South Florida’s commercial real estate sector has been among the hottest in the nation. The growth in new Class A office buildings, warehouse and industrial space, and other commercial properties have been rising unabated throughout the region.
The same holds true for inflation fears that the Federal Reserve Board hopes to alleviate with a wave of recent rate hikes.
So far, the Fed has increased interest rates by 3% in an effort to check inflationary pressures. The most aggressive hike we’ve seen in 40 years and the lingering possibility of a recession leave investors facing a scenario without precedent: a combination of low unemployment with low vacancy, scarce inventory, and some constraints on new construction in commercial real estate (CRE). The amount of capital in the market is aggressively looking for real estate to hedge inflation, viewed as a much safer investment alternative to stocks, cash and other alternatives.
In this CEO Roundtable hosted by Banesco USA and the South Florida Business Journal and moderated by Carlos J. Arboleda of COI Access, executives from the banking, real estate development, sales and leasing, information technology and legal sectors discussed how investors anticipate interest rates will impact cap rates, the possibility of increasing rental rates to tenants, and projections for CRE development and inventory availability in South Florida.
Commercial lending is riding a tide of post-pandemic optimism among real estate developers and property and business owners, even as rising interest rates leave many questions unanswered. The consensus was that there is little doubt that the near future may tamp down on some speculative or questionable investments. But given South Florida’s unique space in the greater CRE sector, and domestic and international investors’ seemingly insatiable investment appetite, what remains could be exciting opportunities for savvy and experienced developers.
CRE Investors bullish
Investors remain bullish on the CRE market, notes a recent survey from Marcus & Millichap. Rising interest rates and inflation have some investors cautious, with the market going through some recalibration. One in four respondents said they buy less CRE, 12% said they’d keep buying, especially in “inflation-resistant” products like self-storage, hotels and apartments, notes the report.
The National Association of Realtors reported in May that it expected CRE to perform well despite the headwinds, especially in the short term. While the commercial market tends to track with the overall economy, CRE is strengthening.
The industrial sector is booming, retail is turning positive, the hotel industry is recovering, apartments are doing very well, and rents are rising in all commercial sectors,” NAR Chief Economist Lawrence Yun said at the time. Multifamily investment was its highest ever in 2021 at $352 billion, notes CBRE.
Higher interest rates already are having an impact. South Florida’s apartment buildings have traded at record prices as rents continue to climb, yet the expectation is that fewer apartment building transactions will occur this year compared to last year, according to a recent Cushman & Wakefield report cited in the South Florida Business Journal. Already, sales volumes slowed through the summer and figures could be 20 to 30% lower than in 2021, noted author Calum Weaver, executive managing director of Cushman & Wakefield.
“Despite the headwinds, multifamily sales activity remains strong as foreign and domestic buyers continue to ‘pour into South Florida,’” the author noted. “Investors view it as a safe, stable, and strong asset class, especially compared to turbulent stock, Bitcoin, or exotic NFTs.”
Banesco has had only a few deals lost to rising interest rates. What is happening is greater due diligence by investors to crunch any deal’s numbers. Corrective forces at play likely won’t broadly temper the market, panelists agreed. A gradual adjustment in valuations could occur, said Calixto García-Vélez, CEO of Banesco USA. He called any curbing of the rapid appreciation of the last three years “a good thing.” Scarcity will have the opposite effect of rising interest rates. Any analysis of cash flow will see higher debt service load, when coupled with rising rates, could put pressure on valuations, he said.
Liquidity remains across the market among REITs, private equity, hedge funds, even family offices and others. The million-dollar question is the impact of foreign buyers. With cash in hand seeking America’s generally safe real estate investment market, they’re not as affected by rising interest rates.
The impact of the Fed’s rate hikes haven’t been baked into market returns as of yet, said Chris Drew, senior managing director and co-head of the Miami office of JLL Capital Markets. Any recession shouldn’t be deep, with asset values high and balance sheets strong among businesses and consumers.
“Overall, fundamentals still feel relatively good from that perspective,” he said.
The overall status of the current CRE market is that land values are down +/-30% and overall CRE asset values are also down from peak values based on the significant increase in interest rates and the lower rental rate growth, Drew said. “However, based on the strong fundamentals we do believe that the market particularly in South Florida will continue to outperform the broader CRE market.”
The migration borne from the pandemic continues to drive market realities. While South Florida rent hikes led the nation as executives and well-paid remote workers relocated here, signs point to increases to slow as remote workers return to their points of origin due to employers’ demands that they spend more time in the office. But Florida’s projected 22 million population – slated to grow by 900 a day or 2% – translates to a need for jobs, retail and supportive industry, said Noam Kaminetzky with Meridian Capital Group.
“Florida is not going to slow down,” he said.
New markets flourishing
The numbers bear that out. Banesco has experienced record demand since 2021, said Nelson Hidalgo, the bank’s executive vice president and head of corporate banking. Growth that had been relegated to South Florida is now reaching into parts of the state once seen as “tertiary markets,” he said.
Closer to home, submarkets like Brickell, the Miami central business district and Coral Gables are strong, even as new markets emerge. In a reflection of strong market fundamentals and Miami’s enduring allure, the arrival of a host of top-name tech and investment firms signals capital and confidence in the market.
Those arriving in Miami or elsewhere in Florida include Microsoft, Goldman Sachs Group Inc., Virtu Financial, Blackstone Inc., Tiger Global Management, and Citadel, whose head, Ken Griffin, told employees, “right now Florida has an opportunity to capture a new moment in America.”
“The arrival of Citadel was a game-changer for us,” Drew said of the hedge fund, which has acquired tens of millions of dollars in commercial real estate, especially in the Brickell Avenue submarket. Griffin himself reportedly spent $109 million in a record Miami home buy. “We’ve never seen a hotter investment market than Florida right now, even better than 2006.”
Some are looking smaller for big gains. COFE Properties has staked its claim in small-bay industrial and storage units, typically rented by small business service providers, said Ignacio Portuondo. As supply is removed from the market, even smaller warehouses are knocked down to make way for large-bay storage, industrial and small-bay remains alluring, he said.
“Any business starts in a warehouse like this,” he said. “Why industrial? Industrial is concrete, concrete, concrete. There’s dwindling supply and a ton of demand.”
Scarcity has had little dampening effect. Bordered from the Atlantic to the Everglades and Florida Bay to the south, or as Portuondo put it, between the “alligators and sharks,” the only remaining parcels are mostly Miami-Dade County’s western developable areas, tri-county infill and Palm Beach County’s agriculture land, which is quickly giving way to suburban sprawl. As prices rise and properties run scarce, and investors are heading up the coast.
Shane Decker with Infinity Properties recently closed on a $35 million deal for a 20-building portfolio totaling 262,000 square feet in Jensen Beach an hour north of West Palm Beach, and in Longwood, an industrial market in northern Orlando. Infinity also late last year added an 86,000-square-foot parcel in Kissimmee to its portfolio. In all, Infinity owns some 350,000 square feet of industrial assets in the Orlando MSA.
WFH looms large
The commercial office real estate industry is navigating changing dynamics with the rise of hybrid working environments and greater demand for digitally-enabled buildings and spaces. But delivering on this demand brings increasing amounts of complexity. Andrea Quiroz with Pragma, a provider of hard-to-recruit IT specialists in cloud migration and AWS, said South Florida’s proximity to the Americas makes it an ideal market for the nearshoring trend. The company itself grew from 300 to 1,000 employees during the pandemic.
It’s no secret that work-from-home has been enabled by much of the same technology that’s simplifying banking. Felipe Uribe, CEO with tech firm iuvity, said technology offerings like robotic process automation and artificial intelligence will impact banking and financial services from loan processing management, data analytics and improvement of management practices.
He called it evolutionary and full of opportunities across the commercial real estate sector. Released from rote roles and functions, people will be free to participate in other key areas. It also will free up capital. For example, in the residential market, transactional costs top 7%.
“That’s too much. It’s an inhibitor. The industry needs to get more efficient” with technology that will manage properties and make credit decisions, he said. “The business models will change.”
What’s holding back further evolution, even the transformational impacts of tech on banking, is the regulatory schema. It will be up to the banking industry to help guide this. Just as the “next generation” of professionals are taking the helm of business, the eventual adoption of fintech across the commercial real estate sector will be huge, he said.
“Investments in technology and innovation must be a core strategy of all banks. Banesco has made and will continue to make significant investments in workflows, artificial intelligence and robotic technologies to develop advanced suite of products and services, enhance the value proposition to customers and improve internal efficiencies,” Garcia-Velez said.
Slowly it’s happening, Decker said. He recently purchased a facility where the 75 tenants were accustomed to paying by check or cash. When his company insisted on digital payments, resistance was strong. “Half of them said, ‘I’d rather leave,’” he recalled.
That is, until they registered and paid online. “Ten of them called and said, ‘that was the easiest thing ever,’” he said.
Tech, CRE and South Florida have a shared interest in a mutually beneficial future, Uribe said. The level of global interest the region is generating from the tech sector and investment world have drawn both headlines and huge investments. The region will become a tech hub, with among its skills being a specialization in real estate technology. “This is going to be another Silicon Valley,” Uribe said.
Headwinds remain. A shrinking supply of developable land, the need for affordable, workforce housing, and supply chain could impact near- and long-term returns. Despite widespread return-to-office edicts from employers, and the flight to quality among companies seeking office spaces with more modern amenity sets, the sublet market is rising, especially in the suburban markets, Drew said. “The best buildings are outperforming the market,” he said.
“The notion that you don’t need as much space, that’s certainly still there. There’s no way around that,” said Roland Sanchez-Medina Jr., with SMGQ Law. The challenge is balancing a company’s or firm’s cultural needs while also developing younger talent, and whether they will need current expansive and expensive space to accomplish that.
Market conditions may raise questions for future development. Forbes wrote of CRE’s role as a hedge against inflation. As interest rates rise, as inflation continues even subtle growth, a property’s value will grow as its cost of ownership stays the same.
“This is not so much so, however, for properties currently or planning to be under development,” they wrote. “Inflation often leads to increased costs for labor and materials, slowing down property development as a result.”
The ‘unknown unknowns’
As the saying goes, what about the unknown unknowns? The Russian invasion of Ukraine, and the midterms and upcoming 2024 presidential elections will bring looming questions, Drew said. “It’s just more challenging to know what tomorrow will bring. There’s just macro headwinds.”
While Florida’s population growth continues with inbound migration, and money follows people, García-Vélez cited former Fed Chair Alan Greenspan’s warning of “irrational exuberance” during the dot-com stock market bubble of the 1990s. The realities on the ground are different today versus those of the “dot-bomb” fallout and even the great recession.
Banesco’s credit portfolio, and that of much of the banking community, remains strong. Delinquencies and non-performing loans are at record lows, as are consumer and business debt levels, leaving banks in a better position to weather a market softening.
“What I’m hearing is that the general mood is optimism,” said García-Vélez. “Unlike other economic cycles where people have been concerned about the impact on business and personal finances, this time people understand the inflationary environment. The Fed has to raise rates to curb that. We’re not hearing any unreasonable concerns.
“Business-people continue to be optimistic because there’s a lot of economic activity, sales are strong, airplanes and hotels are full,” he continued. “The manufacturing sector is very strong because of continued demand. In one word, I am optimistic.”
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