The BAN Report: CRE Green Shoots / Southwest Pivots / Can Wells Escape the Cap? / Extreme Weather Costs / Multifamily Webinar Tuesday

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CRE Green Shoots

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According to Bloomberg, CRE activity is picking up.

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Buyers and sellers in US commercial real estate are increasingly convinced that the beleaguered market is reaching a bottom.

But the big question remains: At what price will beaten-down offices, apartments and other properties actually change hands?

 

Signs abound that there will soon be an answer. With prices down 19% from a peak in 2022, the commercial-property market is starting to come to life. In part, that’s because lenders and owners want to cut their losses and make new investments now that the Federal Reserve’s first rate cut in four years is bringing some clarity on where valuations stand.

 

“There’s going to be definitely more activity in 2025 and it’s going to be a mix of drivers that’s going to lead to significant instability for some, with some significant opportunity for others,” said David Aviram, co-founder of Maverick Real Estate Partners. Struggling properties that took on too much debt at much lower rates will drive many of the transactions, he said.

 

Sellers have had to offload properties at steep discounts in recent months. Earlier this year, investors agreed to buy a New York City office building at 67% less than its 2018 purchase price. The former Chicago headquarters of Cboe Global Markets Inc. sold this summer for about half of its pre-pandemic value.

 

Data this year through July underscores just how tough a market it’s been. Transactions were down 5% from a year earlier to $203.8 billion, according to MSCI Inc. But lately, transaction volumes are showing “steady” improvements, the data provider said in a report.

 

“Yields are higher than they’ve been in over a decade and the fundamentals are pretty strong and improving,” Todd Henderson, head of Americas real estate at DWS, said Tuesday in an interview with Bloomberg Television. “We like the dynamics in the market.”

 

More companies are also willing to provide loans. An investor looking to raise $120 million of debt to acquire a portfolio of Florida warehouses received a dozen bids from major banks and insurers, according to Michael Gigliotti, a senior managing director at Jones Lang LaSalle Inc. who’s working on the transaction. Three months ago, that type of deal would have received four to five offers, he said.

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“You’re getting the triple whammy: Players, prices and indices are all cooperating,” said Gigliotti. “It feels like there’s been a switch flipped. Everybody seems excited and we’re calling it the beginning of a new liquidity cycle.”

 

Investment titans are preparing to jump in to provide certain loans at higher interest rates than a few years ago. Fortress Investment Group and Goldman Sachs Group Inc. are seeking to raise money from investors for new real estate investment trusts for commercial property loans. Elliott Investment Management-backed lender Ascent Developer Solutions said loan demand is double what it was just two or three months ago, according to AscentDS’s Chief Executive Officer Robert Wasmund.

 

We are definitely seeing market conditions improve for commercial real estate, especially after the drop-in rates. The 10-year is now 125 basis points lower than its peak late last year. The data only shows a nominal increase, but the trajectory has certainly improved. Many of our banks are telling us that more construction loans are paying off, making it easier to provide new loans to their borrowers.

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Southwest Pivots

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Under pressure from an activist investor, Southwest Airlines today announced a three-year turnaround plan today while raising revenue projections.

 

Southwest Airlines announced a three-year plan on Thursday to revitalize its operation and customer offerings as it defends against an activist investor calling for new leadership and a strategy overhaul.

 

The plan expands on a series of changes by Southwest in recent months, including plans to add premium seats, introduce red-eye flights and replace its pick-your-own seating system with assigned seats, starting in 2026.

 

The airline said on Thursday that it would begin selling vacation packages and was partnering with international airlines, starting with a connection in Baltimore via Icelandair next year. It also announced a $2.5 billion share repurchase program and plans for operational changes, including turning planes around faster and finding ways to save on costs.

 

“We’re now ushering in a new era at Southwest, moving swiftly and deliberately to transform the company,” Bob Jordan, the airline’s chief executive, said in a statement.

 

Southwest shares jumped more than 9 percent after the announcement, which came ahead of a day of events the airline scheduled for investors and analysts.

 

The airline is making the moves under rising pressure from an activist hedge fund, Elliott Management, which has amassed a stake of more than 10 percent, worth almost $2 billion. Elliott has said the airline is underperforming and has placed blame on Mr. Jordan, who has worked at the airline for decades.

 

The hedge fund contends that Southwest can better contain rising costs and improve profit margins. To do that, Elliott says, the airline needs new board members and a new chief executive. The hedge fund plans to call for a shareholder meeting as soon as next week to vote on candidates it has proposed for the airline’s board, mostly former industry executives.

 

Southwest in response has accused Elliott of failing to “engage constructively” with the airline. On Thursday, the airline also said that it had appointed a new board member, Robert Fornaro, the former chief executive of both Spirit Airlines and AirTran, which Southwest acquired more than a decade ago.

 

Southwest once reported strong profits consistently even as other airlines lost money and sought bankruptcy protection. But its financial results in recent years have disappointed some investors, who point to airlines that have adapted more quickly to shifting market demand by, for example, selling more premium seats.

 

Mr. Jordan has acknowledged that the airline needs to make some changes. The airline is in the middle of rolling out better internet service, in-seat power outlets and larger overhead bins.

 

But it is not clear whether Southwest, which has become one of the world’s biggest airlines by being different, can now do well by acting a little more like other airlines.

 

“They don’t need to become another legacy airline,” said Savanthi Syth, a Raymond James Financial analyst. “They just need to adapt, and they need to differentiate themselves.”

 

Other carriers have spent the past two decades redesigning their planes, fares and policies. Unlike Southwest, many airlines now charge bag fees and offer restrictive basic economy fares to bargain hunters and premium seats to more affluent travelers. Those changes are widely credited with helping airlines make more money.

 

Anyone who got an MBA in prior decades probably did a case study on the greatness of Southwest Airlines, so there recent struggles have been surprising to many. Today’s investor presentation indicates they want to make a few key changes but not lose their differentiated strategy. These two slides seemed fairly representative of how they intend to stay differentiated while pivoting in a couple new areas.

 

 

The management team is responding to investor pressure without agreeing to all of the demands from Elliott Management, who want to fire the CEO and revamp the Board.  

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1) Enhance the Board of Directors: The Board should be reconstituted with new, truly independent directors from outside of Southwest who have best-in-class expertise in airlines, customer experience and technology.

 

2) Upgrade Leadership: Southwest must bring in new leadership from outside of the Company to improve operational execution and lead the evolution of Southwest’s strategy.

 

3) Undertake a Comprehensive Business Review: Southwest should form a new management and Board-level committee to evaluate all available opportunities to rapidly restore the Company’s performance to best-in-class standards.

 

In other words, we believe that competent new leaders, working through a deliberate and thoughtful process, should chart the course forward for Southwest. We do not support the Company’s current course, which is being charted in a haphazard manner by a group of executives in full self-preservation mode. Trusting these executives to implement “transformative” strategic changes and make “difficult decisions,” when they have proven incapable of competently running the airline, represents a long-term risk to the business and its culture. We have seen time and again that when underperforming management teams try to implement measures without proper governance or the right expertise, companies fail to address their strategic challenges and often make matters worse.

 

When the activist investor wants a new board and new management, it leaves little room for negotiation. In this case, it appears there must be a winner and a loser, and time will tell if the current leadership can fend off a determined activist.

 

Can Wells Escape the Cap?

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After nearly seven years of being subject to a Federal Reserve growth cap, Wells has submitted a review in order to get the cap lifted, most likely new year.

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Wells Fargo & Co. has entered a key new phase of its almost seven-year effort to escape a Federal Reserve cap on its assets, a punishment that has become the most feared in banking.

 

Behind the scenes, the firm has submitted a third-party review of its risk and control overhauls to the Fed for the central bank’s analysis and sign-off, according to people familiar with the matter. That follows a years-long process in which Wells Fargo had to submit a plan and get it accepted — which took multiple tries — and then enact it and hire an outside auditor to assess its implementation.

 

Shares of San Francisco-based Wells Fargo surged as much as 6.5% after Bloomberg News reported the submission, their biggest intraday increase in seven months.

 

Wells Fargo executives still see the cap stretching at least into next year while the Fed reviews the submission, the people said, asking not to be identified discussing the confidential matter. Along the way, the regulator could request more information or additional work. And, even then, removing the restriction requires a vote by the full Fed board.

 

Spokespeople for Wells Fargo and the Fed declined to comment.

 

The cap limits the bank to its size at the end of 2017 — about $1.95 trillion of assets — curbing the company’s potential to boost profits. The unprecedented sanction was a dramatic parting act by Janet Yellen as her term as Fed chair ended in early 2018. At the time, frustrated regulators were struggling to force the bank to address a pattern of consumer abuses and compliance lapses.

 

Initially, Wells Fargo’s then-bosses signaled the cap might not last long, suggesting to investors that the firm could complete much of the work that same year to meet regulators’ demands. But that optimism soon faded as both sides realized how much it would take to overhaul internal oversight from bank’s branches up through its board.

 

Charlie Scharf inherited the task when he joined the firm as chief executive officer five years ago. His team submitted a plan in September 2020 that was accepted within months. The firm has spent the intervening years on implementation, reviews and preparing the latest submission.

 

The regulatory sanction is easily one of the costliest ever levied — a multibillion-dollar drag on earnings and the stock — leaving analysts obsessing over any signs of progress toward getting it lifted. Shares of Wells Fargo, while up 37% over the past year, are still trading below where they were when the measure was enacted.

 

During the cap’s lifespan so far, JPMorgan Chase & Co. has swelled 64% to more than $4 trillion of assets — meaning the nation’s largest bank has added almost an entire Wells Fargo to its balance sheet.

 

Many of Wells Fargo’s actions the last few years, such as exiting much of the mortgage market, divesting from CMBS servicing, etc., have been driven by managing the organization to a $1.95 trillion cap. During COVID, in which banks balances sheets exploded, it was especially difficult. In 2020, for example, the entire banking industry grew its assets by 17.4% while Wells grew by 1.5%.

 

Extreme Weather Costs

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As Hurricane Helene arrives on shore today, extreme weather events are putting pressure on local government budgets, who will need to raise taxes on their citizens.

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Extreme weather is pressuring local budgets, sticking Americans with the bill and putting the $4 trillion market for state and local bonds at the center of the climate-change fight.

 

Clyde, Texas, will likely face increased borrowing costs after the city defaulted on debt last month during a drought. Higher parking fees at the beach in Naples, Fla., are helping repay bonds sold to rebuild the city’s hurricane-damaged pier. Residents of Texas, Louisiana and Oklahoma will spend the next two decades chipping away at the multibillion-dollar cost of maintaining power during a 2021 winter storm.

 

“We’ll be paying off the bond for the four days of electricity for years to come,” said Georgetown, Texas, Mayor Josh Schroeder.

 

The market for municipal bonds has become a testing ground for the increasing demands that heat, water and wind are putting on local communities. Investors fret that volatile, damaging weather patterns in coming years will punish critical infrastructure and imperil the nation’s roads and bridges, sewers and energy grids, coasts and forestlands. As of Thursday morning, Hurricane Helene was barreling toward the Florida Panhandle and more than two dozen counties had ordered residents to evacuate.

 

Clyde is the latest U.S. city to suffer a climate-related default. In December, a Paradise, Calif., city agency missed payments on bonds issued in better days, before a downed power line in a drought-ravaged forest sparked the huge 2018 Camp Fire. In November, Californians will vote on whether to borrow $10 billion to address issues such as rising sea levels and forest fires.

 

The U.S. Senate Budget Committee held a hearing earlier this year titled “Safeguarding Municipal Bonds from Climate Risk.” Worldwide, climate shifts are expected to lead to tens of trillions of dollars in new debt issuance by 2030, according to a report Wednesday by the Institute of International Finance, a global trade group.

 

Muni bondholders are paying attention. Bond-research firms have been paying up for data pinpointing which communities are most likely to experience climate disaster. S&P Global Ratings in 2020 began highlighting environmental risks for investors. Pimco analyst Emily Robare said on a panel a few years ago that the asset manager has questioned whether climate concerns have rendered some munis inappropriate for lower-risk portfolios.

 

So far, bondholders aren’t demanding higher interest rates from communities more vulnerable to climate change, according to a 2022 study. But that could change in the next five to 10 years as private and state insurers and federal aid are stretched thin, according to the study’s author, Breckinridge credit analyst Erika Smull.

 

Quite simply, it’s going to be more expensive to live in communities with climate issues.    Property insurance is skyrocketing in states like Florida, Texas, and California and municipalities are going to be forced to raise property taxes to plug budget holes caused by extreme weather.

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Multifamily Webinar Tuesday

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What’s the outlook for Multifamily? Challenges include persistently higher interest rates, oversupply in certain markets, and higher operating costs. Many properties have basis and debt issues and rents can only go so high. However, fundamentals remain strong with home ownership out of reach for many Americans. Many investors with dry powder are poised to capitalize on the marketplace disruptions.  

Our four experts, each bringing a unique perspective and deep understanding of multi-family, will cover a variety of important topics. This highly topical webinar will cover:
 

•  State of the debt and capital markets

• Leveraging incentives from opportunity zones to tax credits

• The NYC Multifamily Problem

• Excess supply in “hot” southeast markets

• Managing higher costs from insurance to labor

• Office conversions

• Rising Regulation

• Will lower rates break the development logjam?

Join our free webinar on Tuesday, October 1, 2024, at 1:00 PM EST with four dynamic and banking experts, featuring:

• Neil Freeman, CEO, Aries Capital

• Ryan Welsh, SVP, PNC

• Rajen Shastri, CEO, Akara Partners

• Jon Winick, CEO, Clark Street Capital

Registration Details:

Register here

Tuesday, October 1, 2024, 1 PM - 2:00 PM EDT