Second Quarter 2024
The capital markets started the year brimming with optimism that the Fed would make five cuts to interest rates as early as this spring. That not only hasn’t happened but given persistent inflation (the CPI, or consumer price index, a key inflation index, rose 3.5% in March), rate-cut expectations keep dropping. Less than 24 hours after the CPI information was released in April, Wall Street economists began revising their outlooks. Goldman Sachs and UBS now see two cuts starting in July and September, respectively, while analysts at Barclays anticipate just one reduction, in September.
More worrisome is that with inflation stalled north of 3%, the Fed could scrap cuts altogether. One indicator, the so-called supercore inflation, excludes volatile food and energy costs (as does the CPI), yet also strips out shelter and rents costs. Energy costs rose 1.1% in March after a 2.3% hike in February, and shelter costs are up 5.7% from a year ago.
Commercial (and residential for that matter) mortgage rates are not expected to decline much from its current high-6s and 7% levels, as the U.S. 10 Year Treasury bond was trading at a 4.584% yield in early April, a 50-basis point increase from a month earlier. While the elevated bond yield negatively impacts borrowing costs, it is worth noting that the 10-year rate is still lower than its long-term average of 5.86%.
Which leads to current outlooks on Cap Rates, which on a blended basis for all property types increased from 6.4% to 7% in 2023. Some surveys and market watchers are indicating that Cap Rates may have peaked and, despite turbulence, could decline later this year.
Meanwhile, one sign has emerged that financing for real estate is improving. Nearly $18 billion of U.S. commercial-backed securities were issued in the first quarter this year, or roughly three times the volume issued in the first quarter last year, according to trade publication Commercial Mortgage Alert.
Even so, in the 12 months ending in February, investors bought $360 billion worth of U.S. commercial property, about half the volume of the previous 12 months, reported MSCI Real Assets.
Defaults outlook: With all the loan maturities coming due across the country for all property sectors – and the accompanying gloom in terms of distress in the system, some analysts have begun reminding us that a similar situation played out from 2010-2012 on the heels of the Great Financial Crisis. At the time, the market expected waves-upon-waves of loan defaults, yet it never materialized. Why? Because owners and lenders were able to work things out using extend and blend and extend and pretend loan adjustments and capital infusions to keep the lights on. That same situation could develop as we go deeper into 2024, 2025 and 2026.
Another cause for defaults not to happen on a grand scale with some of the ultra-large property trades of late – and by three of the industry’s stalwart investors – Blackstone, Boston Properties and Brookfield Asset Management.
Brookfield recently put in motion the sale of one of its distressed trophy office towers in Downtown Los Angeles, with Consus Asset Management of South Korea agreeing to buy 777 South Figueroa Street, a 1 million-square-foot asset also known as 777 Tower, for about $145 million. That is close to half the value of a loan backed by the building. In February, Brookfield notified investors through an SEC filing that it defaulted on $289 million in debt tied to the building.
By contrast, Boston Properties (BXP) has gone on the offensive by, among other moves, buying out joint venture partners in three office investments the company principally holds. The assets are in New York City, Washington D.C., and Santa Monica. The REIT bought out a partner’s 29% interest in 360 Park Avenue in Manhattan, an unspecified partner’s 50% share in 901 New York Avenue. A 548,000-square-foot office building in Washington, DC, and a partner’s 45% stake in the 1.2-million-square-foot Santa Monica Business Park.
Blackstone is also capturing opportunity. One of the world’s largest real estate investors has agreed to acquire the owner of upscale apartment buildings for about $10 billion. Blackstone is taking private Apartment Income REIT, known as AIR Communities, which owns 76 rental housing communities that are primarily in coastal markets, including Miami, Los Angeles and Boston.
Earlier this year, Blackstone President Jonathan Gray said on an earnings call that: “We can see the pillars of a real estate recovery coming into place. We are, of course, not waiting for the all-clear sign and believe the best investments are made during times of uncertainty.”
His statement is reminiscent of one of the most revered quotes from iconic investor Warren Buffett: “Be fearful when others are greedy, and be greedy when others are fearful.”