to $10mm, rates are at Libor + between 450 basis points and 600basis points; loans $10mm to $20mm, rates at Libor + between 400 basis points to 600 basis points; and loan $20mm+, rates at Libor + 300 basis points to 425 basis points) and LTVs between 75% and 60%.  Most such funds are currently looking at value add properties in areas with market growth and to borrowers with real track record.
  • Banks – still out of the mainstream. Mostly relationship loans with difficult rate lock-ins.
  • GSEs (Government sponsored enterprises) – Fannie, Freddie and HUD very active in multi-family market and are the majority funders. In 2015, GSEs funded about $90b with $17b in uncapped loans. Rates are currently around Libor + 250 basis points, although pricing is volatile. Freddie funding loans under $5mm.

 

         One key concern raised by one of our speakers is that Europe is already in  recession. Because tests are retrospective the existence of a recession will not likely be confirmed until this fall. Spain, Portugal and huge number of jobless refugees are straining the EU. This time, the recession will spread from Europe to the USA unlike the great recession.

Marijuana-leaf_sized[1] (00153800)

Florida’s Right to Medical Marijuana Initiative Amendment returns to the ballot in November, Amendment 2. If passed, Florida will join a growing number of states that have some form of legal marijuana. While recognized by these states, the sale and use of marijuana is still criminalized. As such, federal banks have not accepted reputable marijuana growers and dispensers as customers and the marijuana industry is a cash business.

             Increasingly, commercial real estate has become a favorite way for marijuana entrepreneurs to protect and grow their money. Colorado, perhaps the center of the legal marijuana industry, provides an interesting look at what could happen in Florida. In the Denver area, over 3.7 million square feet of industrial space is occupied by the industry. However, landlords generally don’t like to lease to grow houses and dispensaries for fear of potential issues with the federal government including tax issues and criminal liability. Landlords are also concerned about nuisance to other tenants from odors and strain on a building’s electric and water capacity and potential fire hazard. Marijuana related tenants are often charged 4 to 5 times the market rate for space. On the plus side for landlords, rent is paid in cash as tenants have no access to bank accounts.

             Many marijuana business people are investing in real estate for these reasons. With no access to bank accounts, storage of cash is a major concern. The business owners are finding that owning their own properties is a good entry into the real estate world. The value of marijuana related property in Colorado is appreciating rapidly. And, there is plenty of cash available to invest in other properties. In effect, marijuana business owners are legally “laundering” their cash and expanding their businesses.

             If Florida approves Amendment 2, will we see a mini real estate boom? It is possible. Certainly, the industry will be highly regulated, but the business owners will face the same problems that Colorado owners face; the biggest being that banks won’t take their money. The risk and cost of storing cash in a house or an office is high and many owners will look for safe, quick investments to park their cash. Real estate is the obvious choice.

        00170457

        Commercial Real Estate lending continues to explode. Through the third quarter of 2015, CRE loans outstanding totaled over $1.8 trillion.  Over the last 8 years or so, CRE underwriting standards have eased somewhat.  The Federal Reserve, FDIC and Comptroller of the Currency issued a Joint Statement at the end of 2015 warning about this problem.

“The agencies have observed substantial growth in many CRE asset and lending markets and increased competitive pressures are contributing significantly to historically low capitalization rates and rising property values. At the same time, other indicators of CRE market conditions…do not currently indicate weaknesses in the quality of CRE portfolios…. [T]he agencies have also observed certain risk management practices at some institutions cause concern, including a greater number of underwriting policy exceptions and insufficient monitoring of market conditions to assess the risks associated with these conditions.”

        The statement directs financial institutions to reinforce prudent risk management practices and to maintain discipline in CRE lending. Examiners will be closely watching lending practices in the future.

        Lenders have not yet reacted to the statement nor announced plans to change underwriting standards or practices or whether they will scale back CRE lending as a direct result of the statement. But, the question becomes ‘do the agencies see the current CRE conditions as similar to the conditions that lead to the housing bubble and crash of the late 2000’s?’  There, housing values continued to increase, to the point that they were artificially high.  Good underwriting practices were totally ignored and, the combination of the 2 in addition to teaser loans, led to mass loan defaults. Yes, I am purposefully leaving out the CMBS aspect of the bubble, but, from the bank/consumer side, the agencies’ statement of concerns sounds very similar.

        For now, we need to take the statement as a warning – not just to be careful in our CRE lending and borrowing practices. But that the good times in commercial real estate will not last forever.  We know that they never do.  Developers, investors and lenders can hedge against another devastating crash by not growing complacent and succumbing to short cuts as everyone did with the housing crisis.  With good due diligence and smart practice, the next “crash” will only serve as a “market correction”.

    Get Blog Updates

    Get news, insights, and commentary delivered straight to your inbox!
    Click Here

    About Us

    Welcome to Assouline & Berlowe’s Florida Real Estate Law and Investment Blog with news, insights, and commentary for investors, developers, and their advisors.

    Topics

    Recent Updates

    Archives

    Stay ConnectedLinkedIn

    STAY TUNED!
    Get Blog Updates
    We'll send you an email whenever we add a new post.
    Stay Updated
    Give it a try, you can unsubscribe anytime.
    close-link
    Get news, insights, and commentary delivered straight to your inbox!
    Click Here
    close-link