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
SHAREABLE FLIPBOOK DOWNLOADABLE PDF
In particular, the bank consumer and CRE lending divisions are under close observation by the Fed for possible signs of credit deterioration.
The November 2023 Supervision and Regulation Report states that the Federal Reserve Board of Governors has stated that there are issues even if they believe the “banking sector remains sound overall.” The lending of banks to commercial real estate was one of the problematic areas they identified. Overall, the banking sector is still solid. According to their writing, banking institutions “continue to report capital and liquidity levels above regulatory minimums.” Despite recent pressure on net interest margins, earnings performance has remained strong and consistent with pre-pandemic levels. The decrease in deposits caused by the financial strains in March has abated. Overall, loan delinquency rates continue to be low.
Yet, banks have raised credit loss provisions, and delinquencies for CRE and certain consumer sectors have risen from their low levels. Some banks continue to face elevated liquidity and interest rate concerns, which can be partly related to rising funding costs and large fair-value losses on investment securities. While not the primary problem, CRE is significant enough to be mentioned separately. Delinquency rates for consumer and real estate loans, which “increased slightly during the first half of 2023,” were one culprit, according to the report. It’s hardly shocking that “the CRE office loan segment showed the largest increase in delinquency rates for the largest firms.”
According to the report, S&P and Moody’s have downgraded the bank sector’s credit rating. They both mentioned CRE exposure and rising interest rates, which have caused some banks’ long-term bond holdings to significantly lose value. The Federal Reserve noted that although loan delinquencies are low, larger banks are building up their reserves to protect themselves from lending losses. But that’s not all that’s happening. While larger banks become more cautious and hoard more cash, they are decreasing lending, while smaller banks are increasing their CRE credit activity. Despite the fact that the Fed’s research focuses mostly on large banks, those are the organizations with the resources to more readily endure an issue with CRE loans.
According to estimates, the $33 billion CRE loan portfolio held by Signature Bank would see a fire sale, driving values 15%–40% below face value. In an era of constrained price discovery, this kind of outcome would probably impact loans and property assessments in general. Between 2024 and 2026, waves of maturing office loans are also expected in significant markets. Delinquency rates for CRE bank loans have already reached a 10-year high.
“They wrote that some firms, particularly in the office segment of CRE, have indicated in public earnings releases that they expect increased loan losses.” Supervisors thus keep a careful eye on loan quality and underwriting. A horizontal review has been conducted recently to mitigate exposures to possible declines in CRE markets.
In the end, tighter banking regulations affect all banks, larger ones more so since they attract more attention, but smaller ones eventually close out of prudence or in the event that things go wrong. Recall that following the Global Financial Crisis in 2010, 155 banks closed. 530 closed in 1989 following the savings and loan crisis of the 1980s. There is a chance that banks may become less willing to take on CRE loans, and there isn’t likely to be enough nonbank lending to make up for it, especially because federal regulators are currently preparing to increase their level of oversight of them as well.
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.
1. GROSS DOMESTIC PRODUCT
- Real GDP rose by 4.9% during the third quarter of 2023, its fastest pace since the fourth quarter of 2021, according to the advanced estimate from the Bureau of Economic Analysis (BEA).
- Continuing the post-pandemic storyline, robust consumer spending largely drove the increase in output but was also accompanied by increases in the other key components: net exports, residential investment, and government spending.
- Consumer spending rose 4.0% during the third quarter, following a tepid 0.8% in Q2. According to the BEA report, consumption accounted for 55% of the total increase in GDP.
- Stocks reacted little to the news, as markets forecasted an increase of 4.7% during the quarter — not far off from the eventual tally. Still, the substantial GDP numbers, alongside a continued decline in core-inflation prices, further complicate the Federal Reserve’s next steps as they try to tame inflation while keeping the US economy afloat.
2. CPI INFLATION
- According to the Bureau of Labor Statistics, the Consumer Price Index rose by 0.4% month-over-month in September, following a 0.6% increase in August. The index is up by 3.7% over the past 12 months.
- Prices rose more than the consensus expectations as shelter continued to place upward pressure on overall prices, accounting for over half of the total increase. Still, several items in the index saw prices
climb at their slowest pace in years, including food, which is at its lowest rate since March 2021.
- Gasoline prices also played a significant role in the monthly rise in CPI, with the energy index increasing by 1.5% in September.
- The indices for used cars and trucks, as well as apparel, decreased during the month.
- Excluding food and energy, core-CPI cooled for six consecutive months to 4.1% annually and just 0.3% month-over-month. The slowdown in core inflation rates signals what Fed policymakers may do moving forward, considering their emphasis on these items in their rate-setting strategy.
3. 2024 COMMERCIAL REAL ESTATE OUTLOOK
- In a recent survey of industry stakeholders for their 2024 Commercial Real Estate Outlook Report, Deloitte highlights expense mitigation as the top priority for respondents as their focus shifts to managing industry headwinds as transactions and rents slow.
- According to the report, respondents pointed to capital availability and costs as the most concerning industry fundamentals, with half expecting both measures to worsen in 2024.
- 60% of firms also indicated a concern about meeting environmental, social, and governance (ESG) compliance, while many are looking to outsource to drive overall efficiency.
- 61% of firms say their core tech infrastructure relies on legacy programs. Still, roughly half are making efforts to modernize as attention shifts to efficiency and technological ways to gain a competitive edge.
4. INDEPENDENT LANDLORD RENTAL PERFORMANCE
- On-time rental payment rates in independently operated rental units improved marginally in October 2023, rising to 82.6%, according to the latest reporting from Chandan Economics and RentRedi.
- The on-time payment rate is up by 21 bps from the month prior and 102 bps from the same time last year. Encouragingly, on-time payment rates have now held above 82% in eight of this year’s ten months — a threshold only surpassed once in all of 2022.
- October’s forecast full-payment rate, which takes on-time payments, late payments, and expected late payments based on historical trends, came in at 92.8% — remaining unchanged from the month prior and matching the sector’s post-pandemic high watermark.
- Western states continue to hold the highest on-time payment rates in the country, led by Utah (93.8%), Idaho (91.7%), Colorado (90.6%), Washington (89.9%), Oregon (89.5%), Arizona (89.1%), and North Dakota (88.7%).
- In October, small multifamily (5-49 units) rental properties held the highest on-time payment rates of all
sub-property types, at 83.2%.
5. MORTGAGE APPLICATIONS
- US mortgage applications fell by 1% during the week ending October 20th, following a substantial 6.9% decline in the previous week, according to data from the Mortgage Bankers Association.
- The index that tracks application volume has fallen to its lowest level in 1995 as higher interest rates convince many would-buyers to remain on the sideline, while sellers are deterred from slowing or declining prices, stifling transaction volume.
- New purchase applications fell by 2.2% from the previous week, offsetting the more tepid 1.8% increase in applications to refinance a home.
- The average rate on a 30-year fixed mortgage climbed by 20 bps during the week to 7.9%, the highest mark for mortgage rates since September 2000.
6. UNDERGRADUATE ENROLLMENT RISES FOLLOWING YEARS OF
DECLINE
- After three consecutive years of declines, undergraduate enrollment at US colleges and universities this Fall increased for the first time since the onset of the COVID-19 pandemic, according to data from the National Student Clearinghouse Research Center.
- Enrollment is up 2.1% year-over-year and 1.2% from the Fall of 2021. Community colleges accounted for 59% of the undergraduate increase, while students of a Black, Latino, and Asian background accounted for most of the growth in both undergraduate and graduate enrollment.
- Before the pandemic, college enrollment had already been declining and was only accelerated further by the pandemic’s social and economic impacts.
7. NEW HOME SALES
- New US single-family home sales climbed to a 19-month high in September, rising an impressive 12.3%, according to the latest data from the Census Bureau.
- Experts note that a chronic shortage of homes has pushed up construction activity in recent months, which is beginning to impact the transaction level as builders offer buyers interest-rate buydown incentives that funnel demand into newly built properties.
- According to Commerce Department data, most of the homes sold in September were in the $150,000- $499,999 price range.
- Meanwhile, median home prices are also falling due to new supply coming online. The average price of a single-family home fell by 12.3% in September, its steepest drop since 2009.
8. CONSUMER SENTIMENT
- According to the University of Michigan’s latest preliminary estimates, US consumer sentiment fell to its lowest level in September as concerns over personal finances, inflation, and short-term business conditions mounted.
- Both the current conditions and future expectations sub-indices similarly fell to a five-month low during the month, while year-ahead inflation expectations rose from an expected rate of 3.2% in August to 3.8%, its highest since May. Five-year ahead inflation expectations also rose, climbing from 2.8% to 3.0%.
- Expectations for long-run business conditions were little changed in September, signaling that while consumers are cautious in the face of short-term developments, they generally expect conditions to
improve in the future.
9. INDUSTRIAL PRODUCTION
- US industrial production, a useful proxy measure for manufacturing demand and, by extension, a leading indicator for Industrial real estate, rose by 0.3% month-over-month in September, beating consensus expectations of a flat reading, according to Federal Reserve data. Total production is up by an annual rate of 2.5% in the third quarter.
- Manufacturing output, which accounts for 78% of industrial production, rose 0.4% during the month following a 0.1% decline in August.
- Mining output rose by 0.4%, its fourth consecutive month of growth, while utilities fell by 0.3%.
- In Manufacturing, the strongest gain on a percentage basis were wood products, primary metals, and plastics and rubber products. Meanwhile, apparel/leather, as well as printing and support, saw the steepest monthly declines.
10. US RETAIL SALES
- US retail sales rose by 0.7% month-over-month in September, beating expectations by 40 basis points, according to the latest data from the Census Bureau.
- While slightly below the August rate of 0.8%, retail trade continues to post strong growth as US consumers continue their years-long post-pandemic spending spree.
- Miscellaneous retail sales showed the most strength, rising 3.0% month-over-month, but also experienced the most volatility after falling 3.6% monthly in August. Non-store retailers also had a strong month, climbing by 1.1%, likely boosted by the Labor Day weekend. Auto and parts also posted solid gains, rising by 1.0% during the month.
SUMMARY OF SOURCES
- (1) https://www.bea.gov/news/2023/gross-domestic-product-third-quarter-2023-advance-estimate
- (2) https://www.bea.gov/data/gdp/gross-domestic-product
- (3) https://www2.deloitte.com/us/en/insights/industry/financial-services/commercial-real-estate-outlook.html
- (4) https://www.chandan.com/post/independent-landlord-rental-performance-report-october-2023
- (5) https://www.mba.org/
- (6) https://nscresearchcenter.org/stay-informed/
- (7) https://www.census.gov/construction/nrs/index.html
- (8) http://www.sca.isr.umich.edu/
- (9) https://www.federalreserve.gov/releases/g17/current/default.htm
- (10) https://www.census.gov/retail/marts/www/marts_current.pdf
Time and time, the same crucial errors are committed.
The CRE sector differs from every other sector in that it uses a transaction-based paradigm. Transactions involving the sale, financing, and leasing of goods and services are the industry’s lifeblood. The industry as a whole, its participants, and the firm all profit more as there are more interactions. The year 2021 saw unprecedented transaction volumes and a tremendous CRE boom.
The most prosperous organizations and people in the sector are typically skilled in marketing, financing, and/or leasing CRE property. However, the same crucial errors are consistently made when pursuing these transactions, which typically leads to subpar performance, the loss of equity in a property, or the loss of the property in foreclosure. The following are the top 15 commercial investing blunders that we’ve identified:
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- Purchasing real estate at a low cap rate. Even if the investor thinks that potential rent increases in the future, which may not materialize, will offset the low initial return, cap rates below 5.0% are not warranted. Purchasing CRE at cap rates under 5.0% is comparable to purchasing a tech stock at a 100 price-to-earnings ratio.
- Not varying a nationwide portfolio by region, sector, and type of property. Numerous major funds are diversified by kind and region by national firms, but industry diversity is often overlooked. In Silicon Valley, 70% of apartment tenants and 70% of office tenants, if an investor purchases only flats and offices, are employed by the technology sector. Many apartment residents could lose their jobs and be unable to pay their rent if the IT sector experiences a slump. They could even go back home or share rooms with roommates. The apartment market will suffer as a result of this. The office market will suffer if many of the internet companies fail on their leases or reduce the amount of space they need.
- Not carrying out all of the necessary financial and property due diligence before buying a portfolio of properties. Many institutional investors that purchase huge portfolios made up of dozens or hundreds of properties don’t perform enough due diligence at the individual property level. They either employ unskilled third-party organizations to perform the property-level due diligence or they just examine the larger and more expensive homes in the pool.
- Purchasing real estate using negative leverage. Negative leverage is a “no-no” in commercial real estate because it happens when the cap rate is lower than the mortgage constant, which means the cash-on-cash return will be lower than the cap rate. Many businesses buy real estate using negative leverage in the hope that rising rents will more than offset the low initial return.
- Fund a long-term real estate asset or portfolio with short-term floating-rate financing without the added security of a swap or collar. In the past two years, when the Fed abruptly increased the federal funds rate from 0% to 5.25%, this is what has happened. Due to the sudden surge in interest rates brought on by floating-rate debt and the lack of interest rate protection, many CRE investors are now frantically trying to cut their financing costs and risk.
- Using a terminal cap rate that is lower than the going-in cap rate when underwriting an acquisition. To “juice up” the internal rate of return on the equity in a transaction underwriting, this is frequently done by the acquisition team or another internal division within a large CRE business.
- Institutional investors who provide funding to sponsors with junior management teams with little expertise. The senior management group should be older, with members having seen at least the two most recent secular CRE downturns, from 1987 to 1992 and 2007 to 2012. Having team members with extensive and long-term expertise and understanding of various property kinds, markets, and economic recessions is one of the most crucial factors in CRE investing success.
- Utilizing excessively upbeat rent predictions while underwriting a deal. This frequently happens when an inside group trying to grow or acquire a deal wants to improve the transaction’s appearance.
- Not looking into the retail tenants’ sales per square foot, a crucial indicator when purchasing shopping centers. The sales per square foot of the anchor tenants, after the cap rate, is one of the most crucial indicators when purchasing retail complexes. A center with high sales per square foot is in a prime location, will remain fully leased, and is in high demand among tenants and customers.
- Utilizing a high leverage of above 75%. High leverage is one of the dangers associated with CRE investing and was one of the factors contributing to the Great Recession from 2007 to 2012.
- Not granting top staff members an equity stake in the business, holdings, or fund. The “golden handcuffs” are what are referred to as CRE. Your top personnel will depart if you don’t look after them, joining your competition.
- Not including in a real estate firm the 15 CRE hazards. Risks in the firm’s investment strategy include those related to cash flow, value, tenants, the market, the economy, interest rates, inflation, leasing, management, ownership, legal and title issues, construction, entitlement, liquidity, and refinancing.
- Investing in real estate segments where the investment firm has no prior experience, such as hotels and senior housing, which are more operational businesses than real estate deals. Senior housing is often 80% to 100% operating business and 0% to 20% real estate deal, while hotels are normally 70% operating business and 30% real estate deal.
- When buying a sizable portfolio of CRE assets, not getting the Kmart discount. When a sizable CRE portfolio changes hands, it usually consists of Class A queens, Class B pigs, and average Class B transactions. The buyer needs to receive a discount of at least a 1.0% higher cap rate to account for the risk of the Class C properties.
- Not double-checking the formulas in an XL underwriting spreadsheet because every CRE underwriting worksheet contains at least one mathematical inaccuracy. When creating a challenging Excel underwriting workbook, this is a regular occurrence, thus businesses should ensure that all calculations are double-checked by an impartial third party.
We are ready to assist investors with Santa Ana commercial real estate properties. For questions about Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.
Debt financing is not available to all borrowers or even all industries, but it is not inaccessible either.
According to MSCI’s research on global capital trends for August 2023, CRE investment sales have been declining and disappointing. It has been demonstrating this for months.
The credit ones are linked to the sales ones. There is a widespread belief that obtaining funding is virtually impossible because many banks are exposed to risk from CRE loans, lending requirements are becoming more stringent, and there are concerns that government-sponsored companies may not reach their lending caps.
But MSCI essentially advised holding on. According to the company, “off-the-cuff statements from industry participants might lead one to believe that the commercial real estate markets are in free fall with no debt available.” The reality, however, is more complicated, with certain industries dealing with illiquidity in the debt portion of the capital stack while others are merely dealing with more expensive debt. Each circumstance has unique effects on future investment performance and activity.
When compared to the pace of the first quarter, loan originations tracked by the company increased by 31% in the second quarter. In the second quarter, variables often raise originations, but from 2013 to 2022, the average rise was only 17%. “If the market were viewed through the prism of a typical second quarter, one might conclude that the slide from a time of excessive liquidity in 2021 and 2022 is complete.”
The numbers weren’t consistent; they were drastically dispersed according to category. $51.2 billion in multifamily originations were made in Q2. From 2015 to 2019, the pre-pandemic five-year average was 4% higher. The highest rise was in industrials, which witnessed originations of $17.2 billion, or 45% more than the average for that property type. The total for retail was $14.2 billion, 15% below the five-year average. $10.7 billion was spent on hotels, which was a 17% decrease from the average from 2015 to 2019. Office saw the highest decline, as might be expected: -52% and $15.1 billion.
Taking a look at both industrials and multifamily, it is obvious that funding is available. However, MSCI noted that using debt no longer offers the same advantages as in the past. “LTVs at origination have decreased for both sectors as lenders take precautions against the risks posed by declining real estate values. Apartment LTVs peaked in 2021 at 64.5%, while industrial LTVs reached a maximum of 59.1%. In Q2 2023, these LTVs decreased to 59.4% and 56.1%, respectively. For these areas, it might be preferable to claim that there is no loan available rather than that there is no cheap debt with lenient conditions like there formerly was.
But it is easy to understand how the sales of the category and the availability of credit for it might move together given the decline in the number of offices.
We are ready to assist investors with Santa Ana office properties. For questions about Property Management, contact your Orange County commercial real estate advisors at SVN Vanguard.
1. INTEREST RATE DECISION/ECONOMIC PROJECTIONS
- At its September 20th meeting, FOMC officials left their benchmark interest rate unchanged, just their second pause since they began tightening rates in March 2022.
- Markets and onlookers were well-prepared for the decision, with futures markets pricing in a no-hike scenario in September for the past several weeks. Like their recent pause in June, officials leaned their decision on recent data, expressing a need to “proceed carefully” in determining the direction and magnitude of the policy decisions moving forward.
- Key officials have signaled their expectation that at least one more rate increase will occur before the year’s end. In its accompanying Summary of Economic Projections, the Fed’s dot-plot forecasts an additional 25 bps hike in 2023 before two cuts in 2024. Notably, this month’s projections indicate two fewer rate cuts in 2024 compared to their last projections released in June.
- The Fed’s projections also revised up expectations for 2023 end-of-year economic growth, forecasting GDP to rise 2.1% this year.
2. CONSUMER CONFIDENCE
- US consumer confidence fell to a four-month low in September, eroded by resurging concerns around inflation and a potential US recession, according to the latest data from the Conference Board.
- Consumers continue to shift towards a more pessimistic outlook despite relatively upbeat views about the present day. One of the components of the Conference Board’s index—the present situations index— which assesses consumers’ opinions on current business and labor market conditions, rose slightly during the month. Meanwhile, the expectations index, based on consumers’ short-term forward outlook on those same conditions, has fallen for back-to-back months.
- After recession fears reduced throughout the summer, they are evidently on the rise again. According to the report, consumer fears of an “impending recession” ticked up slightly during the month.
3. HOME SALES & PRICES
- Sales of new single-family houses in the US fell 8.7% to a seasonally adjusted annualized rate of 675,000 properties in August, according to the latest data from the US Census Bureau.
- The decline in August is in line with recent mortgage rate movements, which have continued to rise in September and could signal further downside effects to demand on the horizon.
- The Midwest witnessed the most significant decline in sales on a percentage basis, dropping -17.2%, while the South saw the steepest rise, climbing by 7.5%.
- The median price of a new single-family home sold was $430,300 in August, down from $440,300 one year ago.
4. INDEPENDENT LANDLORD RENTAL PERFORMANCE
- On-time rental payments in units operated by independent landlords remained robust in September 2023, with 82.6% of tenants completing their monthly payments on time, according to the latest data from Chandan Economics.
- Despite sliding slightly from August, September’s national on-time payment rate remains above its 12-month average (82.4%). Currently, it stands 241 bps higher than September 2022 — reflecting the sector’s arch of continued improvement.
- September’s forecast full-payment rate, which takes on-time payments, late payments, and expected late payments based on historical trends, came in at 92.7% — decreasing by a marginal 19 bps month-over-month.
- Western states continue to hold the highest on-time payment rates in the country, led by Colorado (92.6%), Utah (91.5%), Arizona (88.3%), North Dakota (88.1%), Washington (87.7%), and California (87.1%).
- Small multifamily (5-49 units) rental properties held the highest on-time payment rates of all sub-property types in September, coming in at 83.2%.
5. DALLAS FED MANUFACTURING INDEX
- According to the latest data from the Dallas Fed’s manufacturing Index, manufacturing activity—which has fallen consistently over the past year— accelerated its decline in September.
- The Dallas Fed index serves as a helpful barometer for nationwide manufacturing activity. September was the first month since May that the decline in activity has accelerated and signals a continued deterioration in business activity even as recession fears have reduced in recent months.
- Meanwhile, the production subindex of the report rebounded by nearly 20 points in September and climbed to its highest index reading of 2023. The New orders subindex of the report also rose during the month but remained in contraction as consumer demand continues to soften, but at a slower rate compared to earlier this year.
- The shipment subindex also moved higher and close to zero— a level consistent with neither expansion nor contraction.
- An uncertainty gauge of the index also saw a notable increase, in line with recent sentiment movements in small business optimism and consumer inflation expectations.
6. BEIGE BOOK SUMMARY
- According to the Federal Reserve’s most recent Beige Book summary, contacts from most bank districts reported modest economic growth to end the summer.
- Consumer spending on tourism was stronger than expected, though many expect the surge to trail off as the fall begins and consumer savings rates seemingly dwindle.
- Retail spending continued to slow, especially on non-essential items. New auto sales expanded in many districts, but this was more linked to increased inventory and availability rather than increased demand. The next edition of the Beige Book, due out in mid-October, will better reflect the impact of the recent United Auto Workers (UAW) strike, which began on September 15th.
- Manufacturing contacts across several districts noted improved supply chain activity and a better ability to meet existing orders, but most districts saw a decline in new orders over this period.
- Single-family homes were the one sector where supply did not increase, indicative of the significant inventory constraints the housing market has felt following its pandemic-era boom. Construction activity has risen in recent months, but several districts note that the construction of affordable housing units remains underwhelming relative to demand.
7. POTENTIAL ECONOMIC IMPACT OF UAW STRIKE
- On September 15th, the United Auto Workers initiated a strike against the three major unionized US car manufacturers, GM, Ford, and Stellatis—striking all three for the first time in history, with potentially significant short-term implications for the US economy.
- Beyond the implications for the manufacturers and their workers, downstream effects from the strike include potential car dealer shutdowns, exacerbating existing car inventory shortages, increased vehicle prices, and potentially widening bond market credit spreads.
- If prolonged, the strike could even influence mortgage rates, particularly in regions of Michigan and Ohio, where closed plants may result in a regional recession. Slower growth in these regions could send rates lower, benefiting homebuyers but potentially stoking inflation further. Income loss among workers may also affect local spending and home-price trends.
8. GOVERNMENT SHUTDOWN
- The prospects of a fourth Federal government shutdown in the last ten years were raised this week after Congress failed to agree on either a stopgap or permanent spending bill with an October 1st deadline swiftly approaching.
- The immediate impact of a government shutdown is mainly felt by Federal workers, who are often furloughed as a result, while others work with delayed pay, which can seep into local economic fundamentals.
- According to an analysis done by Pew Research, since the passing of the 1974 Congressional Budget Act—which outlined the modern structure of the appropriations process— Congress has only passed all its required appropriation measures on time four times. Further, there have been five government shutdowns since 1995.
- Typically, Congress relies on continuing resolutions (CR) to buy itself time to address legislative budget gridlocks, which usually extend funding levels from the prior year for existing programs. However, it is unclear if Congress can rely on a CR this time, as the current difficulty preventing an agreement surrounds a push by some House members to enact deep spending cuts to existing programs.
9. CRE OFFICE LOAN MATURITIES
- Out of roughly $1.1 billion in office loan balances that had original maturity dates in August, only 7.7% were reportedly paid off, according to a recent analysis by Moody’s Analytics.
- The analysis notes that declining payoff rates are explained mainly by the underlying performance of maturing loans rather than a deterioration in the ability of stronger-performing loans to complete payoffs. According to Moody’s Analytics data, 70% of the August loan maturities had “significant lease rollover” and debt yields below 8%.
- Looking at the payment status of loans set to mature in 2023 but did not pay off, 40% continue to make monthly payments, while 60% are non-performing.
10. PRODUCER PRICE INDEX: IMPLICATIONS FOR RETAIL
- A new analysis by Trepp notes that a significant surge in the Producer Price Index (PPI) in August may add pressure to consumers whose spending has kept retail margins afloat in the face of rising interest rates.
- According to the BLS, the PPI for final demand goods rose by a seasonally adjusted 0.7% in August — 30 basis points above its July rise and the largest month-over-month increase since June 2022.
- The increase in wholesale prices significantly outpaced advanced forecasts by WSJ economists and signaled a persistence of production cost pressures on manufacturers. According to Trepp’s analysis, this may further increase acquisition and sell costs for sellers, resulting in compressed Retail NOI and revenues.
SUMMARY OF SOURCES
- (1) https://www.federalreserve.gov/newsevents/pressreleases/monetary20230920a1.htm#:~:text=The%20Board%20of%20Governors%20of,%2C%20effective%20September%2021%2C%202023
- (2) https://www.conference-board.org/topics/consumer-confidence
- (3) https://www.census.gov/construction/nrs/current/index.html
- (4) https://www.chandan.com/independent-landlord-rental-performance-report
- (5) https://www.dallasfed.org/research/surveys/tmos/2023/2309
- (6) https://www.federalreserve.gov/monetarypolicy/beigebook202309.htm
- (7) https://www.npr.org/2023/09/15/1199673197/uaw-strike-big-3-automakers
- (8) https://www.pewresearch.org/short-reads/2023/09/13/congress-has-long-struggled-to-pass-spending-bills-on-time/
- (9) https://cre.moodysanalytics.com/insights/cre-news/ma-cre-office-loan-maturity-monitor-remainder-of-2023-looks-no-better/
- (10) https://www.globest.com/2023/09/25/new-ppi-concerns-put-the-retail-market-on-notice/
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