Background: The Hoyt Institute is an invite only think tank based in North Palm Beach, Florida, where industry research leaders and academics partake in a few days of in-depth discussions on topics of interest to the commercial real estate industry and housing analysts. Fractional ownership, climate change and risk assessment, housing affordability, and property insurance trends were among the topics discussed in recent meetings.

Introduction: One of the high priority topics this year was valuation and marking existing properties to market. In a discussion led by Jim Costello of MSCI, with input from Jacques Gordon, Bob White, Bill Hughes, Will McIntosh, Glenn Mueller, Chris Macke, Jeff Fisher, Paige Mueller, John Mangin, Steven Paynter, Stephen Malpezzi, myself and several others, without specific attribution, here are some of the general comments:

• Transaction volume, across the board, for all property types is thin by historical standards. This makes it harder to find comps for valuation and marking property to market. Until interest rates fall significantly, or prices adjust fully, volume will remain thin.
• The RCA CPPI (value index based on repeat sales) suggests that many office properties are down in value from 10% to 25% in just the past few years, and perhaps 35% to 50% from before COVID. Many office properties will soon be coming back to lenders, unable to support refinancing or with existing debt exceeding value. Discounts of 50% to 75% are generally necessary for feasible conversion to alternative uses.
• Some of the distressed office properties are convertible to residential or other uses. Steven Paynter, with Gensler, developed an algorithm that quickly assesses feasible convertibility using a scorecard that considers floorplates, envelope skin, floor to ceiling height, walkability, HVAC and several other variables. Gensler’s scorecard suggests that about 30% of all office property could be physically adapted to residential use, with sufficient natural light and/or window access. Feasible price declines necessary to make this profitable are significant which may explain why other analyst suggest only 15% of office property is financially feasible for conversion. Some cities, like New York, are making it easier to convert office property into residential, although bedroom window access remains a constraint. If 10% to 15% of the office stock would be converted into residential, many markets would be back to equilibrium with respect to occupancy rates for both office and residential markets.
• US appraisers seem under pressure from sponsors/clients not to write down commercial property value estimates to the extent that the market would dictate as this will result in return performance metrics that underperform the market benchmarks, such as NCREIF, if other sponsors and owners do not behave in a similar manner. That is, there is a penalty to being first to mark down property and having your investment performance dive below the general market benchmark that is supposedly reflective of peer property portfolios. There is a fear of investor redemption runs as a result of poorer than market performance, when in reality, it is merely honest reporting. Some sponsors hope to stall such write-downs long enough for interest rate declines to offset and reverse these value impacts.
• The US NCREIF based indices and RCA CPPI seem to be lagging the actual market more than observed in Europe. The US-based appraisers, trained via the Appraisal Institute, resist over reliance on what is considered speculative data such as trading volume, listing price, changes in list price, time on the market, the number of bids on property for sale and so there is more reliance on historical transactions and thin trading. This results in lagged and possibly skewed valuations. In contrast, RICS seems to encourage more use of technical market condition indicators and capital market trends, including interest rates, which results in more aligned value estimates and less lag.
• Stubborn or systematic lags in valuation may spur more interest in commercial automated valuation models, CAVMs. AVMs are agnostic about values, and the better ones as observed in the residential market do incorporate changes in market conditions and technical variables such as list prices, months of remaining inventory, sales volumes, time on the market, sales prices as a percent of list price, foreclosure rates and credit standards.
• Industrial property seems to be in the best shape with respect to trends in rent, insurance and financing. Very little industrial distress is expected in the next year.
• Retail has already transitioned and weathered the impact of ecommerce, with neighbourhood grocers and experience-based retail doing well. Some retail has converted to micro-fulfilment centres, self-storage, ghost kitchens, medical clinics, and residential since COVID.
• Multifamily, because of the sheer size of the market, along with office are the most exposed to refinancing woes and NOI impacted by higher property insurance expense. Property in coastal areas – especially Florida – are now experiencing dramatic increases in property insurance rates, or the inability to cover all risks. This will impact values along with the higher interest rates and lower LTVs. Loan modifications will help to a limited extent, until regulators crack down on banks overly exposed to CRE debt. See note below about banks.
• Solid fundamental multifamily property will be refinanced with equity infusions and those with more leverage and CMBS funding will likely not be able to refinance. Some distress will appear in the coming months and in 2025.
• While the US has enough multifamily building going on to satisfy growing demand, nationwide, new supply is highly concentrated in Texas, Florida and a few other states, suggesting that some markets will be facing flat or declining rents in the next few years, despite positives in migration. We also have pent-up demand with doubled and tripled family households sharing space because of affordability challenges. New supply at the local level tends to reflect the ease of entitlement and permitting as much as new demand. New government mandates and the fear of government intervention restricts developer interest in markets like California, except for large scale projects.
• Office property vacancies remain high with the WFH movement, shared space and hybrid work solutions resulting in most tenants downsizing footprints when leases renew. Class C property has been more stable as a result of less leverage and lower base rents. Again, conversion of 10% to 15% of the office stock would go a long way to rebalancing both the office and residential markets. The WFH trend has also favoured suburbs over CBDs, and second and third tier cities over large cities.
• Professor Rebel Cole suggested that as many as 1000 US banks (of some 4600 total) could go under or be absorbed by other banks in the next year or so, as a result of underwater real estate loans. Any bank with more than 300% of equity in CRE financing, especially office property, is considered at risk of going out of business by regulators. Today, depositor runs take less than a day with the ability to use mobile phone applications to withdraw money within minutes based on rumours about bank troubles, versus the days of week-long ques outside of banks with depositors trying to withdraw funds. Fewer banks are likely in the future and the US will have numerous bank branches available for sale for the foreseeable future.
• Data centres will remain among the fastest growing niche products for years to come. Self- storage also has shown a fair degree of stability and resiliency.
• AI is impacting all property sectors in terms of operational efficiency, managing and reporting. It remains to be seen if Yardi can bring such efficiencies to WeWork and make a non-profitable business model profitable.