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 our annual assessment of the multi-family fundamentals. We synthesize and present information gathered from various industry research, public resources, and our own research.
- Economy: Positive year-end employment and economic trends. Rising short rates, a flattening yield curve, and tightening spreads.
- Cyclical highs and volatility in property prices
- Feature: Our year-end assessment of multi-family fundamentals
The year 2017 represented a continuation of the bull market in multi-family fundamentals, per unit prices, and in financing, however, several clear warning signals associated with a late-cycle asset class have now appeared. This year represented the eighth year of growth in national price per-unit (other than 2014), the eighth year of effective rent growth (other than 2009), and continued stability in the risk premiums offered relative to US Treasuries. Additionally, the strong US economy has begun to exhibit signs that could be traditionally associated with slowdowns. Tax policy, immigration, and interest rates may all influence market conditions.
Overall, our outlook for multi-family fundamentals includes moderating rent, NCF, and price growth. We expect elevated vacancy rates, and possibly a slowing economy late in 2018 into 2019. Falling asset prices could slow property sales, lending, and pressure borrowers seeking to refinance. The rapid rate of prepayment in certain multi-family pools could slow, and loans could potentially extend if enough pressures mount. As home prices potentially become more affordable in the long term, risks to the multifamily asset class may result.
For the complete commentary, stats and graphs:
- The December 2017 jobs report noted that the economy added 148,000 jobs this month. The majority of jobs were created in healthcare (31,000), construction (30,000), and manufacturing (25,000). Retail jobs declined by some 20,000 workers, reflecting the longer-term trends in this sector.
- The unemployment rate declined for the year to 4.1%, from 4.7%. The current rate is the lowest since 2003. The participation rate was relatively steady at 62.7%. BLS also notes that average hourly earnings increased year over year by some 2.50% to $26.63/hour.
- The 10-year US Treasury yield finished at 2.40%, essentially flat from the prior year end of 2.45%. We have seen noticeable 2/10 flattening in 2017 of 74bps YTD, with the current level at a low of 51bps. 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 tax reform. The Federal Reserve Bank of Atlanta estimated 4Q17 GDP growth in the 3.3% range.
- Effective rent growth – National average of 3.64% year over year, showing some sings of slowing. Industrial growth now leads multi-family growth, reporting 6.44% versus 4.23%. Retail and Office lag in the 1.95% area.
- Vacancy rates – For the trailing 1-yr period, vacancy rates increased slightly for all property types, (10 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
- Credit spread tightening beginning to show across all sectors as investors compete for product. 2017 CMBS conduit issuance of $48.5bn was relatively flat compared to 2016’s $48.0bn. Issuance may have slowed as investors dealt with new risk retention structures and the maturity wave. FHLMC issuance of $62bn grew 20% year over year, single asset issuance topped $36bn (almost double the prior year), and $7.6bn of CRE-CLO’s were issued as well.
- CMBS risk retention pricing – Horizontal subordinates in the 16% area, L-shaped subordinates in the 18% area.
- Conduit delinquency rates dropped to 3.00% 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.
- 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.
- Increasing interest rates – 2017 saw several rate hikes on the short end with 80bps in 1m LIBOR year over year. Significant flattening of the 2/10 yield curve from 125bps to 51bps at year end.
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