REJournals.com Features Lee & Associates Research

The lowest vacancy rate in 15 years. That’s the milestone the U.S. retail sector hit in the fourth quarter of 2022, according to the latest research from Lee & Associates.

And that’s just the start of the good news from the company’s fourth quarter 2022 retail report. According to Lee & Associates, the retail sector saw 20.7 million square feet of net absorption in the fourth quarter of last year. That brought the year’s total net absorption in this space to 74.8 million.

How strong are those numbers? Lee & Associates reports that this demand was the most seen in the retail sector since 2017 and exceeded new supply by 30 million square feet.

At the same time, the overall U.S. retail vacancy rate fell to 4.2% in the fourth quarter, the lowest this figure has been in 15 years.

This all happened despite the higher prices that consumers face for food, gas and housing. The retail sector has thrived even as interest rates rise. U.S. retail sales, excluding auto, gasoline and non-store retailers, rose to a new monthly record of $384 billion in September.

What’s behind the strong performance? Retailers got creative during the height of the COVID-19 pandemic, boosting their delivery services, offering curbside pick-up and making it easier for customers to order items online and pick them up in brick-and-mortar stores.

And once lockdowns ended and retailers were allowed to open fully for business? Shoppers returned in droves. This inspired merchants to lease up a net 72.4 millions square feet in 2021 and 74.8 million square feet in 2022.

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Business Insider Features Lee & Associates New York City's Greg Tannor

The first legal dispensary in New York state opened its doors in December, but a commercial-real-estate expert said cannabis-business owners have some hefty obstacles to overcome before they can follow suit.

In March 2021, the state of New York legalized recreational marijuana for adults, but it took nearly two years for the Office of Cannabis Management to approve the first 36 business licenses for dispensaries. The next hurdle is finding the right real estate for stores,  Greg Tannor, a real-estate executive with Lee & Associates NYC, told Insider.

According to Tannor, opening a brick-and-mortar dispensary isn't quite the same process as a opening a brick-and-mortar coffee shop or clothing store. There are "buffer zones" that cannabis-business owners must take into account while shopping for real estate.

"Buffer zones are crucial for approval for the OCM," Tannor told Insider. "These locations have to be outside of a certain vicinity of schools, places of worship, parks, and other dispensaries."

To comply with New York's buffer zones, a cannabis business cannot be within 500 feet of school or within 200 feet of a house of worship, according to a report from Bloomberg. The businesses must also be 1,000 feet away from other dispensaries, Tannor added.

Hesitant landlords are another hurdle license holders will have to overcome to open storefronts. Marijuana's illegal status at the federal level coupled with the poor reputation of illicit New York smoke shops means building owners often have reservations about leasing to legal dispensaries.

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GlobeSt.com Features Lee & Associates Industrial & Multifamily Research

The current economic headwinds have been a cause for alarm in certain sectors. Not so for industrial and multifamily, however. With US industrial vacancy at 4% and multifamily’s pipeline tightening, the data from Lee & Associates’ Q3 2022 Market Report shows both sectors have room for rent growth.

It’s a story about fundamentals that point to continued strength, according to Jeff Rinkov, CEO of the broker-owned real estate services firm.

Industrial Strength Continues Beyond Amazon

“The industrial leasing story continues to be the strongest theme maybe in all of commercial real estate with demand remaining robust,” Rinkov said. “We see pre-leasing of Class-A buildings and a rising tide of rental rate growth for B and C buildings that are well-located. Historic rate increases and rental growth are supporting the development and have been supportive of higher land prices for the last several years.”

Industrial vacancy at end of the third quarter settled at that 4% number, up 10 basis points from Q2, according to the Lee & Associates market report. Approximately 850 million square feet of industrial space are under development in the US with about 38% pre-leased.

“How the other 62% of that product gets leased and how quickly I think will tell the story for the next 18 months,” said Rinkov, adding that there is space coming back to the market, led by Amazon shedding millions of square feet of warehouse capacity, but it is getting absorbed very quickly and at “higher and higher rates.”

Multifamily Moves

Although apartment rent growth of 5.7% through Q3 was down considerably year over year, it’s still more than twice the annual average rate of 2.5% over the past decade, Lee & Associates reported.

“The multifamily sector has seen a very compelling story for rental increases and rent growth,” Rinkov said. “As a general economy, we’re underhoused so housing development that is happening is being well received. We do see an interest in people returning to CBD and metropolitan submarkets.”

Lee & Associates reported a 29% year-over-year increase in the average per-unit sale price to $233,974 at the end of the third quarter.

“Multifamily seems to be the asset class where there’s historically been the greatest amount of liquidity, cap rate compression, and the most voluminous trading because of the differentiation in the types of ownership, from the institutional to regional and all the way down to mom & pop owners,” Rinkov said. “Well-located product is going to continue to be developed and absorbed at very significant rental rates.”

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Bisnow.com Features Lee & Associates New York City's Greg Tannor and Jessica Gerstein

After more than a year of build-up, vendor license applications awarded by New York State's Office of Cannabis Management are slated to open at some point in the next 30 to 90 days. As the dawn of NYC's formal cannabis retail market edges closer, aspiring vendors have accelerated their searches for available retail space and are signing lease agreements with a range of different conditions, experts in the space told Bisnow.

Crucially, more spaces are also appearing on the map as landlords become more willing to do deals in spite of potential risks. Valentino said his client, a national cannabis brand, is willing to pay market rents in the deal in a location and retail environment in which most tenants are looking for discounts.

The number of potential cannabis tenants has quadrupled over the past 12 months, said Greg Tannor, a cannabis leasing expert and Lee & Associates' executive managing director and principal. Those exploring options for space include everyone from experienced business owners to aspiring entrepreneurs looking at densely populated NYC.

“Everyone out there thinks that they can go and win a retail license, hence more activity in the market,” Tannor said. “People think that it's like a license to print money, when there's a lot more detail into it. It's an extremely competitive licensing process.”

The OCM intends to award the first cannabis vendor licenses in the state to applicants with prior convictions related to marijuana, or who have family members with prior convictions. The OCM has also promised to match up to 150 of the first round of licensed vendors with a property obtained by the state government as part of its $200M social justice fund.

But there's no limit to the number of second-tier licenses that will be available, an OCM spokesperson told Bisnow by email — leaving applications open to anyone with a demonstrated business plan who is willing to submit all the paperwork required by the state.

“We have been busy from day one, but now I feel like the floodgates opened,” Lee & Associates Senior Leasing Associate Jessica Gerstein said.

Because applications for retail licenses aren't even open, let alone allocated, the deals for space being struck aren't for traditional leases, rather a mix of arrangements.

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WealthManagement.com Features Lee & Associates New York City's Ben Tapper

Rising interest rates, inflation and fears of a recession are starting to change the calculations of how to get the best returns for commercial real estate investors. Should they continue to favor multifamily and industrial assets, which have served them well through the pandemic disruption? Or switch to higher risk, but higher yield investments? It looks like the best approach might be combining the two strategies.

Ben Tapper, a senior managing director and director of the national investment services group with Lee & Associates, says any outlook needs to be broken down by region. In some parts of the country, rent regulations make multifamily assets less desirable. The area’s job and population growth trends also make a difference, Tapper adds.

There are other asset types that are attractive in a rising interest rate and inflationary environment, according to Tapper, but a lot of that has to do “with your acquisition basis.”

In addition, properties that require greater supporting infrastructure and carry higher replacement costs make for more desirable investments in today’s environment, he notes. One example is the medical office sector, where it’s expensive to build out the necessary infrastructure such as HVAC, X-ray-proof walls and MRI machines.

“Things like that are more cost-intensive to put into a building, creating a greater stickiness in the tenant, greater predictability and greater stability,” Tapper says. “I think in a rising interest rate and inflationary environment that’s what a lot of investors are seeking.”

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Bisnow.com Features Lee & Associates New York City's Greg Tannor

The cannabis industry touches almost every commercial real estate asset class, from industrial to retail to office and flex. Despite its many obstacles, a fervent desire by developers to capitalize on the emerging industry is translating to increased demand for space. A 2021 survey by the National Association of Retailers found that in states where recreational or medicinal marijuana is legal, 36% of members had seen increased demand for warehouses, 23% for storefronts and between 18% and 28% for land.

Greg Tannor, principal and executive managing director at Lee & Associates NYC and part-owner of a retail dispensary in Massachusetts, said investors are attracted to the higher rents commanded by cannabis operations. Some landlords also charge a “cannabis premium,” or an additional fee tacked onto a lease in areas where there is greater competition for properties.

“For the most part, there is not a lot of back and forth in terms of negotiating rents because of the need for space and the limitations surrounding buffer zones along with debt and financing on buildings,” he said.

When a state legalizes recreational cannabis, jurisdictions decide whether or not to allow retail storefronts, and Tannor said many initially choose to opt out. In New Jersey, for example, around 400 municipalities chose not to participate. That drove demand for properties in areas that opted in through the roof, Tannor said.

Some jurisdictions will opt back into a state’s program once they realize the industry’s tax revenue potential. As of December 2021, marijuana sales translated to about $10.4B in tax revenue for states where it is legal, according to a report by the Marijuana Policy Project.

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WealthManagement.com Features Lee & Associates Twin Cities's Susan Wilson and Chris Jacobson

The medical office sector couldn’t be in better shape despite fears of the impact from telemedicine and given the demand for health care, the industry should be robust over the next 12 months, according to analysts.

A segment known for its stability and resistance to recessions set record highs for asking rents in 2021 as vacancies decreased–a trend expected through the next year and beyond. Development of new medical office buildings continues after a slowdown at the start of the COVID-19 pandemic, and for quality properties on the market, investors are gobbling them up quicker than ever. That’s coming off record highs in sales volume and pricing in 2021.

None of that demand is a surprise given an aging population along with migrations and relocations that have picked up since the start of the pandemic in 2020.

“I think you’re seeing vacancy in older medical buildings that are now picking up office tenants, while class-A and class-B (medical offices) have lower vacancy. And if they are strictly medical they do much better,” said Susan Wilson, a healthcare real estate advisor for Lee & Associates and vice president of Lee & Associates Healthcare group.

Medical office rents historically grow at a steady rate of 2 percent to 3 percent year–over-year, but that pattern is being challenged by current conditions.

There are limits, however, to how much medical office rents can grow, according to Chris Jacobson, a healthcare real estate advisor for Lee & Associates and vice president of Lee Healthcare.

“It’s never going to go through the roof,” Jacobson said. “They can only afford what they can afford with reimbursement from insurance. They can only see so many patients and do so many procedures a day. It’s not like they can sell more coffee.”

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When the pandemic engulfed the world last year, few analysts predicted that the multifamily sector would flourish and thrive so well. Most suspected that the sector would be on life support. Yet, despite a year-long national eviction moratorium, there hasn’t been a better time to be a big apartment-building landlord.

Multifamily-property values have increased 13 percent since before the pandemic and more money is being invested now in apartment buildings than in any other type of commercial real estate. How did this happen and what explains this? Lee & Associates’ research will delve into why the multifamily sector, contrary to past predictions and present-day misperceptions, is flourishing as never before.

1. Measured on an annual basis, national asking rents rose 10.3 percent in August.

That marked the first double-digit increase in the more than 20 years the data of 13 million professionally managed apartments has been collected, and in several cities, the rent increases were much more significant than the national figure.[1] August rents rose more than 20 percent year-over-year in Phoenix, Las Vegas and Tampa. Similarly, monthly rents were up more than 20 percent in comparable markets such as Boise, Idaho and Naples, Florida.

2. Multiple factors explain this rise in rents.

Younger adults who lived with family last year are now renting their own apartments, and middle-income workers who have been priced out of the housing market have few options. If they want to live in an apartment, they must pay higher rents. Moreover, demand for new apartments is outstripping the capabilities of developers to supply them.

3. Apartment occupancy rates hit a record high of 97.1 percent in August.

This is a critical metric landlords use to determine how much they can increase rent. As the occupancy increases, so too does the capability of landlords to increase rents. Additionally, household incomes for new renters at professionally managed properties also reached a new high of more than $70,000 a year.[2] This further strengthens the leverage landlords have over renters.

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