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 reviews 2019’s credit performance and what we can infer about asset class-default trends. We synthesize and present information gathered from various industry research, public resources, and our own research.
- Feature – Year in Review: 2019 Default Trends
- Economy – Slow and steady. Record budget and trade deficits in a time of record-low unemployment.
- Three trends we are watching
Year in Review: 2019 Default Trends
One of the most common conversations among investment professionals begins with the question, “so what are you guys seeing”. Year-end 2019 gives us that opportunity to step back and take a look at the past year’s CMBS collateral performance and credit trends. This analysis helps us identify any consistent themes or patterns and helps to answer the common question.
We reviewed data on over 23,600 conduit loans, identifying any loan which defaulted or transferred to the Special Servicer during the calendar year 2019.
For a deeper look at 2019 default patterns and the all-important reason for default across the various asset types, we selected the top 10 loan defaults in each of Office, Retail, and Hotel. We analyzed the loan basis at default, current performance, debt yield, and primary reason as we could best determine from published servicer comments and other research.
- The November jobs report noted that the economy continues to grow with 266,000 jobs created. Employment in the health care and professional and business services category again led in jobs creation as we may expect. Healthcare has added 414,000 jobs over the past 12 months, while professional and technical services added 278,000, while the financial services sector added 116,000 for the same period.
- The unemployment rate remained stable at 3.5%, among the lowest levels since 1969. The participation rate also remained unchanged at 63.2%. Average hourly earnings showed some growth (3.1% year over year), continuing at a slow and steady pace. As of November 2019, El Centro CA, and Yuma AZ continue to have reported the highest unemployment in the nation, while the Dallas, TX, New York, and Los Angeles MSAs lead the nation in the number of jobs created.
- The 10-year US Treasury as of this writing was 1.77%, declining around 92bps from one year earlier. Much of the decline reflects overall concern around global trade tensions, economic weakness abroad, and geopolitical uncertainty. The 2/10 spread has now recovered to 27bp from inversion over the summer. In September 2019, the US budget deficit widened to almost $1 trillion, with the US trade deficit also widening to $884 billion. With record budget deficits at all-time lows in unemployment, our outlook is cautious on the economy, interest rates, and commercial real estate values.
- Effective rent growth – National average shows a 1.72% one-year growth rate, the slowest growth rate in the past 5 years. Multi-family rents grew 3.1% for the year, while industrial was less than 1% year over year.
- Vacancy rates – For the trailing 1-yr period, vacancy rates improved slightly in multi-family and retail properties, with deterioration in office and industrial properties. Estimated deliveries for 2019 increased by 4% for multi-family but declined by 16%, 5%, and 16% for office, retail, and industrial properties respectively. Absorption was less than 1.0x for all property types. We expect continued vacancy increases as heavy construction pipelines are delivered.
- National property prices for multi-family increased by 7.85% on a rolling 3-year basis, while hotel properties showed a 3.3% increase after 6 consecutive months of declines. Continuing its macro-decline, retail has lost value per unit (3yr basis) nearly every month for the past 3 years.
Debt Capital Markets
- Credit spreads generally tighten in 2019 with CMBS BBB – coming in approximately 140bps for the year. Year-end 2019 CMBS conduit issuance of $49.6bn is leading last year’s issuance by approximately 23%. Competing products such as SASB, FHLMC, and CRE-CLO have seen $45.4bn, $69.5bn, and $19.5bn of issuance at year-end 2019 respectively.
- CMBS risk retention pricing – Horizontal subordinates in the 14% area, L-shaped subordinates imply pricing of the Non-Rated conduit bonds in the 16%-25% area.
- Conduit delinquency rates dropped to 1.40% this month, reflecting continued improvement.
Trends to Watch
- Cyclical highs in property prices – All property types experiencing price volatility at the national level. Multifamily, hotel, and industrial building at a very robust pace. Over-levered properties finding their way into rated securitizations.
- Sector overbuilding – Hotels, student housing, multi-family, and now industrial are some of the most over-built asset classes across the market. Construction slowing somewhat relative to prior years. Helps absorption, however, we remain concerned about inventory already in the market.
- The retail purge – Retail assets from malls to local unanchored centers, to single-tenant, retail continues to struggle. Constitutes over half of all defaults in 2019. Maturing mall loans having difficulty refinancing even at lower leverage points.
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