June 2024

North America

·US office markets affected by more than its UK equivalents. Vacancy rates in major US office markets are significantly higher than their UK counterparts. While both countries have seen vacancy rise since the pandemic, US cities like San Francisco and Seattle grapple with rates exceeding 15%, compared to a more modest 3.5% increase in key UK markets. This is likely due to a stronger work-from-home culture fuelled by factors like spacious homes and long commutes in the US. This contrasts with the UK, where city centres offer a mix of workspaces, shops, entertainment, and cultural attractions, making them more appealing destinations even outside of work hours. Looking ahead, London seems poised for a significant increase in office supply, with over 20 million square feet under construction, which compares to the 15 million square feet pipeline in Boston and less than 10 million square feet underway in New York respectively. This surge in development suggests greater confidence in the future of the UK office market compared to the US. (Source: CoStar, Knight Frank, British Land, 2024)

Office vacancies at highest levels in major US cities

·Fortress secures first ever Industrial Outdoor Storage-backed CMBS loan. Fortress Investment Group closed a record-breaking $708 million refinancing deal for industrial outdoor storage (IOS) facilities on the West Coast. This included a groundbreaking $493 million single-asset, single-borrower commercial mortgage-backed securities (CMBS) loan – the first ever for IOS properties. This deal underscores Fortress' belief in IOS as a compelling asset class for investors. The company cites factors like rising tenant demand, limited new supply, and low maintenance costs as key drivers of this market. The CMBS loan itself is secured by a well-positioned portfolio of 41 properties across California, Seattle, and Portland. These properties boast a combined 1.9 million square feet of building space and sit on 6.2 million square feet of land. Notably, 75% of the properties are within a mile of a highway, and all are conveniently located within 25 miles of a port. With an occupancy rate exceeding 98% for both building space and land, this portfolio is a clear winner for Fortress. (Source: Fortress, CoStar, Moody’s, 2024)

West Valley 29 in Auburn, Washington- largest property backing the CMBS loan

·Netflix to open second Immersive Entertainment Venue in Dallas Mall. Netflix plans to launch its second permanent entertainment venue, Netflix House, in a former department store at Galleria Dallas. This comes after announcing a similar venue at King of Prussia mall in Pennsylvania. These sites will feature interactive elements from popular Netflix shows, along with themed merchandise, dining options, and virtual reality experiences. The Dallas venue will take over the 180,000-square-foot space of a former Belk store, while the Pennsylvania venue will occupy the 120,000-square-foot former Lord & Taylor space. This initiative is part of a trend to transform vacant mall areas into engaging entertainment destinations. (Source: Los Gatos, Simon Property Group, CoStar, Netflix, 2024)

Rendering of Netflix House planned for Galleria Dallas

·KKR tries to increase investor confidence in its Real Estate Fund. Global investment firm KKR is taking steps to enhance investor confidence in its $1.2 billion KKR Real Estate Select Trust (KREST) as commercial property values decline. In response to a two-year downturn caused by rising interest rates and decreased investor capital, KKR has unveiled a shareholder priority plan. This includes a commitment from KKR affiliates to cancel up to 7.7 million KREST shares if the net asset value per share drops below $27 by June 2027, effectively increasing per-share value by reducing the number of shares. Additionally, KKR has injected $50 million of new capital into KREST. This approach, mirroring a similar move by Blackstone, aims to protect non-KKR shareholders from short-term price declines while allowing them to benefit from any future recovery in the real estate market. (Source: KKR, CoStar, 2024)

KREST’s 1,015-Unit apartment complex in Philadelphia (Presidential City)

·Rising credit risk in US multifamily alarms banking regulator. The Office of the Comptroller of the Currency (OCC) has identified growing credit risks in the multifamily real estate sector, particularly due to overbuilding of luxury apartments in cities like Nashville and Salt Lake City. High borrowing rates and increased operating costs, such as insurance, are putting significant strain on property owners. Multifamily properties are experiencing stress with significant impacts in rent-controlled areas like New York City and California. Although multifamily properties are under increasing stress, the office sector remains the primary concern for banks, with property values dropping 13% since 2021 and an additional 15% decline expected by the end of 2025. The OCC categorises these risks as moderate but warns of further complications from upcoming loan maturities and refinancing challenges, especially for interest-only loans. (Source: CoStar, OCC, 2024)

Europe

·Larger office buildings in UK face greater challenges with yields on the rise. Office yields are climbing across the UK due to higher interest rates and increasing vacancy rates, with larger buildings being hit hardest. Buildings over 20,000 square feet have seen yields increase by nearly 300 basis points to exceed 9%, while smaller buildings have experienced a smaller rise of 40 basis points. The gap between yields for large and small buildings is now the widest it has been this century, at 170 basis points. Transactions involving large offices have declined significantly due to financing challenges and decreased investor demand, leading to a vacancy rate of 9.7% in large buildings compared to 5.3% in smaller ones. (Source: CoStar, 2024)

Bigger Discounts for Larger Office Buildings

·Prologis UK launches Flexxtra, flexible warehousing service. Unlike traditional leases, Flexxtra offers on-demand warehouse space by the pallet, allowing businesses to scale up during peak seasons without long-term commitments. This turnkey solution also frees clients from managing warehouse operations. Located at Prologis Park Wellingborough West DC4, a new facility with 70,000 pallet capacity, Flexxtra will be managed by a team consisting of Prologis UK, Kinaxia Logistics, and Visku's Pallet Hotel platform. They will handle everything from receiving goods to fulfilling outbound orders for up to 30 customers simultaneously. Prologis believes Flexxtra will be a game-changer in the logistics industry, offering much-needed flexibility for businesses and potentially nurturing the UK's next big success story. (Source: CoStar, Prologis, Kinaxia Logistics, Visku, 2024)

·TPG secures €1bn financing to boost logistics platform expansion. TPG has arranged a €1 billion debt facility from Ares Management and Blackstone to support its recent acquisition of Intervest and drive its expansion into a significant European logistics platform. This financing will refinance Intervest's existing debt and support its growth, with part of the funds allocated to current development projects. At the end of last year, Intervest's portfolio was valued at €1.42 billion, consisting of 79% logistics assets (€1.1 billion) and 21% office assets (€314 million). TPG plans to sell the office assets, valued at around €300 million, to focus exclusively on warehousing. Ares has been particularly active, recently providing a £500 million loan to the Langham Estate and a €440 million loan to refinance the Generator Group's hostel portfolio across Europe. Additionally, Ares financed a €208 million loan for a 546-unit multifamily property in Wembley Park, London, and, along with EQ Group, acquired 21 hotels from Landsec for £400 million, with Blackstone supporting this with a £360 million acquisition and capex loan. (Source: Green Street, TPG, Ares, 2024)

·City of London’s prime vacancy rates at five-year low. The City of London's office market is experiencing a significant polarisation, with prime space experiencing a surge in demand. Vacancy rates in 5-Star rated buildings have plunged to a five-year low of 8.3% of total City market vacancy, representing a substantial 6.7% decrease year-over-year. This stands in stark contrast to the overall City vacancy rate, which currently sits at a 20-year high. This trend reflects a "flight-to-quality" as businesses prioritise modern, sustainable workspaces to attract talent and meet environmental goals. This targeted absorption in high-grade buildings has shrunk available prime office space to a mere 1.8 million sq ft, well below the long-term average. Landlords are expected to react by developing more premium office spaces, potentially exacerbating vacancy rates in older stock. (Source: CoStar, Colliers, 2024)

Prime Offices in City Show Robust Demand

·French hotel titans, AccorInvest and Covivio, close landmark asset swap deal. In a move to streamline their holdings in the French hospitality sector, hotel giants AccorInvest and Covivio have announced a strategic €393 million asset swap. This deal will see Covivio regain control of a portfolio of 24 economy and midscale hotels valued at €266 million, while AccorInvest will acquire 10 hotels for €208 million. The agreement extends beyond individual properties, also involving stakes in joint ventures partially owned by Covivio. AccorInvest will transfer control of 19 properties currently leased from these ventures in exchange for a portfolio of six hotels owned by Covivio. This strategic move offers benefits for both companies. AccorInvest anticipates a €22 million reduction in leasehold charges, leading to improved operating margins. Covivio, on the other hand, sees an opportunity to directly manage the hotels it acquires, potentially unlocking significant growth potential. (Source: CoStar, AccorInvest, Covivio, 2024)