CAP RATES FOR STNL ON THE RISE

Spreads continue to rise: large for retail, moderate for offices, and low for industrial.

In 2023, 440,000 completions brought supply to its greatest levels since 1987.

1. 2024 US MULTIFAMILY OUTLOOK

• According to a recent forecast by Yardi Matrix, the US multifamily sector faces a mixed outlook in 2024. While apartments have performed relatively healthily during the Fed’s ongoing tightening cycle, sector valuations will face challenges from a wave of supply coming online alongside rapid growth in costs and mortgage rates that are likely to remain high in the short term.
• The report notes that economic growth is likely to slow in 2024, potentially inducing a commercial real estate market reset with higher financing costs, acquisition yields, and lower leverage and values.
• Multifamily rent growth is likely to remain positive in 2024 but diminished by recent standards as supply grows and absorption slows. Supply growth sits at decades-long highs, with more than 1.2 million units under construction and over half of a million deliveries expected in 2024.
• Expenses such as materials and maintenance continue to rise rapidly, with income growth projected to slow, shifting the focus of the industry towards increasing operating efficiency and cost-cutting.
• Transaction volume fell by 70% in 2023, according to Yardi, and activity is expected to remain weak in 2024.

2. FOMC ECONOMIC PROJECTIONS

• The FOMC’s December 2023 Summary of Economic Projections updated the Central Bank’s interest rate and growth forecasts for 2024, with the consensus expecting to cut rates by 75bps next year.
• Policymakers spoke of the recent dampening of economic and job growth indicators despite the better-than-expected performance of each in recent months.
• According to the FOMC’s growth projections, GDP growth is expected to finish at 2.6% this year compared to their previous projection of 2.15%. Growth is expected to fall in 2024 to 1.4%— ten (10) basis points below their September projection.
• According to the FOMC’s inflation projections, the PCE price index was revised lower for the end of 2023 (2.8% vs 3.3%) and 2024 (2.4% vs 2.5%).
• The Unemployment rate is expected to finish 2023 at 3.8% before rising to 4.1% in 2024.

3. MARKET INTEREST RATE PROJECTIONS

• According to the latest data from the Chicago Mercantile Exchange’s Fed Watch Tool, the FOMC is expected to leave rates unchanged at their January 2024 meeting, though projections for rate cuts have steadily increased as inflation continues to cool.
• A solid majority of the Fed futures market (85.5%) see no rate hike in January compared to 14.5% who see a 25-bps cut on the horizon. However, just one month ago, the share of futures projecting a rate cut in January was a measly 0.2%. While forecasts for a January rate cut remain in the minority, the rise in its probability reflects the continuing cooling of inflation and economic growth forecasts in recent weeks.
• Looking towards the second FOMC meeting of 2024 in March, a solid majority (71.3%) expects a 25-bps cut, compared to just 17.1% who expect rates to be held at their current level. The March forecast likely reflects suggestions from the FOMC’s latest Summary of Economic Projections, which forecasts at least three rate cuts next year.

4. 2024 BUSINESS TRAVEL TRENDS FORECAST

• According to recent forecasts by Morning Consult, the travel industry is expected to continue its recent momentum into 2024 as business travel is projected to rise.
• The report notes that business travel decision-makers are 13 percentage points more likely to say that business travel will increase next year than those who say it will decrease.
• While business travelers are a smaller share of the sector compared to leisure travelers, they tend to spend more, therefore contributing a greater share of overall revenue to the sector. The slow post-pandemic recovery for corporate travel has limited the industry’s rebound, but next year could be a turning point. Roughly 3 in 10 business travel decision-makers say work trips will increase in 2024.

5. 2024 RETAIL TRENDS FORECAST

• The Retail industry is expected to expand investment in AI in consumer-facing applications in 2024, but influencers will remain key to marketing strategies moving forward despite the shift, according to forecasts by Morning Consult.
• Despite recent attention to generative AI, consumers continue to trust recommendations from influencers more than AI tools, according to the analysis.
• Retail brands will need to adopt AI cautiously and are unlikely to divest from influencers, which has implications for both retail industry employment and real estate investments used for marketing purposes.
• Somewhat surprisingly, Gen Z consumers, who are being introduced to AI in Retail in their younger years, put more faith in influencer recommendations than any other consumer cohort, while millennials are most likely to trust AI. Still, consumer trust in influencers outweighs trust in AI across all generational cohorts.

6. 2023 POPULATION GROWTH

• States in the southeastern US once again saw the highest population growth of any region in 2023, led by South Carolina (+1.7%), Florida (1.6%), and Texas (1.6%), according to recent estimates released by the US Census Bureau.
• In 2022, South Carolina, Florida, and Texas ranked 3rd, 1st, and 4th, respectively, and in 2021, ranked 6th, 8th, and 7th, respectively. Idaho, which ranked 1st and 2nd in 2021 and 2022, respectively, dropped to 4th place in 2023.
• Other states in the Sun Belt, which saw a large increase in population throughout the pandemic years, have since fallen out of the top 10 for growth, particularly Arizona and Nevada.

7. Q3 2023 BANK CRE LOAN PERFORMANCE

• Mortgage origination volume for bank-held CRE loans fell steeply in the third quarter, led by a drop in office loan originations relative to pre-COVID levels, according to Trepp.
• Underwriting terms for new originations during Q3 also show weakness relative to those made in previous quarters. Net charge-offs, delinquency rates, and occupancy levels all reflect more stress in CRE relative to the first half of 2023.
• The delinquency rate for all Bank CRE loans rose from 1.15% to 1.50% in Q3, continuing a growth trend that began after Q3 2022 when delinquencies fell to a pandemic-era low of 0.67%.
• The non-current rate rose from 0.95% in Q2 to 1.29% in Q3, its steepest jump in the post-pandemic era.

8. COMMERCIAL REAL ESTATE PRICES

• Commercial real estate prices fell -8.0% year-over-year in November but remained flat on a monthly basis, according to the latest data from MSCI Real Capital Analytics.
• Property prices have trended downward alongside a fall in sales volume this year, which dropped 60% in November. Still, the monthly and annual price changes reflect an improvement over much of 2023. Early in 2023, CRE prices were charting declines of close to 2.0% month-over-month, while annual declines were consistently in the double-digits around mid-year
• Industrial posted the only annual or monthly increase, increasing 1.8% year-over-year and 0.9% month-over-month.
• Office prices led annual declines charting at -14.9%, followed by Apartments (12.1%) and Retail (-6.7%).
• Monthly declines followed a similar pattern, with Office sector prices falling -1.0%, followed by Apartments (-0.7%) and Retail (-0.3%).

9. CONFIDENCE BOOSTS APARTMENT DEMAND

• According to a recent report by Real Page, a recent rise in consumer confidence is boosting apartment demand.
• After hitting a 30-year low in 2022, the University of Michigan’s Consumer Sentiment Index rose steadily in 2023 as inflation eased and recession forecasts missed the mark.
• According to a Globe Street analysis of the relationship between consumer sentiment and apartment demand, during uncertain times, renters may opt to stay in a Class B property longer rather than moving into a Class A one, but as that uncertainty fades, pent-up demand begins to materialize. However, since housing isn’t a discretionary expense, rebounds in consumer sentiment impact items like shopping or travel more directly than housing.

10. HOUSING STARTS

• US housing starts unexpectedly soared in November, climbing 14.8% month-over-month to an annualized 1.56 million units, the highest increase in six months. Falling mortgage rates and low inventory have helped push the rise in US construction.
• Single-family housing starts rose by 18%, the highest for the segment since April 2022. Single-family permits similarly jumped by 18%. Starts are climbing faster than completions, suggesting that units under construction should continue to climb in the months ahead.
• Housing start growth rose at its fastest pace in the Northeast (100%), followed by the South (16.3%), the West (2.1%) and the Midwest (1.4%).

SUMMARY OF SOURCES

• (1) https://www.yardimatrix.com/publications/download/file/4915-MatrixMultifamilyNationalReport-Winter2024?signup=false
• (2) https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20231213.htm
• (3) https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
• (4) https://pro.morningconsult.com/analysis/travel-trends-2024-ai-business-travel
• (5) https://pro.morningconsult.com/analysis/2024-retail-trends-generative-ai-influencer-marketing
• (6) https://www.census.gov/newsroom/press-releases/2023/population-trends-return-to-pre-pandemic-norms.html
• (7) https://www.trepp.com/trepptalk/bank-cre-loan-performance-q3-2023-office-charge-offs-delinquencies
• (8)https://info.msci.com/l/36252/2023-12-20/y19wnw/36252/1703110097zFm6zbyH/2312_RCACPPI_US.pdf
• (9) https://www.realpage.com/analytics/consumer-confidence-apartment-demand/
• (10) https://www.census.gov/construction/nrc/pdf/newresconst.pdf

Corporate real estate owners are forced to devise innovative plans for the upcoming year due to rising cap rates and interest rate volatility.

1. CPI INFLATION

• The Consumer Price Index (CPI) fell to 3.2% year-over-year in October, 50 basis points below the September reading, and follows two consecutive increases in annual CPI.
• Monthly CPI was flat, marking the first time the economy has experienced no month-over-month inflation since July 2022. Further, the annual increase in CPI in October was its lowest for the CPI since March 2021.
• Energy prices dropped sharply in October; however, the declines were offset by the rise in shelter costs. Still, shelter costs, which have been the key culprit behind upward price pressure in recent months, increased by just 0.3% monthly in October, 30 basis points below September’s reading.
• Markets responded positively to the news after the annual reading came in 10 basis points below economists’ consensus forecast for October. The Dow jumped 1.5% on the day of the release as investors renewed hopes that falling pressures could boost consumer confidence and provide room for the Fed to halt its interest rate tightening cycle.

2. THANKSGIVING INFLATION

• As Americans sit down to this year’s Thanksgiving feast, the inflation on their plates has — thankfully — improved since last year.
• According to the BLS Consumer Price Index, the bulk of this year’s inflation is stuffed into the turkey, which has seen average prices rise by 7.2% in the past year. Meanwhile, Ham — the proverbial silver medalist of the Thanksgiving feast — is up by only 0.5% year-over-year.
• Fresh fruits and vegetables are serving up a healthy side of savings, with average prices down 0.1% from last year. Staples such as eggs (-22.2%), butter (-3.7%), and milk (-1.6%) are also seeing prices fall from a year earlier.
• Looking ahead to Black Friday, while conclusive data are unavailable from the BLS, the Analysts at Chandan Economics forecast that negative rates of inflation are highly probabilistic for the New York Jets offense as well.

3. COMMERCIAL PROPERTY PRICES

• According to the MSCI Real Assets Commercial Property Price Index (CPPI), CRE valuations are down 8.0% year-over-year through October 2023. Apartment prices have seen the most severe declines in the past year, falling 13.7%.
• Office (-9.5%) and retail (-7.2%) also posted sizable year-over-year declines. The only core-property type to still see price growth over the past twelve months is industrial, which saw valuations grow a meager 1.2%.
• Tertiary markets are, on average, seeing more pricing pain than major markets. CRE prices in non-major markets are down 9.0% year-over-year through October, while major market CRE prices are down by slightly less (-4.6%).

4. GOVERNMENT SHUTDOWN AVERTED

• On November 16th, President Biden signed Congress’ recently passed continuing resolution (CR) that extends current federal funding levels until early 2024, averting an imminent government shutdown and freezing congressional spending battles until the new year.
• The CR was the second short-term funding bill advanced by the House since September, reflecting persistent legislative deadlock in D.C. as legislators debate spending cuts, aid for Ukraine, and other hotbed items.
• The new CR is multi-tiered. The package funds part of the government, including the Department of Agriculture, HUD, and Transportation, through January 19th but funds the Defense Department through February 2nd. The CR also excludes supplemental packages covering items such as aid for Ukraine, Israel, and border security — punting those debates into later.

5. FHFA CUTS GSE LENDING CAPS

• The Federal Housing Finance Agency (FHFA) recently announced that it has cut the lending caps for Fannie and Freddie to $70 billion each in 2024, in line with 2021 levels.
• In 2023, the FHFA lowered its lending caps for government-sponsored entities (GSE) to $75 billion each, down from $78 billion in 2022. While the 2024 levels will be the lowest in 3 years, they remain well above pre-pandemic levels as the agency straddles the line between assisting housing supply amid an affordability crisis and reigning in inflationary demand.
• Keeping in line with 2023 mission funding goals, the FHFA will require that at least 50% of Fannie and Freddie’s multifamily business be mission-driven affordable housing. Further, loans classified as supporting workforce housing will be exempt from volume caps.

6. EMERGING TRENDS IN REAL ESTATE: 2024 ISSUES TO WATCH

• As part of the 2024 ULI-PwC Emerging Trends in Real Estate (ETRE) Report, a broad survey of CRE professionals weigh in on the most salient factors presenting challenges for the industry in the year ahead. Among economic and financial issues, on a scale of 1-to-5 (1 = no importance, 5 = great importance), respondents consider interest rate costs (4.70), capital availability (4.30), and income growth (4.08) as
  the most pressing issues.
• Among social and political factors, housing costs and availability top the rest of the field (4.21). Following at the top of the list are concerns about immigration policy (3.56) and political extremism (3.39).
• Construction labor costs (4.46) are a primary concern among development factors. Other issues raising concerns are material costs (4.31) and construction labor availability (4.30).

7. EMERGING TRENDS IN REAL ESTATE: 2024 PROPERTY TYPE OUTLOOK

• According to the respondents of the Emerging Trends in Real Estate (ETRE) survey, multifamily properties maintain the best investment prospects in 2024 of any core-property type. On a scale of 1-to-5 (1 = abysmal, 5 = excellent), multifamily scored 3.70 in the 2024 ETRE survey.
• Following closely behind are single-family housing (3.68) and industrial (3.63). Hotel (3.33) and retail (3.27) follow next and remain on the positive end of the scoring spectrum. Trailing behind is, predictably, office, which holds a score of 2.60 in the 2024 survey.
• Compared to last year’s results, the investment outlook improved for multifamily, single-family, and retail assets. The outlook remains unchanged for hotels and worsened for industrial and office assets.

8. HOUSEHOLD DEBT TRENDS

• Nationally, 26% of all Americans have debt in collections, according to data from the Urban Institute.
• The data tool, which highlights the geography of debt in America by debt type and observes differences by age and race, among other factors, shows that debt collection affects 22% of households in White communities and 35% of households in communities of color.
• Young adults aged 18 to 24 are also vulnerable to certain debt types, such as student loans. Still, despite just 3% of young adults having student loan debt in default, a staggering 20% have some form of debt in collections. Medical debt arises as a key culprit, with 10% of adults ages 18 to 24 having some medical debt in collections.

9. SMALL BUSINESS OPTIMISM

• According to the NFIB Small Business Optimism Index, sentiment fell for a third consecutive month in October, its lowest level since May. Data from the report suggests that a lower share of businesses reporting nominal sales growth and positive profit trends help explain the declining sentiment.
• A net negative 17% of all small business owners reported higher nominal sales in the past three months, the lowest share since July 2020. While the net share of owners expecting higher real sales volume improved from September, it remained a net negative 10%.
• 21% of owners cited inflation as their single most important problem, a one-point drop from September. A net positive 30% of owners reported having raised average sales prices in October, while the frequency of positive profit trend reports was a net negative 32% during the month.
• 43% of owners report having job openings that are hard to fill, unchanged from September but close to historical highs. A net 24% of owners plan to raise compensation levels in the next three months, a slight uptick from last month.

10. NAHB HOUSING MARKET INDEX

• According to the Wells Fargo NAHB Housing Market Index — a monthly gauge of homebuilder sentiment — conditions continue to worsen through November 2023.
• The HMI, which describes conditions above an index reading of 50 as improving and below as worsening, fell to 34 in November, marking the lowest point in 2023 to date. Moreover, driven by entrenched high prices and a recent surge of interest rates, the HMI has now slid for six consecutive months and has held at or below 50 since August.
• Regionally, the Northeast housing market is faring better than the rest of the country, holding an index reading of 53 in November. The South (35) follows in second, with the Midwest (32) and the West (28) trailing further behind.

SUMMARY OF SOURCES

• (1) https://www.bls.gov/news.release/cpi.nr0.htm
• (2) https://www.bls.gov/cpi/
• (3) https://www.msci.com/our-solutions/real-assets/real-capital-analytics
• (4) https://www.nbcnews.com/politics/congress/senate-approve-funding-government-shutdownstopgap-bill-rcna125325
• (5) https://www.globest.com.cdn.ampproject.org/c/s/www.globest.com/2023/11/20/fhfa-cuts-gselending-caps/?amp=1
• (6) https://knowledge.uli.org/-/media/files/emerging-trends/2024/2024-etre-us.pdf?rev=25970db4b6c445beb65ce5c042e93b07&hash=A9E8A8809B89A71C46BD7D3BA0A26F1B
• (7) https://knowledge.uli.org/-/media/files/emerging-trends/2024/2024-etre-us.
  pdf?rev=25970db4b6c445beb65ce5c042e93b07&hash=A9E8A8809B89A71C46BD7D3BA0A26F1B
• (8) https://apps.urban.org/features/debt-interactive-map/?type=overall&variable=totcoll
• (9) https://www.nfib.com/surveys/small-business-economic-trends/
• (10) https://www.nahb.org/news-and-economics/housing-economics/indices/housing-market-index

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In particular, the bank consumer and CRE lending divisions are under close observation by the Fed for possible signs of credit deterioration.