Commercial Mortgage Delinquency Rates are on the Rise

Delinquency rates for lenders with the strictest underwriting guidelines are somewhat higher.

The most recent Commercial Delinquency Report from the Mortgage Bankers Association shows that, for the third consecutive month, there was an unanticipated increase in commercial mortgage delinquencies in the third quarter of 2023.

In prepared remarks, Jamie Woodwell, MBA’s Head of Commercial Real Estate Research, stated that rising interest rates, shifts in certain aspects of the real estate market, and uncertainty around property valuations were the main causes of an increase in delinquency rates across all major capital sources.
According to Woodwell, “CRE market activity remains muted, further complicating the situation.”

Mortgage performance varies significantly depending on the type of property, according to data from the MBA survey that was made public earlier this quarter.
According to Woodwell, a wide range of factors, including deal vintage, term, and market conditions, also influence which loans are under pressure. These distinctions are probably going to stay significant in the upcoming year.

Delinquency rates for banks and thrifts (90 days or more past due or non-accrual) based on the unpaid principal balance (UPB) of loans are 0.85% in Q3, up 0.18 percentage points from Q2 2023.

With 60 days or more past due, the life company portfolios had rates of 0.32 percent, up 0.18 percentage points from Q2 2023.
The rate for Fannie Mae loans (60 days or more past due) was 0.54 percent, up 0.17 percentage points from Q2 2023.

Loans from Freddie Mac that were 60 days or more past due had a 0.24 percent default rate, up 0.03 percentage points from Q2 2023.

The percentage of CMBS loans in REO or 30 days or more past due was 4.26 percent, up 0.44 percentage points from Q2 2023.

According to Selina I. Parelskin, CEO and founder of Beacon Default Management, the research presents a dire image of the status of the CRE capital markets, but the situation may well be considerably worse. She informs GlobeSt.com that while these figures include loans for building and development, private lenders and debt funds are not included in this list.

“A few of these have lent many tens of billions of dollars on high-leverage multifamily syndicated loans, where the sponsor has a very small amount at risk compared to their investors and lenders,” the spokesperson stated. “Some of these use their own bank lines.”

The debt fund will not be paid back in full, the investors and borrowers have lost all of their equity, and the underlying warehouse or credit facility will suffer a loss. A large number of these funds are expected to experience loan losses.

According to Parelskin, almost 25% of the loans held by these funds are either matured or in default.

According to her, the majority of debt funds ignored inflation worries and believed that interest rates and cap rates would remain at historically low levels. Up to 80% loan to cost and the equivalent of 3.25% cap rates on in-place income were required at the time of going into underwriting.

According to Parelskin, a lot of bankers are working hard to adjust their problematic debt.

However, based on our discussions, we anticipate a notable increase in commercial mortgage delinquency rates by the end of Q1 2024, as the spokesperson stated.

Vice President of MetroGroup Realty Finance, Ivan Kustic, tells GlobeSt.com that the MBA data supports the originators and suppliers of these mortgages that his company is experiencing.

Banks and thrifts are generally on the lower end of the recourse spectrum, while Fannie and Freddie are on the lower end due to their reputation as highly performing multifamily assets, Kustic stated.

According to him, life insurance businesses that practice conservative underwriting and have lower loan-to-value ratios often have fewer delinquencies.

According to Kustic, the CMBS has a rate of 4.26%, which is significantly higher than the other four lending groupings. It also has more aggressive loan values and more liberal underwriting.

Thus, he explained, the lenders with the most aggressive underwriting standards will see slightly higher delinquencies than the other four lending groups when we see stress in the real estate market.

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 AND FALLING ENERGY PRICES

• The latest PCE price index rose in line with consensus expectations in October, but the divergence between the core and headline numbers reflects the disinflationary impact of falling energy prices in recent months.
• According to the Bureau of Economic Analysis, the core inflation rate, which excludes food and energy costs from calculations and is the Federal Reserve’s preferred measure for monetary policymaking, climbed 0.2% month-over-month and 3.5% over the past 12 months. However, headline inflation (including food and energy) remained flat for the month.
• Falling energy prices largely explain the static headline numbers even as core prices climb. In October, energy prices fell a massive 2.6% month-over-month, significantly dampening the inflationary impact of other goods, such as food and housing, that gained during the month.
• As the Fed’s preferred measure rises while the more publicly visible headline data flattens, it compilates its short-term interest rate policy decisions. However, officials will likely be looking to see if falling energy prices dampen prices of core consumer goods and whether falling headline inflation helps shift future inflation expectations.

2. MORTGAGE RATES FALL

• The average rate on a 30-year fixed rate mortgage fell for the sixth consecutive week during the week of December 7th, charting at 7.03%, according to Freddie Mac data.
• The latest reading reflects a notable decline in Treasury yields that began toward the end of October as bond markets recalibrated for an increased likelihood of the Fed ending its interest rate tightening.
• Rates continue to sit close to multi-decade highs but have fallen off of a rent peak of 7.8% reached in late October. According to Freddie Mac’s Chief Economist, while purchase activity initially increased in response to falling rates in early November, this improvement in demand has receded in the past week.

3. 2024 NATIONAL HOUSING MARKET OUTLOOK

• According to Bright MLS’s 2024 National Housing Market Outlook, market watchers should expect a fall in mortgage rates next year that could lead to an uptick in home sales, while prices will likely remain relatively stable.
• The report’s authors project that mortgage rates, which reached north of 7.0% in 2023, will settle between 6.0% and 6.5% in 2024 as the Federal Reserve appears poised to pause or loosen its interest rate policy in the near term.
• Many economists have noted resilient housing demand in 2023, but a financing environment that has dampened transaction volume as would-be buyers and sellers wait for each other to blink. According to the forecast, a downward shift in mortgage rates should also loosen pent-up demand for homeownership, resulting in higher home sales volume.
• Home prices are projected to remain stable in 2024 as several factors push and pull on market prices. Median home prices grew by roughly 13.7% annually between 2019 and 2022. Such growth rates are high by historical standards, so while increased activity next year may reinvigorate price growth, a continued higher-rate environment will likely moderate the housing market’s growth ceiling.

4. CONSUMER CONFIDENCE

• Consumer confidence rose in November following three consecutive monthly declines, according to the latest data from the Conference Board.
• The increase was led by a rise in future optimism, as the expectations sub-index of the report, which measures the short-term outlook for income, business, and labor market conditions, rose during the month. The present situation index, where consumers assess current business and labor conditions, fell slightly.
• Despite the increase in the expectations index, the measure remains in the recessionary range, according to the report’s analysis. Consumer recession fears have recently abated to their lowest levels of the year. However, roughly two-thirds of consumers still perceive a risk of recession over the next 12 months.

5. FED BEIGE BOOK

• Economic activity has slowed in the past several weeks, according to the Federal Reserve’s latest Beige Book, which summarizes recent anecdotal sentiments about US economic conditions.Four of the twelve Fed districts reported modest growth, two districts indicated flat conditions, while the six others cited overall declines.
• Retail and auto sales were reported as mixed across the country, while sales of discretionary items and durable goods declined as consumers expressed more price sensitivity in their spending decisions.
• According to respondents, travel and tourism activity remained robust, but demand for transportation services was sluggish overall.
• In other areas, manufacturing activity was mixed, demand for business loans declined, and consumer credit conditions remained healthy, according to servicers—despite an uptick in delinquencies.
• Commercial real estate activity continued to slow. Moreover, several districts reported a slight decrease in residential sales and inventory.

6. CONSTRUCTION SPENDING

• Construction spending rose by 0.6% between September and October, according to the latest readings from the US Census Bureau, roughly in line with economists’ expectations.
• Private construction increased by 0.7% in October, primarily driven by a 1.3% rise in residential spending, specifically in the single-family segment. Multifamily construction decreased slightly during the month, declining by 0.1%.
• Non-residential construction rose by 0.1% in October. Meanwhile, spending on manufacturing projects fell by 0.4%, but factory construction continues to climb, partly reflecting the market effects of the White House’s push to on-shore semiconductor manufacturing. Public construction spending rose by 0.2% in October.

7. JOB OPENINGS AND LABOR TURNOVER

• US job openings fell 6.6% month-over-month in October, according to the latest Job Openings and Labor Turnover Survey from the Labor Department.
• Current job openings stand at 8.73 million nationwide, the lowest total for the US since March 2021. The current ratio of job openings to available workers declined between September and October from 1.3 to 1.0.
• The consensus forecast by economists leading up to the report was 9.4 million, well above the actual readings. Fed officials watch the report closely for signs of labor market slack or tightness, and the falling ratio between openings and workers may signal that the labor market is shifting towards a higher slack environment.

8. SINGLE-TENANT LEASE SUPPLY RISES

• Inventory in the single-tenant net lease (STNL) market jumped in Q3, according to recent Globe Street reporting of brokerage data. Properties on the market increased by nearly 19% quarter-over-quarter.
• While new supply could help dull inflationary pressures from consumer goods, newer properties are arriving at roughly double the rate of older stock falling off the market, limiting price growth.
• According to the analysis, the most significant contributor to the surge was big-box properties, which saw a 144% increase in retail space during the quarter.
• Distribution facility supply also rose, climbing by 19% between Q2 and Q3, partly reflecting the increased use of sale-leaseback within the industrial sector.

9. CRE LOAN COLLATERAL

• According to an analysis by MSCI Real Capital Analytics, the price of loan collateral has seen a significant drop-off over the past year; however, most loans remain above their origination value, dampening the effect of the market correction.
• 81.5% of loan collateral has experienced a price decline in the past 12 months, but only 40% have values below their origination amount.
• Still, roughly half have experienced price corrections that have pushed loan-to-value (LTV) ratios into a “danger zone” that could limit refinancing capabilities. Of those in the “danger zone,” 58% face loan maturities within the next five years, while 37% face maturity within three years. The recent activity signals that market risk could lessen as the macroeconomic environment evolves in the near future, but that current levels warrant increased attention to market activity.

10. PENDING HOME SALES FALL

• Pending home sales, a useful leading indicator for future housing demand, fell by -1.5% in October, according to the National Association of Realtors.
• Declining activity was concentrated in the US’s West, Midwest, and South regions. In contrast, the Northeast region saw an uptick. Transactions fell in all four regions on an annual basis.
• The West region experienced the steepest monthly decline, with activity falling a drastic 6.0% between September and October. The South region fell by 1.9% month-over-month, while the Midwest fell by a more modest 0.4%. The Northeast region climbed by 2.7% on the month.
• Notably, this year’s continued slowing activity has produced new lows for the index, which originated in 2001. This reflects the impact of generationally high mortgage rates, which continues to dampen prospective homebuying.

SUMMARY OF SOURCES

• (1) https://www.bea.gov/news/2023/personal-income-and-outlays-october-2023
• (2) https://freddiemac.gcs-web.com/news-releases/news-release-details/nearing-seven-percent-mortgage-rates-continue-decrease?_gl=1*17est5i*_gcl_au*NDQ4MzU4NzA0LjE3MDE5Njk2MjM.&_ga=2.112390148.1813790579.1701969623-1128088453.1701969623
• (3) https://www.brightmls.com/article/2024-national-housing-market-outlook
• (4) https://www.conference-board.org/topics/consumer-confidence
• (5) https://www.federalreserve.gov/monetarypolicy/beigebook202311.htm
• (6) https://www.census.gov/construction/c30/c30index.html
• (7) https://www.bls.gov/news.release/jolts.nr0.htm
• (8) https://www.globest.com/2023/12/07/single-tenant-supply-sees-a-big-jump-in-q3/
• (9) https://www.msci.com/www/blog-posts/assessing-the-health-of-us-real/04177027314 utm_source=pardot&utm_medium=email&utm_campaign=real-estate-newsletter-11-29
• (10) https://www.nar.realtor/newsroom/pending-home-sales-fell-1-5-in-october

With seasonal slowdowns, rents are probably going to stay low for another month or two.

November is the fourth month in which the national median rent for multifamily buildings has declined, falling 0.9% month over month to $1,340, according to Apartment List. Because of the low demand over the holidays, rent growth is probably going to keep going downhill for another month or two.

Growth from the previous year was -1.1%. Apartment List stated that the current situation “stands in stark contrast to the prevailing conditions of 2021 and 2022 when rent prices were surging and year-over-year growth peaked at 18% nationally.” However, the national median rent is still roughly $250 per month higher than it was just three years ago, even with this cooling off.

6.4% is the national vacancy rate, which is a little higher than it was before the pandemic. Given the number of apartment buildings that are continuously being constructed, it is unlikely that this will change anytime soon. On the other hand, local markets, not national ones, determine construction levels. As previously predicted by GlobeSt.com, there will be a great deal of fluctuation in the upcoming year, with certain metro areas experiencing severe gluts.

According to the business, rents decreased regionally in 89 of the 100 largest cities in the country in October, and prices are declining year over year in 68 of these 100 cities. “The California markets like Oakland, San Francisco, and Long Beach, where apartment demand remains sluggish, are concentrated in the sharpest rent declines over the past year.”

Rewinding to November of 2017, that drop was the second biggest Apartment List had ever experienced. They stated, The only other time November brought a greater decline was the previous year when rents dropped by 1.1 percent as the market entered the still-present period of sluggishness. In contrast, November declines averaged 0.5 percent from 2017 to 2020.

The Midwest and Northeastern markets are experiencing the fastest rent growth. Providence (4%), Milwaukee (4%), Louisville (4%), Chicago (3%), Oklahoma City (3%), Hartford (3%), Boston (3%), New York (3%), Washington, D.C. (2%), and Indianapolis (2%) have had the highest rent increases during the previous 12 months.

Austin(-6%), Portland, Ore.(-5%), San Francisco(-4%), Phoenix(-4%), Atlanta(-4%), Orlando(-4%), Raleigh(-4%), Jacksonville(-4%), San Antonio(-3%), and Salt Lake City(-3%) had the smallest rate of increase in rent.

The rate of vacancy has recovered to levels higher than before the outbreak. They stated, Changes in the balance between the number of vacant apartments available and the number of renters looking to move into them are largely responsible for the price fluctuations that have rocked the rental market over the past three years.

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

While certain metro areas that had significant demand during the epidemic now exhibit weakness, others that were hardest hit during the pandemic now show strength.

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

1. WEWORK BANKRUPTCY, CRE IMPACT

• On November 6th, co-working trailblazer WeWork filed for Chapter 11 bankruptcy, bringing additional unease to an office sector battered from the residual effects of the remote-work revolution.
• Over the previous decade, including before the pandemic, many office landlords around the world looked to the co-working giant as the future of office life, with leasing to the firm proliferating across many global economic hubs. However, as those bets soured in recent years, owners have increasingly turned to debt financing to stay afloat, raising concerns that a reduction of leased space by WeWork could place a wave of distress on a sector already facing high vacancy rates.
• There are also concerns about the ripple effect of the bankruptcy on small and mid-sized banks, which are disproportionally exposed to commercial property debt on their balance sheets. Still, US banks remained highly liquid, limiting the risk of the CRE exposure to the broader financial system.
• Notably, many WeWork leases are in Class B buildings, which predictably have had a tougher challenge with occupancy compared to Class A buildings during the current downturn. This may increase the challenge that landlords will face in filling new vacancies. So far, WeWork has filed to terminate nearly 70 leases worldwide.

2. COMMERCIAL PROPERTY PRICES

• According to the MSCI RCA Commercial Property Price Index (CPPI), all US commercial sectors posted annual price declines in September, matching August’s -9.0% year-over-year drop. However, average prices were flat month-over-month, potentially signaling that we are close to the cyclical nadir for commercial prices.
• The apartment sector posted the most significant year-over-year decline in CRE for the second straight month, but declines in the sector have eased in the third quarter compared to earlier this year. Apartment prices fell by -0.3% month-over-month and -12.8% year-over-year in September.
• The industrial sector, which has been the best-performing CRE sector during both the pandemic-era boom and the current market downturn, fell -0.8% annually but climbed 0.2% month-over-month from August. The directional shift of the sector in September may serve as another signal that commercial prices are reaching their floor.
• Retail prices were down -0.1% from August and -6.9% year-over-year. Meanwhile, suburban offices fell -0.3% from August and -9.0% annually. CBD office prices were unchanged monthly but declined -5.6% year-over-year.

3. CRE MARKET INSIGHTS, OCTOBER 2023

• The National Association of Realtors’ (NAR) monthly report on CRE insights notes that the commercial real estate market continues to experience rising vacancies and slowing rent growth in October but that labor market fundamentals and seasonal factors represent tailwinds that are keeping the sector stable.
• NAR notes that the multifamily segment has seen resurging demand in 2023 as mortgage rates mount, dampening homebuying activity. Net absorption in the sector has risen by 33% over the last 12 months, while construction unit deliveries are up 17% from last year.
• Rent prices in the industrial sector continue to expand and remain above pre-pandemic levels despite a recent deceleration in rent growth. Vacancy rates have moderated back towards pre-pandemic levels; however, this is primarily due to a 43% increase in square footage delivered over the past year.
• Retail sector vacancies now sit at a 10-year low of 4.1% as of September. Rent growth has eased but remains above pre-pandemic levels. Further, consumer spending remains strong despite higher goods prices, keeping the sector on solid footing.

4. INTEREST RATE DECISION

• At its November 1st policy meeting, FOMC officials held interest rates unchanged at their target rate of 5.25% to 5.5%. The Fed has now held rates unchanged for two consecutive months, a first throughout its current tightening cycle that began in March 2022.
• While acknowledging the favorable trajectory of US inflation pressures, Fed Chair Jerome Powell refrained from claiming victory, indicating that the economy remains above the central bank target of a 2% longterm average.
• Powell also cited the resiliency of the US economy, stating that taming inflation will likely require a slowdown in the labor market and economic growth. Real US GDP grew by 4.9% in the third quarter, its fastest pace of growth in nearly two years.
• Several Fed watchers and experts foresee the Fed holding rates at current levels well into next year, citing the economy’s ability to grow at current borrowing rates as a hedge against the downside risks of keeping rates higher for longer. Meanwhile, elevated inflation expectations suggest that rate cuts would be too risky of a move for policymakers to make in the short term as they attempt to re-anchor inflation expectations towards their 2% target.

5. FINANCIAL STABILITY RISKS

• The October release of the Federal Reserve’s semi-annual Financial Stability Report notes that several aspects of the US economy remain on solid footing, including leverage in the financial system, funding risks, and borrowing by businesses and households. However, strains in the CRE industry, persistent inflation, and geopolitical risks are the most significant near-term risks to the financial system.
• Despite the rise in debt servicing costs, the report notes that debt-to-GDP ratios among households and businesses remain close to historical averages.
• Price-to-earnings ratios among equities are elevated, but bond market risk premiums remain near the middle of their historical distribution, signaling low risk.
• Still, risks are rising in other areas. The Fed notes that a significant slowdown in US economic growth could dampen profits in non-financial businesses, including real estate. High leverage levels in these sectors could expose them to stress and defaults in a recession scenario.
• Geopolitical risks to global markets have increased. Russia’s ongoing war against Ukraine continues to impact energy and agriculture markets, and more recently, Hamas’ attack on Israel and the ensuing response risks spilling over into a broader Middle East conflict and could lead to adverse effects on global markets.
• The banking system remains sound, according to the report, despite vulnerabilities exposed during the bank failures in the spring 2023. Most US banks remain highly liquid with capital ratios close to previous decade averages.

6. OCTOBER JOBS REPORT

• According to the Bureau of Labor Statistics, the US economy added 150,000 new jobs in October, the smallest monthly growth total since June. The unemployment rate ticked up marginally to 3.9%.
• Last month’s growth came in under the consensus forecast of 170,000 and is a sharp decline from a strong showing in September when firms added nearly 300,000 new payrolls.
• The Health Care (+58,000), Government (+51,000), and Construction (+23,000) sectors led all occupations in gains, while manufacturing posted a decline, in part due to the persistence of auto strikes during the month.
• Average hourly earnings increased by 0.2% month-over-month and 4.1% year-over-year in October. Annual wage growth has charted above inflation in consecutive months since May, giving workers a boost in real wages. Upcoming CPI data will confirm whether real wages have continued to grow in October.

7. DECLINE IN APARTMENT STARTS EXPECTED

• A recent survey conducted by John Burns Real Estate Consulting suggests that apartment developers expect starts to decline further over the next 12 months following a 40% decline in starts so far in 2023.
• The survey points to increasing debt cost challenges for developers, as construction pricing remains relatively unchanged from previous years, but higher interest rates raise project costs. According to the survey, developers would need a 10-20% decline in construction costs to offset higher debt financing costs.
• Analyzing the report, Real Page SVP and Chief Economist Jay Parsons notes that the industry has recently enjoyed a generational high in apartment starts. Still, this phase is coming to a close as borrowing costs settle at new highs and price gains slow as supply catches up to demand.

8. LOGISTICS MANAGERS INDEX

• The Logistics Manager’s Index, a composite score that denotes expanding or contracting activity in the warehousing and transportation sector and a key proxy indicator for Industrial property activity, posted a third consecutive increase in September. It is the most robust performance for the sector since January.
• Warehousing prices slowed in September but continued to climb, while both warehouse and transportation capacity fell, signaling increased activity and demand relative to supply.
• Transportation prices fell but at their slowest rate since September 2022.
• Inventory levels have recently moved back into expansion after five consecutive months of contraction.
• It is to be seen whether the recent expansion is due to seasonal factors or a sign that the economy is picking back up again. Notably, month-ahead expectations by survey respondents in September were at their strongest in 2023.

9. MANUFACTURING PURCHASING MANAGERS’ INDEX (PMI)

• The US ISM Manufacturing Purchasing Managers’ Index (PMI) dropped in October from a 10-month high in September, indicating further contraction in the US manufacturing sector.
• The contraction in new orders accelerated from the previous month and charted its 14th straight monthly decline. Survey respondents noted lower demand from both domestic and foreign markets.
• Production also slowed, with a sharp decline in the backlog of orders, partially offsetting a decline in demand for new products.
• Sector employment also contracted following an increase in September, while input prices fell for the sixth consecutive month.

10. US PERSONAL SPENDING

• According to the Bureau of Economic Analysis, personal spending in the United States rose by 0.7% month-over-month in September, an increase from August and beating market expectations of a 0.5% growth rate.
• Spending on services rose sharply, increasing by $96.2 billion or 0.8% month-over-month. Within services, international travel, housing and utility services, healthcare, and air travel saw the most significant increases.
• Spending on goods also rose during the month, climbing by $42.5 billion, or 0.7% month-over-month. In the goods category, prescription drugs, motor vehicles, and parts contributed the most to September’s growth.

SUMMARY OF SOURCES

• (1) https://www.bloomberg.com/news/articles/2023-11-07/wework-s-collapse-is-latest-blow-to-newyork-san-francisco-office-markets
• (2) https://info.msci.com/l/36252/2023-10-18/xzzn44/36252/1697663732SmMj3Ch7/2310_RCACPPI_US.pdf
• (3) https://www.nar.realtor/commercial-real-estate-market-insights/october-2023-commercial-realestate-market-insights
• (4) https://www.federalreserve.gov/newsevents/pressreleases/monetary20231101a.htm
• (5) https://www.federalreserve.gov/publications/2023-october-financial-stability-report-overview.htm
• (6) https://www.bls.gov/news.release/empsit.nr0.htm
• (7) https://yieldpro.com/2023/11/developers-expect-further-decline-in-apartmentstarts/#:~:text=Apartment%20developers%20expect%20a%20further,Investor%20Survey%20dated%20October%2030.
• (8) https://www.the-lmi.com/
• (9) https://www.ismworld.org/
• (10) https://www.bea.gov/news/2023/personal-income-and-outlays-september-2023

This past Monday at the Globe St.’s Multifamily Conference, investment property owners discussed the difficulties of continuing to be successful today and the value of flexibility.

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/

The SVN Vanguard team can help with your Commercial Real Estate needs. We can help you find the ideal commercial property for sale or lease. Interested in discussing on Buying or Leasing Office Space? Contact us.

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

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

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 SVN Vanguard team can help with your Commercial Real Estate needs. We can help you find the ideal commercial property for sale or lease. Interested in discussing on Buying or Leasing Office Space? Contact us.