CWCapital Markets Update - Third Quarter 2019

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 the value of location as it relates to retail outlet centers as an asset class. We synthesize and present information gathered from various industry research, public resources, and our own research.

  • Feature – Outlet Centers – The value and the location…it matters.
  • Economy – Slower growth. Record budget deficits and trade deficits in a time of record-low unemployment.
  • Three trends we are watching

Featured

Outlet Centers — The Value and the Location

Following the great recession over 10 years ago, retail consumer preferences have shown a meaningful shift toward value, cost-conscious, and discount-based consumption. This shift coupled with the macro-trend of online shopping resulted in the well-publicized decline in retail sector, and in particular, the regional mall.

Wherever there is decline, however, there is also opportunity. Factory outlet centers are positioned as an alternative to both consumers and retailers and may just fit the bill. Value propositions for each of the interested parties: consumer, retailers, and real estate owners.

The Economy

  • The September jobs report noted that the economy continues to grow but at the slower pace of 136,000 jobs created. Employment in the health care and professional and business services category again led in jobs creation as we may expect. Professional services showed a 25% reduction in the rate of growth year over year, however. Employment in the retail sector, specifically clothing and accessories, fell by 14,000.
  • The unemployment rate declined to 3.5%, among the lowest levels since 1969. The participation rate was 63.2%. Average hourly earnings showed some growth (2.9% year over year), but earnings growth is also slowing since our last report (3.5%). As of October 2019, El Centro CA, Yuma AZ continue to have reported the highest unemployment in the nation with both over 22%. Portland ME, Burlington VT, and Ames IA report the lowest with rates less than 2.0% each.
  • The 10-year US Treasury as of this writing, rate was 1.84%, declining approximately 84bps from last year end. Much of the decline reflects overall concerns and worry around global trade agreements, or the lack thereof, economic weakness abroad, and geopolitical issues. The 2/10 spread has now recovered to 20bp 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. Other than 3 years around the financial crisis, both the US budget deficit and the US trade deficit are now at the highest level in the last 50 years. This as the rate of unemployment is at its lowest in 50 years. We remain cautious on prospects for the economy.

Property Markets

  • Effective rent growth – National average shows a 2.88% one-year growth rate, relatively flat to the rate at our last writing. Multifamily rents grew 4.6% for the year, while retail growth continues to lag at 1.85%, continuing to slow.
  • Vacancy rates – For the trailing 1-yr period, vacancy rates declined (improved) in multifamily and retail properties but increased in office and industrial properties. First half 2019 deliveries slowed by 25%-30% across multifamily, office, retail, and industrial properties. Absorption was positively impacted, but more related to slowing construction pipelines. We expect continued vacancy increases across all categories as heavy construction pipelines are completed.
  • National property prices for multifamily increased by 6.3% on a rolling 3-year basis, while hotel properties showed a 6 th consecutive month of declines year over year. Continuing its macro-decline, retail has lost value per unit (3yr basis) nearly every month for the past 2 years.

Debt Capital Markets

  • Credit spreads generally tighten in 2019 with CMBS BBB- coming in approximately 145bps year to date. YTD19 CMBS conduit issuance of $29.6bn is leading last year’s issuance by approximately 7% or $1.9bn Competing products such as SASB, FHLMC, and CRE-CLO have seen $28bn, $48bn, and $14bn of issuance YTD, respectively.
  • CMBS risk retention pricing – Horizontal subordinates in the 14% area, L-shaped subordinates imply pricing of the Non-Rated conduit bonds in the 24% area.
  • Conduit delinquency rates dropped to 1.53% 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-building a concern. Over-levered properties finding their way into rated securitizations.
  • Slowing construction deliveries – First half 2019 property deliveries across asset classes appeared to have finally started to slow relative to the same period last year. Although this helps absorption figures, we remain concerned about the amount of inventory delivered across asset classes and in certain markets.
  • Economic uncertainty – Global trade uncertainty, the impact of tariffs, ballooning deficits, trade deficits, and the potential for negative real interest rates provides the basis for general concern over asset prices and performance across the CRE asset class.

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