The commercial real estate sector had a jolt when the Federal Reserve increased interest rates by 75 basis points in June and again 75 basis points in July. Fortunately, there are ways around and fixes for these possible obstacles. Investors in the five to 150 unit small balance lending (SBL) segment of the multifamily housing market have a number of choices to accomplish their goals of financing multifamily portfolios. View the timeline above in larger resolution by clicking here.
A recent webinar entitled “Financing Amid Rising Rates: Best Approaches for $1M-$15M Multifamily Loans” featured market professionals from Walker & Dunlop who discussed how to successfully navigate the current financing environment. Tim Cotter, director of capital markets, Allison Herrera, senior director of SBL, and Allison Williams, senior vice president and chief production officer, made up the expert panel.
In a range of finance contexts, these seasoned experts have discovered strategies to close agreements and have shared their insights and advice. The following advice will assist you in navigating the current financial landscape and gaining momentum if you are an owner of five to 150 unit properties in need of loans ranging from $1 million to $15 million.
Step 1: Take into Account All Available Capital Sources
Walker & Dunlop asked viewers about their current sources of capital during the webcast. With 70% of respondents saying they had recently worked with a bank or credit union, bank and credit union funding was the most common.This source of funding is appropriate for a variety of uses, including conventional and construction financing that cannot be covered by interest-bearing debt. However, taking out a loan from one of these highly regulated institutions may have certain drawbacks, including recourse for all or part of the loan, tougher underwriting standards, and possibly limited capital availability in the coming months.
Due to these factors, buyers in the multifamily market’s $1 million–$15 million segment should look outside of banks and credit unions for their financing options. The Department of Housing and Urban Development (HUD), life insurance companies, Freddie Mac and Fannie Mae, as well as commercial mortgage-backed securities, make up the whole spectrum of funding sources (CMBS).
Here is a quick summary:
Agency finance: The US government founded Fannie Mae and Freddie Mac with the goal of financing affordable homes in both good and bad economic times. Their programs are less susceptible to market volatility as a result.
If you are aware with the nuances and requirements of the program, agency financing can be executed more quickly because it is non-recourse, which gives it an advantage over many bank options.
Additional benefits for multifamily SBL borrowers include:
80% maximum loan-to-value (LTV)
a low ratio of debt service to total debt (DSCR)
Early interest rate locks and interest rate holds
a more accommodating pre-payment framework with cash-out options than other government funding packages
HUD financing: This option may be appropriate for SBL borrowers who have the time and resources for a more drawn-out execution procedure as well as for comprehensive reporting and documentation following closure. HUD programs are renowned for offering competitive borrowing rates and leverage that can be greater than that provided by Freddie Mac and Fannie Mae. Longer terms, up to 30 years, complete amortization, and a reduced debt service coverage ratio are all options for borrowers.
HUD offers programs available for development as well as financing market-rate homes as well as affordable and rent-restricted housing.
Don’t let your thoughts be constrained by the idea that life insurance firms only invest in low-leverage, institutional-quality deals involving fully leased properties in significant metropolitan centers. There are options for loans of different sizes, ranging from $1 million to $15 million, and some life companies are willing to finance older assets that require renovations. Additionally, life insurance firms provide many of the benefits of agency financing, including non-recourse terms and relatively quicker and more efficient execution.
CMBS: Despite being frequently seen as “financing of last resort” and with spreads now expanding, CMBS can be an excellent choice for:
Deals that don’t mesh well with agencies or life firms
Sponsor with a negative credit history
A contract having a distinctive quality
The last thing to keep in mind is that not all financing needs to be long-term or permanent. Bridge loans with terms of 2 to 5 years are an excellent choice for:
Objects that need further stabilization
After-purchase property rehabilitation
Purchasing a house that hasn’t been stabilized because of a recent occurrence, such as damage to some of the units
Changing to a permanent loan transaction, a refinance, or a sale
These loans frequently feature fluctuating interest rates, but they may also include a ceiling on those rates for your safety. For additional loan funds for uses like rehab work, such loans might be underwritten to pro forma operating income, which is the predicted cash flow once the property is stabilized and occupied versus where it is now.
Step 2: Control What You Can
There are several factors that an SBL borrower can influence as long as interest rate volatility persists, despite the fact that you cannot control inflation, the Fed, or geopolitical events.
You should start with your current portfolio. Have you got a loan with a pre-payment penalty or one that you weren’t quite ready to restructure a few years ago? It could be wise to go over these scenarios once more and look into refinancing possibilities.
Look at your net operating income to acquire the best leverage and highest LTV:
Are your operating costs as minimal as possible?
Can you cut any fees that aren’t necessary?
Are you performing maintenance in the most efficient manner possible?
Finally, organize your paperwork. Having the required documentation on hand expedites the process because you want to lock in an interest rate as soon as feasible.
Think about cap rates at every stage. These are still still moving independently from the Treasury rate and at historic lows. However, the strong rent growth of today is probably going to change things. Continued rent growth will influence cap rates because it will contribute one of the biggest increases to operational revenue. As a result, you could conclude a loan at a cap rate that is far lower now than it would be at year’s end.
As a result,
Work with an expert on your future steps, whatever they may be. They’ll have an up-to-date understanding of who is financing in the $1 million to $15 million range, how much they are loan, and under what terms and conditions as the market changes. You can download the Walker & Dunlop financing guide to learn more about your possibilities.There is never a bad time to begin. An experienced partner can monitor the market, assess potential lenders, and even assist you in locking in a rate early that is based on your cash flow or anticipated stabilization even if your property is just in the planning stages.
You can be sure that your multifamily ambitions won’t need to be put on hold by having a complete understanding of your funding alternatives, taking preemptive measures, and receiving expert advice. Regardless of what happens with interest rates in the next months, a professional will be able to ensure that 2022 is a year of progress rather than pauses.
We are ready to assist investors with Santa Ana multifamily properties. For questions about Commercial Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.
Markets overreacted optimistically to Chairman Powell’s earlier remarks.
Many people had begun to think that the Federal Reserve might start to scale down the interest rate rises as a result of some easing in the producer price index and inflation. That news would be welcomed by the CRE sector. However, it’s unlikely to arrive. Certainly not this year.
The minutes from the Fed’s July meeting were made public. Although it is a two-week in the past mirror, it is close enough to show how the Central Bank is viewing the economy and its goals. It appears that a small improvement in some areas of the economy is insufficient for a significant shift.
They stated that “recent indicators of spending and production have softened. Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.”
“In assessing the appropriate stance of monetary policy, the [Federal Open Market] Committee will continue to monitor the implications of incoming information for the economic outlook,” they continued. “The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.”
It’s a lengthy way of cautioning markets against getting their hopes up too fast.
Quincy Krosby, chief global strategist for LPL Finance, noted in an email that, “The Fed minutes stressed that the campaign to curtail inflation [will continue] until the Fed believes inflation has fallen enough to reach levels commensurate with price stability, This suggests that the market’s optimistic reaction to Chairman Powell’s July press conference was premature. That a parade of Fed speakers came out with a nearly orchestrated response following the July Fed meeting warning market participants that the Fed is by no means close to easing its campaign was dismissed by the market.”
Bill Adams, chief economist at Comerica Bank, added in a separate note, “It’s a no-brainer to expect rate hikes to continue in the near term. As the Fed’s July monetary policy statement said, the FOMC “anticipates that ongoing increases in the target range will be appropriate,” and that still holds, even with WTI back under $90 a barrel. Comerica forecasts a half percentage point increase in the fed funds rate at the Fed’s next meeting in September, but it’s a close call between that and another hike of three-quarters of a percent.”
We are ready to assist investors with Santa Ana Commercial Real Estate properties. For questions about Commercial Real Estate Investments, contact your Orange County commercial real estate advisors at SVN Vanguard.
As an investor, you don’t want to wish anyone bad luck but it might comfort you to know that you may benefit if the economy declines.
While nobody wants a recession, they are at times a natural result of the business cycle. Although the pandemic recession was an exception in that regard, there is a good probability that the United States could go through another one in the near- to mid-term.
In a recession, the strongest companies will probably profit first, albeit at the expense of weaker ones. According to Jahn Brodwin, co-leader of the real estate solutions business and senior managing director at FTI Consulting, “patience and working capital are typically the two ingredients that insure a successful real estate investment. When an investor lacks one or both of these during a recession, it can lead to forced sales at inopportune times at less-than-optimal prices or worse, lead to foreclosures. The corollary to that, of course, is that those with the funds available today will likely have some excellent buying opportunities.” The CEO of the Klotz Group of Companies, Jeff Klotz, contends that the typical ebb and flow is “healthy.”
According to Klotz, “A recession in today’s economy will slow inflation and generally level out the economy which is good for everyone… It will also ease up on the challenges created from the current ‘boom economy’ and make the availability of reasonably priced goods, materials, and labor much more accessible which is something that is extremely beneficial for commercial real estate.”
While wood prices have decreased and are now at 2018 levels rather than the absurd heights of last summer, there are still significant supply chain issues for many other building products and materials. Eddie Lorin, founder and CEO of Alliant Strategic Development, concurs that removing pricing pressure off materials, combined with greater stabilization of construction labor and increased rents, is “really not that bad for developers of market rate apartments.” A general slowdown could provide some breathing room for the whole supply chain.
Naturally, with all these factors in consideration, it is assumed that a recession is imminent. Not everybody is confident. Palladius Capital Management CEO, Nitin Chexal asks, “What recession?… Unemployment is sitting at 3.5% with several million job openings. We are seeing supply chain issues begin to moderate. Rental demand from multifamily to student housing to industrial remains robust. The overall health of the economy continues to be favorable for commercial real estate.”
Our Orange County commercial real estate brokers will help you every step of the way in finding the right commercial investment property, contact us for details.
The deviation is known as a “great divergence” by analysts.
According to a recent research from Moody’s Analytics, rent growth in the office and multifamily sectors is no longer trending together. This new development shatters a long time trend in which the two sectors frequently followed the same path.
Analysts describe the anomaly as a “great divergence,” noting that last year was the only time that rentals for offices and multifamily buildings really moved in the opposing ways.
“Companies haven’t fully reopened offices, but households come back to cities anyway,” they say. “Further, in a rebuff of the historic link – it wasn’t just suburban apartment markets feeling the positive demand shock, dense urban areas bounced back, with many having apartment rent levels that have now fully rebounded.”
Office market performance also trended below the US average in cities like New York, Tampa, Orange County, Charleston, and Greenville, with asking rents ticking up 0.8% from 2021 to 2022, while multifamily rents in the same markets “skyrocketed.” And in Minneapolis, St. Louis, and Columbus, all of which had office markets that were above average last year, the apartment market is performing far below the national average.
“If people choose where to live based on their office locations, this divergence should not be as evident,” the analysts say. “Lifestyle must play a very critical role in this divergence, though the single-family market, zoning regulation, industry types and other factors affect it as well.”
According to a recent RentCafe poll, San Francisco, Jersey City, Manhattan, Philadelphia, and Boston witnessed the most increases in Gen Z renters’ lease applications over the past year, with rises of up to 101%. Moreover, a quarter of recent renters in San Diego, Los Angeles, Manhattan, and Philadelphia are also Zoomers.
However, Moody’s also noted that asserting that remote labor has no adverse effects on urban apartment markets would be “premature.”
In an era of hybrid and totally remote office employment, they claim, “it is likely that as households age into child rearing, the typical pull of suburban/exurban life could become stronger.” But it’s also true that a particular lifestyle only exists in urban areas.
If households followed work as the dominant pattern in contemporary life, we may now be approaching an era where work follows households, the analysis suggests. Whether this transition is temporary or permanent, however, remains to be seen.
“At a minimum, the link between office and multifamily performance has dramatically weakened over the past year,” they write. “The US economy is based heavily in the production of knowledge, and the main resource in the process is skilled labor. If firms still believe there is value in the office, even in a hybrid capacity, they will look to locate within striking distance of those workers. The link may not be permanently broken after all, but instead, economic strength may be diversifying and shifting towards where people want to be. Time will tell how this dynamic between office and apartment property types plays out.”
We are ready to assist investors with Santa Ana multifamily properties. For questions about Commercial Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.
It remains uncertain whether any extra assistance beyond the monies now available will be provided.
Given the end of widespread financial assistance to people who needed it—and frequently did not receive it—a backlog from the moratorium, the challenge of obtaining court statistics, and other factors, it is difficult to estimate the current eviction rates. The Eviction Lab at Princeton University estimates that landlords file 3.6 million eviction proceedings annually.
A summit on long-lasting eviction prevention reform was held by the White House and the Department of the Treasury. The summit focused on the use of remaining American Rescue Plan (ARP) funds from ERA and State and Local Fiscal Recovery Fund (SLFRF) assistance,” both of which, by definition, won’t last for very long.
According to figures cited by the Biden administration, things appear to be better than usual after the pandemic-induced slump. According to an analysis of data gathered by the Eviction Lab at Princeton University, “despite projections of an eviction “tsunami” following the end of the CDC eviction moratorium in August 2021, eviction filings nationally have remained 26% below historic averages in the 10 months since the end of the moratorium.”
Although the administration credits this to its numerous meetings, the promotion of the use of funds to provide legal assistance, and other recommendations conveyed to state and municipal governments, it is unclear exactly how or why things changed. They claim a major factor was the drive for eviction diversion programs in 180 jurisdictions spread over 36 states. However, the greatest strategy to prevent evictions in a market where rents are rapidly increasing and inflation is depleting consumers’ financial resources, particularly those of lower-income individuals, is likely making sure that people can pay their rent.
According to the National Multifamily Housing Council, the White House’s aim was “to discuss future actions in this space and highlight states and localities that they feel are ‘getting it right.’”
Beyond urging state and local governments to use leftover ERAP monies and State and Local Fiscal Recovery Funds (SLFRF) to help tenants and housing providers who are having difficulty, the organization claimed that it was “unclear what specific efforts the White House will undertake.”
While the Eviction Lab did report that since mid-March 2020, landlords have filed for 1,103,236 evictions in the six states and 31 cities it tracks, it is unknown what proportion of rental homes in the nation that includes. The pandemic eviction moratorium was also in effect during this time; it was only lifted in August after the Supreme Court determined that the CDC lacked the power to continue the activity.
As a result, it’s hard to say where things stand right now, how much difficulties tenants are having due to inflation while also experiencing a robust job market, and whether or not landlords are experiencing exceptionally high levels of difficulty.
We are ready to assist investors with Santa Ana Commercial Real Estate properties. For questions about Commercial Real Estate Investments, contact your Orange County commercial real estate advisors at SVN Vanguard.
“It is the larger sized deals where cap rates are moving.”
Net-leased healthcare assets owners across the US are seeing assets that might have sold for a cap rate in the mid-fives last year now trading with cap rates in the 6 percent range according to the Ben Reinberg of Alliance Consolidated Group of Companies.
Although Reinberg’s isn’t one size fits all in terms of current net lease transaction climate, it does help to show the approach some sellers are taking. Referring to a building he personally sold, “We wanted to sell and we didn’t want it to sit for however long it would take to get back to the mid 5s. Who knows, it could soon be at a 6.5 cap rate,” adds Reinberg. Due to client confidentiality, he refuses to disclose any other information regarding the transaction.
As buyers and sellers gauge rates and prices, analysts point out that deal flow is marginally slowing down. With many sellers clinging to market characteristics from a few months ago, a gap between offer and asking prices is starting to appear.
According to Reinberg, “…A lot of folks are holding onto assets especially if they have a good yield, and buyers have to protect themselves on pricing as the cost of capital rises.”
Inflation, rising interest rates, and fluctuating cap rates are important factors within the asset class, but like everything else with net lease, moderation and stability remain its distinguishing traits.
Although the current state of net lease is a little “off,” its risk-adjusted returns are still quite attractive, according to Will Pike, vice chairman and managing director of CBRE’s Corporate Capital Markets group and the Net Lease Property Group. “It is still active even if pricing is changing.”
Take for example, a property may have traded with a cap rate in the low to mid 3s at the beginning of the year. Now, that same property might sell for a cap rate in the low to mid-4s, especially for larger-sized deals.
Pike stated that there hasn’t been any movement in the $3 million to $8 million price bracket. “The upper 3s are still in force with them. It is the larger sized deals where cap rates are moving.”This is simply a matter of various capital buckets for private deals and institutional ones, he argues, and the larger sized deals are where cap rates are moving. According to Pike, “The higher-yielding deals at smaller price points are seeing less of an impact while higher price point transactions that are lower yielding are more affected.”
He comes to the conclusion that net lease is in a fantastic position overall. “It outperforms the greater CRE market during times of crisis. It had a higher share of the overall CRE market during COVID-19 and the Great Financial Crisis. It does well because of the dependable nature of its cash flow.”
Our Orange County commercial real estate brokers will help you every step of the way in finding the right commercial investment property, contact us for details.
Real estate investors throughout the country can breathe a sigh of relief as the Senate passed its historic $430 billion Inflation Reduction Act of 2022 without including the carried interest tax increase.
On a 51-50 party-line vote, the law was approved, with Vice President Kamala Harris casting the deciding vote.
Positive reactions followed the decision to drop the carried interest tax increase. Many noted that keeping the benefit would have created more barriers to housing development.
According to Jeff DeBoer, CEO of the Real Estate Roundtable, ” The carried interest provision would have been a disincentive to investment in real estate particularly in housing… It would have discouraged capital coming into the industry at a time when lenders and the capital markets are already tightening.”
After Senators Chuck Schumer and Joe Manchin announced that they would eliminate the carried interest clause late on Thursday night, Democratic Senator, Kyrsten Sinema subsequently decided to support the legislation.
Sinema also included a provision for an excise tax of 1%, which is expected to generate around $74 billion. She and three other western colleagues added $4 billion for drought resilience.
While the carried interest loophole is protected, real estate leaders are focusing their attention on other aspects in the bill that might impact the CRE market.
Also included in the bill is an increase to the corporate tax minimum, which is expected to generate 40% of the additional income needed to pay for the package as it moves on to the House. In order to enable property owners to deduct the costs of purchasing and developing rental property from their taxes, Sinema also fought for the addition of a depreciation tax deduction exemption.
Abraham Leitner, a tax attorney with Goulston & Storrs, adds that while the new exemption might be another significant gain for real estate investors, certain real estate entities might not be so fortunate.
“Tax on stock buybacks could potentially affect REITs. I think that some REITs have taken advantage of distributions in excess of basis that are dividends,” Leitner stated. “We have to see what the legislation actually says but many REITs do make distributions that are not dividends and it will be curious to see if the tax is going to hit those.”
Senators also allocated $5 billion to incentivize emission reduction over the following ten years. The clause would provide funds for more environmentally friendly, reasonably priced housing and building projects that would reduce carbon emissions.
According to DeBoer, “Those provisions could be stronger and could be more robust, but they are nonetheless positive incentives to be more energy-efficient in the types of equipment and technologies that people use in buildings.”
The Inflation Reduction Act, which intends to fund organizations working toward the nation’s target of reducing carbon emissions by 40% by 2030, is being hailed as the largest expenditure package yet to address global warming challenges.
Investors won’t be concerned about the carried interest tax increase in the near future, but some experts think the discussion is far from over. Every few years, killing carried interest resurfaces as a contentious issue, most notably when it was proposed in 2017 under the Tax Cuts and Jobs Act.
According to Matthew Berger, vice president of taxes for the National Multi Housing Council, “It’s clearly an issue that’s been discussed for well over a decade at this point… It has its proponents and it’s our job to educate policymakers and the policy world at large about the pernicious impact it would have if it were enacted on our industry’s ability to develop housing that this country so desperately needs.”
We are ready to assist investors with Santa Ana Commercial Real Estate properties. For questions about Commercial Real Estate Investments, contact your Orange County commercial real estate advisors at SVN Vanguard.
As borrowing costs rise, a sale-leaseback can be a more appealing way to raise money.
Money doesn’t have as much value anymore, but it also isn’t getting any cheaper for companies looking to expand. The Federal Reserve has increased interest rates from 25 to 50 to 75 bp in response to inflation that is at a 40-year high. For businesses short on cash, loans might no longer make sense. However, Tyler Swann, managing director at W.P. Carey, believes that if inflation persists, a sale-leaseback could become a compelling alternative.
According to Swann, “A sale-leaseback allows you to lock in your cost of capital for a very long term,If you take the view that interest rates are going to continue to rise, locking in that cost of capital today could be very valuable for you.”
A sale-leaseback occurs when a company sells its real estate for cash and then leases it back from the seller for an extended period of time. A REIT or other institutional investor that is able to get the most out of a real estate asset is frequently the buyer-landlord. The seller-lessee business gains from being able to reinvest the asset’s value into the enterprise.
Swann states the general justification for sale-leasebacks more succinctly: If you’re not in the business of real estate, why be in the business of real estate?
According to Swann, “It is almost always the case that an owner of a business can earn more on reinvesting money in their business than they can on having that money locked up in real estate, It’s more capital-efficient to have that building owned by investors who want to take that risk specifically.”
The fact that a business’ needs differ from an investor’s on this two-way street of capital efficiency in an inflationary environment.
“Because of the Fed’s aggressive stance on raising rates, short-term rates are probably going to rise pretty meaningfully in the next six to 12 months,” says Swann. “But because the investments that we’re making are such long-term investments, we’re locking in our returns and borrowing costs for a very long period of time. So we’re most focused on what long-term interest rates look like.”
Swann advises would-be seller-lessees to weigh the capitalization rate of the property against the projected lease term and timetable of rental increases, as well as against the market as a whole, while thinking about a sale-leaseback. This latter juxtaposition can be startling in an inflationary economy.
“If you look at the broader debt markets, particularly high-yield debt markets, they’re in very bad shape right now. Interest rates for high-yield debt have skyrocketed recently,” according to Swann. “And that has made sale-leaseback financing, [where cap rates have] not risen nearly as much, a much more attractive option on a relative basis.”
Our Orange County commercial real estate brokers will help you every step of the way in finding the right commercial investment property, contact us for details.
1. GDP
- Real GDP declined by an annualized 0.9% in Q2 2022, according to the advanced estimate released by the Bureau of Economic Analysis (BEA). The decline follows a 1.6% annualized contraction in Q1, placing the US economy in a technical recession, though one has not yet been officially declared by the National Bureau of Economic Research (NBER).
- Private inventory investment, residential fixed investment, federal government spending, state and local government spending, and nonresidential fixed investment declined during the quarter, while exports and consumption increased. Imports also increased, contributing negatively to growth.
- Retail trade registered the most significant decrease within private inventory investment, which mainly reflected a contraction among general merchandising stores and vehicle dealerships. A decline in brokers’ commissions led to a reduction in residential fixed investment. Meanwhile, a drop in nondefense spending was partially offset by a rise in defense spending, but not enough to avoid a decline in total federal government expenditures.
- Decreased investment in structures led to declines in both nonresidential fixed investment and state and local government expenditures. A rise in service expenditures led imports. Meanwhile, the increase in exports reflected an increase in industrial supplies, materials, and travel. Consumption was powered by a rise in food services and health care expenditures.
2. INTEREST RATE HIKE
- On July 27th, the FOMC voted to increase the Federal Funds Rate by 75 bps to help tame inflationary pressures. The increase follows initial increases of 25 and 50 bps in March and May, respectively, and another 75 bps hike in June. The current Federal Funds Rate sits at 2.25%-2.5%—its highest level since December 2018.
- Since tightening began in March, the committee has consistently signaled its intent to follow through with rate increases until inflation and inflation expectations were confidently under control. In a statement after their Wednesday meeting, Fed Chair Jerome Powell stated that the committee believes we may need a “period of growth below potential in order to create some slack” and that they may, at some point, slow their pace of rate increases in order to observe the impact of their initial policy moves.
- Stocks initially climbed on the news, as futures markets had already accurately priced in an anticipated 75 bps hike. Following the announcement of the increase, a plurality of traders still forecast another 75 bps increase at the FOMC’s next policy meeting in September.
3. INDEPENDENT LANDLORD RENTAL PERFORMANCE
- The on-time collection rate for independently operated residential properties fell by 114 bps between June and July, landing at 80.1%, according to the latest Independent Landlord Rental Performance
Report by Chandan Economics.
- Gateway markets have maintained higher on-time payment rates than units located elsewhere for seven consecutive months through July 2022; however, they also registered a significant 240 bps decline between June and July. The July on-time rate for Gateway markets stands at 80.4%, while non-gateway markets registered an on-time rate of 80.0%.
- Sun Belt rentals have underperformed the rest of the US for four consecutive months, though the spread has begun to narrow. Between June and July, on-time payments in non-Sun Belt regions fell by 160 bps while the rate inside of the Sun Belt only declined by ten bps, shrinking the gap between the two to just six bps. The Sun Belt’s growing success has seen some affordability issues arise, as markets re-price more quickly than some existing residents can handle.
- 2-4 Family rentals maintained the highest on-time payment rate of all sub-property types in June, though they also saw a slight decline, coming in at 81.3% for the month.
4. RESIDENTIAL MORTGAGE DEMAND
- During the week ending on July 22nd, mortgage demand in the US, including both purchases and refinancing activity, declined to its lowest level since February of 2000, according to the Mortgage
Bankers Association of America.
- Mortgage applications fell by 1.8% week-over-week despite an eight bp decline in the average rate on a 30-year fixed rate mortgage. Economic uncertainty and broad affordability challenges appear to have left some potential buyers on the sideline as purchase activity declines.
- The refinancing rate fell by 3.7% week-over-week while loan purchases fell by 80 bps.
5. MSCI RCA COMMERCIAL PROPERTY PRICE INDEX
- Commercial real estate prices climbed by 18.5% year-over-year through June, according to the latest data from MSCI RCA’s All-Property index. The index rose by 1.3% month-over-month.
- June’s pace is on par with growth rates seen in recent months and is a tad under the record 19.5% growth registered earlier this year.
- Industrial outpaced all other property types in quarterly and annual growth rates, climbing by 4.8% and 26.9%, respectively. June marked the ninth consecutive month of above-20% year-over-year growth for the sector.
- Apartment followed close behind, with a 23.7% year-over-year rise in the index. Prices in the Apartment sector rose 1.6% from May to June—the highest monthly increase among the sub-indices.
- Annual growth in the Retail sector was little changed, with an 18.8% climb— just 110 bps below its record high, which was reached earlier this year.
- Suburban office slowed to 9.7% year-over-year, while CBD office rose by 7.6%.
6. LUMBER PRICES
- A recent analysis by the National Association of Home Builders shows that, on average, lumber price increases during the pandemic added $14,000 to the price of a home and $51 to monthly rents.
- The study looked at the basket of goods that feed into lumber and wood pricing, such as framing lumber, plywood, oriented OSB, particleboard, fiberboard, shakes, and shingles. It is also based on Home Innovation Research Labs’s estimate that new single-family homes use roughly 2,200 square feet of softwood plywood, 6,800 feat of OSB, and 15,000 feet of framing lumber.
- In addition to lumber prices, home price appreciation has climbed due to factors such as interest on construction loans, broker’s feeds, and other margins, plus market demand factors. Rising wages for construction workers have also contributed.
7. PCE INFLATION
- The PCE Price Index increased by 7.1% in Q2 2022. The Q2 increase matches that of Q1, which is the fastest rise since 1981.
- Core PCE prices, which exclude the cost of food and energy and are the Fed’s preferred inflation gauge when considering monetary policy decisions, increased by 4.4% in Q2 compared to 5.2% in Q1.
- The price index has accelerated or remained the same in five of the previous six quarters. On July 27th, The FOMC initiated its second consecutive 75 bps rate hike to tame inflationary pressures.
8. OFFICE DEMAND
- VTS reported a 6% decline in demand for new office space in June as remote work remains a factor in many tracked markets, according to the latest office demand index (VODI).
- Demand on the local level has seen increased volatility, reflecting growing uncertainty among potential tenants as companies consider upcoming recessionary risks. According to the June report, more than half of the markets tracked saw a demand swing greater than 10%. New York City registered a -15% decline month-over-month while San Francisco saw demand climb by 16%.
- In part, the decline in June is in-line with pre-pandemic seasonal norms. For comparison, the VODI fell by 7.1% in June 2019 and 5.9% in June 2018.
- Office demand in tracked markets is a massive 25.9% lower than in June 2021, though this partly reflects base effects from a wave of pent-up demand stemming from last year’s vaccine rollout.
9. REGIONAL DIFFERENCES IN CONSUMER SENTIMENT, RETAIL
SALES
- A new Morning Consult study shows that regional inflation and unemployment variations contribute to significant differences in consumer sentiment and, therefore, spending activity.
- According to the analysis, while inflation remains a nationwide concern, in May, there was a 2.6% gap between price growth in the highest region, the West South-Central US (9.9%), and the lowest, the Middle Atlantic US (7.3%). Their findings suggest that if the regional inflation gap persists for the remainder of 2022, it will amount to a more considerable drag on consumer sentiment in the Mountain region of the US than in the Middle Atlantic.
- Employment outcomes exhibit a similar gap looking between different regions. The study’s findings suggest that continued variation in the labor market recovery would continue to drive differences observed in consumer sentiment and likely spending.
- On a state-by-state level, sizable differences in consumer sentiment and retail sales persist. According to US Census Data for March (the latest available data at the time this study was conducted), Vermont led year-over-year changes in retail sales with a 12.5% increase, while Pennsylvania registered a modest 1.7% increase. Hawaii led changes in consumer sentiment, with a 1.4% year-over-year increase through March, while South Dakota led all declines with a decrease of -25.0% year-over-year.
10. TREASURY DEPARTMENT AFFORDABLE HOUSING GUIDELINES
- On July 27th, the Treasury Department released new guidelines meant to increase access of American Rescue Plan disbursed funds by state and local governments. The updated guidance is designed to
boost the supply of affordable housing.
- The update guidance widens the use of State and Local Fiscal Recovery Funds (SLFRF). Most notably, they are now permitted to be used to finance long-term affordable housing loans.
- The Treasury’s updated guidance also allows SLFRF funds to be used for the development, repair, or operation of affordable housing units, so long as it helps to maintain long-term affordability of the housing units.
SUMMARY OF SOURCES
- (1) https://www.bea.gov/news/2022/gross-domestic-product-second-quarter-2022-advanceestimate
- (2) https://www.federalreserve.gov/newsevents/pressreleases/monetary20220727a.htm
- (3) https://www.chandan.com/_files/ugd/df56fe_8cccce5ce9ac4b67851830309d9d1838.pdf
- (4) https://www.mba.org/news-and-research/newsroom/news/2022/07/27/mortgageapplications-decrease-in-latest-mba-weekly-survey
- (5) https://www5.rcanalytics.com/webmail/71612/1320089930/d196fa9edcdbcd28870f742246c5dcb4284d1bc9d62a4b45c2f8d05f65f5dc44
- (6) https://eyeonhousing.org/2022/07/since-pandemic-onset-lumber-products-have-added-14kto-house-price-51-to-rent/?_ga=2.244320773.1488509329.1658951870-1774177786.1658951870
- (7) https://www.bea.gov/data/personal-consumption-expenditures-price-index#:~:text=A%20measure%20of%20the%20prices,reflecting%20changes%20in%20consumer%20behavior
- (8) https://stagingwww.vts.com/vts-office-demand-index-july-2022
- (9) https://morningconsult.com/2022/07/13/weak-consumer-sentiment-impacting-regional-retailsales/
- (10) https://home.treasury.gov/news/press-releases/jy0889
Pulling The Punch Bowl
As the US began to recover from the depths of the COVID-19 recession in 2020, a debate took place over whether the nation would experience a sustained period of high inflation. Many predicted a transitory price spike as fiscal stimulus made its way through the economy, boosting demand while global supply chains were still thawing. However, two years later, severe supply chain imbalances persist, worsened partly by geopolitical tensions, and transitory has become just another internet meme.
In response, the FOMC—the Federal Reserve’s rate-setting body— has voted to increase the Federal Funds rate at its last three meetings and has amplified the increases by 25 bps each time. After a new generational-high inflation reading in June, some Federal Reserve officials are even mulling a full-percentage point increase at their next meeting. Policymakers now face the task of trying to tackle high inflation without sacking economic growth in the process.
Historically, Commercial Real Estate (CRE) has been uniquely positioned to absorb both inflation and monetary tightening effects. In this piece, the SVN® Research team explores the latest forecasts for inflation and interest-rate policy in 2022 while detailing how CRE investments are better suited against high-risk environments than most.
Watching With Interest
The persistence of above-target inflation over the past several quarters forced the Fed’s once reluctant hand into action as it attempts to keep a handle on price stability. Through June 15th, the FOMC has conducted three consecutive rate increases. First, a widely anticipated quarterpercent hike in March, followed by a half-percent increase in May, and a three-quarter-percent rise in June.
The most recent increase is the committee’s most aggressive action to tighten credit conditions since the early 1990s.
A key question moving forward is how long and aggressive Fed tightening will go? Of course, this squarely depends on the path of inflation, and so far, price pressures have shrugged off the Fed’s actions. In June, the Consumer Price Index (CPI) registered an 9.1% year-over-year increase, the fastest increase since 1981. Prices of food and gas, while typically removed from monetary policy considerations, continue to exert immense pressure on American wallets. Both have been exacerbated by Russia’s invasion of Ukraine and the ensuing Western economic sanctions.
Future markets have been swift to price in these developments, predicting a steep path for interest rates. According to the Chicago Mercantile Exchange’s Fed Watch Tool—which tracks the market’s anticipated path of the Fed Funds— the consensus expects several more rate hikes this year, with the year-end Federal Funds rate landing at 350-375 bps.
In the weeks since the FOMC’s initial hike, future market sentiment has grown even more hawkish, primarily in response to incoming economic data that they believe will force the Fed’s hand into an increasingly aggressive stance. The US economy continues to exhibit strong job growth, adding 372,000 payrolls in June, while consumer spending is up 9.2% from one year ago despite a decade-low in consumer confidence.
Markets are betting that this mix of economic conditions will likely keep policymakers’ foot on the pedal in the near term barring a directional shift in inflation-related indicators—and so far, they’ve been correct. In his recent Senate testimony following the FOMC’s three-quarter-percent point hike in June, Fed Chair Jerome Powell reaffirmed the Fed’s commitment to price stability, staying that they “can’t fail,” and his confidence that “ongoing rate increases will be appropriate.”
Steady Landing
A separate but growing concern facing the US economy is that increases in borrowing costs may dampen demand to the point where it tips the US economy into a recession. In an ideal world, the Fed is eyeing a “soft-landing” as they look to raise interest rates fast enough to defend the dollar against an extended period of above-target inflation while leaving room for growth. Soft landings aren’t easy, though, and the Fed’s urgency increases the risk of a policy-triggered recession.
Markets are increasingly pricing-in higher probabilities of a recession over the next year. According to the latest Bloomberg monthly survey of economists, experts now see a 30% probability of a recession in the US within the next 12 months. Other warning signals are beginning to flash as well. In June, S&P Global’s flash US Composite PMI Output Index, a measure of current manufacturing and service sector conditions, fell to its slowest pace in five months. Similarly, June data revealed that consumer confidence collapsed to its lowest level in more than a year.
Treasury markets have ebbed on the question— in April, the measure inverted for the first time since 2019, an often-reliable signal of an upcoming US recession. A second inversion occurred on July 8th.
The fallout of the Russia-Ukraine War introduces an additional, double-edged risk into the picture. Elevated energy prices don’t only contribute to inflation but can be a significant barrier to growth, as credit conditions elsewhere tighten simultaneously.
According to the BLS, energy prices are up 41.6% over the last 12 months through June. Much distress followed a ratcheting-up of Western sanctions on Russian oil exports, making predicting our inflation peak even more complicated. However, in recent weeks, prices at the pump have fallen, elevating hopes of a peak in price movements.
Our Future Hangs in the Balance Sheet
Despite the gloomy introduction to this analysis, real estate property has long served as a hedge against dollar inflation. In contrast, Commercial Real Estate has outperformed equity markets since the tightening cycle began. Comparing year-over-year CPI inflation against MSCI RCA’s Commercial Property Price Index (CPPI) dating back to December 2001—the earliest date of comparable data— real estate values have not only consistently outpaced inflation but did so twice as fast when CPI was above 2% annually compared to when CPI was at or below 2% annually. In the 116 months where inflation was at or below the Fed’s 2% annual inflation target during the observed period, commercial real estate prices grew by an average of 3.04% year-over-year. In the 128 months where inflation was above 2% annually, commercial real estate prices rose by 6.24% year-over-year.
Through our latest battle with inflation, both CRE and broader equity markets initially performed strongly, but when tested by COVID uncertainty and then the Fed’s tightening cycle, CRE has proven to be the more stable asset. When consumer prices began to climb to overheated levels in early 2021, the economy saw a strong performance, and annualized monthly returns for the S&P 500 outpaced commercial real estate price growth. However, as the Omicron wave roiled stock markets in the fall of 2021, CRE’s stability held strong.
Further, while the S&P 500 has collapsed under the uncertainties of 2022, CRE as a whole— driven by longer-term supply and demand fundamentals— continues to experience similar growth levels to early 2021. According to MSCI Real Capital Analytics National All-Property Index, through May 2022, CRE prices are up 4.4% from where they finished in 2021 and 18.6% year-over-year. Comparatively, through May 2022, the S&P 500 had fallen by 13.3% from the start of the year and 1.7% year-over-year.
Across CRE and at the sub-sector level, there are signs that pricing momentum has slowed— at least compared to the lofty highs of the past year. If prices grew as quickly as they did between April and May for an entire year, annual CRE price growth would total 14.3%. Industrial and Apartment continue to lead the way for the CRE sub-sectors, with annualized monthly growth rates currently sitting at 24.4% and 19.2% through May, respectively. Retail and Office follow next, with growth rates at 13.3% and 9.6%, respectively. Notably, while these growth rate totals are below their recent peaks, the compass continues to point north— an accolade that is increasingly rare in most financial sectors thus far in 2022.
Forward Guidance
While we expect growth to fall from the highs observed in the market over the previous two years, few predict a significant breakdown. During a recent forum with members, National Association of Realtors (NAR) director Lawrence Yun pointed to land development as a growing opportunity in the coming years as the nation continues to try and address a significant housing shortage.
Further, Yun pointed out that Industrial and Retail assets continue to see high demand from inventory buildup and post-pandemic food traffic. On Office, while admitting that the sector faces unique challenges from the structural shift in remote work, NAR points out that they’ve seen “improvement in some midsize markets as companies seek more affordable office locations away from major US cities.”
During most periods of economic uncertainty, good opportunities will present themselves, but a diligent understanding of today’s challenges is critical in enabling the best strategies. The Commercial Real Estate industry is uniquely prepared for our current environment due to excess demand causing much of our economic headaches rather than sluggish growth. While The Federal Reserve’s policy actions seek to calm some of this demand deliberately, its intent to stop at some level that is consistent with inflation-stable economic growth implies that there is some room for the most prudent investments.
