SVN | Research Economic Update 10.13.2023

1. SEPTEMBER JOBS REPORT

The US economy added 336,000 new jobs in September, according to the Bureau of Labor Statistics, almost double the consensus forecasts. The unemployment rate remained unchanged at 3.8%.
September’s employment growth was the highest since January, reflecting continued economic and labor market growth despite higher interest rates and falling business sentiment.
While the figures are strong, gains were mostly seen in industries that had lagged during the post-COVID recovery, and some economists suggest that this may reflect workers being forced to accept positions with lower pay as the breadth of opportunities dwindled.
Average hourly earnings rose by 0.2% during the month and 4.2% year-over-year, both measures growing at their slowest all year.
The report has expectedly brought closer inspection of the Federal Reserve’s upcoming interest rate decision. However, fed futures markets have overwhelmingly foreseen a no-hike scenario at the FOMC’s November policy meeting.

2. JOB OPENINGS AND LABOR TURNOVER

Preceding September’s jobs report was the BLS’ Job Openings and Labor Turnover Survey, which showed that job openings rose larger than expected in August, a leading indicator of the labor demand that caught some forecasters off-guard after the recent jobs report.
Openings rose to 9.6 million, with hires and total separations remaining stable at 5.9 million and 5.7 million, respectively. Among separations, quits and layoffs/discharges were mostly unchanged at 3.6 million and 1.7 million, respectively.
Following the report, markets fell out of concern that the Federal Reserve would renew its rate increases in the face of a continuing hot labor market. However, futures markets have remained firm on a no-hike forecast for the November meeting.

3. FOMC MEETING MINUTES

Minutes from the Federal Reserve’s September meeting show that on balance, officials believe that one additional rate hike will be needed in 2023, though consensus on the forecast was fairly weak.
In the FOMC’s Summary of Economic Projections, about two-thirds of members forecasted one additional rate hike before the end of the year. Members also predict that the median federal funds rate in 2024 will be 5.1%, above the 4.6% forecast at the June meeting.
However, officials were unanimous on the need to keep rates elevated until inflation returns to its 2% long-run target and to “proceed carefully” on future rate decisions as the US economy deals with multidirectional economic forces.

4. THE RISE OF SMALLER FLOORPLATES

As the Office sector grapples with post-pandemic impacts, transactions containing assets with smaller floorplates have become an increasing share of deal volume, according to data from MSCI.
While the percentage of office transactions containing smaller floorplates had steadily risen between the Great Financial Crisis and 2020, it has accelerated during and after the pandemic as companies reassessed their space needs in the face of the new remote-work equilibrium.
Transactions in the 5-10k square-foot range have jumped from about 18% of the market pre-pandemic to roughly 25% today, while the under 5k share has jumped from about 10% pre-pandemic to 15% in 2023.
Both remote work’s impact on offices and shrinking space demand is more than a US phenomenon.
Global deal volume for offices has declined to the lowest since 2008, while smaller floorplates now take up half of all European office transactions, reflecting a global industry shift.

5. HOME AFFORDABILITY

Home affordability fell in the US during the third quarter of 2023 compared to the previous quarter, according to the latest US Home Affordability Report by ATTOM.
Affordability fell in 99% of the counties tracked nationwide by ATTOM, extending a two-year trend of declining home affordability.
Entrenched higher mortgage rates and a modest uptick in asset prices during the third quarter have led to further affordability constraints, with homeownership now requiring 35% of today’s average wages to meet costs. Common lending standards call for a 28% debt cost-to-income ratio, rendering today’s levels unaffordable.
Counties with the largest populations that were unaffordable in the third quarter were Los Angeles County, CA; Cook County (Chicago), IL; Maricopa County (Phoenix), AZ; San Diego County, CA; and Orange County, CA.

6. CHINA RE TROUBLES: IMPACT ON GLOBAL GROWTH

In a previous SVN economic update, our team forecasted little impact from China property giant Evergrande’s woes on US markets, but recent distress in other parts of China’s real estate sector and its economy at large may pose risks to global markets.
“Country Garden,” China’s largest property developer, recently indicated that it may default on US dollar-denominated bonds. Believed to account for up to 30% of China’s GDP, a broader crisis in the nation’s property sector would weigh on its entire economy. China has been the largest source of growth for the world economy in recent decades.
The IMF recently cut its forecasts for Chinese growth and noted that commodity exporters that rely on Chinese demand could be at risk ahead. Still, there is little to suggest that the nation’s property market woes will significantly spill into US commercial real estate.

7. CRE & NET ZERO

A new report by HSBC reviews how the real estate sector is transitioning to net zero, highlighting operator views and strategies in approaching the challenge.
According to the report, 97% of real estate companies say net zero is commercially important to their
business.
56% of real estate companies say that technology developments are helping them progress towards their net zero goals, while 39% claim to be spending more than 10% of capex on the transition, with 51% expected to do so within the next three years.
Retrofitting and embodied carbon received specific shoutouts in the report as critical segments of the company’s strategies. Retrofitting existing buildings is believed to be less carbon-intensive than building new ones, while policymakers are increasingly looking to embodied carbon to make new construction more sustainable.

8. TAX INCENTIVES FOR LOAN MODIFICATIONS & DEBT RELIEF

A recently proposed bi-partisan US House bill aims to amend the tax code for commercial real estate borrowers during loan modifications. The bill zeros in on the cancellation of debt income policy and treats debt forgiveness as a taxable event, where borrowers are taxed on the amount canceled.
The proposal would expand the cancellation of debt income to policies to include pre-2022 loans canceled between 2023 and 2027. It also aims to preemptively respond to the challenge of $1.5 trillion in commercial real estate debt maturing by 2025.
If passed, the legislation could alleviate the distress in the industry by incentivizing loan modifications and debt workouts. While the house sponsors crossed party lines, the bill will still need to seek support in the US Senate and the White House for eventual approval.

9. UBS SIX BURNING QUESTIONS ON REAL ESTATE

A recent report by UBS attempts to answer 6 of the “most burning questions” facing CRE in the face of converging economic trends.
Regarding housing affordability, the firm confirmed trends showing higher stress levels than in recent years, noting that renting is “significantly less” expensive than buying in 48 out of 50 of the largest markets.
Regarding the housing supply and demand imbalance, UBS views that the “lock-in effect” from previously low interest rates will keep homeowners in a holding pattern for some time while would-be homebuyers remain cautious, perpetuating the imbalance.
The firm expects home prices to stay afloat due to the supply-demand imbalance with potential increases in 2024. It also predicts that CRE distress may increase in the short run, but a highly capitalized financial system likely limits its impact.
Regarding office conversions, UBS projects that only 10-15% of existing office stock may be viable for this solution. Meanwhile, they see residential and industrial markets as the most robust CRE investment opportunities in real estate.

10. DATA CENTERS AND NUCLEAR POWER

Data centers have grown in importance in the CRE space as our digital economy needs to converge with an office sector looking to reinvent itself. As SVN Research has covered previously, power demand has driven much of the strategy on where to construct new centers, and a recent operator has turned to an unorthodox source for power needs: nuclear reactors.
According to an analysis by Globe Street, data center operator Standard Power will deploy up to two dozen small modular reactors (SMR) to power new centers in Ohio and Pennsylvania for AI training and blockchain mining.
The 24 reactors will generate roughly 2 gigawatts of power, similar to the scale of reactors used to power
US Navy subs and aircraft carriers.
Experts note that with older grid capacity shrinking and a lack of new sustainable options on the market
as demand for AI and other intensive computing rises, nuclear power presents a creative but controversial
solution.

SUMMARY OF SOURCES

(1) https://www.bls.gov/news.release/empsit.nr0.htm
(2) https://www.bls.gov/news.release/jolts.htm
(3) https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
(4) https://www.msci.com/www/quick-take/office-property-the-rise-of-the/04098315173
(5) https://www.attomdata.com/news/market-trends/home-sales-prices/attom-q3-2023-u-s-homeaffordability-report/
(6) https://www.axios.com/2023/10/11/chart-chinas-real-estate-struggles
(7) https://www.business.hsbc.com/en-gb/campaigns/transition-pathways/real-estate?cid=HBEU:JS:REALESTATE:D6:GBM:L7:XXG:HPP:9:TS:5:0923:005:TP
(8) https://finance.yahoo.com/news/house-bill-create-tax-incentive-212951670.html?utm_source=newsletter.credaily.com&utm_medium=newsletter&utm_campaign=landlords-under-pressureas-insurance-costs-skyrocke
(9) https://www.ubs.com/global/en/investment-bank/corporate-broking-pitchhiscox/overview/_jcr_content/mainpar/toplevelgrid_818842007/col1/accordion/accordionsplit_1965171366/innergrid_copy/xcol2/teaser_copy/linklist/link.0983566995.file/PS9jb250ZW50L2RhbS9hc3NldHMvaWIvZ2xvYmFsL2NvcnBvcmF0ZS1icm9raW5nLXBpdGNoL2RvY3MvaW5zaWdodDgta2V5LXF1ZXN0aW9ucy1hbmQtYnVybmluZy1pc3N1ZXMtc2VwdDIwMjMucGRm/insight8-key-questions-and-burning-issuessept2023.pdf
(10) https://www.globest.com/2023/10/12/nuclear-powered-data-centers-coming-to-ohiopennsylvania/

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The East Coast comes next, and both are due to the volume of new apartment supply.

RealPage reports that the Midwest area has a substantial lead in apartment growth performance thanks to new apartment supply volumes and rent reductions rather than price rises in several regions of the country.

In fact, year-over-year net inventory growth in 2023 increased by 1.4%, while effective asking rents in the Heartland increased by 3.1% in the year ending in August of that year. Although those figures fell short of the region’s 10-year average, they were far above the trend seen in other parts of the country where annual rent reductions are taking place.

There is yet another exception. In the East, events are also different from those in the majority of other parts of the country, where they are registering annual rent reductions. The year-over-year net inventory growth is up 1.2%, and the growth in the East is more mild than in the Midwest at 2.5%. Once more, it is due to an increase in completed apartment buildings.

However, in contrast to the Midwest and East Coast, where they are “swelling,” according to RealPage, but at a slower rate and affording operators what it also refers to as “some breathing room,” the other regions are discovering that new deliveries weigh down on pricing power.

However, taking a look at some of the other markets provides a more accurate national perspective. As of August 2023, the Carolinas’ effective asking rent change year over year was -0.5%, and its year over year net inventory growth was 3.6%. In the Mountains/Desert region, year-over-year net inventory growth was 3.2%, and the effective asking rent change was -2.1%. In Florida, the year-over-year growth in effective asking rent was 0.7%, and the year-over-year growth in net inventory was 3%. In the Southeast, year-over-year net inventory growth was 2.6%, and year-over-year effective asking rent change was -0.2%. In Texas, the year-over-year change in effective asking rent was -0.3%, and the year-over-year change in net inventory was 2.2%. Last but not least, on the West Coast, the year-over-year net change in asking rent was -0.8%.

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And that’s without taking into account the impact of rising Treasury yields.

Everyone in the industry is aware of how difficult the CRE refi market is at this point. However, the connection between high interest rates and many lenders, particularly banks, tightening their requirements and even withdrawing from the markets is still unclear.

To better understand at least one mechanism in place based on the Secured Overnight Financing Rate (SOFR), CRED iQ conducted some data analysis. This is “a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities,” according to the Federal Reserve Bank of New York, rather than looking at a rate range the Federal Reserve sets for the federal funds rate. Instead of self-reported data that banks could manipulate for profit like the old LIBOR measure did, the data is based on transaction costs that have actually been gathered.

It makes sense that the firm highlighted that adjustable rate CRE loans provide a hurdle when interest rates are rising. The increasing rate tidal indicates that there is a significant likelihood that whatever floating rate a plan has foreseen won’t be enough unless an investor, developer, owner, or operator has prepared ahead.

According to CRED iQ’s research on floating loans, 44% of loans with near-term expirations will have rate cap agreements that expire before the loans mature. According to the Federal Reserve Bank of New York’s SOFR data, it is obvious that the increase in SOFR is having a significant impact on upcoming floating rate loan maturities.

a warning that correlations don’t always imply causality. Even though two sets of data are trending in the same direction, they may not fully or even mostly be responsible for one another’s moves. Many apparent correlations between lending and SOFR were discovered by CRED iQ. When researching Fannie Mae floating rate issuance, they discovered “effects of the rising interest rate environment, including the aggregate Average Original Note Rate, Average Loan Scheduled Interest Due, and how these metrics vary by Seller.”

According to CRED iQ, “it is clear from the analysis of the trailing twelve-month (TTM) data that the average interest due on Fannie Mae loans has increased by over 280%.” If rates rise on a floating rate loan, then more money flows into rent-taking with less available to enhance DSCR and lower property values increasing LTV. “This surge is exerting substantial pressure on Debt Service Coverage Ratio (DSCR) and Loan-to-Value (LTV) ratios for these properties.”

Remember that there are other factors as well, such as rising Treasury yields. They act as markers for secure returns that can be used to calculate risk-adjusted management. Over 5.5% yields are on the short end of the Treasury curve. On Monday, September 25, a 1-year is 5.46%, and a 10-year is 4.44. To exit a safe investment, investors require a large return. The biggest asset management, BlackRock, believes that rates will remain high and may even continue to rise from their 16-year highs.

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1. CPI INFLATION

The Consumer Price Index rose 3.7% year-over-year and 0.6% month-over-month in August, its largest monthly increase this year, according to Wednesday’s release by the Bureau of Labor Statistics.
Energy was responsible for much of the increase in headline inflation, rising 5.6% on the month, including a 10.6% increase in gasoline offset by other key energy metrics.
Core-CPI, which excludes food and energy prices from the calculation, rose 0.3% from July and 4.3% year-over-year, hotter than many economists expected. Shelter continued to be a pivotal contributor to core CPI, while prices for other core items, such as used vehicles and airfare, continued to decline.
Just one week after the CPI release, FOMC officials are set to meet to conduct their newest policy decision, where they are largely expected to hold rates steady.

2. INTEREST RATE OUTLOOK

According to the Chicago Mercantile Exchange’s Fed Watch Tool, an overwhelming majority of futures markets (97.0%) expect the FOMC to hold the benchmark Fed Funds rate unchanged at 5.25-5.50%.
Despite a hotter-than-expected core-CPI inflation reading in August, officials prefer the Bureau of Economic Analysis’ PCE core inflation, which, while currently hovering slightly above the CPI measure, has shown a steadier decline over the past year.
Fed policymakers have recently positioned themselves with a more balanced outlook on inflation, viewing underlying price pressures as fading but cautious about taking their foot off of the break too prematurely. Presently, futures markets do not predict a rate cut from current levels until June 2024.

3. CONSUMER INFLATION EXPECTATIONS

US consumer inflation expectations for the year ahead rose to 3.6% in August, up from 3.5% in July, according to the New York Fed’s monthly survey.
This month marked the first time since March that consumer inflation expectations increased. One-year-ahead inflation expectations for rent ticked up 20 basis points to 9.2%, gas up 40 basis points to 4.9%, and food up 10 basis points to 5.3%.
Median home-price expectations for one year ahead climbed 30 basis points to 3.1%, its highest mark since July of last year.
Despite the broader rise in inflation expectations, they remain well below where they were one year ago. August’s marginal increase is unlikely to move the Fed away from its likely decision to hold rates firm in September.

4. AUGUST JOBS REPORT

The US economy added 187,000 jobs during August, continuing a positive but annualized downtrend as job openings continue to fall from their March 2022 peak. The unemployment rate jumped to 3.8%, its highest level since February 2022.
Health care experienced the largest gain by sector (+71,000), followed by leisure and hospitality (+40,000), social assistance (+26,000) and construction (+26,000).
Transportation and Warehousing was the biggest loser (-40,000), likely impacted by a recent major bankruptcy in the trucking industry.
Partially explaining the rise in the unemployment rate is an expansion of the labor force, which increases the number of people looking for jobs relative to job openings, distorting the unemployment rate. The labor force participation rate rose to 62.8% in August, the highest since February 2020, shortly before the COVID-19 pandemic in the US.
Average hourly earnings increased 0.2% month-over-month and 4.3% over the past 12 months, a slowdown from previous months. The slowdown in wage inflation is a crucial signal that underlying inflation pressures are easing in the United States.

5. SMALL BUSINESS OPTIMISM

The Small Business Index, produced by the National Federation of Independent Business (NFIB), declined slightly in August from the previous month, the first monthly decline since April.
Small Business optimism rose steadily throughout the spring and early summer months, indicative of fading recession fears and re-anchored inflation expectations. However, the recent downtick may signal a reversal in sentiment as experts warn that US recession risks remain. At the same time, Fed policymakers indicate a willingness to keep rates restrictive in the medium term.
23% of small business owners indicated that inflation was their single most important problem, up two percentage points from July.
The share of owners expecting better business conditions over the next six months declined, discouraged by lower future sales growth prospects.

6. LOGISTICS MANAGERS’ INDEX

The Logistics Managers’ Index (LMI), a diffusion index that measures activity in Inventory, Warehousing, and Transportation, rose in August at its fastest pace since February.
The increase arrives after five consecutive months of declines, each registering all-time lows for the index. Sector activity is a key barometer for the underlying fundamentals impacting Industrial Real Estate.
August’s expansion was driven by increased activity across all eight LMI sub-metrics. While inventories remain in contraction, the rate of decrease has slowed, while inventory costs and warehouse pricing have risen.
Transportation utilization has also moved from contraction territory to neutral, while transit pricing continues to fall, but at a slower rate than in previous months.
While it is unclear if LMI’s trend toward expansion is a one-off or here to stay-, concurrent trends in wages and consumer spending levels, alongside anecdotal evidence from industry participants, support the latter.

7. WHOLESALE INVENTORIES

Wholesale inventories in the US fell by 0.2% between June and July, according to the latest data available from the US Census Bureau. On an annual basis, inventories remain up by 0.5%.
Inventory levels performed worse than market forecasts but slightly recovered from a steeper 0.7% drop between May and June. Levels have now declined for five consecutive months.
The most significant declines were in furniture (-2.9%), hardware (-0.8%), electrical equipment (-0.8%), and durable goods (-0.3%).
On the flip side, inventories of petroleum rose (4.9%), as well as farm products (3.4%, and non-durable goods (0.1%).

8. DATA CENTER TRENDS

Power availability appears to be the primary driver of data center development in the US, according to a recent analysis penned in Globe St.
Rental rates appear to increase faster in areas where data centers already exist. While these agglomerations aren’t completely surprising, it questions why newer markets with cheaper available aren’t emerging more quickly and normalizing nationwide rents.
As the article notes, one key reason for this is the power requirements for such real estate ventures. These requirements have forced developers to prioritize space with existing power infrastructure suitable for their needs, keeping rents high and skyrocketing construction activity in the sector.

9. REDBOOK RETAIL INDEX

The Redbook Index, a sales-weighted index of year-over-year same-store sales growth in the US, has quietly rebounded from two-year lows that snowballed earlier this summer, according to the latest data from Redbook Research, Inc.
Just seven weeks ago, the index had fallen into negative territory, falling by an average of 0.3% year-over-year during July. In August, year-over-year retail sales accelerated and have climbed back to an annual growth rate of 4.6% as of the week ending on September 9th.
The Redbook serves as a leading indicator for the retail industry, showing near-real-time sales data for retailers. At the same time, the more popular Census Bureau measure reports on a one-month lag. The latest Redbook data may signal a continued positive trajectory for the Census Bureau’s sales data, which during July, experienced its biggest annual increase in five months.

10. SPECIAL SERVICING RISES

Special servicing rates, a helpful test for the health of commercial property cash flows and their ability to cover debt service, rose for the seventh consecutive month in August, according to the latest data from Trepp.
Office properties continued to lead increases in special servicing, up 39 basis points during the month. Most other property levels had negligible changes, with multifamily experiencing the second largest increase, rising 32 basis points, while the retail rate fell by 80 basis points.
In total, $1.21 billion in loans were transferred to the special servicer in August. Noteworthy, a single multifamily property in San Francisco that was transferred accounted for 21% of the overall monthly increase. A separate Midtown Manhattan office property that was transferred accounted for 15% of the overall increase.
Special servicing rates for lodging and industrial properties were little changed during August.

SUMMARY OF SOURCES

(1) https://www.bls.gov/cpi/
(2) https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
(3) https://www.newyorkfed.org/microeconomics/sce#/
(4) https://www.bls.gov/news.release/empsit.nr0.htm
(5) https://www.nfib.com/surveys/small-business-economic-trends/
(6) https://www.the-lmi.com/august-2023-logistics-managers-index.html
(7) https://www.census.gov/
(8) https://www.globest.com/2023/09/12/where-the-next-generation-of-data-centers-is-heading/
(9) https://www.redbookresearch.com/
(10) https://www.trepp.com/hubfs/Trepp%20Special%20Servicing%20Report%20August%202023.pdf

The one million apartments currently under development might not even scratch the surface of the country’s housing demands.

Rents have moderated over the past three years as a result of the multifamily sector experiencing a construction boom not seen since the 1970s.

But things might be about to change.

In a recent research, Greg Willett of Institutional Property Advisors predicted that rent growth will return by the spring of 2024 and reach “robust” levels by 2025.

Early multifamily construction started to slow down in 2Q 2023, with starts in important markets declining marginally. According to Willett, this was primarily due to decreased availability to development money. Following the failure of regional institutions earlier in the year, the biggest banks were reluctant to provide money for real estate, while smaller banks were also reluctant. Along with the low rate of rent growth, capital sources were concerned about rising operating costs, particularly insurance rates that “soared above past norms.”

Despite the fact that more than a million apartment buildings are now being built in the United States, the housing shortage in the country may not be much reduced. Only 15 markets have a building pipeline that is about half full, with 30,800 units being developed there. Willett stated that the start volume was down 52% from the quarterly norm of 64,200, which was maintained for nine quarters beginning in early 2021 and ending in early 2023. “From April through June 2022, absolute peak quarterly starts totaled 81,500 units.”

By spring 2024, he said, “the normal seasonal upturn in leasing velocity should coincide with obvious signs that today’s new supply excess is temporary,” causing rents to rise throughout 2025.

Texas shows the clearest indications of a slowdown in apartment development. Even though these metros continue to lead the nation in terms of job growth and apartment demand, starts dropped by 79% in Houston, 74% in Austin, and 64% in Dallas-Fort Worth compared to the previous two years. Rents are consequently expected to increase for them.

Philadelphia, Denver, and Washington, DC, all of which have had dramatically decreased multifamily development starts, are further candidates. Nashville, Phoenix, Miami, Orlando, and Charlotte are all experiencing more gradual drops. Phoenix, Raleigh-Durham, Charlotte, and Dallas-Fort Worth were all at the top of the list for multifamily starts in the second quarter, each with 3,200 to 3,500 units being built, despite the construction slowdowns.

The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for multifamily properties for sale.

Back-to-office orders, absorption, and occupancy improvements merit at least giving the benefit of the doubt.

The office market has been challenging, as both heaven and the tax authorities are aware. Recently, Goldman Sachs reported that office vacancy rates will continue to climb as a result of work-from-home policies, office tower vacancy rates are increasing, and metro area office property sales are generally down year over year in the first half of 2023.

But despite everything, “there is a glimmer of hope in the news surrounding office properties,” as Trepp put it.

One of the news items is that organizations like Google, Amazon, and Meta are promoting going back to work, “signaling a shift in their approach to remote work,” as Trepp’s Vivek Denkanikotte put it. These large corporations must maintain space since they will soon have a three-days-per-week in-office requirement. The weighted average debt service coverage ratios for Amazon and Google properties with outstanding loan balances, according to Trepp, are 2.30 and 2.11, respectively. This indicates significant strength and suggests, though does not guarantee, that refinancing the loans, which total $2.70 billion between the two and mature by the end of 2024, might be simpler than in recent years.

Similarly, although Trepp didn’t mention it, several major financial services firms have also been pressuring staff to return to work, which may indicate another significant economic sector supporting numerous loans.

The metro performance comes next. According to Denkanikotte, the metro areas of San Francisco, Chicago, and Seattle are three of the biggest in the country in terms of office exposure and are home to enormous office buildings for prestigious businesses like Google, Meta, and Amazon, among others. “Office performance in these places was dismal for the majority of 2023 as many of the aforementioned corporations decided to reduce their office presence. Recent data, however, have shown the following encouraging signs.

June and July 2023 saw higher office visits than in any previous month since the epidemic, according to Placer.ai’s July summary, which noted that “return-to-office mandates appear to be slowly but surely moving the needle.”

Washington, D.C. is a regional city. Has the shortest year-over-four-year (Yo4Y) visit gap of any assessed city in July 2023, placing first in total office recovery, according to Placer.ai. “However, San Francisco witnessed the largest year-over-year (YoY) increase in visitors, despite the city’s generally slow return to the office. Even while foot traffic in San Francisco offices decreased somewhat in July 2023 compared to the previous month, it remained higher than it has ever been since COVID. In July 2023, there were more office visits in other cities as well, including New York, Denver, Boston, and Chicago, than there had been prior to the pandemic.

“According to Trepp CMBS data,” the company noted, “San Francisco has the third-largest allotted amount for office assets, at $12.3 billion, behind only Los Angeles and New York. More than 71% of this balance have a DSCR (NOI) above 2.00.

Positive office absorption has been observed in Chicago’s downtown business district. Seattle had more openings, but the downtown area has more workers.

“As we look ahead to 2024 and the maturing office loans, the data reveals a mix of occupancy rates, but the overall trajectory appears to be toward recovery,” noted Denkanikotte. This confidence is further supported by the availability of Class A buildings and the enthusiasm of Fortune 100 corporations to reopen their operations. Despite the significant difficulties the office sector has endured, these optimistic patterns suggest that a better future may be ahead, providing hope and the opportunity for the industry’s rebirth.

The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for office properties for sale or for lease.

1. CPI INFLATION

The Consumer Price Index (CPI) rose 3.2% from one year ago, roughly in line with last month’s increase and climbing just 0.2% month-over-month.
Core prices, which exclude food and energy rose 4.7% year-over-year, the lowest annual increase since October 2021. Core prices also rose just 0.2% from the month prior — a signal that inflation pressures continue to ease across the US economy gradually.
Shelter costs continue to be the primary catalyst behind rising price pressures, increasing 0.4% month-over-month and 7.7% over the past 12 months.
Food prices aligned with headline inflation during July, rising 0.2% from June.
Despite a spike in crude oil prices in July, energy prices rose just 0.1% month-over-month.
Real wages, which adjust wage increases for inflation, rose 0.3% in July and are up 1.1% over the past 12 months. The rise in real wages signals that Americans’ incomes are starting to catch up — reversing some of the inflationary erosion in consumer purchasing power.

2. JULY JOBS REPORT

The US economy added 187k jobs in July, while the unemployment rate remained little changed at 3.5%. July’s level registered below the Dow Jones estimate of 200k job adds.
July’s job growth was slightly above June’s level of 105k job adds but remained well below its postpandemic trend. The job growth levels in June and July are the lowest monthly increases since December 2020.
Average hourly earnings rose 0.4% during the month and have climbed by 4.4% over the past year. The monthly and annual wage increases exceeded consensus estimates, while a slowdown in inflation led to a significant monthly increase in real wages.
Labor force participation had held steady at 62.6% for the past five months.
Stocks reacted positively to the jobs report since, despite falling job growth, the gradual nature of the labor market’s slowdown alongside steady unemployment and labor force participation levels signal a “soft landing” for the US economy.

3. HOUSEHOLD DEBT

Consumer debt rose to a record level during the second quarter of 2023, climbing to $17.06 trillion, according to the New York Fed.
Credit card balances are up 4.6% quarter-over-quarter, rising by $45 billion to $1.03 trillion in the second quarter. Steady consumer spending levels are being amplified by inflation pressures, partially explaining the sharp increases.
Meanwhile, mortgage debt remained relatively stable compared to the start of the year, coming in at $12.01 trillion at the end of Q2. These data largely reflect a slowdown in new mortgage originations and refinance applications, which have fallen in 2023 due to rising interest rates. Mortgage debt accounts for roughly 70% of America’s total debt load.
In a worrying sign, the four-quarter average for credit card delinquencies rose to an 11-year high, a potential sign of an upcoming slowdown in consumer spending levels.

4. INTEREST RATE PROJECTIONS

According to the Chicago Mercantile Exchange’s Fed Watch Tool, Fed Funds futures forecast a 90.5% chance of a pause in rate increases when the FOMC meets at its next meeting in September.
Forecasts were bolstered in recent days after the July CPI report revealed that US inflation pressures continue to soften monthly and annually. One week prior, futures markets were pricing in a less certain 82.0% chance of a pause, which itself was bolstered by a positive July jobs report.
The Federal Reserve initially paused rate increases in June as it looked to glean signals about the health of the US economy from upcoming data, then enacted a 25 basis points increase in July to help reaffirm inflation expectations. The most recent projections from futures markets reflect a belief that the Fed’s
data-dependent approach could incentivize a pause as macroeconomic measures point to a softer landing than many had expected.

5. MORTGAGE RATES

According to Freddie Mac, the average rate on a 30-year fixed-rate mortgage rose to 6.96%, the highest rate since November 2022.
The rise in mortgage rates follows the recent downgrade of the US credit rating alongside a 25 basis points increase in the benchmark federal funds rate by the FOMC in July.
Housing demand remains relatively strong in the face of higher mortgage rates, with supply remaining tight due to the tepid seller’s market, incentivizing many would-be sellers to hold onto their assets until the market environment is more favorable.
Notably, as mortgage rates reached 7.0% in late 2022, housing market activity slowed, a potential signal for what may be ahead in the coming weeks.

6. CREDIT RATING DOWNGRADE

On August 1st, rating agency Fitch downgraded the US long-term credit rating to AA+ from AAA, reflecting growing government debt, a perceived fiscal deterioration over the next three years, and the “erosion” of governance stemming from the latest debt ceiling standoff.
On erosion of governance, Fitch notes a “steady deterioration” of fiscal responsibility over the last 20 years, citing repeated political standoffs and last-minute resolutions. Further, it critiques the US’ lack of a medium-term fiscal framework, citing the complexity of the congressional budget process. The agency
also notes the impact of debt increases and a failure to address medium-term challenges to entitlement programs.
More specifically on debt, Fitch notes that while the debt-to-GDP ratio has fallen from a 2020 high of 122.3%, it remained uncomfortably above pre-pandemic levels, which sat at 100.1% in 2019. The agency projects that the US debt-to-GDP ratio will continue to rise in the coming years and may make the US vulnerable to future economic shocks.

7. THE FUTURE OF CITIES

The debate around the future of cities gained substantial intrigue during the COVID-19 pandemic. Still, experts from universities across the country have recently opined that amenities and “unique attractions” are likely to keep demand for urban living high in the long term.
According to Nicholas Bloom of Stanford, who conducts remote work research, the 12 biggest cities collectively lost about two-thirds of a million residents from city centers during the pandemic. About 60% of those who left moved to nearby suburbs, relatively in line with historical trends. However, relatively few people abandoned urban life altogether, according to Bloom, while urban densification returned to similar levels as in 2010.
Since 2021, population losses in the 12 largest cities have slowed, with many showing signs of gains. While remote work remains prevalent, fewer residents are using it as an opportunity to move to the suburbs than during the early years of the pandemic.
Other experts expressed their view that downtowns and central business districts must evolve beyond office spaces to survive. Many expect city centers to become more amenity-focused with diverse revenue streams. In contrast, smaller cities could benefit from remote work as people seek more affordable options with good quality of life.

8. INDUSTRIAL SECTOR FUNDAMENTALS

A new analysis by Colliers suggests that while fundamentals have softened in the Industrial sector, the fall in demand will likely not be enough to reasonably shift the landlord-favorable environment that exists in the space today.\
According to the analysis, with a vacancy rate hovering close to 5%, lease rates should continue to climb at a slower but positive pace, remaining favorable to those holding the asset.
Further, the revival of US manufacturing is expected to produce logistical advantages for businesses and investors, boosting the Industrial sector’s longer-run fundamentals.
During the second quarter of 2023, the supply of projects under construction fell by 3.4% as interest-rate increases temporarily halted some projects. The construction slowdown will also help operating incomes on existing properties in the short term.

9. HOTEL TO MULTIFAMILY CONVERSIONS

As Lodging delinquencies rise in some metros, some areas have considered hotel-to-multifamily conversions to reduce property vacancies and prevent a significant decline in values.
In New York City, where the industry has seen some success with such conversions, the Lodging delinquency rate stands at 15.3%, according to Trepp. Further, New York’s insufficient supply of affordable housing units has made the potential for such conversions more favorable compared to less housing constrained metros.
Larger metros also continue to experience higher Lodging delinquencies, making them riper for such conversions compared to smaller cities. Houston and Chicago have contributed the most to Lodging delinquencies, with rates of 43.8% and 38.6%, respectively.

10. FORECLOSURES FALL

According to ATTOM’s monthly Foreclosure Activity Report, foreclosure filings are down 9% from June, with a total of 31,877 properties entering foreclosure in July.
According to the report, the decline in filings reflects a rebounding housing market, with home prices experiencing a similar turnaround during July. Still, with various factors at play, including an uncertain interest rate outlook, the foreclosure activity may continue to be volatile over the next several months.
The states with the highest monthly increases in foreclosure rates were Maryland, New Jersey, Delaware, Illinois, and South Carolina. Hawaii, New Hampshire, Idaho, Arkansas, and Alabama saw the most significant monthly declines in July.

SUMMARY OF SOURCES

(1) https://www.bls.gov/cpi/
(2) https://www.bls.gov/news.release/empsit.nr0.htm
(3) https://www.newyorkfed.org/newsevents/news/research/2023/20230808
(4) https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html
(5) https://www.freddiemac.com/?gad=1&gclid=Cj0KCQjwldKmBhCCARIsAP-0rfxtsUBsZIG2h19jzblxT014cZHeZchVdUT9jlJyE9lOuSPri60whUaAnPcEALw_wcB
(6) https://www.fitchratings.com/research/sovereigns/fitch-downgrades-united-states-long-termratings-to-aa-from-aaa-outlook-stable-01-08-2023
(7) https://www.pewresearch.org/short-reads/2023/08/02/majority-of-americans-prefer-acommunity-with-big-houses-even-if-local-amenities-are-farther-away/sr_2023-08-02_big-houses_2/
(8) https://www.globest.com/2023/08/10/heres-why-industrial-will-stay-a-landlords-market/
(9) https://www.trepp.com/trepptalk/revitalizing-real-estate-converting-underperforming-hotels-intomultifamily-units
(10) https://www.attomdata.com/news/market-trends/foreclosures/attom-july-2023-u-s-foreclosuremarket-report/

The average annual increase was 13.6%, while certain locations saw higher increases.

Increased financing prices are not the only financial burden on CRE in general and multifamily in particular. Operating costs have increased significantly, and are unlikely to go down when inflation tides recede. Prices are forecasted to remain high.

The hikes reduce net operating income, which puts pressure on the debt payment coverage ratio, signaling bad news for many operators. That unnerves lenders and may prevent attempts at refinancing.

Trepp has been examining the areas where multifamily has been most impacted, such as the metros where property taxes have increased the most. Another report on property insurance is currently available.

“Trepp finds that the cost of property insurance increased roughly 13.6% on average across the 50 largest MSAs from 2021 to 2022, with a few key southern multifamily markets seeing particularly pronounced insurance expense growth,” the firm stated. Looking at the top 15 multifamily markets, Charlotte-Concord-Gastonia, NC-SC had the lowest rate of growth in 2022 at 15.1%, while Miami-Fort Lauderdale-West Palm Beach, FL, had the highest growth rate at 28.0%.

It doesn’t take much prodding to figure out what might be fueling costs at a far slower rate than the rises. The frequency and severity of natural disasters, such as hurricanes, floods, and wildfires, broke records in 2021, noted Trepp. As a result, property owners now run a higher chance of suffering climate-related property damage. Insurance prices for properties have changed as a result of insurers having to adjust their pricing strategies and policies in response to these rising risks. In our previous study on real estate taxes, we emphasized how the multifamily sector was rising in some developing MSAs. Additionally, this trend can push up insurance costs for multifamily complexes.

It might even get worse. In a statement released at the end of May, State Farm stated that it would cease accepting new applications, including all business and personal lines property and casualty insurance… due to historic increases in construction costs outpacing inflation, rapidly expanding catastrophe exposure, and a challenging reinsurance market.

Allstate stated in November 2022 that it was giving up on the commercial insurance market in five states.
Trepp examined Florida and Texas in further detail.

Florida is a natural target for tropical storms and hurricanes due to its position, “with the Miami, Jacksonville, and Tampa MSAs experiencing an average rise of 24.9% in insurance expenses from 2021 to 2022.” In contrast to the average of 14, there were 21 named storms in 2018. Costs for building supplies increased by more than 31% between 2020 and 2022. Yet individuals continue to move there. Despite the fact that Miami has the worst flood risk rating in the country, Trepp noted that 147 multifamily structures with a combined 36,414 units were slated for completion in 2021. This construction volume represented 11.3% of the available inventory in the Miami market, and during that time the vacancy rate fell to under 5%.

The unique feature of Texas’ weather, according to Trepp, lies in its extremes, with both searing hot conditions and uncommon freezing temperatures impacting the region. Insurance companies began to leave the state, whether it was because of the devastating winter storm that left broad sections of the state without electricity and caused a $9.3 billion settlement, the April “Gorilla” hailstorm in the state’s north, or Hurricane Nicholas in September 2021.

In the short run, this rise can be at least partially attributed to inflation, concluded Trepp. And an oncoming surge of private capital might lead corporations to focus on more profitable sectors and forsake higher-risk ones. “However, it is essential to recognize that extreme weather has played a crucial role in reshaping the insurance premium landscape in the past several years.”

The SVN Vanguard team knows investors need an experienced commercial property management company by their side. Contact us for multifamily properties for sale.

1. INFLATION

The consumer price index (CPI) rose by 0.2% month-over-month and 3.0% year-over-year through June, according to the latest numbers from the Bureau of Labor Statistics. June’s monthly pace was a slightly uptick from May, but inflation continued to trend down on an annual basis.
Shelter remains the largest contributor to month-over-month price increases, accounting for roughly 70% of the increase. Food prices rose 0.1% in June, 10 basis points below the previous month’s rate—this was mostly driven by the ‘food away from home’ index, which rose 0.4% in June, while food at home saw no change. Energy prices rose 0.6% in June but have fallen -16.7% over the past 12 months.
Excluding food and energy, core inflation also rose 0.2% in June, but was the smallest 1-month increase in core prices since the summer of 2021. Since core-inflation is more consequential in central bank policymaking, the core-CPI’s two-year low represents a significant milestone.

2. CONSUMER INFLATION EXPECTATIONS

Inflation expectations by US consumers for the next 12 months fell for the third consecutive month in June to 3.8%, its lowest since April 2021, according to the New York Fed.
Consumer inflation expectations have gradually fallen from a June 2022 high of 6.8%, and June’s downtick follows a year-ahead expectation of 4.1% in May.
Expected price changes for gas declined 40 basis points to 4.7%. Expected price changes for food fell 10 basis points to 5.3%.
Several other sub-components saw a modest rise in year-ahead expected price changes. For college education, inflation expectations rose 1.2 percentage points to 8.3%, expected price changes for medical services rose by 10 basis points to 9.3%, and expected price changes for rent rose 30 basis points to 9.4%. Similarly, home price growth expectations rose for the fifth consecutive month to 2.9%, its highest reading since July of 2022.
The median three-year-ahead inflation expectation remained unchanged at 3% but rose for the five-year horizon, jumping 30 basis points to 3%, its highest reading since March 2022.

3. FOMC MEETING MINUTES

According to the most recent meeting minutes from the FOMC’s June meeting, most officials expect further tightening in the future, but anticipate a slower pace of rate increases compared to the past year.
Last month, concerns by several officials over the outlook for economic growth led to the decision to hold rates steady—its first non-hike decision since February of 2022. While those officials were concerned, many remained committed to future hikes if necessary. In their words, the decision to pause was to allow more time to evaluate progress toward the Fed’s goals of maximum employment and price stability.
Despite the unanimous decision not to raise rates, the minutes revealed the disagreement among members, with several advocating for higher rates due to elevated inflation, while others emphasized the need to pause and observe the effects of a year-plus of tightening.
Additionally, while the pause was a unanimous decision, participants on average project at least one additional hike this year, with a majority anticipating two or more.

4. JUNE JOBS REPORT

The US added 209,000 new jobs in June while the unemployment rate ticked down slightly to 3.7%, according to the Bureau of Labor Statistics.
Job growth continues to hold firm despite fears about higher interest rates, slowing spending and investment, and layoffs across many industries. Employment continues to trend positively in key sectors, with the largest increases seen in government (+60,000), health care (+41,000), social assistance (+18,000), and construction (+23,000).
Payroll growth has certainly slowed in 2023, averaging 270,000 new jobs per month over the first half of the year compared to a pace of 399,000 per month in 2022. Still, despite post-COVID era inflation, and an aggressive monetary tightening cycle that has been used to combat it, the unemployment rate sits just 30 basis points above its March 2020 level.

5. JOLTS

Job openings decreased to 9.8 million on the last business day in May, 496,000 positions below the April rate, according to the latest Job Openings and Labor Turnover Survey (JOLTS) by the Bureau of Labor Statistics. Declines were concentrated in sectors like health care, finance, and other services.
Hires remained steady at 6.2 million, with notable increases in the durable goods manufacturing sectors.
Total separations, which includes quits, layoffs, and discharges, were little changed in May at 5.9 million. Meanwhile, quits increased to 4.0 million. Layoffs and discharges remained stable at 1.6 million. There was a notable increase in layoffs and discharges in the retail trade sector, which climbed by +87,000.

6. NFIB BUSINESS OPTIMISM INDEX

Small business optimism reached a seven-month high of 91 in June according to the latest data from the National Federation of Independent Businesses. The reading beat market expectations of 89.9.
24% of owners report that inflation remained their single most important issue in operating their business, down just one point from May. Nonetheless, only a net 29% of business owners reported higher selling prices compared to the previous month, the smallest proportion since March 2021.
Further, fewer owners are viewing the near future pessimistically. According to the report, the percentage of firms expecting worst business conditions over the next six months, which moved from a net -50 to a net -40. There were also fewer firms reporting difficulty filling job openings.

7. HOUSECANARY MARKET PULSE

Closed prices continue to climb despite the apparent peak in list prices, according to the latest Market Pulse report from HouseCanary. Price cuts have fallen well below their peak in 2022, and year-over-year growth is positive through June 2023.
However, net new listings remain significantly down this year. In June, 264,032 net new listings were placed on the market according to HouseCanary’s data, which amounts to a 35.5% decrease compared to June 2022. Over the last 52 weeks, roughly 2.52 million new listings have been placed on market, representing a 26.7% fall compared to the 52 weeks before.
According to the report’s analysts, market watchers should expect activity to remain at relatively low level through Q3 2023 as the Fed appears poised to continue rate increase through the end of the year.

8. HOME AFFORDABILITY

The median-priced single-family home/condo became less affordable during the second quarter of 2023 compared to historical averages, according to the latest US Home Affordability Report from ATTOM.
This continues a pattern dating back to early 2022, with the most recent report showing that affordability has worsened in the face of recent jumps in home prices. According to ATTOM, the common debt-to-income ratio that is considered “affordable” is 28%. The latest reading showed that the average homeowner would need to contribute 33% of their wages to major homeownership expenses.
The Q2 2023 level is the highest since 2007 and remains significantly above the 25% that was registered just after mortgage rates took off in early 2022.

9. FORECLOSURE ACTIVITY

Foreclosure filings are up 13% during the first six months of 2023 compared to the same period last year, according to the latest Foreclosure Activity Report from ATTOM.
There were roughly 186,000 foreclosure filings between January and June, which in addition to the doubledigit uptick over the first half of 2022, is 185% above the same period in 2021, gradually approaching prepandemic levels.
The greatest increases in foreclosure activity by state, compared to one year ago, were Maryland (+100%), Oregon (+99%), Alaska (+65%), West Virginia (+83%), and Arkansas (+72%). However, the highest total foreclosure rates by state are in Illinois (0.25% of units with a filing), New Jersey (0.24%) and Maryland
(0.23%).

10. LOGISTICS MANAGERS’ INDEX

The Logistics Managers’ Index (LMI), a diffusion index where above 50 signals expansion in transportation and warehousing activity and below 50 is a contraction, fell for a fifth consecutive month to a record low of 45.6 in June.
The fall represents a contraction in the logistics sector, which is primarily driven by falling inventories, according to the report. Inventories fell in June to their second-lowest reading on record, while inventory costs also fell.
Declining inventories are predicably impacting the supply of warehouse space, with warehouse capacity climbing over the month. However, demand doesn’t appear to be falling, with both warehouse utilization and warehouse prices increasing.
Transportation utilization also rose slightly in June, while transportation prices fell, but at a slower rate than in recent months.
Respondents appear optimistic about the chances of a turnaround in the next month, with the average forecast predicting an expansion rate of 55.4% over the next year.

SUMMARY OF SOURCES

(1) https://www.bls.gov/news.release/cpi.nr0.htm
(2) https://www.newyorkfed.org/microeconomics/sce#/
(3) https://www.federalreserve.gov/monetarypolicy/fomcminutes20230614.htm
(5) https://bls.gov/news.release/jolts.nr0.htm
(6) https://www.nfib.com/content/press-release/economy/small-businesses-raising-prices-falls-tolowest-level-since-march-2021/
(7) https://www.housecanary.com/wp-content/uploads/2023/07/Market-Pulse-Report-57.pdf
(8) https://www.attomdata.com/news/market-trends/home-sales-prices/attom-q2-2023-u-s-homeaffordability-report/
(9) https://www.attomdata.com/news/market-trends/foreclosures/attom-mid-year-2023-u-sforeclosure-market-report/
(10) https://www.the-lmi.com/

1. FED INTEREST RATE DECISION

On June 14th, The Federal Reserve announced a pause in interest-rate increases as it assesses the effects of its tightening efforts on the economy, holding the target federal funds rate at 5.0-5.25% while signaling the likelihood of further rate hikes this year.
The decision was unanimous and followed ten consecutive rate-hikes dating back 15 months to March 2022 as the central bank attempted to get spiraling inflation under control.
May’s Consumer Price Index (CPI) report showed falling headline inflation numbers, with prices climbing just 0.1% month-over-month and 4.0% year-over-year, its smallest annual increase in over two years. Futures markets were forecasting a rate pause before the release of CPI data, but May’s numbers likely reinforced the Fed’s decision.
The Fed’s Summary of Economic Projections reveals that despite the pause, policymakers have pushed their expectations of the terminal interest rate further out, with the median forecast projecting a 5.6% federal funds rate by the end of 2023.
Markets climbed on the news and largely shrugged off worries over future increases while fed futures continue to project a rate-cut later this year. Market reactions signal that investors aren’t entirely convinced of the Fed’s hawkish stance and that the Fed funds rate may have peaked. Officials have said they will wait about six weeks to see the impact of policy moves and remain data-dependent in their decisionmaking.

2. CPI INFLATION

The Consumer Price Index CPI) rose just 0.1% month-over-month in May and climbed 4.0% over the previous 12 months, according to the latest release from the Bureau of Labor Statistics (BLS). May’s increase was the slowest annual increase in inflation since May 2021.
Excluding food and energy, inflation was up 0.4% on the month and 5.3% year-over-year. Core and headline inflation numbers have steadily diverged, with core data remaining elevated. This is partially due to falling energy prices, which saw a 3.6% decline in May, causing headline CPI to fall faster than core. Shelter prices remained the largest contributor to price gains in May despite a gradual fall in home prices over the past several months.
Real wages also improved for the average worker as hourly wages adjusted for inflation rose 0.2% on the month.

3. MAY JOBS REPORT

The US added 339,000 new jobs in May while the unemployment rate rose by 0.3% percentage points to 3.7%, according to the Bureau of Labor Statistics.
Job growth continues to hold firm despite fears about higher interest rates, slowing spending and investment, and recent layoffs in the tech industry. Professional and business services added more than 64,000 payrolls in May, while government employment increased by 56,000 jobs, followed by healthcare with a 52,000-job gain. Leisure and hospitality, construction, transportation, and warehouse also posted notable payroll growth during the month.
However, recent waves of layoffs are reflected in the uptick in unemployment, which over the past several months has continued to hover above the 3.4% nadir that it hit in January 2023. The labor force participation rate remains little changed at 62.6%.

4. INDEPENDENT LANDLORD RENTAL PERFORMANCE

On-time rental payments in units operated by independent landlords dipped slightly in May, declining 108 basis points to 82.1%, according to the latest Independent Landlord Rental Performance Report by Chandan Economics/RentRedi.
Despite the decline, the on-time payment rate remains relatively robust and is up by 190 basis points compared to a year ago. However, at the same time, the on-time rate has now fallen by more than 100 bps in consecutive months— which could potentially lead to distress if the trend continues.
As of May 15th, 1.2% of units had paid rent late, and 16.6% had yet to complete full payments. Chandan Economics projects that the late-payment rate for May will increase to 9.5% in the coming months, while the unpaid rate is expected to decline to 8.4%.
Still, the forecast full-payment rate, which include received on-time and late payments plus anticipated late payments in upcoming months, is falling. The expected full-payment rate for May is just 91.6%— the lowest mark in eight months. These data indicate a potential worsening situation with late payments, suggesting a challenging outlook for rental affordability.

5. Q1 2023 SFR TRENDS

SFR continues to perform well compared to other commercial property types despite challenges from rising interest rates and lower home prices, according to the findings from Arbor Realty Trust’s Q1 2023 Single Family Rental Investment Trends Report.
The average SFR Occupancy rate was 94.4% in Q1 2023, with rent growth showing volatility but sustained gains in lease renewal rent growth. On-time rental payments in SFR properties remain healthy, while longterm fundamentals have maintained its favorable investment outlook.
SFR cap rates increased during the quarter, rising to 5.9%, reflecting both a rise in the SFR risk premium d a stabilization in home prices.
CMBS issuance did decline in the sector, reflecting a broader market decline, while debt yields rose, signaling caution from lenders in an uncertain housing market. Still, construction trends remain relatively robust in the sector. In the past year, SFR/Build-to-Rent accounted for a record high of 6.9% of new
single-family construction.
Southeastern Sun Belt states, in particular, show high demand for SFR properties, with lower average land prices contributing to their attractiveness.

6. TROUBLE BREWING IN CRE

Warnings have been growing in volume about potential trouble brewing in CRE, much of which has focused on the estimated $270 billion in CRE loans coming due this year. Tightening lending conditions, increased funding costs, and compressed margins are creating a perfect storm for banks and increasing default risks for CRE loans.
Office space faces challenges due to low occupancy rates resulting from the remote work boom, dampening rental growth. Office property valuations are under pressure from underperformance and interest rates reaching generational highs; refinancing those loans may prove difficult.
Still, historically real estate has been seen as an effective hedge against inflation, and some investors are looking beyond the short-term volatility. Adaptive Reuse, which looks to convert older office buildings into multifamily units, has gained steam recently as a potential solution to office over-supply. Still, several challenges exist both from a financing and construction standpoint.
Though banks nationwide are bracing for a potential CRE storm, some markets are more at risk than others. Markets with high pre-pandemic office supply, such as New York, San Francisco, and Chicago, are more exposed to the potential glut than other metros. Further, a recent wave of tech layoffs has made more tech-heavy cities more susceptible to slowing office demand. Local labor market trends will continue to be an essential barometer of the office market’s future in these metros.

7. A LONG VIEW OF THE OFFICE MARKET

As concerns about the state of CRE grow, some investors are instead taking a long and nuanced view of the future of the office market.
One key factor that will impact office valuations is property age. In addition to the location of an office property and the effect of local economic forces, how old an asset is will also significantly impact its value in the case of a bear market.
Older properties will suffer more due to competition from higher-quality properties. Newer offices that cannot attract tenant demand are also better positioned for adaptive reuse projects, where conversions can be more cost-effective.
There is also the expectation that some office activity will return two to four years from now. Business travel has started to recover from the depths of COVID, and remote work is creating a new quasi-tourist/ remote worker class in several highly amentized cities. While tenants in 2026 may be less interested in old-cubical-style designs left on the market, office properties that blend productivity and hospitality can capture new demand.

8. SELF-STORAGE: A CRE BRIGHT SPOT?

With home prices and mortgage rates too high for many American families, the self-storage market has seen an uptick in space demand as several households downsize or look for space for new consumer items that their current residence can’t accommodate.
Analyzing self-storage REIT performance, shares have averaged a return of 7.27% this year, outperforming the REIT average.
According to data from Hoya Capital, while the sector has seen some softening from 2021 highs in occupancy and rents, they remain above pre-pandemic levels and are less exposed to potential overvalue issues than the broader CRE market.
Funds from operation (FFO) for the Storage REIT sector is on pace for double-digit performance in 2023, following a 3.0% gain in Q1 2023.

9. DELOITTE’S Q2 2023 US ECONOMIC FORECAST

In Deloitte’s latest US economy forecast, new projections arrive for the path of consumer spending, housing affordability, and business investment for the remainder of 2023.
On consumer spending, forecasts zero in on the US savings rate. During the pandemic, many households saved significantly more than anticipated, but savings rates began to shrink as a post-pandemic activity wave met higher consumer prices.
Deloitte projects two potential paths for consumer spending for the remainder of this year: cautious spending as consumers prioritize savings or a continued spending boom driven by summer travel and services.
In housing, the forecast expects the decline in construction activity to continue in 2023, with a modest bounce back to begin 2024.
Business investment is expected to become more selective. Investment in non-residential structures could slow. Investment in equipment and software has slowed from the pandemic-era boom. Still, it may continue to grow modestly as companies struggle with labor costs and competition and look for ways to
become more capital efficient.

10. RETAIL SALES

US retail sales unexpectedly rose in May, climbing 0.3% month-over-month following a 0.4% monthly increase in April. Economists had forecasted a 0.1% decline in May.
Consumer spending appears to be resilient despite the pressure of higher prices and rising interest rates. The largest increases in sales were seen in building materials and gardening equipment (+2.2%), motor vehicles and parts (+1.4%), food services and drinking places (+0.4%), general merchandising stores (+0.4%) and furniture stores (+0.4%).
Sales were flat at health, personal care, and clothing stores and fell 2.6% at gas stations.
Core-retail sales, which exclude automobiles, gas stations, building materials, and food services, rose 0.2% month-over-month, following a 0.6% monthly gain in April.

SUMMARY OF SOURCES

(1) https://www.federalreserve.gov/newsevents/pressreleases/monetary20230614a.htm
(2) https://www.federalreserve.gov/monetarypolicy/fomcminutes20230503.htm
(3) https://www.bls.gov/news.release/empsit.nr0.htm
(4) https://www.chandan.com/independent-landlord-rental-performance-report
(5) https://arbor.com/research/single-family-rental-investment-trends-report-q1-2023/
(6) https://www.thebanker.com/Markets/Capital-Mkts/Commercial-property-market-under-stress
(7) https://www.forbes.com/sites/jamesnelson/2023/05/30/5-factors-to-consider-with-officeinvestments/?sh=2c1ff4b65f3d
(8) https://seekingalpha.com/article/4610463-picking-winner-self-storage-reits
(9) https://www2.deloitte.com/us/en/insights/economy/us-economic-forecast/united-states-outlookanalysis.html(10) https://www.census.gov/retail/marts/www/marts_current.pdf