The Fed’s recent decision to increase the Fed rate by 25bps. Kevin Thorpe – chief economist; Ken McCarthy – senior managing director and Rebecca Rockey – an economist in America’s Research lead a discussion during a webcast on September 18, 2015. Thorpe maintains that Fed’s interest is keep employment stable. Some of the factors that he believes they took into consideration was the volatility of the stock market, the China economic slowdown, collapse of energy prices, weak wage growth and risk of US GDP growth.
Since late 2010, the Fed rate has been 0%. By 2019, CW anticipates the rate increasing to 3% until 2017 and 3.5% by 2019. CW says that even if the Fed does increase rates, this can be seen as a positive signal that the economic fundamentals can support the small increase. In one study, they pointed that from 2004-2008 when interest rates were higher, real estate values increased 50% during this period.
CW sees that in order to fight off potential economic woes in the future, the Fed needs to kick up rates to keep up the growing economy. Thorpe noted that GDP growth between the boom years of 2005-2007 was only 100 bps higher than the current rate of 4% since 2013. He claims that since 2012, there have been 7 million net new jobs.
One of the key issues they addressed what are in a bubble and how would higher interest rates affect CRE? CW was emphatic that because fundamentals for strong job growth will continue to spur housing, leasing and overall investment climate for CRE will only keep upward pressure on pricing and positive momentum of the CRE market.
Below are selected cities showing job growth since Feb. 2010:
San Francisco Bay Area: 24%
CW sees good opportunities in office, warehouse/manufacturing and retail. Since 2007, there have been few new office developments amounting to not more than 5% of total inventory. Absorption of warehouse space has reached 40% mainly coming from the exceptional growth in technology. National office vacancy stands at 17.90%.
The tech hubs have seen stunning job growth that’s impacted rent growth. Since 2010, below are some exciting figures:
San Francisco: 111%
San Jose: 36%
New York: 53%
CW compared levels of valuations from pre-recession until today:
Pre-recession loan value: $1.687 billion
ADL (acquisition, development, construction): $559.9 billion
CMBS: $230.5 billion
Pre-recession loan value: $1.666 billion
ADL (acquisition, development, construction): $241.4 billion
CMBS: $110 billion
Prices since pre-recession peak:
All asset classes: 12.30%
CBD Offices: 38.30%
Major Markets: 28.90%
With Fannie Mae changing their recent borrowing guidelines and their desire to exit the lending market, who was the largest lender for multifamily assets (post crisis) is now being filled by CMBS loans. CBRE reported in their recent June, 2015 Forum for Capital Markets U.S. Lenders that CMBS loans totaled $25.7 billion in Q1 2015 up from $20.4 billion the previous year – a 26% increase. The U.S. Treasury spread for long term loans continue to rise 2.5%-3.0% over cost for 7-10 year debt. According to the Mortgage Bankers Association, $121 billion of non-bank loans will come due this year, of high leverage 10-year loans (non-bank means CMBS loans) that were taken out during the height of the market in 2007. This could present an opportunity to purchase non-performing loans and/or distressed assets over the next 2-years. Depending if these assets were able to recoup increased revenue over this period, will determine if these assets are under water.
In conclusion, CW noted some considerations for keeping up a vibrant investment environment to continue to stimulate the CRE:
More competition for loans among local banks, CMBS
- Loosening of credit standards and higher LTV ratios include debt coverage ratios