November, 2019 - Sachse Construction

Why Own a Property When You Can Profit From the Dirt Below?

Instead of buying or developing buildings, more commercial real-estate investors want only the ground beneath them.

The practice of separating a property from the land, and then renting out that ground to a developer on a long-term basis, is known as creating a ground lease. It is viewed as safer than owning the property because real-estate risk mostly falls to building owners, who usually need to finance a purchase or construction, pay for future renovations and fill the space with tenants.

“You just own the dirt,” said Darcy Stacom, chairman of CBRE Group’s capital markets group in New York.

The business has ballooned in recent years as the prices of most major types of property have rallied for most of the past decade and are starting to look expensive.

This year, investors created ground-lease deals for at least seven major New York City buildings, including the H&M anchored office building on Fifth Avenue and the historic American Telephone & Telegraph Co. building in the Financial District, according to CBRE. The firm knows of only one such deal in 2018.

Investors are also buying the land under properties in Washington, D.C., Philadelphia, San Antonio and Austin, according to buyers and brokers.

The deals still carry some risk for the ground owner. Ground rents typically rise over the term of the lease, but they could fall far behind inflation over the decades, causing the ground lease to lose value.

Owners of buildings, meanwhile, may find it increasingly hard to finance properties on someone else’s land. When the lease expires, land owners get to own the buildings.

“Down the road, there’s typically a day of reckoning that happens,” said Jade Rahmani, an analyst at Keefe, Bruyette & Woods who follows the ground lease business.

Still, some investors see the business only growing. Jay Sugarman, chief executive of the real-estate investment iStar Inc., said investors have barely scratched the surface of separating the ground below trillions of dollars of U.S. commercial real estate.

“We’ve only touched a fraction of it,” he said.

In June 2017, iStar spun off a business that specializes in creating and owning ground leases, now known as Safehold Inc. Mr. Sugarman, who is also chief executive of Safehold, expects the real-estate investment trust to own assets with a total value of $2.5 billion by the end of this year, up from $340 million when it did its initial public offering.

Dividing properties into the land and the structure goes back centuries. Land owners create a long-term ground lease up to 99 years. The leasehold owner pays a ground rent. While the landowners get ownership of the buildings when the lease ends, in most cases they prefer to create a new lease.

Some of the most well-known New York skyscrapers, such as the Chrysler Building, are on leased land.

For a number of years the ground-lease business was discredited by a number of high-profile financial shocks. This was because formulas for rent increases were often dictated by land values. In New York, as values soared, such increases have triggered financial headaches for building owners.

With Lever House, a New York City office building, developer RFR Holding LLC hasn’t been able to refinance the Park Avenue tower because the ground rent is set to rise from $6.15 million to more than $20 million in 2023, according to people familiar with the matter.

“Everyone has an anecdote of a horror story from a ground lease that destroyed value,” said Mr. Sugarman.

An RFR representative declined to comment.

Ground leases are now being structured without the onerous reset provisions that base rent increases on property values. Most new resets are tied to inflation and capped beyond a certain level.

“No one will agree to the old structure,” said Craig Deitelzweig, chief executive of Marx Realty, which has been in the ground-lease business for much of its 104-year history.

These new long-term leases are attractive to investors who want to control a building but hold their costs down, said Joe Bous, a principal at Valor Ground Lease Ventures, which specializes in this business. Investors typically can get back 30% to 40% of what they pay by selling the ground lease, he added.

“If you could lock in about one third of your value structure with 100-year money, isn’t that a good thing if you believe interest rates are going to go to five or six or 7%?” Mr. Bous asked.

Groceries and Glutes: Supermarkets Add Boutique Gyms and Yoga Classes

Supermarkets are trying to entice shoppers with more than just food.

Hy-Vee is teaming up with high-intensity training gym OrangeTheory to build studios attached to two of its stores. In Morristown, New Jersey, ShopRite opened a store with a fitness studio that offers yoga and Zumba classes for its shoppers with loyalty cards. And Whole Foods’ flagship store in Austin, Texas, partners with barre, spinning and yoga studios in the area for classes on its rooftop plaza.

As competition in the grocery industry stiffens, these stores hope to attract time-strapped shoppers by creating convenient experiences that shoppers can’t replicate online. Grocery stores see an opening in the surging fitness industry, one of the rare business areas that has not been cannibalized by Amazon: Over the past four years, boutique studio memberships in the United States have increased by 70%, according to IHRSA, an industry trade group.

“Grocers are understanding that to bring people back in store they must create these activities,” said Jamie Sabat, director of trends and consumer forecasting at consulting firm Streetsense. “They want to create this hangout factor in the store.”

Although grocery tie-ups with fitness companies are still in their nascent stages, bringing on gyms makes sense for health-oriented grocers, said Diana Sheehan, analyst at Kantar Retail. She predicted that H-E-B or Meijer may add a fitness-related concept in the future. H-E-B, the cult-favorite in Texas, already sponsors free yoga in some of its stores.

Experts say grocers have also stepped up their focus on catering to customers’ health demands in recent years. Supermarkets are adding juice bars and health clinics and bringing dieticians into stores.

Hy-Vee and OrangeTheory are testing out studios attached to a full-size Hy-Vee supermarket in Shakopee, Minnesota, as well as a “HealthMarket,” a slimmed-down Hy-Vee store. This 15,000-square-foot concept store in West Des Moines, Iowa — around one-sixth the size of a traditional Hy-Vee — has a pharmacy, health clinic, and hearing aid and sports nutrition areas. It also offers nitro coffee, kombucha and Bevi-infused water.

“We are constantly looking for new partners and innovations that will appeal to our customers and their ever-changing lifestyles,” said Hy-Vee CEO Randy Edeker.

Grocers are not alone in turning to the fitness industry for growth. Malls and brick-and-mortar retailers are betting on gyms and boutique studios to win over their shoppers.

The number of fitness tenants in shopping centers has more doubled over the last decade, according to CoStar. And traditional retailers such as Kohl’s joined with Planet Fitness to add gyms adjacent to a handful of stores, while Lululemon has studios at its new flagship store in Chicago and in Minneapolis.

Planet Fitness offers clues into why companies are eager to bring on fitness clubs: The chain says that when its members go to the gym, 76% of them combine their visits with other shopping.

Office Construction Lifts U.S. Asking Rental Rate, but Slowing Absorption in Q3 Raises Concerns

A rising tide of new office projects may be skewing the national average rental rate upward and obscuring increased leasing challenges for second-generation properties in many markets, Transwestern’s latest U.S. office market report suggests.

Monthly asking rent averaged $26.97 per square foot in the third quarter, representing a 3.4% increase from a year earlier and a five-year gain of 19.7%. Much of that national increase reflects above-market rents at new or renovated projects, where landlords have incurred elevated material and labor costs to complete amenity-rich offerings.

The national vacancy rate has plateaued near 9.8%, equal to the rate one year ago. A dozen of the 49 markets Transwestern tracks showed negative net absorption or an increase in the volume of vacant space for the 12 months ended September. Nationwide, annualized absorption through the third quarter was 57.3 million square feet, or roughly one-third less than the 85.2 million square feet absorbed in 2018.

Office construction is at a cyclical high. Building starts in the 12 months through the third quarter were up 12.1% over the year-ago period, with more than 166 million square feet of projects underway. The sector delivered 18.5 million square feet of new space in the recent quarter, less than the second quarter’s 21.7 million square feet but up 1.3% from a year earlier, while the national economy and average monthly job growth have slowed.

“Developers have responded vigorously to tenant preferences for new construction,” said Jimmy Hinton, Senior Managing Director of Investment & Analytics at Transwestern. “In many markets, new construction is outpacing already moderating tenant demand, creating extra pressure on older-vintage properties. Landlords are increasingly challenged in reconciling capital improvement needs with cycle timing and prospects for suitable investment returns.”

While high-end rents at new properties can increase a market’s average lease rate, new construction drives rent downward when landlords feel pressure to compete for tenants by lowering rates. In Houston, for example, average third quarter asking rent had declined 0.7% from a year earlier.

Stuart Showers, Vice President of Research in Houston, predicts other markets will experience a similar shift in the coming months, and could represent a late-cycle playbook for landlords in other markets, should macro conditions deteriorate.

“The volume of new office construction pushing through Houston has resulted in downward pressure on rental rates, a situation that will manifest throughout second-generation product in a number of the nation’s markets that have high construction activity,” Showers said.

Real Estate Professionals Say Coworking is not a Flash in the Pan

A majority of corporate real estate professionals polled at CoreNet Global Summits in North America, Europe, and Asia in 2018 and 2019 believe that coworking is a trend that will continue to grow and impact their markets.

Some 63% of respondents currently have coworking property within their portfolios, according to a report published by Cushman & Wakefield. What’s more, nearly two-thirds of the companies surveyed have a positive or very positive view of coworking.

The median company surveyed has 3% of its employee base using coworking regularly. This percentage is expected to grow fivefold within the next five years, the survey found.

Across all global regions, the top two benefits to coworking are flexibility (e.g., the ability to quickly ramp office space up and down) and reduced real estate costs. Digital security is the most commonly cited potential downside, with decreased company culture and cohesion and personal privacy named second and third by most respondents.

CRE Industry Preps for New EB-5 Regulations

The U.S. government’s modernization of the EB-5 (employment-based, fifth preference) Immigrant Investor Program goes into effect tomorrow, Nov. 21, sparking a change for the commercial real estate industry. The new regulations, determined by the Department of Homeland Security, will raise the minimum required monetary commitment for foreign investors, marking the first increase in the figure since the EB-5 program’s establishment in 1990.

The new minimums have been adjusted for years of inflation. The minimum investment in assets in a targeted employment area will increase by 80 percent, from $500,000 to 900,000, and the standard minimum investment will rise by the same percentage, going from $1 million to $1.8 million.

“The biggest impact will be felt by the EB-5 investors who now need to invest almost double than before,” Alejandro Navia, managing director with hotel investment company Driftwood Acquisitions & Development told Commercial Property Executive. “In general, the changes will see investors wanting to secure bigger returns in exchange for greater investments they will be making. To secure this, they may want to take a preferred equity position to secure those returns.”

Driftwood has made this model available in its EB-5 offerings for three years.

Foreign investors can expect to see the minimum investment amount go on the upswing again—and again. The new regulations call for the minimum to increase automatically every five years to account for inflation. In its final rule on the EB-5 program on July 24, 2019, the DHS wrote that given that uncertainty and perceived risk affect investment decisions, the automatic adjustment provides predictability and consistency to stakeholders so they can tailor business plans accordingly, without needing to wait for DHS’ determination.

Consequences: to be determined

The new EB-5 regulations also call for a change pertaining to TEAs. The DHS, through the U.S. Citizenship and Immigration Services, will designate TEAs, taking over the responsibility of identifying these geographic areas from the individual states. In a prepared statement, Nicholas A. Mastroianni, president of U.S. Immigration Fund, an official EB-5 Regional Center, said that it is important for investors to understand that the projects they are used to seeing qualify for TEA investments and the lower investment threshold will most likely not qualify under these new regulations.

It’s unclear just how soon the effects of the new EB-5 regulations will be seen in the commercial real estate market; however, many industry experts aren’t expecting a watershed event.

“The changes to the EB-5 program should have a negligible impact on the overall commercial real estate market given that this source of funding is such a small percentage of the total capital that’s available to developers today,” said Michael Bellisario, senior research analyst with financial services company Baird.

Architecture Billings Index Rebounds After Two Down Months

Following a two month decline in demand for design services, architecture billings got a bounce in October, according to a new report released today from the American Institute of Architects (AIA).

The Architecture Billings Index (ABI) score in October is 52.0, up from the September score of 49.7. This score reflects an increase in design services (any score above 50 indicates an increase in billings). During October, both the new project inquiries and design contracts scores moderated from September but remained positive, posting scores of 57.9 and 52.9 respectively.

“Although ongoing uncertainty over the direction of economic growth persists, a strong stock market and growing payrolls at U.S. businesses continue to generate more construction projects,” said AIA Chief Economist Kermit Baker, PhD, Hon. AIA. “With most regional and sector billing scores at architecture firms improving from the previous month, we’re seeing a bit of a rebound from disappointing levels of design activity in recent months.”

Key ABI highlights for October include:

— Regional averages: South (55.5); West (51.3); Midwest (49.9); Northeast (47.2)

— Sector index breakdown: mixed practice (55.2); multi-family residential (54.0); institutional (49.9); commercial/industrial (49.3)

— Project inquiries index: 57.9

— Design contracts index: 52.9

The regional and sector categories are calculated as a three-month moving average, whereas the national index, design contracts and inquiries are monthly numbers.

Redefining Lost Urban Spaces: 5 Ways to Turn a Laneway into a “Lanescape”

Revitalizing laneways creates community, bolsters business, and heightens our collective sense of place. Around the world, people are experiencing the positive impacts of transformed laneways—from the community spirit generated by urban rejuvenation in Athens, to the excitement found in the famous laneway restaurants and bars in Melbourne.

Toronto has approved building homes on laneways. As more homeowners consider this option—converting their garages into fresh living spaces—what will laneways look like in the coming decades? We’re excited to be part of the evolution.

Tourists and guests give us another reason to consider the opportunities of a rejuvenated laneway. Visitors find inspiration in the unexpected fine grain spaces of a city. When people visit a new neighborhood, they look for the authentic. There is nothing more exciting than discovering local treasures in a global city.

The laneway near our office feels orphaned—the only signs of life coming from back-of-house activities like restaurant workers taking out garbage—and it shows the expected signs of neglect that come without champions to nurture the space. Currently, condo balconies face directly onto air shafts and overflowing bins. We see this space as an opportunity for transformation that will allow the residents to breathe deeply and enjoy a view of greenery and urban passersby.

What could we do to improve this laneway? Well, before any changes can be made, the “Laneway People,” aka the community—residents, businesses, politicians, and neighborhood groups—need to come together and start a conversation.

Where do we start? Here are five ideas—based around the themes of breathe, move, frame, celebrate, and inspire—for a pilot laneway makeover.

1. Breathe: focus on fresh air and dampen the sound

First, create room to breathe. The laneway needs some dermabrasion, like the exfoliating technique used by dermatologists. Once you scrub the surface of waste, you’ll reveal a magnificent space.

Next, consider removing or containing garbage bins. Find ways to repackage, reduce, reuse, or recycle waste found in the laneway. Is there a more streamlined way to consolidate waste? A laneway cleanup requires cooperation—and possibly participation—from residents and businesses. Envisioning the future helps to keep the momentum going.

People should expect certain sounds in this laneway, like conversations from nearby pedestrians, occasional car horn honks, or barks from dogs on their way to neighborhood parks. Currently these urban sounds are drowned out by exhaust fans. These fans can be traded in for quieter and more effective technology, to benefit the businesses and their communities.

2. Move: create continuity and emphasize the “L” shape

The potential “L” shape of this laneway fascinates us. At the east end, a chain link fence and a height change prevent the laneway from connecting to another lane that runs north-south. To keep people strolling through the laneway, remove the fence, and design a platform, stage, ramp, or stairs to mediate these two laneways and keep the flâneurs moving. A local laneway like this gives pedestrians and cyclists the chance to avoid the main streets for a moment and find an alternate route.

3. Frame: lighten up

Create an outdoor “room” by adding low lighting and plantings. Treat the laneway pavement and walls as one large canvas to paint a work of abstract art. Painting provides you with a quick and simple way to beautify the space—and cut down on litter—as it gives people the sense that care was taken.

4. Celebrate: tell a story

Tell a story about the history of the neighborhood, perhaps honoring the first people to walk on this land, the original inhabitants of the nearby homes, or the industry that arrived in the area in the early 20th century. Invite local visual artists to illustrate these neighborhood tales.

5. Inspire: get active

What else could encourage community members to spend time in this laneway? Opportunities to be active. Take inspiration from the alleyway basketball hoops of Vancouver, or the ping-pong tables of Paternoster Square in London, England. Employees on their lunch break can stop by to shoot hoops, play checkers, or participate in a ping-pong match.

Holding immense potential

In Orillia, Ontario, our team is currently reimagining the laneways of the city’s downtown. Our Orillia clients recognize that their laneways hold immense potential to be transformed into cultural and recreational connectors and resources.

Laneways can be vital for a city’s beating heart and inspired art. Is your local laneway currently serving the community in the best possible way? The choreography of space is most successful when we change the shape and height of our horizon line as we move through our urban centers. Laneways offer an intimate look into the workings and culture of our multilayered city.

Amazon, Nike Top Retail Social Influence Rankings

An e-tail giant and a major athletic/apparel footwear brand are once again the two most socially influential retailers.

According to the 2019 Engagement Labs TotalSocial ranking of the top U.S. retailers based on social influence, Amazon/Amazon Prime retains the first-place spot with a score of 67.1, while Nike remains in second place at 65. Both retailers held these spots in the 2018 ranking.

Engagement Labs analysis indicates Amazon dominates consumer conversations and is the focus of more consumer talk than any other retail brand. Amazon has consistently performed better than average both online and offline, earning it Engagement Labs’ “Conversation Commander” status. A recent Engagement Labs study indicates that conversations about brands, on average, drive 19% of U.S. consumer purchases.

Meanwhile, Nike held second place despite sharp drops in its social media net sentiment due to controversies relating to its association with former NFL player Colin Kaepernick.

Meanwhile, Kohl’s has moved up to fourth place from seventh, with a score of 60.8, and Costco and Old Navy have joined the list at ninth and 10th, respectively. Victoria’s Secret had the most precipitous drop, falling to 12th place from fifth place just one year earlier. Engagement Labs says this is consistent with widespread reports of Victoria’s Secret business difficulties.

Top 10 TotalSocial Retail Brands Rank Change TotalSocial Score
1. Amazon/Amazon Prime No change 67.1
2. Nike No change 65
3. Ulta +1 62.1
4. Kohl’s +3 60.8
5. Adidas -2 60.7
6. Sephora No change 59.8
7. Macy’s +1 58.8
8. Target No change 58.7
9. Costco +2 58.2
10. Old Navy +3 58

Source: Engagement Labs’ TotalSocial Top 10 Retail Brands 12 months ending September 2019 compared to 12 months ending September 2018.

“Published analytics by Engagement Labs have proven that stronger performance on TotalSocial metrics are linked to business growth, which is why businesses from Victoria’s Secret to Amazon should be focused on improving TotalSocial scores,” said Ed Keller, CEO of Engagement Labs. “Amazon may be the hands-down leader for social influence in retail, but there are plenty of opportunities for other businesses to improve.”

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