Office REITs Stage Surprising Comeback in Q3!

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Office REITs stage surprising comeback in Q3! Infrastructure development required as manufacturing moves back to US; and development boom challenges Miami rents. Let’s delve into today’s topics.

📈 Market Update

🏢 Office REITs Stage Surprising Comeback in Q3!

Despite being the real estate sector’s weakest link since the pandemic, office REITs unexpectedly outperformed the broader market in 3Q 2023. The sector fell just 2.8%, compared to the S&P 500's 3.7% decline - marking office REITs' first quarterly outperformance since 2020. The rally was fueled by SL Green's late June sale of a 49.9% stake in 245 Park Ave, sparking optimism. Hudson Pacific Properties, down 40% YTD, rallied 58% in Q3 to become the top gainer. Vornado and SL Green also posted gains of 25% and 24% respectively.

↪️ The Takeaway:
While signs of strength emerged, the sector remains vulnerable to ongoing volatility. September's robust jobs report sent office REITs to 2009 lows amid concerns of further Fed rate hikes. Though tenant demand is increasing in San Francisco, much stems from tenants with near-term lease expirations. The sector must maintain staying power through fluctuating cycles. As SF Fed President Mary Daly noted, commercial real estate investors must "play the longer game" and have a "strong constitution" amid shifts.

🏭️ Infrastructure Development Required as Manufacturing Moves Back to US

The rapid growth of nearshoring manufacturing and technology facilities back to the US has fueled a boom for construction companies. Firms like Quanta Services, Fluor, and Sterling Infrastructure have seen market values surge over 100% in four years amid high demand. Combined backlogs for major contractors have swelled by $20B over pre-pandemic levels, likely rising further in 3Q. Government incentives have accelerated nearshoring, but the trend began pre-pandemic as supply chain issues underscored overseas reliance risks.

Infrastructure Upgrades Needed to Support Factory Resurgence:
While government stimulus has boosted nearshoring demand, infrastructure enhancements are still required to support new facilities. Sterling Infrastructure's CEO notes infrastructure spending remains below needed levels. Upgrading roads, airports, and other connective infrastructure will be vital to sustain the construction boom. Though nearshoring has progressed rapidly, more infrastructure funding is crucial to fully capitalize on the manufacturing return trend.

⛱️ Development Boom Challenges Miami Rents

Miami's rental market is poised for a surge of new inventory, with over 32,000 units underway equaling 17.7% of current stock. This echoes boom-bust patterns of the past, stoking fears of a correction. However, fundamentals remain solid given Miami's lifestyle appeal, rising incomes, and finite land constraints. While risks exist, Miami differs from past eras with its global allure and immigrant community. Absent a severe recession, Miami may avoid dramatic declines.

Bifurcation Emerging Between Class A and Class B/C:
Early signs of a bifurcated rental market are emerging in Miami. The high-end segment where much new supply is concentrated shows declining rents. However, more affordable rentals have generally held steady. This bifurcation may continue if oversupply pressures mount at the top. While the high-end softens, cheaper units could retain tenant demand, preventing across-the-board declines.

🔍️ The Outlook: 
The limited land supply makes overbuilding difficult compared to other cities. While careful monitoring is required, Miami has shifted from its speculative past. Between its lifestyle appeal, immigrant community, and major corporate relocations, Miami may exhibit greater resilience through cycles than previous decades.

✍️ Further Reading

• Wall Street Isn’t Sure It Can Handle All of Washington’s Bonds (WSJ)

• S&P Eyes Slashing Brookfield Property Partners’ Credit Rating (RD)

• Charge-Offs of Bank CRE Office Loans Surge (GS)

• Retail Is Suffering From Its Own Success (GS)

• Rising Insurance Costs Deter Multifamily Investment and Development in Florida (CS)

• Multifamily Rents Slip in Dallas-Fort Worth Region (CS)

• US Hotel Industry Sells Near-Peak Number of Rooms in September (CS)

• What the New Jobs Report Means for CRE (CPE)

📊 Chart of The Day