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Commercial Real Estate Archives ✔️ News For Finance
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Yesterday morning, two major real estate investment trusts – Realty Income

O
and Vereit Inc. – announced that they’ll be merging this year. The deal includes Realty Income acquiring Vereit in an all-stock transaction, with the latter’s shareholders receiving 0.705 shares of the takeover stock for each of their own they currently hold.

When completed, the new and improved company will have an enterprise value of just under $50 billion. $33 billion of that comes from Realty Income. So the remaining $16 billion will significantly extending its scale advantages.

In addition, “the monthly dividend company” will become the sixth-largest U.S. REIT, therefore moving into the RMZ Index. So this is a big deal, to say the least.

Making it even bigger is this: Immediately following the closing, the companies will effectuate a taxable spin-off of their combined office properties into a new, self-managed, publicly traded REIT called SpinCo.

Key point here: The new company will be internally managed and likely led by an experienced management team. This leads me to wonder if W.P. Carey (WPC) might make a run at this portfolio.

The assets would fit its portfolio like a glove, involving around 76% investment-grade properties with annual rents of $183 million. At a 6% cap rate, that would equate to $3 billion.

Synergies = Accretion

The Realty Income/Vereit merger is expected to:

1.     Be over 10% accretive to Realty Income’s adjusted funds from operations (AFFO) per share – in year one

2.     Add meaningful diversification that further enables new growth avenues

3.     Strengthen cash flow durability

4.     Provide significant financial synergies, particularly through accretive debt refinancing opportunities.

Its growth strategy, meanwhile, will remain focused on obtaining high-quality, single-tenant, net-lease retail and industrial properties in the U.S. and U.K. that are leased to leading clients in their respective businesses. Sumit Roy, president and CEO explained:

“We believe the merger with Vereit will generate immediate earnings accretion and value creation for Realty Income’s shareholders while enhancing our ability to execute on our ambitious growth initiatives.

“Together, our company will enjoy increased size, scale, and diversification, continuing to distance Realty Income as the leader in the net-lease industry. Vereit’s real estate portfolio is highly complementary which is expected to further enhance the consistency and durability of our cash flows.”

Certainly, Realty Income’s exposure to movie theaters like AMC Entertainment

AMC
(AMC) and Regal will fall significantly. That will be a big burden off its back.

Admittedly, the monthly dividend company already has a fortress balance sheet. Proof of that is how it’s the only net-lease REIT with an A3 credit rating from Moody’s

MCO
and an A- from S&P. But according to its calculations, this merger should only end up enhancing its credit-positive attributes.

As such, Realty Income should still be able to consistently grow AFFO per share from here. And shareholders should continue to be very happy.

Dividends-A-Plenty

As Realty Income said in its press release, it’s “one of only three REITs in the S&P 500 Dividend Aristocrats Index” known “for having increased its dividend every year for the last 25 consecutive years.” That’s a title it holds dear, and I can’t imagine it would do anything to jeopardize that position.

So it’s no surprise to hear that “Dividend payments for both companies are expected to remain uninterrupted through the close of this transaction.”

Last August, I explained how, “Realty Income is now positioned to execute on” merger and acquisition activity. And clearly, that day has come.

While really big news, this Vereit deal is no surprise to me. If anything, it’s gotten me pondering other possible outcomes, such as…

  1. Will Store Capital pursue Spirit Capital next?
  2. Will Spirit Capital pursue National Retail Properties?
  3. Will W.P. Carey pursue Broadstone Net Lease?
  4. Will Essential Properties Realty Trust pursue National Retail Properties?
  5. Will Four Corners Properties Trust pursue Getty Realty?

Regardless, Realty Income has outperformed benchmark indices by a “country mile” since its 1994 listing on the NYSE. Driving that success is 24 of 25 years of positive earnings growth, with 5.1% median AFFO per-share growth since 1996.

Even in last year’s pandemic-era situation, Realty Income was just one of three net-lease REITs with positive earnings growth.

The only sad part of the news today, as far as I’m concerned, is that I don’t own more shares in it than I do today.

Long O (and STOR, NNN, BNL, EPRT, FCPT, and GTY)

Analytics firm Placer.ai reported that traffic in a 52-mall sample was up 86 percent over March, 2020. And while that still lags March 2019, mall owners believe we are in rebound mode. What is unknown is how long the pent-up demand will last. And as my colleague Pam Danziger recently reported, a survey of 1,000+ consumers by Nielsen noted merely three in ten consumers expect to do more in-store shopping in the months ahead. That said, Placer.ai marketing VP Ethan Chernofsky indicates that preliminary foot traffic for April looks encouraging.

Anchor Alternatives

While the downfall of many malls has been tied to a decade-long department store contraction, developers of leading malls have been hard at work replacing these moribund retailers with new, in-demand specialty players. Besides theatres, fitness retailers, and even grocery stores there are several categories that are in growth mode, among them sporting goods and home furnishings. Ironically, these are both product segments that the traditional department stores used to do well with.

As I’ve reported, RH

RH
(the former Restoration Hardware) is planting some of their gargantuan Design Galleries smack-dab in the parking lots of some high traffic A-malls. Edina Minnesota’s Southdale being a prime example. Many malls no longer require the vast parking lots they were “born with” and the real estate value of those prime malls make’s the development of destination brands appealing.  

Another home goods retailer finding accommodations at the malls is At Home. That 226 store home furnishings player is in a major growth mode, with plans to triple its size to 600-plus stores. Their newest unit, the first in New York City is a 100,000 square foot store in Rego Park, Queens. Another, along with Whole Foods

WFM
, will anchor a renovated center at the Station Twelve redevelopment in Amherst, NY.

Dick’s Lives Where Sears Did

In early April, Dicks Sporting Goods

DKS
took the wrappers of their first Dick’s House of Sport, in Rochester New York’s Eastview Mall. The hybrid store concept is heavy on interactive areas for testing equipment and regular instore fitness activities. Later in May Dick’s will open the second such store in the Knoxville TN West Town Mall. Both stores were previously Sears locations.

In my own neighboring Minnetonka, MN Ridgedale Center, the Sears is undergoing a major gut job, in preparation for a new 105,000 Square foot Dick’s store. Dick’s is expected to vacate the 101,000 square foot former Galyan’s store, less than a mile away. Dick’s acquired Galyan’s 47-store sporting goods chain in a 2004, $362 million buyout.

Not only has Dick’s been raiding empty Sears boxes in search of prime mall real estate, but in Chicago, it is taking over a former 50,000 square foot Carson Store, in Starwood Retail Partners’ Chicago’s Ridge Mall.

Plug and Play

My Forbes.com article of last April, entitled Rethinking the Retail Supply Chain At A Time Of Crisis suggested that many existing Sears Auto Centers were ideally sized and located to morph into hydroponic vertical gardens to supply fresh fruits and vegetables to area grocery stores, mere yards away. Apparently, I was not the only one thinking of repurposing these pad structures; so was Elon Musk. Directly opposite the new Dick’s House of Sports in Simon Properties Knoxville, TN West Town Mall, will be a Tesla Service Center, occupying the vacant Sears Auto Center.

This all speaks to the fact the future of the shopping mall is hardly “one size fits all.” Their survival is directly related to their locations, demographics, and the willingness of owners and developers to invest in their renewal. Their futures no longer revolve around storing and selling goods. Unified commerce reassigns these spaces into places of exploration, brand building, socialization, and community. It requires bringing new meaning and a broader purpose to the malls.

Community Placemaking

For the past two decades I have been writing about the inevitable evolution of many of today’s malls into a new “hybrid community form.” My book references a May, 1999 Metropolis Magazine article entitled “The Mall Doctor” where I along with architect Jon Jerde, whose firm specialized in designing some of the world’s premier malls, commented that the future of many of these mall environments may involve repurposing into “living-working-buying environments.” Jon Jerde referred to them as “gigantic placeholders awaiting their real life.”

Such transformation often involves cooperation between public and private sectors. Such was the case in my own neighboring Brookfield Properties, Ridgedale Center. The City of Minnetonka had been having discussions with both Brookfield and anchors JCPenney

JCP
, about selling off parking area to develop housing. This led to a 55-plus apartment building project and an additional 3-acre site, purchased back from the developer by the city of Minnetonka.

Minneapolis based landscape architectural firm Damon Farber was hired to design a community park, bringing a whole new vitality to what was acres of asphalt. This lovely green space, along with the adjacent housing will begin to turn a sterile parking lot into a walkable, people-place that complements the site’s mixed-use. These kinds of initiatives will reimagine the very best malls and centers, insuring their relevance and long-term survival in the era of “New Retail.” It further addresses our changing community needs and priorities.

When a mortgage borrower stops paying its loan and the lender eventually decides to foreclose, the lender first needs to accelerate the loan. In other words, the lender needs to tell the borrower that the loan is in default and the borrower must repay it all now. If the borrower doesn’t do that, then eventually the lender goes ahead with foreclosure litigation and eventually, if all goes well for the lender, the borrower loses its real property.

In New York that judicial proceeding can take at least one or two years, even if the borrower has no meritorious defenses. During that whole time, the borrower typically makes no loan payments, pays no real estate taxes, and allows the mortgaged property to deteriorate. (New York’s politicians like to blame the lender for that deterioration.)

Sometimes a lender accelerates the loan and then doesn’t pursue foreclosure, instead sitting on its hands and doing nothing. If that continues for six years in New York, or other periods in other states, then the lender loses its right to foreclose. The borrower doesn’t have to repay the loan. Amazingly, this happens with some frequency.

As a result, it can become very important to determine when a lender actually accelerated a loan, and whether the lender ever withdrew and rescinded the acceleration.

New York law allows a lender to accelerate a loan as part of starting a foreclosure litigation. No separate notice of acceleration is required. Starting the foreclosure litigation, with the right language in the complaint, adequately accomplishes the acceleration.

If the lender later withdraws that foreclosure litigation, does that automatically withdraw the acceleration, so the six-year clock stops ticking? The answer is obvious: if commencement of foreclosure litigation accelerated the loan, then voluntary withdrawal of the same litigation obviously decelerated the loan. That voluntary withdrawal implicitly withdrew the original notice of acceleration, which was just an element of the withdrawn foreclosure litigation.

Although that result seems quite obvious, the New York courts didn’t always see it that way. Instead, they sometimes declared that the lender’s withdrawal of its litigation wasn’t enough to decelerate the loan. And then, if the lender did nothing for a few more years, which can and does happen, the courts decided that the six-year statute of limitations had expired because it started when the lender started the foreclosure action, and it never stopped, even though the lender withdrew its foreclosure action.

If a lender claimed it had decelerated the loan by withdrawing the foreclosure action, the courts sometimes demanded more: a formal notice of deceleration or something else to make clear that the lender no longer expected the borrower to immediately repay the loan in full. Sometimes the courts tried to discern the lender’s state of mind, what the lender intended when it withdrew the foreclosure litigation.

This body of law, driven by goal-oriented trial courts bent on protecting borrowers and cheered on by “public interest” lawyers, gave defaulting borrowers a great new line of defense when a lender finally woke up and decided to try again to foreclose. It was a line of defense that could raise complex factual issues. This further delayed foreclosure proceedings while the borrower continued to not pay the loan, not pay real estate taxes, and not maintain the mortgaged property.

The courts’ receptivity to defenses like these helps contribute to the logjam of foreclosure actions in New York courts. It partly explains why these actions take so long.

New York’s highest court, the Court of Appeals, recently cut through this thicket. In a decision friendly to lenders, the court decided that if a lender accelerates a loan by starting a foreclosure action, then a withdrawal of that action automatically decelerates the loan. That proposition may seem obvious. But it wasn’t always obvious to New York’s lower courts. The Court of Appeals has now taken away one tempting technique to derail foreclosures.

The courts will still welcome a wide range of other creative defenses from borrowers who have stopped paying their loans. Therefore, New York foreclosures will probably still take at least one or two years, even if the borrower has no meritorious defenses.

When a commercial real estate or other business transaction leads to a dispute, the parties sometimes prefer to arbitrate rather than litigate. As one of many reasons for that, they like the confidentiality of arbitration. They don’t see any upside for publicity. Fights don’t look good. And no one wants the world to know confidential information about how they do business, much of which may be disclosed in litigation.

A recent federal appellate decision warns that arbitration might not be as confidential as the parties to business disputes probably think it is and want it to be. But the decision leaves available some easy measures to preserve confidentiality.

The story began when two insurance companies had a dispute. They arbitrated. One of the companies won. The arbitrator issued an award in favor of that company.

A winner in arbitration doesn’t automatically have the legal right to enforce an arbitral award against the loser. Instead, the winner needs to go to court, file the award in court, and ask the court to issue a regular court judgment based on the award. That judgment is just like any other judgment issued by a court. The holder of the judgment, the “judgment creditor,” can use it to grab the loser’s bank accounts and other property.

The insurance company that won the arbitration did exactly that. It filed the arbitration award in court and asked the court to issue a judgment. The company asked the court to seal the court papers, to preserve the confidentiality of the arbitration award. Almost immediately, the winner of the arbitration award withdrew its court filing, presumably because the loser paid or agreed to quickly pay the award. But another insurance company, curious about how the arbitration turned out, filed papers asking the court to unseal the arbitration award.

The federal appellate court ruled in favor of the curious third party, declaring that the filing of the arbitration award was a judicial record, and therefore should be open to the public. The court ordered it unsealed and the interloper got to see the award and whatever secret information it disclosed.

On its face, the decision puts the winner of an arbitration in an awkward position: if they want to enforce their award by obtaining an ordinary court judgment, they must run the risk of losing confidentiality. It’s sort of inconsistent with how arbitration is supposed to work.

In the meantime, the parties to an arbitration (or an agreement providing for arbitration) can do something about this problem themselves. They can say that when an arbitrator issues an award, the loser has, say, 10 days in which to pay it, or to agree to pay it within some short time after that. If the loser does that, then there would be no need to file the award with the court and risk a breach of confidentiality. So the parties could agree that the winner will wait a while before filing the award in court. And the winner might simply wait a bit regardless of what the documents say.

As a second protection, the parties might agree that they will direct any arbitrator to issue as short and simple and award as possible – ideally just a dollar amount that the loser must pay. Such an award minimizes any loss of confidentiality, as opposed to a “reasoned” award, in which the arbitrator might explain the basis for the award and, in doing so, go into details that the parties might want to keep private.

The parties might mix and match, directing the arbitrator to issue two awards. One would require payment of a certain number of dollars and could be the basis for a judgment in that amount, although that judgment would inevitably become a public document. The second award could explain the reasoned basis for the award.

In any case, the decision stands as a warning that arbitration awards need to be handled with care if the parties want to preserve confidentiality. And real estate and other contracts calling for arbitration can take heed from that warning.

Zoom, Microsoft Teams, Google Meet, and many other similar services have rapidly become staples of the real estate and larger business worlds. We have all learned to videoconference. But videoconferencing may produce some awkward surprises if we aren’t careful.

Videoconferencing software often allows the conference to be recorded. Once recorded, the resulting data files can live forever, in the servers of the videoconferencing company or in the local hard drives or network servers of meeting participants. Those data files can include records of sidebar chats during the video call, screen shares, facial expressions, positions taken in contract negotiations, and everything else that happened in the video call.

If the subject matter of that videoconference later goes into litigation, all those videoconference recordings can, in the eyes of the law, become “electronically stored information,” commonly abbreviated as ESI. That means a court can require whoever kept the videoconference files to hand them over to the adverse party in the litigation. It’s part of the “discovery” process, in which litigation lawyers have more or less carte blanche authority to collect documents and ESI that might conceivably lead to relevant evidence in the litigation. Notions of confidentiality and privacy are practically irrelevant. Anyone who doesn’t cooperate may face punishment.

Once those videoconference recordings are handed over, whoever combs through them will have a great opportunity to look for comments that sound bad, admissions, and statements that might be used to impute bad motivations.

Before videoconferencing became so prevalent, ordinary business conversations and decisionmaking took place without hard evidence of what happened and who said what when. People could say mean, inconsiderate, or insensitive things without risk that the conversation would be played back for a judge. Now, however, if some offhand and poorly considered statement can be taken out of context or used in an incriminating way, it’s potentially right there on videotape.

Before videoconferencing, if a decisionmaking process meandered and went down some dead end or even stupid roads, there would be no videotaped record of that. In 2021, that’s not necessarily still true.

One should expect that in the coming months videoconference recordings will become the smoking gun in more than one litigation. Previous technological advances have soon found their way into the courtroom. Just think of what has happened with email, text messages, cellphone records, security camera recordings, police body cameras, and social media postings. Videoconference recordings are probably next.

If history serves as a guide, people will learn about the risks of videoconference recordings only slowly. As a hint of embarrassments to come, consider the recent casual conversation on Zoom between two Georgetown law professors who expressed concern that minority students often landed at the bottom of the class. They didn’t realize that Zoom was recording the conversation. Disclosure of the recording resulted in an immediate determination that the two professors were racist, which in turn resulted in their immediate cancellation.

As a simple and cheap form of insurance, anyone who participates in a videoconference and can control the recording feature should simply make sure it is turned off. They should at least think twice or three times before turning it on. In some videoconference services, the host of the meeting can control whether participants can record the proceedings. If the host chooses to prevent all recording, though, any participant could still conceivably record the videoconference using separate screen recording software, such as Camtasia. That creates its own separate rat’s nest of issues beyond this article.

When ordinary videoconferencing software records a meeting, the software may display a red light somewhere on the screen as a warning. Pay attention. Look closely. The recording light isn’t always very prominent or big.

Once an organization has made a practice of recording videoconferences, it should think twice before deleting that collection. The organization should certainly not start deleting when the subject matter of the recordings seems headed toward litigation. Destruction of ESI in the face of litigation can constitute “spoliation” of evidence, which can trigger its own punishments, sometimes draconian.

As the safest course of action, of course, any organization that uses videoconferencing – which is to say, every significant organization in 2021 – should not create videoconference ESI unless there is a very good reason to do it. Embarrassment (or worse) by videoconference recording is an easy problem to prevent.

Hemant Shah has built a three-decade career working exactly two jobs — both in an area called risk management. Shah founded RMS, a catastrophe risk modeling company for the insurance industry in 1989 while in grad school at Stanford University. From RMS, Shah learned that commercial property owners didn’t have much control over their risk insurance, which required an arduous annual process of documentation, taking photos, and sharing records for insurers to verify, despite it being their risk at the end of the day. He thought it was time to improve the system from the otherside. 

“They do this every year like Groundhog Day,” Shah tells Forbes. “It’s a very challenging process, very laborious. Not only is it inefficient, it’s very difficult to integrate these data sets to produce a picture in the way that underwriters can use.” Information that could help commercial real estate owners lower their costs was easily lost amidst the shuffle. His new company, Archipelago, is looking to make the process easier for the property owners using AI. With co-founder Roger Bodamer, Shah spent two years in research and development, emerging from stealth in August with $780 billion in property already on the platform.

San Francisco-based Archipelago announced an oversubscribed $34 million Series B round on Tuesday as originally reported in the Midas Touch newsletter. The round was led by Scale Venture Partners, with participation from Canaan Partners, Ignition Partners, Zigg Capital, Stone Point Capital Partners  and Prologis Ventures, valuing the company at $184 million. The startup plans to use the funding like many do: hire a bunch to keep up with demand and expand its footprint. Less than a year after launch, Archipelago covers more than $2.3 trillion worth of real estate and counts among its clients real estate giants Prologis and JLL. The service is designed for businesses across commercial real estate including data centers, office buildings and hospitals, among others. Shah says the insurers actually like them, too, with more than 1,000 insurance brokers and underwriters on Archipelago already. 

Commercial real estate companies sign up for a subscription and upload any documents they need to apply for risk insurance, like a recent roof inspection certificate or engineering structural drawings, and Archipelago does the rest. “There is a tremendous amount of data that owners need to gather to then share that is locked inside of documents, photographs and semantics,” Shah says. “We make it easy by enabling these owners not to fill out forms but to upload documents into smart folders, where our machine learning can extract all the critical information that is needed to describe the underlying risk.” The service operates similar to Zoom in the sense that the insurers don’t need to use or pay for the software in order to join and process the documents. 

At Prologis, a real estate investment trust, senior vice president Jeff Bray says he was hooked from the moment the Archipelago team reached out to Prologis for feedback during development.  “I was really frustrated with the fact that for the last 14 years this process has not changed much, even as I and others have tried,” Bray says. “The information I have available to make business decisions today is much different from what I had 15 years ago and yet the process is the same.” Bray adds that Shah’s proven track record in the risk management space didn’t hurt either. 

Archipelago is focused on North America, with plans to break into Europe and Asia. The startup is currently testing pilots with sensor and property tech providers with the future goal of  integrating their data on its platform. Bray adds that this service comes at a time when the risk management sector is at an inflection point due to climate change. The variability of the weather — and mega-storms increasingly the norm — is changing the risk profiles of buildings yearly. It’s not the most immediate concern for property managers mindful of Covid-19 protocols; but it could be the next big one.

“The insurance industry is a very large business and it also plays a fundamental role in the economy,” Shah says. “I’m a big believer that a more data-driven transparent insurance market can unlock more abundant coverage at more cost-effective pricing.”

Husband and wife interior design team, Cortney and Robert Novogratz, known best as The Novogratz just opened up their first retail boutique in the trendy Venice neighborhood of Los Angeles. After years in business, April 2021 was the perfect time to expand their high style, yet accessibly priced namesake furniture line. Located at 1629 Abbot Kinney Boulevard, this converted bungalow is fun, whimsical, and provides a unique shopping experience that’s much needed right now.

Who Are The Novogratz?

If the name Novogratz sounds familiar, it’s because not only are Robert and Cortney Novogratz known for designing high-end homes, hotels, and offices everywhere from The Berkshires to Brazil— they’re also reality stars. The couple, who have seven children together have shared their unique talents and opened up their lives as stars of their own HGTV and Bravo shows.

As a brand, The Novogratz has a major web presence and is available on its own website ShopTheNovogratz, as well as Wayfair, Amazon, and CB2 among others. They’re also collaborated with many other brands including Tempaper.

From sofas to beds, decor, lighting, and rugs, there’s a Novogratz piece for every room in the home.

The House Of Novogratz

One surprising fact is that unlike most brands venturing into retail for the first time, this project was just several months in the making. Quite a feat, the store opened in approximately ten days, which is even more of an accomplishment during the chaotic times of the pandemic.

“We are often contrarians, and right now there is a unique opportunity in the commercial retail space that we felt was a wonderful opportunity. We took the space in the midst of a pandemic, knowing we could use it as a creative and content studio if the world was still not open. It was a risk, and we’re willing to take calculated risks. We felt then when the world opens up, we’d be ready and have something we felt strong about sharing. People need to gather and be social and we wanted to have a place to experience that, when the time is right,” Robert Novogratz tells me.

The bungalow-style house, which measures approximately 2000 square feet consists of six different rooms, each with a different purpose and flavor.

Both the pink exterior and multi-colored interior are the complete opposite of the standard “vanilla box” furniture store. It reflects the style of the designers and the brand itself, truly feeling like a home.

There are six rooms total, each of which has a very different setup. The main room, which is the largest space, features several dining and entertaining areas. The second largest room is designed similarly to a studio apartment complete with a bed, home office, and living area.

From top to bottom, not one inch is wasted, yet the store doesn’t feel cramped. Even the floors are decorated with layers of Novogratz rugs while fixtures hang from the ceilings. With chic gallery walls of framed art, neon signs, and various peel and stick wallpapers from the brand’s collaboration with Tempaper, it overflows with design inspiration and has plenty of space for social media photo opportunities. 

Several of the brand’s sofas and chairs are stationed throughout the space, giving customers a way to experience The Novogratz as never before.

When it comes to accessibly priced furniture, even with a well-known name like The Novogratz behind it, it’s entirely different to see and experience something in person versus online. The retail location allows the product to speak for itself.

The Right Time For Outdoor Living

One of the hallmarks of the House Of Novogratz at least during the current season, is that it’s designed to showcase pieces from the outdoor collection.

While outdoor living is so much a part of Southern California culture, particularly in Venice, the pandemic has also increased interest and sales in this category throughout the country. 

Collaboration With Sarah Jessica Parker

As for the future of the store, one of the plans for space is to feature a rotation of brand collaborations— the first one being with actress and designer Sarah Jessica Parker.

This collection includes a variety of vibrant retro-style outdoor pieces ideal for the spring and summer months. From pink and aqua-colored chaise lounges to lawn chairs and an indoor/outdoor bar cart, many of these pieces have already sold out online. The store also sells a line of exclusive merchandise like shoe print water bottles, reusable bags and makeup cases.

Today Kimco Realty

KIM
, one of the largest shopping center REITs in the US, announced it was merging with Weingarten Realty

WRI
for $5.9 billion in a mix of stock (90%) and cash (10%).  Each WRI share will be converted into 1.408 newly issued KIM stock plus $2.89 in cash per share and upon closing the combined entities will have an enterprise value of just under $20 billion.

Kimco and Weingarten are highly complementary as they own high-quality grocery anchored shopping centers, and the combined portfolio will consist of 559 properties in top MSAs.

One obvious benefit for Kimco is the fact that Weingarten’s portfolio is focused on coastal and Sunbelt markets that have performed relatively well during the pandemic. This merger creates significant synergies (around $30 million to $34 million) as the costs can now be spread across a $20 billion portfolio.

In addition Kimco expects to benefit from debt synergies, thanks in large part to the fact that Kimco is using most of its currency (90%) in stock and the balance in stock (10%).

I spoke with Kimco’s CEO, Conor Flynn and he explained that this merger will generate “lower leverage and enhance the long-term NOI profile” for the combined companies.

Kimco is currently rated BBB+ with S&P and Baa2 with Moody’s

MCO
and Flynn told me that the “next leg up is the A-rating” that the CEO is hoping to see in 2022 or 2023.

The cap rate on the Weingarten transaction should be immediately accretive and I view the 5.8%-ish cap rate to be extremely attractive and Flynn told me that “you can’t get that (cap rate) in the private market right now”.

According to Nareit data there are 18 shopping center REITs with a combined market capitalization of $52.5 billion. In 2020 the shopping center sector generated the second worst total return (-27.6%) behind regional malls (that returned -37.2%).

Although shares in shopping center REITs have rallied year-to-date (+26.1%) Kimco opted to purse Weingarten so it could use its cost of capital to transact the deal (purchase price was 90% in stock).

Another catalyst worth noting is Kimco’s  ability to drive NAV (net asset value) through a collection of mixed-use projects and redevelopment. The combined company has a potential of 41 projects that consist of 34 mixed-use and 7 master planned projects that include 1.7 million square feet in retail and 9,000 multi-family units.

Conor Flynn will remain the CEO of the combined company and Milton Cooper will remain as Executive Chairman. Weingarten will have one Kimco board seat. There is a break up fee of around 2.5% but I don’t anticipate another bid given the fact that it will take a large player like Kimco to execute on such a large transaction.

KIM closed up 2.31% and WRI closed +12.5%.

I own shares in KIM.

It was a very common and typical deal provision: the rent under a 99-year ground lease would increase every year based on changes in the consumer price index (CPI) in that particular year, but the increase was always limited to a range of 2% to 5%. Each year the parties would look at how much the CPI had risen in the preceding year. The rent would then go up accordingly, but always by at least 2% and never by more than 5%. This gave the property owner a reasonable hedge against inflation and protected the tenant from runaway rents.

Then the lawyers got involved. When the rent increase formula was translated into ground lease language, it resulted in a single sentence that continued for 16 lines, containing more than 200 words. That one sentence occupied about a third of a page. It had all kinds of clarifying phrases. It made the same points several times. It included seven separately lettered subclauses.

In calculating each year’s consumer price index, the formula in the ground lease said to go look at the “Base Index” every year, and then measure how much the CPI had increased over the “Base Index.” The “Base Index” certainly sounded like an appropriate starting point for the measurement. It was obviously the base from which each annual calculation would be made.

There was just one problem in the 16-line formula: the benign-sounding “Base Index” wasn’t as benign as it sounded. The Base Index didn’t actually mean the previous year’s CPI. Instead, the definition of this benign-sounding term said the “Base Index” was actually the CPI in effect at the Commencement Date of the ground lease. That definition appeared in the ground lease 13 pages before the annual rent adjustment formula.

Because every year’s CPI adjustment referred back to the CPI at the Commencement Date instead of the previous year’s CPI, every year’s CPI increase started out by measuring the entire increase in the CPI since the ground lease was signed. The rent would then go up, each year, by that entire increase, but subject to an annual cap of 5%. Net effect after the first couple of years: instead of rising within a band of 2% to 5% every year depending on each year’s CPI increase, as the business deal contemplated, the rent would rise by 5% every year, pretty much no matter what.

The landlord refused to change the reference to the Base Index and insisted on applying the ground lease in accordance with its terms. So the landlord claimed it was entitled to, in effect, an automatic 5% rent increase every year, even if the CPI didn’t go up at all in the previous year. This would continue for the remaining term of the 99-year ground lease.

The tenant estimated that the use of the commencement date Base Index – rather than a Base Index referring to the previous year’s CPI — destroyed tens of millions of dollars of value in the tenant’s leasehold position.

A problem like this could happen to anyone in any complex legal document. “Base Index” didn’t remind the reader what the phrase actually meant. Any correct-sounding general phrase used in a legal document doesn’t necessarily mean what it sounds like it means. It might well mean something else. A simple concept might be expressed in so many words that it becomes impossible to understand. Readers have to keep so many words in mind that they miss a fundamental error.

In this ground lease, whoever wrote the 16-line rent adjustment paragraph obviously wanted to confirm and clarify many important details about the adjustment formula. But the writer failed to confirm and clarify the one thing that mattered most. And no one reviewing any draft of the document for the tenant ever picked up on the anomaly.

Is “deal or no deal” a popular refrain from a successful game show or is it the voice of real estate investors who are growing concerned about the potential repeal of Section 1031 of the Internal Revenue Code?  

A recent read of the Biden/Harris tax plan reveals a $4 trillion tax hike, and one of the considerations for funding this massive tax increase is a change of 1031 Exchanges

President Biden’s administration has proposed eliminating 1031 “like-kind” exchanges for investors with annual incomes of more than $400,000, as part of a plan to fund future government spending on childcare and elderly healthcare. 

1031 exchanges have been a part of the U.S. Internal Revenue Code since 1921. The law was originally passed by congress to stimulate economic growth. They allow real estate investors to defer capital-gains taxes when they sell properties by directing the proceeds into new investments, usually within a few months after the sale.  As written, the rule allows investors to perpetually roll over capital gains into successive replacement property purchases, effectively eliminating tax liabilities through estate planning. 

Throughout U.S. history, investors have relied on real estate as a means of generating both income and capital appreciation. Low investment returns and stock market volatility have converged to create enormous demand for income-producing real estate that is often used to fund future liabilities. 

Now, more than ever, investors are looking to their real estate holdings to diversify away from market risk and provide a steady stream of income during retirement. For many 1031 exchange investors, their real estate holdings make up the largest portion of their net worth and are a key pillar in retirement planning.     

Today individual investors and limited partnerships control more than $ 7 trillion in residential and commercial rental property. It’s estimated that one in four Baby Boomers own one or more investment property and annual 1031 exchange transaction volume exceeds $100 billion per year.  

Given forecasted economic and demographic trends (primarily driven by the Boomers), the question is not whether or not investors will be buying investment real estate but rather what types of properties will they buy. 

In light of potential policy changes and evolving tax reform, a possibly even bigger question is will commercial real estate investors be able to utilize 1031 tax deferred exchanges as a means of buying and selling properties in the future?  

If Section 1031 of the IRS code is reformed millions of small retail investors may stand to lose billions of dollars in property values. 

This is not the first time that attempts have been made to eliminate 1031 exchanges but so far it continues to survive threats of repeal because lawmakers generally understand its positive impact on the economy. 

As Brad Watt, CEO of Petra Capital told me, “eliminating exchange rules at a time when the economy is suffering from the coronavirus pandemic would deal a ‘one-two punch’ to real estate values. 1031 exchanges benefit the “everyday” man by allowing smaller and less capitalized real estate investors to increase their income and net worth by temporarily deferring tax on reinvested real estate sales proceeds.” 

Eliminating 1031 exchanges from the current tax code could have a profound negative impact on future real estate values and the economic prosperity of the many small investors who own investment property.    

For investors looking to sell their current investment property, there has historically been a long line of willing buyers. Investors have been eager to purchase stabilized income property with the added benefits of tax-sheltered income and the ability to protect future capital gains by utilizing 1031 exchange rules. 

Now with the twin-threat of coronavirus and looming tax reform, sellers and buyers of investment properties are beginning to recalibrate pricing and income expectations. A modification, or outright elimination of IRC section 1031, could potentially create a real estate recession that mirrors the impact of the Tax Reform Act of 1986. 

However, the impact this time around could be much worse as real estate is now considered the fourth asset class behind stocks, bonds and cash. 

Now, more than ever, investors are relying on the stability of their real estate holdings to hedge against an unstable and unpredictable economy. Adverse changes or elimination of 1031 exchanges would send a shockwave through the economy that would have irreversible consequences on existing investors and potentially eliminate trillions of value in future generational wealth transfer.

Meanwhile, perhaps in anticipation of the elimination or modification of 1031s, there has been a mad rush to get deals closed. Paul Getty, CEO of First Guardian Group, told me, “our phone is ringing off the hook.”

Getty’s firm sees more 1031 transactions as anyone; as he put it, “we have a front row seat.” In December 2020 his company saw a significant spike in 1031s. Mountain Dell Consulting, which tracks 1031 transactions, reported a 15% increase from first-quarter 2020 citing, “the market does not have enough supply for current demand.”

The 1031 exchange law is one of the most important tools in the toolkit for real estate investors and odds are good that there could be changes on the horizon.

Kim Lochridge, executive vice president at Engineered Tax Services told me that “the elimination of the 1031 exchange program would be absolutely detrimental to the real estate markets and industries.”

She added, “real estate folks are learning a current work around by selling and in the same year buying another property and using the bonus deprecation (from a cost segregation study) in order to offset the capital gains on the sale.”

That’s an interesting work around, however as she pointed out, “bonus deprecation begins to phase out in 2023 and is totally expired in 2027, so this would only be a short-term alternative solution.”

Decisions, decisions.