An Eye on Commercial Real Estate in 2017
There are numerous potential changes in 2017, including political, legal and business changes (and continuation of trends already underway), which are anticipated to have a material effect on the commercial real estate market. Many have already been well documented, such as an increase in government spending on infrastructure and in public-private partnerships, as well as increases in interest rates. Summarized below are three changes we believe may have a significant impact on the commercial real estate market in 2017.
Loosening Governmental Regulations on Banks’ Lending
Donald Trump has touted the need to roll-back governmental regulations, particularly Dodd-Frank, so that banks will be less restricted in lending money. Many have argued that the Dodd-Frank regulations, enacted in response to the subprime mortgage crisis, have chilled the ability of lenders to offer financing, including to real estate purchasers, owners and developers. Smaller banks have been hit especially hard, as some of them have not been equipped to navigate the increased banking regulations. Repealing or rolling back Dodd-Frank could reverse this trend, freeing-up lenders to loosen their underwriting lending requirements and allowing more lenders to offer financing to real estate purchasers, owners and developers on an economically viable basis. With more financing available to real estate purchasers, owners and developers, real estate investment, construction and development could accelerate considerably.
On an international level, there is speculation that President Trump could attempt to withdraw the United States from its implementation of the Basel III standards. The Basel III regulatory standards require banking institutions to maintain higher capital levels to protect against the potential losses of risky loans, which are deemed to include real estate construction loans. As a result of Basel III, some banks are currently averse to making construction loans, and where they are willing to make construction loans, the borrowing property owners are finding more onerous loan terms. Similar to the result of an easing of the Dodd-Frank rules, a U.S. abandonment of the Basel III accord could promote a substantial increase in available financing, and accordingly, an acceleration of construction and development.
A Shift in Foreign Investment
One of the biggest question marks of a Trump presidency is the effect of foreign investment on the real estate market. Real Estate Capital Analytics released data showing that in 2015 for commercial property acquisitions in the United States, where the purchase price exceeded $2.5 million, foreign investors spent $99.7 billion, which was a new record. Manhattan topped the international list of cities for global investment for the first three quarters of 2016, with foreign investor acquisitions totaling $14.48 billion according to Real Estate Capital Analytics. It remains to be seen whether President Trump’s presidential campaign, which incorporated harsh rhetoric against certain foreign countries and foreign trade partners, will materially reduce the current level of foreign investment in the United States. At this juncture, it is still speculative whether wealthy individuals and businesses in regions that have been expressly targeted by President Trump, such as China, Central America and the Middle East, will slow their investments in United States real property or shed their current investments either due to fear of increased scrutiny or in order to limit their exposure to potential protectionist legislation that could negatively impact their investment.
In contrast to the fears of decreasing foreign investment due to the potential shift in the stance of the United States on foreign trade, there are some analysts who believe that foreign investment will actually increase as a result of an expansion of the EB-5 program under President Trump’s Administration. President Trump’s businesses have successfully utilized the EB-5 program, which incentivizes foreign entrepreneurs to make commercial investments in the United States by allowing them and certain family members to apply for green cards. There is conjecture that President Trump may be a strong proponent of the EB-5 program and he may increase the number of visas issued under the EB-5 program, which could significantly increase foreign investment in real estate projects.
Continued Rise in Non-Traditional Retail Leases
While many are bracing themselves for the changes that the new presidential administration may bring to the commercial real estate market, some retail owners and development companies are already well underway in adapting to changes in the retail real estate marketplace. Landlords have been trying to stem the tide of increasing vacancies as traditional anchor store stalwarts, such as Macy’s and Sears, have closed stores and/or reduced their bricks-and-mortar growth, especially in secondary and tertiary markets. Landlords of malls in these locations have been forced to become more creative in replacing the income stream from these stores, which (prior to the birth of e-commerce) were thought to be fail-safe. Among the many reactions to this evolution (such as redeveloping malls for new uses, where economically feasible), the growth of non-traditional retail stores, including pop-up shops and hybrid retail store/fulfillment centers, is expected to continue to accelerate in 2017. The lease terms desired by these tenants are typically far shorter than those entered into by more traditional retail establishments, and/or these tenants may demand early termination rights.
While landlords may welcome the rental income offered by these tenants on a short-term, and even seasonal, basis, these tenants very often have less financial viability than traditional retail stores. In addition, these tenants pose issues for the traditional retailers remaining in the landlord’s retail center (or to traditional retail tenants the landlord would like to attract), either because they do not satisfy on-going co-tenancy requirements or are viewed negatively to the tenant mix at the retail center. More often than not, retrofitting and leasing substantial space with these non-traditional retail stores will require mortgage lender consent. Underwriters, whether in connection with approving such a request for consent or in determining the viability of providing financing to a retail center with a substantial portion of the tenancies consisting of these non-traditional retailers, will certainly be assessing the financial impact that these tenants have on the retail center.
In secondary and tertiary markets, this shift in the tenancy mix at retail centers has already caused lenders to reduce their valuation of these real estate assets. As this retail shift continues to accelerate, there is fear that a greater percentage of mortgage loans backed by retail real estate will become non-performing, and real estate investors and developers fear that lenders will only become more wary of lending into traditional retail centers in more markets.
The relaxation of governmental regulations and a shift in foreign trade policy, all key components of Trump’s platform, if enacted, may have a direct impact on the commercial real estate market. Of course, given the uncertainty of the political environment, it is difficult to forecast the scope of these potential changes. The details of any of these regulations and policies, as they become officially proposed, will be closely watched by real estate owners, developers, investors and professionals in order to better assess their impact on the real estate market.
While President Trump’s impact on the real estate market remains to be seen, there is no indication that the reduction in traditional retail anchor tenants will be subsiding and this trend is already impacting the retail real estate market. In substitution of the traditional anchors, an increasing number of tenants are seeking leases for pop-up stores and stores with smaller footprints, and shorter least terms. As this evolution continues to take place, landlords and tenants will be re-considering their priorities in lease negotiations, investors and developers will be re-evaluating retail real estate investment opportunities, and underwriters will continue to re-evaluate their underwriting criteria for retail real estate.
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