CWCapital Markets Update - Third 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 review of current trends in the Student Housing sub-sector. We synthesize and present information gathered from various industry research, public resources, and our own research.

  • Economy: Continued positive employment and economic trends. UST10 yield reaches 7-year high.
  • Cyclical highs in property prices, volatility, and negative fundamentals.
  • Feature: Student Housing – A Study of the Risks


The mere mention of student housing generally brings a generically negative reaction from many market participants. Primary reasons for the reaction include perceptions of:

  • defaults in recently securitized transactions
  • high turnover rates, maintenance costs, property wear and tear
  • market overbuilding
  • falling enrollment rates

To validate these perceptions, we reviewed recent performance information for 1,063 student housing loans in various CMBS, CLO, and Agency securitized transactions identifiable thru Intex.

For the complete commentary, stats and graphs:

The Economy

  • The November 2nd jobs report noted that the economy continues to grow with 250,000 jobs created in October. Employment in the professional and business services category again led with 516,000 jobs created over the past year, leading both construction (330,000), and manufacturing (296,000) for the same period.
  • The unemployment rate remained at 3.7%, the lowest level in decades. The participation rate was relatively steady at 62.9%. Recently, BLS noted state outliers Alaska (currently highest at 6.7%), and Hawaii (lowest rate at 2.1%). For cities, the Ames IA, Idaho Falls ID, Iowa City, IA, and Fargo ND Metro areas all report less than 2.0% unemployment, while Merced, Bakersfield, El Centro CA, and Yuma AZ all report over 7.0% unemployment.
  • The 10-year US Treasury yield at 3.19% has broken out recently and has reached levels not seen since 2011. The 2/10 spread is 30bps, showing slight steepening in the past month, but still relatively flat. Historically, inverted yield curves can signal an economic slowdown. With continued economic strength, the Federal Reserve is expected to continue its tightening cycle. The US budget deficit rose 17% in its 2017 fiscal year to $779 billion. The break-out in 10-year rates could signal a housing and commercial real estate slow-down in the months to come. Combined with the lower tax revenues, increasing deficits, and trade tensions, we remain watchful for signs of real estate price weakness. The Federal Reserve Bank of Atlanta recent GDP forecast has now trended down to 3.9%.

Property Markets

  • Effective rent growth -National average now 2.23% year over year, continuing to slow. Multi-family rents showed a 3.00% increase for the year, while retail growth continues to fade at 1.32%.
  • Vacancy rates –For the trailing 1-yr period, vacancy rates increased slightly for all property types, (20 to 130bp). 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 increased by 6.80% on an annualized 3-year basis, while retail properties lost 5.29% on the same basis. 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 $27.8bn is off last year’s levels by approx. 18.7%. Competing products such as FHLMC ($45bn), SASB ($28bn), CRE-CLO ($9bn), and balance sheet lenders continue to take market share.
  • CMBS risk retention pricing -Horizontal subordinates in the 14% area, L-shaped subordinates in the 16% area.
  • Conduit delinquency rates dropped to 2.16% this month. Estimated 72% 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.
  • Rising Interest Rates -recent break-out in the 10-year, growing deficit, trade tensions may pressure property values.
  • Student housing performance – declining enrollment, demographics, technology, overbuilding impact performance.

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