CWCapital Markets Update - First Quarter 2018

In This Issue

In this issue of the CWCapital Markets Update, we focus on the fundamentals and trends affecting national commercial real estate debt markets. Our feature includes a framework for analyzing relative value in securitized debt products. We synthesize and present information gathered from various industry research, public resources, and our own research.

  • Economy: Continued positive employment and economic trends. Rising rates, the ever flattening yield curve, and spread tightening.
  • Cyclical highs and volatility in property prices
  • Feature: A framework for relative value in securitized commercial real estate debt markets


Comparing investment options in securitized CRE can be challenging. In this edition, we outline one possible approach to comparing various alternatives. Our first step is to take a high-level look at certain fundamentals. This macro review can help inform our view of economic trends, overall property trends, risk premiums, and market trends.

Secondly, we review characteristics of four main investment alternatives in securitized commercial real estate debt as well as current risk retention guidelines (detailed in offering materials).

For the complete commentary, stats and graphs:

The Economy

  • The March jobs report noted that the economy continues to add jobs creating 103,000 this month. Some 22,000 job creations were in the durable goods manufacturing segment, with gains also to show in mining, health care, and professional services. Retail jobs declined by some 4,000 workers, reflecting the longer-term trends in this sector.
  • The unemployment rate remained unchanged at 4.1%, the lowest level since at least 2003. The participation rate was steady at 62.9%. BLS notes state outliers of Alaska currently 7.3%, and Hawaii with the lowest rate at 2.1%. For cities, Nashville and the San Francisco bay area have lowest rates (2.7%), Buffalo the highest at 5.8%.
  • The 10-year US Treasury yield at 2.96% has been testing the 3.00% level for several weeks. The last time yields topped 3.00% was seven years ago in 2011. We have seen continued 2/10 flattening of 5bps YTD, with the current level at a low 46bps. Historically, inverted yield curves can signal an economic slowdown. Among the many factors that could influence interest rates in the near to medium term are the Federal Reserve’s continued tightening cycle on the short end, the “unwinding” of its quantitative easing balance sheet, increased global growth and recovery, and increased deficits as a result of reform. The Federal Reserve Bank of Atlanta forecasts 2018 US GDP growth at 4.1% while consensus forecasts are closer to 3.1%.

Property Markets

  • Effective rent growth – National average of 2.27% year over year, continuing to slow. Of note, Industrial growth now leads multi-family growth, reporting 3.33% versus 2.92%. Retail and Office lag in the 1.50% area.
  • Vacancy rates – For the trailing 1-yr period, vacancy rates increased slightly for all property types, (20 to 60bp). Higher deliveries in all property types except retail, with multi-family absorption below 1.0x deliveries for first time since 2009. We expect continued vacancy increases as construction pipeline is delivered.
  • National property prices report declines and volatility in all sectors this year, although we remain near peak levels.

Debt Capital Markets

  • Significant credit spread tightening across all sectors as interest rates rise and investors compete for product. YTD18 CMBS conduit issuance of $9.2bn topped YTD17 by 7% as investors became more comfortable with risk retention and the maturity wave. FHLMC issuance was nearly 50% greater than CMBS at $17.2bn, with $9.8bn of single asset deals and $3.2bn of CRE-CLOs also coming to market.
  • CMBS risk retention pricing – Horizontal subordinates in the 14% area, L-shaped subordinates in the 17% area.
  • Conduit delinquency rates dropped to 2.85% this month. Estimated 80% of delinquencies in the 06/07 vintages.

Trends to Watch

  • Cyclical highs in property prices- national average hotel, retail, and office property prices experiencing volatility. Hotel risk premiums have widened out appreciably year to date. As property values increase, we see certain sponsors re-levering and extracting equity. Multifamily valuations and construction a concern.
  • Credit spread tightening in a rising rate environment – Credit spreads across all sectors have tightened by over 200bp since early 2017. Competition for product, rising rates, and other factors driving spreads to 3-year lows.
  • CMBS conduit market share – in our July 2016 update, we noted the decline in market share of conduit CMBS. Only 62% of maturing loan volume was being replenished to the sector. Overall issuance appears flat with Agency, SASB, and CLO issuance all gaining share.

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