Charlotte developer Clay Grubb, who is rarely shy of strong opinions, offered a bleak outlook on the commercial real estate market during a chat Wednesday.
Among his main concerns is that the Federal Reserve is not reacting promptly to a historic collapse in real estate. The Fed relies on verifiable data, but the lack of transactions because of stalled market conditions means there’s little for the central bank to consider.
“Just because the market is frozen doesn’t mean the values haven’t changed,” he says. “The Fed is waiting for the data, but it will be way too late by the time that data comes in. We’ll be in a world of hurt.”
Grubb believes that many suburban office buildings have lost 70% of their value in recent years because of rising interest rates and a struggling economy, while many older downtown office properties are down at least 50%. Even fully leased buildings are worth perhaps 30% less than three years ago, he suggests.
He cites one of his office buildings that is 100% leased, but needs to be refinanced. No lenders are interested in backing the deal because of concerns over market conditions, while banks are facing regulatory pressure to avoid office projects, he says. “It may be the first building in our history where we give the keys back to the lender.”
Industrywide, Grubb is concerned that commercial property owners will face a “rash of bankruptcies among tenants. That’s the next shoe to drop.”
He is urging the Fed to emphasize it won’t raise rates for at least three or four months, hoping to calm the market.
Grubb Properties is mostly focused on apartment development, more than office projects. While it operates in 26 cities, it sold virtually all of its properties in the Southeast during the pandemic, reaping record prices because of red-hot demand from multifamily investors, he says. Many of those apartments were built in the 1980s and ‘90s.
The company redeployed much of that money into moderate-income apartment projects in several major metropolitan areas including Los Angeles, New York and San Francisco, where prices had declined in the pandemic. A slump in values in California enabled Grubb to pay much less than the $200,000 per unit of land cost at which apartments were trading during peak periods.
“California is now arguably the most pro-multifamily development state in the country,” he says, partly because officials are seeking to solve the state’s homelessness crisis. Grubb Properties has a project in Santa Monica that was permitted for 60 units, then the City Council approved density bonuses that enabled the company to add 40 more units. “When land trades for more than $200,000 per unit, adding 40 units is a huge deal for us,” he says.
Grubb concentrates on so-called “essential housing” for middle-income workers. It relies on six floor plans, duplicating the projects wherever it operates. Most new apartment development nationally has involved higher-priced luxury apartments.
While property owners face serious challenges, Grubb says “It’s not as bleak as in 2008 because a big sector of the economy is resilient.” While real estate asset prices have declined, employment remains surprisingly strong, he notes.
Construction and labor costs continue to be stressful for developers in the Southeast. Grubb Properties’ project in downtown Winston-Salem was completed at a cost of $200,000 per unit. Expanding the development now would cost more than $300,000 per apartment, he says.
Developers also are seeing a sharp decline in medical office development because financially pressed hospital systems have slammed the brakes on expansion, he says. “It had been one of the most resilient parts of the office market, but it has now stopped,” he says. “If you are a contractor for medical office, you are having your worst year.”