In This Issue
In this issue of the Capital Markets update, we focus on the fundamentals and trends affecting national commercial real estate debt markets and feature a look at asset NOI growth relative to published valuations. We synthesize and present information gathered from various industry research, public resources, and our own research.
- First signs of a potentially slowing economy
- Property price volatility
- Feature – Conduit collateral: Rich or Cheap vs the Fundamentals
Conduit Collateral – Rich or Cheap vs Fundamentals?
Given recent market focus on property valuations, we offer a fundamentals-based review of valuations across the CMBS sector. Our analysis is based on the following methodology:
- Our review included 430 conduit transactions issued since 2005
- We located 1,170 properties whose loans were securitized at least twice (generally 10 yrs apart)
- We compare NOI and Appraisal/Unit for each property at initial and most recent securitization
- We calculate implied long‐term growth rates for both NOI and Appraisal, then develop a multiple which compares the two. Our analysis makes appropriate adjustments for outliers, then compares the average multiple for each class
- Allows for easy comparison across asset types relative to cap rate analysis
- Multiples of 1.0x imply comparable growth rates between fundamental cashflow and property values
- Multiples above or below 1.0x can be driven by sector cap rate compression, low interest rates, macro factors such as the growth in on‐line shopping, or basic mis‐pricing
- Although most sectors are at cyclical highs, we see some concern in multi‐family garden apartments, limited service hotels, and self‐storage facilities, all appearing to have priced in multiples ahead of underlying fundamentals for the past 3 years. Multi‐family deliveries could present additional challenges to that sector’s ongoing pricing. Conversely, pricing pressure is particularly evident in the office sector, as prior overbuilding and macro driven declines continue
- More important than ever, asset level underwriting may reveal not only overvalued assets, but undervalued assets and opportunities in an oversold sector
For the complete commentary, stats and graphs:
- The March jobs report noted that only 98,000 jobs were added to the economy, with the unemployment rate falling to 4.5%, the lowest level since 2008. The participation rate improved slightly to 63.0%. The Bureau of Economic Analysis reported GDP growth at 0.7%, the lowest level in 3 years. Possible signs of an economic slow‐down.
- The Bureau of Labor Statistics notes continued job growth in financial and professional services, healthcare and now mining. Average hourly earnings rose by 2.7% year over year, which represents a growing trend. The BLS notes the decline in retail trade jobs with employment in general merchandise stores declining by 89,000 jobs since October 2016. This trend could continue as internet shopping continues to grow. WTI crude oil back to just under $50/bbl.
- The 10‐year US Treasury yield has fallen to 2.32%, testing post election lows. Our measure of GDP growth over the trailing 1, 3, and 5 year periods at 2‐3% on average. Forward trade policy, potential deficits associated with tax reform, and geopolitical events bear watching and could influence currency and interest rate trends.
- Effective rent growth ‐ National average of 2.91%. Multi‐family leads at 5.39%, retail lags at 1.42%.
- Vacancy rates – For the trailing 1 and 5 year periods, vacancy rates have improved across all broad categories. Of course, individual properties will vary, and sectors may experience increases with building. The multifamily sector has seen the highest deliveries in over 18 years. We expect vacancy increases are likely in selected areas.
- National property prices report decreases and some volatility in multi‐family prices, along with retail and hotel prices as previously reported.
Debt Capital Markets
- Q1‐17 CMBS conduit issuance of $8.3bn lagged Q1‐16 by 15%, and lagged 2015’s $13.4bn by over 37%. We expect further comparative lags in 2017 as risk retention and increased capital requirements now apply.
- CMBS risk retention pricing ‐ Horizontal subordinates in the 14% area, L‐shaped subordinates in the 18% area.
- Current conduit delinquency is reported at 3.79% according to Trepp. Although this level varies, maturity wave and conduit market contraction are driving the reversal of several years of declining delinquency.
Trends to Watch
- Cyclical highs in property prices ‐ national average hotel, retail, and office property prices experiencing volatility. Risk premiums have widened out in all sectors except multifamily. As property values increase we see property re‐levering with less and less sponsor equity. Multifamily valuations relative to cyclical highs, construction. Property levels of concern.
- Transformation of the lending and investing base ‐ as conduit lenders and securitized markets withdraw, balance sheet and agency lenders increasing share. Subordinate investor base evolving to a new set of investors, including insurance, funds, and others with long term funding (in addition to traditional b‐piece/ special servicer firms).
- Maturity wave and risk retention ‐ increased loan defaults as maturities meet the securitized markets. Receding liquidity, risk retention, bank capital rules, and regulatory requirements. Overall maturity defaults (later than 90 days past maturity) at 13.7% down from a 22% peak in July 2016, according to Morningstar data.
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