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Inflation Pumps the Case for Sale-Leasebacks

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

2. INTEREST RATE HIKE

3. INDEPENDENT LANDLORD RENTAL PERFORMANCE

4. RESIDENTIAL MORTGAGE DEMAND

5. MSCI RCA COMMERCIAL PROPERTY PRICE INDEX

6. LUMBER PRICES

7. PCE INFLATION

8. OFFICE DEMAND

9. REGIONAL DIFFERENCES IN CONSUMER SENTIMENT, RETAIL
SALES

10. TREASURY DEPARTMENT AFFORDABLE HOUSING GUIDELINES

 

SUMMARY OF SOURCES

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.

First Citizens Bank subsidiary CIT’s managing director and group head of real estate finance, Chris Niederpruem, discusses how the situation of the economy is impacting bank lending.

Over the past two and a half years, the bank lending environment, like the rest of the commercial real estate industry, has dealt with a number of factors that have turned it on its head, including the pandemic, global inflation, and various sectors’ performance relative to that of their pre-pandemic numbers. To find out more about the situation of bank lending today, Partner Insights met with Chris Niederpruem, managing director and group head of real estate finance at CIT, a division of First Citizens Bank.
Commercial Observer: Last October, we discussed the situation of bank lending for commercial real estate. What have some of the largest changes been since then in this environment?
Chris Niederpruem: The interest rate environment has altered how commercial real estate investors and lenders see their underwriting, which is the most noticeable change from last fall. Debt plays a significant role in how investors decide on deals. It’s a very different scenario than it was six to twelve months ago because of increased interest rates, the prospect of further rate hikes, and the looming threat of a potential recession. Due to the higher cost of debt, commercial real estate acquisitions frequently have less leverage. How that will affect valuations is the unfinished puzzle piece. We haven’t experienced a rate environment like this in a very long time.
How has this affected the level of competition in this sector of the market?
The environment for competition has undoubtedly altered. There was a lot of unmet demand for commercial real estate lending and investing last year as we were coming out of the worst of the pandemic, and a lot of money had been generated. Therefore, the industry experienced a record year for deal volume last year, and it was very competitive. There has been a decrease in deal volume as a result of the changing interest rate environment and some other changes in the capital markets. Both buyers and sellers are transacting considerably more slowly now. Other lenders and investors now have chance as some lenders have backed off or reduced their enthusiasm for lending. Although it remains a competitive market, it is somewhat more measured than in 2021.
How has the landscape of commercial real estate finance been impacted by the rise in inflation?
The cost of materials and labor has gone up, which has affected construction. Additionally, while estimating a property’s future cash flow, you must take increasing expenses into account and then attempt to balance them with growth in the income or rental side. How much of the markets where rents have historically increased still have growth? For instance, during the past year, rents for multifamily units have increased by double digits in some southeast cities. How much growth is still possible given the impact of inflation on the expense side? Many lenders and investors have been obliged to think more carefully about those issues.

Are there any current national or international developments that, in addition to inflation, have an impact on the financing landscape?

The capital markets have been unstable due to a variety of factors, such as global political unpredictability, rising interest rates, and potential future recessions. These factors have disrupted the capital markets, posing difficulties for lenders who self-finance. Due to this, they are no longer as willing or able to lend as they were in 2019 and 2021. That presents a barrier for certain lenders and an opportunity for others (I’ll skip 2020 for obvious reasons).

Has the demand for specific lending products changed at all during this?

Yes. The most obvious is that investors are increasingly looking for financing options with longer terms and more fixed rates than in the past. In a situation when interest rates are rising so quickly, this shift is common. That’s what we’ve observed, and most lenders, I believe, have noticed an increase in requests for that kind of product.
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.

You’ve probably heard of the three-card monte, a confidence game where participants are duped into placing a wager on the premise that they can pick out the “money card” from a group of three face-down playing cards.

Now comes the “three-round burst,” a tactic described in a recent Federal Trade Commission case in which a purported credit repair business disputes all negative items in a person’s credit records not once, not twice, but three times until it all but bullies the credit agency into finally caving in to the request to delete the in question items.

According to Point Perspective, a risk management business, this “credit washing” scam is common in the auto financing industry. It is currently permeating the mortgage industry, and if it hasn’t already, it will probably move into the multifamily market.

In order to put an end to what it claimed was a dishonest credit repair scheme that claimed it could repair consumers’ credit, the FTC won an injunction against Turbo Solutions, which also goes by the name Alex Miller Credit Repair, and Miller himself in April. Of course, it frequently fell short.

The company stated that “advanced disputing” could eliminate negative information from people’s credit records, but the FTC accuses Turbo and Miller of engaging in credit washing, which is a methodical approach to disputing unfavorable tradelines on false pretenses. Filing an affidavit claiming you are a victim of identity theft is one way to make a false claim.

According to the FTC, the business would dispute tradelines by filing identity theft allegations on IdentityTheft.gov, often with the consent of the customer.

A credit reporting agency has the right to refuse to delete negative information from its files if it believes that an identity theft report was made inadvertently. But Miller and his businesses persisted despite this.

Multifamily Risk

Landlords and property management companies should be aware of additional scams kinds.Point Perspective, a company that uses artificial intelligence to detect fraud, claims to have found more than 6,700 fictitious employers that are connected to more than $1.7 billion in financing requests in the car industry alone. The risk management firm also claims that each week it uncovers “up to 100 new bogus employers.”

These problems are related to phony websites and forged pay stubs, and they are frequently used to persuade lenders to call phony phone lines in order to confirm a candidate’s fictitious employer.

The risk management firm further notes that some of the applicants who used fictitious employers also utilized fictitious credit reports, sometimes known as synthetic identities.

As one might anticipate, businesses are at risk when applicants present fraudulent credentials. They have a default rate of 40% to 100% in the auto industry. This can prevent landlords in the apartment industry from receiving rent payments and might encourage crime in certain neighborhoods.

In a statement announcing the Turbo/Miller order, Samuel Levine, the director of the FTC’s Bureau of Consumer Protection, stated that “IdentifyTheft.gov is a resource for consumers, not scammers.” “Those who abuse this resource by filing fake reports can expect to hear from us.”

The Justice Department also committed to stopping credit repair companies from participating in this sort of illegal behavior by using “all tools” at their disposal.

However, it would be prudent for multifamily interests to pay attention. Property managers should take whatever measures they think necessary to protect themselves against these kinds of challenges, rather than waiting for an attack. It could be expensive to ignore something.
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. 

The approach, according to First American Financial Corporation, would be to slow asset development.

 

First American Financial Corporation research suggests that cap rates may finally begin to regain some of their worth.

With regard to the first quarter of 2022, the company’s potential capitalization rate (PCR) model “estimates capitalization rates based on the historical relationship between interest rates, rental income, current occupancy rates, the amount of commercial mortgage debt in the economy, and recent property price trends.”

As the corporation pointed out, supply chain problems brought on by the epidemic have prevented inflation from being the “transient” phenomenon that the Federal Reserve had projected it would be. The Federal Reserve eventually began tightening monetary policy, most recently increasing its benchmark interest rates by 75 basis points, the biggest one-time increase since 1994.

The 10-year Treasury note saw a spike as a result, rising from around 1.7 percent in early January 2022 to a high of 3.48 percent at the time of the rate hike. Yesterday’s 10-year closing rate was 2.97 percent. First American predicts that the 10-year yield would likely increase due to further anticipated quantitative tightening—the Fed lets bonds it owns mature and then removes them from its balance sheet, eliminating the extra money it had injected into the economy.

Investors utilize the 10-year as a relatively risk-free method of investing and to assess the worth of riskier investments, such as commercial real estate. For an investment to be considered worthwhile of the risk, it must now yield higher returns.

According to Xander Snyder, senior commercial real estate economist at First American, “since capitalization (cap) rates are a measure of return on an asset, higher “risk-free” rates mean sellers will need to lower their price expectations or increase cash flow, if that’s an option, to entice buyers seeking competitive yields, which should also push up cap rates.
Although cap rates are currently close to record lows, the PCR model predicts that cap rates will eventually rise due to slower price increases. However, not every form of CRE property is in the same situation. Snyder noted,” “Multifamily and industrial assets set first-quarter price growth records, increasing at a faster rate than any other first quarter in the past 20 years, while office and retail assets were a drag on overall CRE price growth in the first quarter. However, a record amount of industrial square footage is currently under construction and expected to come to market later this year, which may slow price growth for industrial assets and put further upward pressure on the potential cap rate as the year progresses. ”
First American stated in April that cap rates were set to decline further at the time, but circumstances have since changed.
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 movement for multifamily rent regulation has gained momentum nationwide over the past few years, and the pandemic has increased political and popular support for tenant safety. The effects that these policies will have on their business and their capacity to create housing have been vocally expressed by multifamily owners as a source of concern.

Owners are actively avoiding markets with rent limits or seriously considering leaving markets that enact these rules, according to a report by the National Multifamily Housing Council from earlier this year.

However, according to industry experts who spoke with Bisnow, California’s state and local rent control and limit regulations haven’t had a significant influence on multifamily financing. However, some projects, like value-add deals, have become more challenging to complete as a result of these and other laws affecting multifamily developments, particularly the still-in-effect eviction ban in Los Angeles.

Across the country, rent control is becoming more prevalent. In 2021, St. Paul, Minnesota, approved a 3 percent rent cap. According to a recent article in The Wall Street Journal, legislation that might establish rent restrictions has been proposed in at least a dozen states. The legislation would forbid landlords from raising rents by a percentage more than 2% to 10%. According to the WSJ, nationwide rent increases since the start of the pandemic have averaged 18%. According to Insider, the states with cities that are considering similar restrictions are diverse in terms of geography, demographics, and ideologies. They include Arizona, Florida, Illinois, Kentucky, New Jersey, New York, Washington, and Massachusetts.

In 2019, Gov. Gavin Newsom signed AB 1482, which places a 10-year cap on how much landlords can raise rent in a sizable number of buildings throughout the state. California has had rent regulations in various forms for decades. Rent increases of more than 5% plus inflation per year are prohibited for multifamily landlords, as well as for owners of condominiums and single-family houses who are 16 years of age or older. According to the statute, landlords are also required to give “just cause” for evictions.

According to Doug Perry, senior vice president of sales at Archwest Capital, the law didn’t have the significant effect that many in the CRE industry had hoped.

The landscape didn’t shift overnight, according to Perry, whose company is a direct commercial lender with a nationwide concentration on multifamily and mixed-use properties. Rent control rules haven’t affected the way we underwrite loans, but they have made some situations a little more difficult.

For instance, it could be more challenging to complete a value-add project that entails purchasing a property with a lot of unfinished maintenance, upgrading it, and then boosting the rent.

According to Perry, “Those projects don’t get done as much because they can’t be done from a compliance standpoint with the rent control laws.”

There are workarounds that can be useful, such as “cash for keys,” in which a renter is given a lump sum in exchange for leaving a rental property. Most of the time, the rent for the apartment can be changed to reflect market rates. However, it can cost a lot of money to evict residents, and that money isn’t going toward the main goal of these projects, which is to improve the building so that the apartments can draw higher-paying renters.

According to Perry, “Sometimes the cost of doing that drives the cost of the whole project to the point that it’s just not a profitable project, and it doesn’t make sense.”

The impact of municipal rent control laws, as opposed to state-level ones, may be greater for smaller investors and individual owners who have investments in areas with such laws, according to Perry, but this is only a problem for specific projects and not a general problem.

Value-add deals may take longer to complete if there are eviction moratoria, like the one that is still in place in Los Angeles.

Shahin Yazdi, partner and managing director of George Smith Partners, which arranges loans for CRE borrowers nationwide, said that it is “simply not as realistic” for the borrower to expect to be able to turn an entire building when there is an eviction moratorium and you can’t perform no-cause evictions.

Instead, it is necessary to diminish expectations, either that it will take longer to empty the building or that it won’t be empty enough. This means that the transactions must make financial sense even if only a portion of the building—say, half or a third—is made accessible to new, wealthier tenants. But in other situations, the resilience of multifamily during the epidemic has made this conceivable.

Regarding Los Angeles and its current eviction moratorium, Yazdi noted, “Multifamily continues to be a strong performing asset, even with people not paying. The foreclosure rates didn’t skyrocket. Landlords, maybe they did some deferred payments, but they continue to make their mortgage payments, so it’s a great asset class for lenders.”

Despite the optimistic response from the lender side, a study released in January 2022 by the National Multifamily Housing Council revealed that efforts to enact rent control are having an impact across the country, not just in California.

The study asked 78 CEOs and senior executives at national “apartment-related firms” if the growing number of areas that had implemented, strengthened, or were considering rent control or rent ceilings had an impact on development and investment decisions. According to 32% of respondents, people who practice rent control already shun those markets, and 26% indicated they had reduced their investment in those markets as a result of the local rent control policies.

But nearly as many respondents — 23% — said they don’t plan to change anything about their investments or developments in these areas despite rent control.

Despite the growing popularity of rent control pushes across the country, California seems to stick out among the crowd. Respondents to the NMHC survey were asked to list markets they are specifically avoiding, either due to existing rent control measures or the threat of new policy adoption. Of the 31 respondents who answered this question, 55% indicated specific markets in California or the state as a whole, NMHC said.

According to Jim Lapides, vice president of strategic communications for the National Multifamily Housing Council, “California is a uniquely difficult place to operate” because of the state’s rent control laws as well as the laws that local governments have either approved or are preparing to pass. It adds up for every city that enacts new rent control legislation and every moratorium that is still in place.
Despite these obstacles, investing there is still profitable, according to Lapides, and investors will continue to do so. According to a year-end analysis by CBRE, which used data from Real Capital Analytics, the greater Los Angeles region attracted $58.8B in investment expenditures in 2021, making it the biggest beneficiary of those funds. With nearly $35B in tourism, the Bay Area placed fourth. The statistics showed that apartments were the asset class that attracted the greatest investment in the East Bay and greater LA. (Offices in San Francisco received the most investment.)
According to Lapides, “California is always going to be an attractive market —  there’s tens of millions of people that live there, there are huge markets, it’s important for the industry. But this trajectory that they’ve been on is really going to hurt them.”
Perry, by comparison, sees a pattern of adaptation to the hurdles that California has created so far.
“The reality is rent control is here, statewide, it’s been here for a while, and we’ve learned to live with it, adapt to it, and make it work both from a lending standpoint and from a borrower standpoint,” Perry said.
Our Orange County commercial real estate brokers will help you every step of the way in finding the right multi-family property, contact us for details.

CRE loans on bank balance sheets increased significantly.

On July 6th, the Federal Reserve’s Federal Open Market Committee (FOMC) minutes from its June meeting were made public, and they contained some fascinating information for the real estate sector.

The first was a direct reference to bank lending for commercial real estate:

“Commercial and industrial (C&I) and commercial real estate (CRE) loans on banks’ balance sheets expanded at a rapid pace in April and May. Issuance of both agency and non-agency commercial mortgage-backed securities (CMBS) stepped down slightly in May from its strong pace earlier in the year. Small business loan originations through April were in line with pre-pandemic levels and indicated that credit appeared to be available.”

For a majority of borrowers, residential mortgage credit was “widely available” through the month of May, however independent of the Fed’s observations, persistently increasing rates are discouraging most borrowers. According to information from the Mortgage Bankers Association that Trading Economics has compiled since January, there have been twice as many weeks in which the number of mortgage applications fell in contrast to weeks in which numbers of mortgage applications showed increasing numbers.

The minutes stated that  “While refinance volumes continued trending lower in April and May amid higher mortgage rates, outstanding balances of home equity lines of credit at commercial banks posted the first significant increase in more than a decade, likely reflecting a substitution by homeowners away from cash-out refinances.”   Bank interest rates for C&I and CRE loans have climbed, and yields on non-financial business bonds are far above pre-COVID levels.

According to Alex Killick, managing director at CWCapital,  “Commercial real estate has historically been a hedge against inflation, and we continue to see sturdy rent growth in the multifamily and hotel sectors.”  That being said, Killick noted that cost inflation, notably for staffing and insurance, is impacting NOI margins, particularly on office and retail properties where tenants are on long-term fixed rent leases with escalations of 2% to 3% annually, below the rate of expense inflation.

Killick also states, based on Fed notes and plateauing trends of some commodity prices, looming fixed rate loan maturities in 2023 and 2024 represent “the biggest near-term risk in CMBS,” with projected refinancing charges between 1 and 2 percentage points higher than current rates. Where NOI has also been influenced by rising expenses, may go through a level of distress that is greater than anything we haven’t experienced prior to the 2020 COVID default wave,” he adds.

Al Lord, CEO of Lexerd Capital Management, which largely focuses on multifamily – what he claims is a present bright spot. Lord says interest rate increases would negatively influence financing costs of commercial real estate projects and on the margin, we anticipate some projects to be canceled. The demand for rental housing is so robust that, despite increases in the cost of financing MF real estate projects, this asset class is predicted to do well for investors through at least 2023.

Despite a seemingly sunny outlook in the apartment market, prudence is advised, according to Dave Nelson, chief investment officer of the multifamily-focused investment firm Hamilton Zanze. Nelson tells GlobeSt.com that while apartment fundamentals are still solid, apartment returns are being threatened. “The large difference between buyers and sellers is reducing but not completely, and the gap will increase as the Fed minutes hint at another rate hike. This is not a moment to be alarmed, but rather to assess robust regional market fundamentals with large job drivers and exercise caution when making purchases.
The SVN Vanguard team can help with your commercial real estate needs. We can help you find the ideal commercial property for sale or lease. Interested in discussing a sale-leaseback? Contact us.

Generally speaking, real estate has generated profits during most recessions.

According to one market observer, investors “shouldn’t be concerned of an oncoming recession” and instead should think about the economic outlook over the next 3, 5, and 10 years.

Because there are so many different economic crosscurrents at play, it’s difficult to predict whether and when the next recession will occur. According to John Chang of Marcus & Millichap, these factors make it very hard to anticipate a recession, and even while “the risks are mounting,” a recession is not a given.

On the one hand, according to Chang, job growth is strong, with 488,000 new positions added each month on average this year. 3.6 percent is the current unemployment rate, and 5.2 percent is a significant pay growth rate. Additionally, despite recent stagnation in retail sales, they are still growing by almost 8%.

According to Chang, ” “Those are all positive economic readings pointing to a steady growth outlook.” Chang also notes that on the other hand, we have rising interest rates, a declining stock market, a record-high inflation rate of 8.5 percent, and declining confidence levels. There is in many respects a fear element at play that can force individuals to cut back on their spending and bring about a recession.

Therefore, is it really important if the US experiences a recession? Chang says it depends on the situation.

Chang claims that the current situation is unlikely to experience the liquidity shortage that the Great Financial Crisis did, which limited real estate investment. Although there are many different reasons and repercussions for recessions, Chang believes the US is likely to see one similar to that of the 1981 or 1990 downturns. Strong growth and rising inflation in the years before both of these periods influenced the Fed to raise interest rates aggressively, as we are seeing today. Chang observed significant variation among property types, with apartments, for example, holding up well in the 1980s and dipping mildly negative in 1991 – though “nothing like the hit the sector took in 2009,” he says. Yields softened in both recessions, but not to the extent of the decline in 2009.


The location and asset will determine a large portion of the risk to CRE investors. However, according to Chang, “in general, real estate has generated good returns through most recessions.” “And even when returns fell, there was typically strong, steady growth in its wake. Therefore, yes, economic downturns do affect commercial real estate, but not nearly as much as we may think.

We are ready to assist investors with Santa Ana commercial properties. For questions about Commercial Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard. 

1. FED POLICY MEETING

2. MSCI REAL CAPITAL ANALYTICS

3. APARTMENT INVESTMENT MARKET INDEX

4. GLOBAL SUPPLY CHAIN PRESSURE INDEX

5. CONSUMERS CUT BACK ON DINING

6. NAIOP OFFICE SPACE DEMAND FORECAST

7. INDEPENDENT LANDLORD RENTAL PERFORMANCE

8. NFIB SMALL BUSINESS SURVEY

9. CHICAGO FED NATIONAL ACTIVITY INDEX

10. CMBS DELINQUENCIES

 

SUMMARY OF SOURCES



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