CWCapital Markets Update - Second 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 SASB Office markets. We synthesize and present information gathered from various industry research, public resources, and our own research.

  • Economy: Continued positive employment and economic trends. Relentless flattening of the yield curve, spread tightening in the deep credit space
  • Cyclical highs in property prices, volatility, and Retail’s negative fundamentals
  • Feature: Relative Value in the SASB Office Market


One of the hottest sectors in securitized CRE debt markets this year has been the Single Asset / Single Borrower space. For example, 2018 has seen 55 deals issued so far aggregating $25.4bn. This represents 80% of 2017’s volume with the typically heavy fall season yet to come. As of this writing, SASB issuance volume equals the traditionally larger conduit issuance for the year. This is further evidence of the shift between conduit and SASB market share.

We review basic information about the sector below (Table 1), and then focus on some interesting spread differentials, and on relative value in the Office component in particular. As with any other sector, Office offers several varieties of deal types and unique risks. Investors can choose from not only short-term floating rate deals, but also 10 year fixed rate deals, and securitized ground leases.

For the complete commentary, stats and graphs:

The Economy

  • The July jobs report noted that the economy continues to grow with 157,000 created this month. Employment in the professional and business services category grew by 51,000, with strong growth in manufacturing (37,000) and health and social services (34,000). Retail jobs remained relatively stable, amid declining long-term trends.
  • The unemployment rate declined to 3.9%, the lowest level since at least 2003. The participation rate was steady at 62.9%. BLS notes state outliers of Alaska currently 6.9%, and Hawaii with the lowest rate at 2.1%. For cities, Nashville and the San Francisco bay area previously reported the lowest rates (2.7%), Buffalo the highest at 5.8%.
  • The 10-year US Treasury yield at 2.84% has been stable below the 3.00% level for several weeks. We have seen continued 2/10 flattening of 44bps YTD, with the current level at a low 24bps. 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, the risk of trade tariff cycles, and increased deficits as a result of tax reform. The Federal Reserve Bank of Atlanta forecasts 2018 US GDP growth at 4.3%.

Property Markets

  • Effective rent growth – National average of 3.01% year over year, continuing to slow. Multi-family rents showed a 4.21% increase for the year, while retail growth continues to fade.
  • Vacancy rates – For the trailing 1-yr period, vacancy rates increased slightly for all property types, (20 to 110bp). Deliveries in all property types began to slow relative to 2017’s pace. Absorption for all asset classes is less than 1.0x, with retail turning negative (-1.09x), the first sector to do so since the financial crisis. We expect continued vacancy increases in multi-family as construction pipeline is delivered.
  • National property prices for multi-family declined by 0.45% year to date, while other sectors showed some growth. Continued price volatility in all sectors this year, and we remain at or near peak levels.

Debt Capital Markets

  • Credit spreads at senior most levels stable, but significant tightening in credit spreads down the stack. YTD18 CMBS conduit issuance of $21.5bn is off last years levels by approx. 7.5%. Competing products such as FHLMC ($37bn), SASB ($25bn), CRE-CLO ($8bn), and balance sheet lenders continue to take market share.
  • CMBS risk retention pricing – Horizontal subordinates in the 14% area, L-shaped subordinates in the 19% area.
  • Conduit delinquency rates dropped to 2.37% this month. Estimated 80% of delinquencies in the 06/07 vintages.

Trends to Watch

  • Cyclical highs in property prices- all property types experiencing price volatility at national level. Retail experiences negative absorption and slowing construction. Multifamily valuations, construction, and cash-out refi’s 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.
  • Student housing performance – competition from universities, other operators and factors impacting performance.

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