3 min read December 2022 — In an interview with Invest:, Mark Popovich, senior managing director and Pittsburgh office co-head of JLL Capital Markets, talked about the strategies the company is implementing in the current economic landscape when there is still a great deal of uncertainty around issues like interest rates and a recession on the horizon. Popovich also provided insight into how a variety of markets are doing coming out of the pandemic, including office, retail, hotel and industrial.
What have been some milestones or highlights from the last 12 months for JLL?
We had a very good 2022 and were very active in Pittsburgh, especially in the first half of the year. We started to see a slowdown in the third quarter as deals we had in the market were getting repriced downward by the buyer market because of concerns about interest rates, a possible recession and inflation. As an investor, when there are three major risks like these that are all equally pressing and you have already been actively investing for the prior 24 months you are most likely going to sit on the sidelines and wait to see what happens. Because a lot of buyers went to the sidelines, there were fewer investor pools.
2023 is somewhat of a concern for us because activity seems to be slowing but one bright spot is that the 10-year Treasury is back to where investors are starting to feel more comfortable, although there is some uncertainty about how long it is going to stay there. The permanent refinancing market may get traction if there is interest rate stability, but short-term construction financing is going to be more challenging.
On the investment side, it is still choppy but less so with multifamily and especially with the 10-year where it is as you can borrow from the agencies very competitively. Industrial is still in high demand but has retrenched somewhat from 12 months ago. Hotels are very good as well as retail. Office is a challenge right now because it is difficult to quantify the demand. To help effect an office trade today, we’re seeing some sellers provide Seller financing to bridge the gap where lenders are underwriting office and where buyers need the leverage to be to allow the deal to underwrite.
Overall, things are moderating back to 2019 metrics, which is expected because the activity and investor appetite that we witnessed in 2021 and early 2022 was not sustainable.
What strategies are you implementing to navigate the current landscape?
One thing that is unique and an opportunity is we have a yield inversion with short-term rates higher than long-term rates. Typically, permanent loans have prepayment penalties, so this scenario is set up perfectly to allow borrowers to prepay their loans with little to no prepayment penalty. Recently, we defeated a CMBS loan and the way that works is that if the replacement Treasury rate is higher than the coupon rate, the borrower actually makes money. Here is a scenario where we were able to defease the loan and as a result the borrower made money and we were able to refinance them into a fairly competitive long-term rate. We will focus on short-term maturities and run those economics for borrowers to inform them of that situation. We are actively targeting property verticals that can transact and right now that is apartment, industrial, followed by hotel and retail.
How does the economic landscape compare to other downturns?
Each downturn is unique, and I’ve been around to experience them since the early 1990s. This one is a little different as people are generally positive about the economy and there’s no liquidity issue but there is short-term uncertainty. Many investors feel like the next 12 months will be a challenge primarily on short-term rates and the possibility of entering a recession. There is also the positivity that interest rates and inflation will moderate, and the recession will not be that impactful. We are going to have to be very creative in connecting the dots for clients and helping them manufacture deals that are beneficial to them. In a way, this helps us because clients lean on us more and we can really add value.
What are client expectations and what are they looking for?
For apartments, there is still a significant investor appetite for this product. For industrial, 12 months ago, buyers were really looking for industrial deals with shorter-term leases. They wanted to take advantage of rolling tenants to higher market rates and high single-digit rent growth. Investors now want more cash flow certainty, so industrial is still very much in favor but transitioning back to what historically investors wanted – longer-term credit leases. Retail is interesting because it just went through the most unbelievable stress test. The retail that has come out on the other side of it and has shown good occupancy is looked at by investors as valuable, with generational holding power. There is a lot of money in hotels with business travel starting to come back and leisure travel has exploded. Part of that is likely because of remote office work as hotels and even resorts are adjusting to accommodate guests who are technically still at work. I believe that the days of putting in a vacation request and taking off work for a week are pretty much gone and people are just taking trips while “technically” being at work.
Office is still a question mark because the demand side is difficult to underwrite with certainty. It will take some time for there to be more clarity on office demand and return to office fundamentals. One trend that we’re seeing for tenants who are renewing during this period is that they tend to take less space, but they are willing to pay higher rent and move to better space in a flight to quality. In the end, tenants are getting better space at an overall occupancy cost that is the same or less than their prior space.
What is your outlook for the firm and the commercial real estate market in the region for the near term?
Pittsburgh is interesting because we look good in the bad times but bad in the good times when compared to high-growth markets. We are not a high-growth market, but we are a strong yield and relatively stable market. This stability suits lenders who like that we aren’t a boom-and-bust market and many of our borrowers are local regional development firms that tend to develop or buy and hold. Certain real estate funds are attracted to Pittsburgh because our stabilized projects can balance their portfolio and offset their more opportunistic deals. This just means that we must work a little harder to compete with the flashier markets like Austin, Charlotte and Nashville
I am very optimistic about 2024 and 2025 where rates and recession fears are expected to moderate. The issue is the uncertainty surrounding inflation, interest rates and recession. It doesn’t matter as much where these issues eventually land, because we can underwrite whatever it ends up being, it’s the uncertainty that’s causing people to pause and remain on the sidelines until there is more clarity.
Lately, we are making an effort to get in front of clients and lenders to discuss what’s going on in the market and share with them our collective wealth of research information and real-time transaction data to help them navigate the next 12 months.
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