Q1 2023 Commercial Real Estate Investment Update
The commercial real estate industry has seen significant shifts and challenges over the past year, and the first quarter of 2023 was no exception.
As we reflect on the first few months of the year, it’s important to examine the trends, developments, and opportunities that have emerged in the commercial real estate investing landscape, and how they’ve influenced our investment decisions at Excelsior Capital.
From the impacts of ongoing global events, to shifts in investor preferences and changing market conditions, the first quarter of 2023 has presented unique challenges and opportunities for investors looking to navigate this dynamic industry. In this blog post, we’ll take a closer look at the overall performance of our portfolio and provide insight on our investment strategy for the remainder of the year.
A Hot Market for Industrial and Medical Office Space
Industrial/flex and medical office buildings continue to be strong performers in the commercial real estate space and two asset classes we’re currently focusing on.
Industrial/ Flex Space
The rapid growth of e-commerce and the increased demand for last-mile logistics have driven the demand for industrial/ flex space, with online retailers and logistics companies seeking out warehouses and distribution centers to support their operations. Additionally, the pandemic-induced supply chain disruptions and the reshoring of manufacturing have further supported the growth of the industrial real estate market, providing opportunities for investors to capitalize on the trends shaping the industry. With strong fundamentals and positive market conditions, we believe industrial real estate is expected to remain a solid investment option.
Medical office buildings (MOBs) have shown extreme resilience, and have emerged as a highly sought-after asset class, with strong demand for healthcare services driving occupancy and rental rates. Additionally, the aging population and increasing healthcare needs have further supported the growth of MOBs, making them an attractive investment option. Unlike other asset classes, MOBs have continued in an upward trend since the start of the pandemic, and show no signs of slowing. As we move further into 2023, the outlook remains positive, with increasing investor interest and favorable market conditions supporting the growth of this asset class.
Vacancy Rates at an All Time Low
In 2022, many new leases and renewals became a big challenge to execute, due in large part to pricing pressure on materials and supplies for build outs and tenant improvement projects. However, the market has shown signs of growth and recovery and there has been an uptick in overall leasing activity since the start of the new year. We’ve felt the effects within our own portfolio, as our vacancy rate across our portfolio now stands at a record low of 6%.
A snapshot of current leasing activity within our portfolio:
Leasing activity at our medical office properties continues to be extremely active. We’ve experienced an influx of new tenants looking to sign, as well as interest from current tenants wanting to renew and expand their lease. Regarding our recent MOB acquisitions, there is significant interest from potential new medical users as we work to fill existing vacancies.
Industrial/ Flex continues on its historical bull run, and does not show any signs of slowing down in the near future. Within our industrial portfolio, we continue to accumulate a waitlist of tenants at many of our properties. The increased demand has allowed us to raise rents from $8-$13 at Littleton Road, one of our assets in North Fort Myers, FL. We have also seen a significant amount of interest in vacant spaces at Riverwood Research Center, located in Southfield, MI, and Airport Commerce Center II, located in Lakeland, FL.
A Decline in Deal Volume
The commercial real estate industry, as a whole, is feeling the effects of rising interest rates and facing the reality that debt options are simply not as strong as they were 1-2 years ago.
Current debt environment
At Excelsior, this has forced us to remain disciplined on the underwriting side, and continue to focus on quality over quantity. We are seeing much less activity and lower transaction volume, and securing attractive debt is the biggest inhibitor to executing on transactions at the moment. Lenders are cautious across all asset classes and focused on preferred sponsors, as they adjust to uncertain valuations in an environment of dramatic and compressed increases in mortgage rates.
Having a strong brokerage network has been instrumental for us in sourcing new, off market opportunities in today’s market. Given the significant decrease in deal activity, being able to get a first look has opened the door for more valuable opportunities than we could have found otherwise.
Additional Factors to Consider
1031 Investments are on the chopping block…
In March, the Biden administration released its proposed 2024 budget and, once again, IRC Section 1031 was brought up in discussion.
President Biden has proposed a budget that includes measures to increase taxes on high-income individuals and corporations, in an effort to cut the country’s deficits. One such measure is to close tax loopholes that benefit real estate investors, including 1031 Exchanges.
Biden’s administration is not the first to go after this real estate advantage, and its consistency as a topic does lend to some consideration. So, if you have a property that is likely to be sold in the short-term that has a low basis, then it may make sense to consider a 1031 Exchange in the near future to be grandfathered in. Of course, we always highly recommend talking to your CPA and other advisors when considering if a 1031 Exchange is the best option for you.
At Excelsior Capital, we have extensive experience in 1031 Exchanges and would be happy to discuss the topic in further detail if you are considering executing a 1031 Exchange.
A Promising Outlook
As Marcus and Millichap mentioned in a recent update: “Entering 2023, investors were surveyed about their investment outlook and plans for the coming year. Given the many headwinds the market still faces, the stated plans of investors may be surprising. While there’s a perception that investors have hit the pause button en masse, 59 percent of investors indicated that they plan to remain active in the first half of this year. Purchasing commercial real estate was the most popular investor plan, with 34 percent of the respondents saying they plan to buy commercial real estate in the first half of 2023. Another 17 percent indicated they plan to both buy and sell commercial real estate, while 8 percent indicated they plan to sell assets only. Of the active investors, nearly three quarters — 73 percent — indicated that they plan to grow their portfolios in 2023. Of the remaining investors, 13 percent plan to decrease their portfolio and 14% plan to keep their portfolio size stable, with offsetting purchases and sales.”
Going into the remainder of the year, we’re prioritizing the delivery of consistent and attractive returns for our investors, and placing emphasis on long-term value creation. In times of economic turbulence, we look at this as an opportunity to strengthen our current relationships and lean into an investor-centric approach.
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