Originally published by The Wall Street Journal Commercial real estate is showing the first signs of cooling in more than a year, disrupted by rising interest rates that are already causing some deals to collapse.  Property sales were $39.4 billion in April, which was down 16% compared with the same month a year ago, according to MSCI Real Assets. The decline followed 13 consecutive months of increases.  Hotels, office buildings, senior housing and industrial properties recorded big drops in sales. Sales of other property types, such as retail and apartments, rose in April, but analysts and brokers said activity may be now slowing in those sectors, too, as rising interest rates keep some investors from making competitive offers.  In March, total commercial property sales had risen 57% from the same month a year before.  “To have it go from a very fast pace of growth the month before—the speed of that transition is shocking,” said Jim Costello, chief economist at MSCI Real Assets. A drop in sales can be an early indicator of stress in real-estate markets because prices are usually slower to change, he added.  After an early-pandemic scare in which sales of most types of commercial real estate declined, commercial property sales began rebounding in late 2020. Low interest rates and strong demand, especially from multifamily and industrial tenants, fueled property sales throughout 2021 and into this year.  Now, with interest rates considerably higher—the yield on 10-year Treasury notes, a common benchmark for commercial mortgages, has nearly doubled this year—property investors that rely on large amounts of debt have been some of the first ones to fall out of the market, brokers and investors said.  In some cases, investors are finding that with the increased cost to borrow, their near-term rate of return runs below the interest rate on their mortgage. Lenders, in turn, are now tightening their standards for more-speculative deals, brokers said.  In certain sectors, such as smaller industrial and retail real estate, prospective buyers that wrote letters of intent to purchase properties weeks ago are now dropping their bids because the cost to borrow has risen so quickly, said Joshua Campbell, a senior vice president at Stan Johnson Co., a commercial real-estate brokerage.  “That was not happening two to three years ago,” Mr. Campbell said.  Other investors are walking away from deals already in contract. Innovo Property Group recently backed out of an agreement to buy a Midtown Manhattan office tower for $855 million after surging interest rates made it harder to find a mortgage, according to a person familiar with the matter. The about-face meant the investor lost its $35 million deposit, according to another person involved in the deal.  Surging interest rates in recent weeks have left many investors with a choice between losing their deposit or paying much more than expected for their mortgage, said Jay Neveloff, a partner at law firm Kramer Levin Naftalis & Frankel LLP.  Most have been moving ahead with planned purchases, he said, but other investors are more cautious now about signing new contracts. That will inevitably drive down prices. “The pricing can’t be blind to changes in capital markets,” Mr. Neveloff said.  As the buyer pool narrows and interest rates rise, sellers are becoming more likely to make concessions to close deals, said Henry Stimler, an executive in the multifamily capital-markets division at the Newmark real-estate firm.  His firm recently brokered the sale and financing of a $457.5 million multifamily portfolio concentrated in the Carolinas, where rent growth has been strong over the past year.  “It’s now turning into a buyer’s market,” Mr. Stimler said.   

Originally published by Commercial Property Executive A volatile stock market combined with rising interest rates and inflation have yet to disturb capital pouring into net lease properties. The passive income strategy, invariably explained as a bond wrapped in real estate, provides investors with long-term credit tenants that are largely responsible for all of a property’s expenses, including real estate taxes, insurance and maintenance.  Public and private investors alike continue to plow capital into net lease assets to eek-out a return in what for the last several years has been a low yield environment. Coming out of 2021, in which industrial assets accounted for half of the $103 billion in record annual sales, single-tenant net lease deals in the first quarter of 2022 totaled nearly $21.7 billion, a year-over-year increase of 30 percent, according to Stan Johnson Co., a Tulsa, Okla.-based net lease brokerage.  Unsurprisingly, industrial asset sales drove the lion’s share of the first quarter business at $11.4 billion. Office and retail accounted for $6.9 billion and $3.3 billion, respectively.  Nationally, the average cap rate for net lease industrial properties dropped 17 basis points to an average of 6.6 percent in the first quarter this year from the fourth quarter last year, while office and retail cap rates experienced smaller declines to 6.7 percent and 5.75 percent, respectively, according to the Boulder Group, a net lease brokerage based in suburban Chicago.  For much of 2021, the benchmark 10-Year Treasury yield was below 1.5 percent, and interest rates for long-term debt were between 3 percent and 4 percent for many conventional net lease deals. That environment has dramatically changed since the end of 2021. Now interest rates are roughly 100 basis points higher, following the 10-Year bond yield’s spike of some 140 basis points to more than 2.9 percent. So far, demand for net lease properties hasn’t slowed, even following the Federal Reserve’s 50 basis point hike of the federal funds rate in early May.  “Buyers are starting to point out that interest rates are rising, but the rates aren’t full factored into the market yet,” said Jonathan Hipp, head of the U.S. Net Lease Group at Avison Young in Washington, D.C. “Quality assets with quality tenants in quality locations are still trading aggressively.”  Capitalization rates are supposed to adjust upward with such an interest rate move, although with a time lag. But observers suggest that buyers waiting for a substantial move in cap rates are likely to be disappointed.  “The correlation of interest rates and cap rates is not 100 percent, and investment demand and supply are so out of balance that cap rates won’t move as far as investors would like,” said Randy Blankstein, president of the Boulder Group. “I think there is going to be a minor adjustment to cap rates for office and retail. But industrial property cap rates may continue to compress, even in a potentially rising rate environment, because industrial remains the darling of all the sectors.” Market in Transition  It wasn’t that long ago that lenders had interest rate floors because treasury yields were so low. But with the coincidental rise in treasury and interest rates, lenders and borrowers are readjusting to the market. In some cases, that means borrowers must decide whether to accept a lower cash-on-cash return or return funds to limited partners. At the same time, lenders need to deploy debt to meet their 2022 allocation targets.  “I haven’t come across any lenders that are pulling back, especially on industrial and medical office deals,” said Nicole Patel, first vice president of Four Pillars Capital, a Dallas-based mortgage banker launched by Stan Johnson in 2021. “Demand is so high right now that I can’t imagine cap rates moving. So either lenders are going to have adjust their underwriting to support current cap rates, or borrowers are going to have to be comfortable bringing more cash to the table.”  Lenders that were providing debt for 70 to 80 percent of an asset’s value a few months ago have generally dropped leverage to 60 to 70 percent, observers say. But the amount of debt a borrower receives, as well as the interest rate, also depends on location, whether the surrounding market is declining or growing economically, the strength of the sponsor, and whether a lender is over or under its allocation for a particular product, among other variables, said Ben Reinberg, CEO of Alliance Consolidated Group of Cos., a Chicago-based real estate investment firm that owns more than $350 million in medical properties.  “Lenders are hedging right now,” he said. “They want to deal with experienced borrowers who understand debt coverage requirements and don’t overleverage their properties. But for the right deal, there is real demand to finance net lease properties.”  The fact that plenty of all-cash institutional and high-net-worth individuals buyers are active in the market is likely helping to keep downward pressure on cap rates, Hipp suggested. Although they can tick up significantly between the signing of a letter of intent and closing, interest rates have yet to sour any deals on which he’s working. At the moment, he’s not too worried if they do become an issue.  “I wouldn’t advise a seller to raise his cap rate 100 basis points to make a deal with a particular buyer work, because with the amount of capital that’s driving the market, I think there’s an all-cash buyer or someone else out there who would be able to close,” he said. “If you need debt to win the competition for an asset, that might put you at a disadvantage.”  Inflation Influence  In addition to rising interest rates, inflation is beginning to emerge as a concern for some net lease investors. Notably, rent increases built into leases may not keep up with inflation, which spiked 8.5 percent in March, the biggest annual jump in 40 years. Plus, long lease terms associated with net lease assets prevent landlords from quickly adjusting rental rates to market conditions in the same way that owners of apartments and hotels can.  Given the opportunity, net lease buyers are looking to secure healthier rent hikes going forward. Alliance Consolidated, for example, is pushing for a 3 percent annual increase in sale-leaseback transactions, and it may pay slightly more for an asset to achieve it, Reinberg said.  While some net lease agreements tie rent increases to the consumer price index, they are typically capped at around 2 percent annually. But many net leases today feature fixed annual rent increases, also of about 2 percent. Thus, continued high inflation could dramatically curb interest in the sector as the economics of deals become infeasible.  “Buyers have become hyper-focused on rent bumps and escalations in existing leases,” Blankstein said. “People want to make sure that they’re protecting the buying power of their cash flow streams.” 

The last two years have been challenging to say the least. Conditions across the commercial real estate market have been shifting as investors battle everything from the uncertainty surrounding 1031 exchanges to a shortage of quality on-market supply. Effects of the COVID-19 pandemic continue to linger, influencing remote versus in-office working, supply chain issues, additional e-commerce growth and reliance, labor shortages, inflation and demand for logistics-related and essential retail investments. In this dynamic environment, one of the most frequent questions investors are asking themselves is, “how do I know if this is the right time to sell or hold?” While there’s no crystal ball to see what 2022 holds, there are a few factors impacting the market today that can help real estate investors make the right decision for their unique situation or long-term strategy. Enthusiasm of Selling in a Frothy Market The market is currently seeing very robust levels of investment and demand across multiple sectors, geographies and property asset classes. Pent up demand and lack of supply, paired with the threats of increased interest rates and capital gain taxes, have created an emotionally driven environment. Bidding wars, full price offers and record low cap rates are becoming the new normal, but this has opened the doors for many investors looking to divest of assets. Buyer confidence is on the rise as debt remains cheap, so those investors who have been waiting for the right time to sell may find that now is the perfect opportunity to capitalize on high demand and secure outstanding pricing. "Pent up demand and lack of supply, paired with the threats of increased interest rates and capital gain taxes, have created an emotionally driven environment." The Rise of Industrial and Essential Retail Single-tenant net lease industrial product is high on the wish list for investors right now, due in part to recent changes in retail demand and perception during the pandemic. Consumers were forced to change their habits, and we saw investors gravitate away from retail concepts deemed “non-essential.” In the wake of this shift, many retailers have revised their business models in an attempt to remain relevant and competitive in today’s environment – they’re now offering delivery, curbside pickup and online ordering. Furthermore, we’ve seen retailers rely more heavily on their logistics components. Warehouses, last-mile distribution facilities and fulfillment centers have never been more critical to a retailer’s operation, and this trend is creating significant opportunity for the investor community. Owners of outdated or functionally obsolete industrial space, for example, may be seeing increased demand, especially if their asset is well-located or has an abundance of land. Landlords who’ve resigned themselves to holding on to these assets due to lack of demand or unfavorable offers in the past may wish to take advantage of surging demand levels and trade out or up. "Warehouses, last-mile distribution facilities and fulfillment centers have never been more critical to a retailer’s operation." Rental Rates and Interest Rates While many investors may choose to sell in today’s high-demand market, that strategy won’t be right for every investor or asset. Rental rates are rising in many geographies and asset classes, and landlords might find they have the ability to increase their cash flow by re-tenanting or renegotiating leases. New vacancies caused by pandemic-related conditions give owners the opportunity to secure a new tenant at current market rates. Additionally, with interest rates still so low, owners who are committed to a longer-term hold strategy should consider refinancing. There will never be a one-sized-fits-all strategy for real estate investing, and owners should be careful to avoid knee-jerk reactions to shifting market conditions. Buyer demand is translating to outstanding opportunities for those investors positioned to sell, but rising rents and inexpensive debt creates a favorable environment for landlords looking to hold. Each investor’s situation should be carefully considered before deciding if now is the time to sell or hold, but opportunities are abundant for investors considering both options. hbspt.forms.create({ region: "na1", portalId: "7279330", formId: "23715151-751b-4c4d-a56f-265edfb3bc70" });

Stan Johnson Company, one of commercial real estate’s leading investment sales brokerage firms, has announced the launch of a new affiliate debt services company, Four Pillars Capital Markets. The new firm will provide debt and equity financing solutions for commercial real estate investment properties. Four Pillars Capital Markets is a company built on the following principles: Service, Excellence, Collaboration and Access. The firm’s professionals are committed to providing personalized, white-glove service to clients along with access to best-in-class insights, market data and capital providers. By leveraging the latest technology, a unified shared services platform and deep relationships with capital sources, investors in the historically underserved middle market now have a new choice in capital markets that is built on a legacy of client service. “As part of our strategic growth plan, we have identified an opportunity to provide better service to our existing clients, attract new clients and offer a diversified capital markets platform,” said Stan Johnson, President and CEO. To help lead this new service line, the firm has also announced the hire of Farhan Kabani. Previously with Mark One Capital, an affiliate of Marcus & Millichap, Kabani has more than 15 years of commercial real estate finance experience and has secured over $5.0 billion in debt and equity capital for clients. Kabani joins Four Pillars Capital Markets as Partner and, with support from the Stan Johnson Company executive team, will lead the new real estate capital markets brokerage. “I’m honored to embark on this new opportunity,” said Kabani. “The Four Pillars national platform offers access to a deep pool of capital sources, and we have a unique opportunity to build a team that will provide unparalleled service to clients in the middle market. This is a very exciting opportunity to elevate the standard of service and client experience that investors expect when hiring a firm to source the best capital solution for their real estate financing needs.” Four Pillars Capital Markets has identified key geographies for future expansion in order to provide the best national coverage for clients. About Four Pillars Capital Markets: Four Pillars Capital Markets, an affiliate of Stan Johnson Company, is a real estate capital markets brokerage firm dedicated to providing the highest level of client service. With over $5.0 billion in capital sourced and decades of industry experience, Four Pillars Capital Markets provides debt and equity financing to commercial real estate investors as they acquire or refinance office, industrial, retail, healthcare, multifamily and specialty assets. To learn more about Four Pillars Capital Markets, please visit: www.fpcm.com.