Q&A: ‘Reckoning is coming’ for commercial real estate

Q&A: ‘Reckoning is coming’ for commercial real estate

Commercial real estate veteran Bill Katter recently began writing a new chapter in his career after 18 years with United Properties, a gig that found him working on the $450 million RBC Gateway development in downtown Minneapolis and other notable projects.

In December, Katter became a partner with Interstate Development, an Eden Prairie-based commercial real estate and investment company. Katter, a Finance & Commerce Power 30 honoree, leads the company’s institutional investment activities.

Katter has been in the real estate business since the early 1990s. During that time, he has seen a lot of ups and downs in the commercial real estate economy and has worked on a wide range of investments and developments.

In the following interview, Katter talks about his new duties with Interstate, his experience working on the massive RBC Gateway project, how he got started in commercial real estate and more.

He also shares his real estate market outlook for the coming months. Not especially bullish about the next 18 months, Katter quips that the theme in the business is to “stay alive until ’25.”

The interview has been edited for length and clarity.

Q: Tell us about your transition from United Properties to Interstate Development.

A: I would say it was an appropriate time for me to transition. I’m 56. I had run a very large development company for a very long time, and it was an appropriate time for me to transition into, I would say, becoming an owner of the real estate and not necessarily just an employee.

So it was an exciting opportunity for me also knowing that the work I was doing as a developer, running a really big development company, was probably not going to be the same. The outlook was just not going to be the same in the business for development.

And so my work at Interstate, we have nine buildings under contract here right now. We’re busy buying real estate. And the reason we’re doing that is because prices are down.

Interstate is a pretty large company, actually, and I’m not an investor in every single building of theirs by any stretch. But they have over 50 buildings and growing. And we’re all about buying buildings below replacement value — good buildings.

We’re good at finding tenants. Sometimes the buildings we buy have tenants and, of course, we like the fact that existing buildings have immediate cash flow, and there’s some tax benefits in terms of depreciation for buying existing buildings.

Q: Talk about some specific investments you’re pursuing.

A: Of the nine buildings we have under contract, seven of them are a collection. It’s a one-seller portfolio of some very high-end retail properties in Edina. I’ll just say they are in Edina in that 50th and France district. And some industrial buildings are part of that package in Minnetonka and Plymouth.

And then we also have a building under contract up in Roseville that we’re trying to convert to life sciences. We have another building we just put under contract where it will be industrial outdoor storage.

That is a big staple of what Interstate does. There’s a big demand for industrial buildings that have outdoor storage. The cities increasingly don’t like that, the tier one cities. They’re trying to up-zone their land, and it’s made those opportunities more scarce and drives up the rent. So we like that product type because of the rent growth and long-term stability of it in a more-scarce market.

We’re also working on some ground-up development. We broke ground right about the time I joined the firm on 109 rental homes, a build-for-rent community in Woodbury. We are just opening that community up now in June. We have our first homes delivered and being rented as we speak.

And I am working with a large industrial client to get them a new headquarters in the metro area here. We’re pursuing a couple of large properties. They’re a minimum 50-acre user. I’m working to secure a site and get their entitlements done. And as part of that, we may buy some extra land and do another housing rental community and some spec industrial.

A: What was it like working with United Properties on RBC Gateway?

Q: That was the largest individual project accomplishment of my career. There was no question, it was very complicated, very fun. I consider Jim Pohlad a personal friend. Jim was, of course, my boss at the United Properties and he helped me get that project done.

Jim and the Pohlad family enabled that project to get built and I obviously was a key part of that as well. But it was just a significant accomplishment for the city, for the family, and for me and United Properties.

I don’t think there’s likely going to be another project quite like that built anytime soon. I think the outlook for that kind of development is not strong in the next few years. Unfortunately, that’s just the market reality right now. It’s tougher.

Q: I wanted to ask you about that. In December, you accurately said the market would be soft. What are your thoughts now as we head into the second half of 2023?

A: It’s really tough sledding. Interest rates are still rising. My general sense is banks are starting to see more issues in their existing commercial lending portfolios, and so that will make them less inclined to make new loans. It’s just a chain of events.

I think our real estate industry, particularly development pipelines, is going to have a reckoning here over the next year, year and a half, where maybe they’re not worth what they thought they were going to be worth when people started them. And so if the values are coming down, that means loans need to be resized and it can be a painful period of time in the business.

And so, I think there will be some stress in the developer world and in the lending world, and I think companies that are not too deep into the development game are poised to probably take advantage and do things if they’ve got cash set aside and/or existing buildings. So that’s the focus here, to do some very targeted development where we have customers behind us and also to buy existing buildings where we can get that cash flow going day one.

Q: We’re living in interesting economic times. We just had another strong jobs report, people are hiring. On the other hand, there are fears of a recession and the lending situation, as you said, is challenging.

A: It feels very much like a reckoning is coming. I don’t want to make predictions about that, but we can’t continue to have rising interest rates forever without consequences. And inflation has not shown, probably, enough signs of abating. That’s got everyone a little bit nervous. There’s just no question, it’s a time of greater uncertainty.

The only thing I would say is when will it turn, right? And that’s anyone’s guess, but the theme in our business now is, “Stay alive until ’25.” And so I think it could be kind of a bumpy 18 months here. But the message from me would be, this is also a great opportunity to come in as a value-add investor in the new platform.

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