🤖 How an AI bubble could impact CRE

👋 Hello, Best Ever Community!

In this week’s newsletter, AI flirts with a bubble, home prices reach record highs, and one investor hits a pandemic home run.

Today’s edition is brought to you by Viking Capital, a multifamily boutique firm with nimble investment sourcing, structuring, execution, and asset management capabilities. Learn more about Viking Capital here.

🎧 ICYMI: Brandon Cobb, CEO of HBG Capital, joined us on the Best Ever Show today to share how he’s turning Tennessee farmland into entry-level housing communities. Listen to the full episode on Apple or Spotify.

Let’s CRE!

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CRE HEADLINES

📈 Multifamily Starts Spike: As of June, 880,000 apartment units were under construction, down 11.4% year-over-year. However, developers completed 656,000 apartments in buildings with five or more units, marking a 40.2% year-over-year increase and a 26.2% rise from May 2024.

😑 Industrial Rents Flatten: Over 100 million square feet of new industrial space was completed in Q2, far outpacing the 30 million square feet of net absorption. This imbalance pushed the U.S. industrial vacancy rate to 6.5%, causing rents to flatten despite a 4% year-over-year increase in asking rent.

💰 CMBS Issuance Up 3x: Domestic private-label CMBS issuance reached $42.29 billion in H1 2024, nearly 3x the $16.47 billion from the same period in 2023, according to Trepp. The number of deals also increased significantly, with 61 in H1 compared to 25 in the same period of 2023.

⚖️ Premiums vs. Values: Rising insurance premiums have put downward pressure on multifamily property values across the U.S., particularly in Sunbelt markets. Nationwide, multifamily values have declined by 3.6% since late 2019.

🏢 Out of Office: Washington D.C.’s office vacancy rate hit a new high of 22.4% in Q2 from less than 14% in Q4 2019, while six government agencies have lease expirations between 2024 and 2027 that could see them give up close to 600,000 square feet of office space.

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HOW AN AI BUBBLE COULD IMPACT CRE

Big Tech's race to dominate generative AI has sparked a trillion-dollar investment in data center infrastructure, making it one of the hottest sectors in commercial real estate. But while giants like Amazon, Microsoft, Google, and Meta bet heavily on AI, critics are beginning to emerge, questioning the potential payoff and waving warning signs of a potential AI bubble.

Big Investment: Since ChatGPT's debut in late 2022, tech giants have poured unprecedented resources into expanding AI computing power. And they’re not slowing down. Blackstone estimates $2 trillion in global AI investments over the next five years while Goldman Sachs forecasts $1 trillion in U.S. AI capex.

• Power Struggle: Many big players believe that computing power is the key to AI dominance. With AI models rapidly becoming outdated, companies are aggressively stockpiling hardware and constructing facilities to house it. Even OpenAI founder Sam Altman is considering self-developing data centers as the firm looks to create its own AI chips.

• Mo Data, Mo Problems: A single query to an AI chatbot can use nearly 10 times as much power as a Google search. Thus, the AI investment boom has accelerated an already rapidly growing data center sector. While data center capacity totaled 19 gigawatts in 2023, it’s been estimated that they’ll require 35 gigawatts by 2030. Globally, data center inventory is expected to triple within six years, with facilities growing increasingly larger.

Bubbling Up: Critics argue that the exorbitant costs of AI infrastructure may not be offset by future revenue. They warn that investor enthusiasm for AI is hype-driven and misplaced, potentially setting the stage for an AI bubble.

• Cause: “Over-building things the world doesn’t have use for, or is not ready for, typically ends badly,” Jim Covello, head of global equity research at Goldman Sachs, said in a recent report. “And my guess is that if important use cases [for AI] don’t start to become more apparent in the next 12-18 months, investor enthusiasm may begin to fade.”

• Effect: “Many dot-com companies that drove the internet change went broke doing it,” Erik Gordon, a professor at the University of Michigan's Ross School of Business, told Business Insider. “Many AI companies driving as big a change will go broke or lose half their value…. The giant AI pioneers won't go broke, but if AI losses drive their stock prices down, lots of investors will suffer.”

The Big Question: AI infrastructure buildout is projected to cost over $1 trillion in the coming years, covering data centers, utilities, and applications. So it stands to reason that AI must solve complex problems beyond its current design capabilities to justify that investment. The crucial question, according to Covello, is: What $1 trillion problem will Al solve? The answer remains to be seen.

WHAT IT ALL MEANS

An AI bubble burst could severely impact CRE’s data center sector, potentially leading to overcapacity, stranded assets, and market consolidation. As the need for larger, more expansive centers has driven development into more remote, non-traditional markets, newly developed locations for AI-focused data centers might face oversupply, and owners could be left with underutilized or obsolete facilities that are costly to maintain and challenging to repurpose.

_{💻 VIKING CAPITAL}
AVONDALE HILLS

Viking Capital presents Avondale Hills, a luxurious 240-unit, Class A asset surrounded by vibrant development and economic growth in the Atlanta, GA, MSA.

Strategically located in a hyper-connected area directly across from the MARTA transit station, Avondale Hills offers a modern living experience with premium amenities, positioning it as a best-in-class property.

Avondale Hills also offers a lower-risk strategy to add value by increasing below-market rents and stabilizing expenses and occupancy. At a 30%+ discount to replacement cost, Viking Capital is buying this property at an extremely competitive basis for a standout investment in one of Atlanta's premier submarkets.

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INTERACTIVE MAP SHOWS RECORD PRICE GROWTH

Home sales are plunging in the U.S. as prices hit record highs. To illustrate these price increases, ResiClub created an interactive county-by-county map that shows where home prices are up the most from March 2020 to June 2024.

Since March 2020, smaller "Zoomtown" markets, beach towns, deep exurbs, and mountain areas have experienced the most significant home price increases, largely fueled by pandemic-era demand.

➡️ To see where your county or your investments fall, view the interactive map here.

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$3.5M VALUE INCREASE IN JUST 3 YEARS

Jade Laye and the team at Laye Capital Investments added $3.5 million in value to this multifamily property in just three years during a pandemic. Here's how they did it 👇

🏢 Property Details: This 120-unit property is located in West Memphis, Arkansas, and was purchased in March of 2019. It’s a Class C property with 99% occupancy at the time of purchase. Although the general area was high crime, the sponsorship team was familiar with the location and knew this property was in a good pocket.

💸 Finances: The property was purchased for $5.5 million. The team secured a 10-year, $4.8 million, 4.58% fixed rate Fannie Mae loan and raised $1.5 million in capital with a TIC (tenancy in common) structure.

💼 Business Plan: The $650,000 CapEx budget ($4,000 per unit) was used to upgrade the appliances, paint, flooring, and backsplashes. The team also raised rents by $50 per unit. It was a LURA deal with capped rents.

🍾 Projected Results: The property sold in July of 2022 for $9 million. Investors realized 9-14% monthly distributions (even through COVID), 42.8% IRR, and 2.8x return.

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