March 31, 2021
Looking at the United States as a massive real estate asset is instructive. One could say that the American Society of Civil Engineers Report Card is our property condition report. The 2021 grade is “C-“ with special attention on public roadways, water systems, broadband capacity and the energy grid. A $2 trillion infrastructure plan is being discussed in Washington with uncertainty about how to pay for it. Bond markets are guessing that some increased deficit spending will be involved. The 10 year T bumped up to its recent high of 1.74%. The sell off in treasuries is largely based on the anticipation “inflation is coming, it has to be.” Last week’s PCE index (the Fed’s preferred inflation metric) came in at 1.3% annually. Other factors contributed such as fiscal year end selling of US Treasuries in Japan. The data: the next round of economic reports will tell the tale of the nascent recovery and may indicate signs of inflation. Last month’s reports were dragged down by the February storms that hit much of the country. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
March 24, 2021
Yesterday’s testimony from Fed Chair Powell and Treasury Secretary Yellin included further assurances that ultra accommodative policies will continue. His most resonant comments were regarding the economic recovery which he described as “far from complete” and that sectors of the economy “remain weak”. He again reiterated his belief that the official unemployment rate undercounts actual joblessness. He pegs the actual rate is close to 10% (the official announcement this month was 6.2%). Fed Governor Lael Brainerd chimed in yesterday with a speech. She indicated that the Fed decisions will be results based and they need to see employment on solid ground before making any policy moves. Treasuries rallied on the patient messaging and also on a “flight to quality” amid worries of a “third wave” Covid resurgence in Europe (Germany and the Netherlands imposing new lockdowns). The 10 year T is at 1.61%, down 15 bps from last week’s high.
The February durable goods orders report indicated a 1.1% decrease after 9 consecutive months of gains. This is being blamed on supply chain issues combined with winter storm disruptions. The manufacturing sentiment remains very strong. The next few months of reports should be very telling as some level of normalcy returns. The blocking of the Suez Canal may be significant. 10% of the world’s trade runs through this key passage which now has a distressed cargo ship turned sideways.
As the lockdowns took hold last year, financing for hotel properties froze up across the board. As usual, CMBS is the bellwether to watch. The bridge/construction lenders and equity providers all need to underwrite to the permanent loan market. The general guidance from originators and rating agencies is as follows: take 2019 stabilized income, discount it by 20% and then size the loan to a 12-13% debt yield. It’s a start and hopefully as the anticipated pent up demand for travel ramps up, underwriting standards should improve from there. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
Markets Rally on Ultra Dovish Fed, Significant Re-openings (Theaters, Gyms, Theme Parks) Boost Confidence
March 17, 2021
Today’s Fed meeting was more of a market mover than usual, as evidenced by the stock market hitting a record high this afternoon. For our Sponsors that watch the 10-year treasury closely, Fed Chair Powell did not disappoint today! He did everything he could to convince jittery bond markets that there is no reason to panic (sell). Recent developments (Over $3 trillion in stimulus, vaccine distribution numbers higher than expected) have sent GDP growth and inflation predictions upward. Powell is always hyper aware of Bernanke’s infamous 2013 “taper tantrum” press conference that sent 10-year yields rocketing within minutes.
Today, Fed Chair Powell made several specific statements with the obvious intent of removing any ambiguity or uncertainty.
- The policies of rates at zero percent and $120 billion in monthly bond buying are in full effect, with no rate increases planned until 2023.
- As for any tapering of bond purchases, he spoke directly to the bond bears, “As we approach it, well in advance, we will give a signal”. He couldn’t have been clearer unless he executed an order to buy another $100B in treasuries right there at the press conference.
- Social message? Powell reiterated that the Fed is willing to let inflation (as defined by the PCE) to run at “above 2%” for an “extended period, to get to full employment. At the same time, he noted the racial disparity in employment and the share of displaced jobs during the pandemic. This is a departure from the “old school” Fed targets of “2 and 5” (ie. don’t raise rates until inflation is above 2% and/or unemployment is below 5%). Inflation is seen as so much less volatile than historically. He seems to be following the “K shaped” recovery theory, with upper and lower classes on different paths. The Fed is determined to let the slack in employment and wages fully recover before making any policy moves. He basically instructed the bond market not to sell off every time a “transitory” inflationary data point is released. The 10-year held at about 1.65% with no major spike in yields. The only bazooka left in Powell’s arsenal would be a repeat of “Operation Twist” whereby the Fed sells short term treasuries (3 month – 2 years) and buys large amounts of 10-year Treasuries. We shall see if that becomes necessary.
Focus on Retail and the Reopening of Society: This week’s announcements of the reopening of movie theaters and gyms in California, along with partial capacity openings of Dodger Stadium, Angel Stadium, Disneyland, etc. are further advances in the reopening of society. CMBS lenders are open for business for well-performing retail properties and even some hotels at the right basis. With the recent rally in CMBS bonds and relatively low treasuries, originators can price risk in retail with an attractive loan rate. This is significant as CMBS is the traditional permanent loan execution for retail. Their willingness to lend unlocks bridge and construction lending for the product type. Of course, everything depends on the path of the virus and fingers are crossed. By David R. Pascale, Jr. , Senior Vice President at George Smith
March 10, 2021
Today’s “routine” Treasury auction attracted a huge amount of attention as markets are focusing on potential inflation and rising rates. The recent increase in Treasury yields (0.90% to 1.50% since Jan 20) has unnerved markets in our highly levered economy. The specter of inflated assets being “marked to market” in a higher rate environment has fostered recent market volatility. Investors are hypersensitive to signs of inflation. Today’s passing of the $1.9 trillion stimulus package, recent gains in oil prices, and anticipated unleashing of pent up consumer demand are both harbingers of economic growth but also potential warning signs. Today’s CPI report indicated a 0.4% increase for February with an annual increase of 1.7%. These figures were in line with expectations (note that the February Personal Consumption Expenditures, the Fed’s preferred inflation index, will be announced on March 26). Todays closely watched 10 year Treasury auction went well. With more than adequate demand, the 10 year settled at 1.52% (this was significant as it helped alleviate market concerns that the increasing issuance of Treasuries is not sustainable). A poorly subscribed auction could have triggered a massive sell off, sending yields up towards 2.00%. Stock markets rallied with the Dow index up over 450 points or about 1.5%. (It’s interesting to note that an equity position in the Dow index would yield 1.5% in 8 hours of trading today and that yield would take 10 years to achieve in the bond market!) Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith
February 24, 2021
The 10 year Treasury hit a pandemic era high of 1.41% yesterday before settling today 1.38%. Fed Chair Powell’s congresional testimony yesterday and today assured the market that highly accomadative policy will contine. Any changes will be gradual and telegraphed well in advance. He made it clear that the Fed’s main concern is unemployment and not rising prices. The current Fed policy regarding monthly asset purchases and zero rates will not be affected until full employment (defined as a 4% unemployment rate) is achieved. The Fed is willing to tolerate inflation above 2% for a whille in order to acomplish their employment goals. As of now, despite warning signs the Fed’s preferred inflation idicator, the PCE (Personal Consumption Expenditures) has yet to hit 2%. The PCE release next week will be closely watched. Stay tuned.
February 17, 2021
The bond market is experiencing its “worst” January/February performance in years. The 10 year Treasury yield started 2021 at 0.91% and hit 1.30% this week and is now at 1.28%. The next critical level would be at about 1.50-1.60%. That was the last “normal” level before the March pandemic market disruption. Of course we are not “back to normal” yet. But lower levels of new Covid cases and hospitalizations combined with vaccine distribution is cause for optimism (nearly 20% of the US adult population has received at least one dose). Bond markets are historically “forward looking” as buyers are anticipating economic conditions down the road. The recovery is expected to unleash pent up demand for goods and services. Goldman Sachs increased their US GDP forecasts for 2021 and 2022 to 6.8% and 4.5% respectively, an increase of 0.2%. This week saw spikes in oil (hitting $60 per barrel, a pandemic high) and industrial metals led by copper and tin (now at multiyear highs).
The case against inflation: slack in the labor market stubbornly holding down wage inflation. Increasing wages is a major focus and goal of the Fed. Today’s minutes from the January Fed meeting indicate the Fed sees the economy as “far from” their goals. The minutes specifically target a “broad” labor market recovery and inflation of at least 2%. Neither of these goals will be accomplished in the near future. Until then, the zero percent interest rates and $120 billion of bond buying will continue. Goldman Sachs predicts the next rate hike by the Fed in the second half of 2024 and the Fed will start tapering asset purchases in early 2022.
Focus on Self Storage: The CMBS rally continues with originators still quoting in the 2.80-3.25% range even with the uptick in Treasuries. The composition of recent pools shows a strong appetite for loans on self storage facilities, a strong performer during Covid. This appetite has spread throughout capital markets as bridge and construction lenders join in funding well located self storage facilities at tighter spreads. It’s a sponsor driven market as the specialty nature of the product type makes operator expertise critical. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith
February 10, 2021
As Congress closes in on another large stimulus package, the economic data gives policy makers incentive and “inflation cover”. Last week’s jobless claims and unemployment reports indicate stalling job creation and persistent unemployment, justifying the need for further stimulus. A debate has arisen as some influential economists are warning against too much stimulus that may lead to inflation later in the year. This leads to concerns that the Fed may put the brakes on the nascent recovery by raising rates. Today’s CPI data indicated a 1.4% annual increase. Much of the inflation was due to rising oil prices (as the OPEC producers remain united in their resolve to keep production low, for now). However, inflation may firm up in the middle of the year as continued vaccinations, stimulus and pent up demand spur consumer spending. Also, the annual CPI averages will shed last year’s deflationary months (March, April, May).
CMBS Update: Huge demand for CMBS bonds (and corporates) are spurring a rally in fixed rate spreads. AAA 10 year bonds are trading at about Swap + 60 after hitting a high of Swap + 200 last year. Distressed loan volume seems to have peaked and is improving, even for hotels and retail. Originators are quoting tight spreads in the sub 200 range for lower leverage and/or larger well underwritten loans. 10 years of Interest Only is common at lower leverage for the right transactions. This rally and the tightening in corporate bonds is causing Life Companies to also tighten up. We are seeing rates from some life companies in the 2.50% range (but lower leverage than CMBS and limited or no interest only). Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith
February 3, 2021
Today, GSP kicked off our annual MBA meetings (via Zoom) with debt funds, banks, insurance companies, credit unions, CMBS originators, private equity funds and mortgage REITS. The message for 2021: lenders are flush with capital, 2021 real estate allocations are up, lots of capital chasing well underwritten transactions. After a year which included a near shutdown in capital markets for months and conservative underwriting, many lenders are taking an aggressive posture this year.
Vaccinations, a hope for the return to normal life, additional stimulus and continued Fed policy contribute to the optimism in the capital markets. Trends include: Life companies diversifying as they add debt fund originations to their core lending programs. Some are considering uncovered ground up construction loans in addition to the traditional construction perm combos. Senior lenders allowing/encouraging sub debt to create high LTC capital stacks, banks ramping up construction programs shut down for much of 2020, more non traditional construction lenders, retail and hotel loans being considered (at the right leverage with a good story), floating rates dropping due to increased competition which is pushing originators to be more aggressive on LIBOR floors and tighter spreads. Bridge to bridge lending is available for properties needing more time/money to stabilize as Covid slowed down reposition timelines. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith
January 27, 2021
Today’s Fed meeting was the first of eight for 2021. Fed Chair Powell set the tone for the year as he reiterated many of the 2020 issues that remain. Powell remarked, “We have not won this yet”, in reference to the economic recovery. He tamped down recent comments by Fed governors regarding a pullback in Fed bond purchases. He spoke about the $120 billion in monthly bond purchases that will continue until “substantial further progress” is made on both employment and inflation. The Fed is more concerned about job market weaknesses and less concerned about inflation. The message is that any changes in policy will be telegraphed months in advance and a reappearance of inflation would be allowed to “run” for a while before any policy changes. This should forestall any chances of a 2013 style “taper tantrum” where long term rates spiked quickly in a sell off due to confusing messaging from then Fed Chair Bernanke. This policy combined with the potential of “yield curve control” should give comfort to commercial real estate borrowers that the bedrock index for financing, the 10 year T, is benefiting from the accommodative monetary policy. The 10 year T closed today at 1.02%, after hitting a high of 1.15% earlier in January.
What about spreads? CMBS, Agency and Life Companies are pricing 10 year loans in the 2.75% – 3.75% range generally as a variety of factors are helping spreads stay:
(1) Overall economic recovery and the hoped for “return to more normal”;
(2) Investor appetite for real estate based bonds: CMBS, Fannie, Freddie, (especially in the Covid era); and
(3) Rising oil prices stabilizing the huge corporate bond market as energy companies are large issuers of debt.
This calms volatility in overall credit spreads. Floating Rate: The healthier securitization market is creating more liquidity in the bridge loan market (usually via Collateralized Loan Obligations or CLOs). Well underwritten apartment bridge loans are being funded in the 4.00% all-in range or lower. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 20, 2021
Incoming Treasury Secretary Janet Yellen’s confirmation hearings this week were illuminating. She urged Congress to pass another large stimulus package. She also endorsed a market-determined dollar value . This means the US will not weaken the dollar to create competitive trade advantage for US businesses. The continuing stimulus/deficit spending combined with ultra-accommodative Fed policies is expected to lower the dollar’s value against other currencies. This way the US can “naturally” allow the dollar to devalue while maintaining a position that allows us to point the finger at other nations that are engaging in overt currency weakening. With the Fed continuing to buy $120 billion in bonds per month and expanding its balance sheet up to $10 trillion, the flood of dollars is definitely contributing to asset inflation across the board (stocks, bonds, real estate, etc). Meanwhile consumer inflation remains low, allowing for loose fiscal and monetary policy. The threat to this policy is runaway inflation, which could force rates higher, threatening asset valuations. However, commercial real estate could then return to it’s status as an inflation hedge. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 13, 2021
2020 was a year like no other and 2021 is starting out with turmoil and change. Let’s look at some trends to watch in 2021.
Covid and the return to “normal”: The U.S. is experiencing record spikes in cases, hospitalizations and deaths while the pace of vaccination has been slower than expected. In the U.S., over 10 million people have received at least one dose, about 3.3% of the population.
Optimism: New policies, wider distribution (mass vaccination centers, availability at pharmacies, etc.), and the expected approval of more vaccines should increase the pace. Estimates of normalcy range from Memorial Day to Labor Day.
Fiscal Policy/Inflation Outlook: Look for further stimulus as the recovery has been bumpy and uneven. The Fed estimates that the unemployment rate amongst the lowest paid workers is over 20%. The results of the Georgia runoff elections resulted in Democratic control of the Senate. Combined with recent economic data indicating that job growth stalled in December, this greatly increases the likelihood and expected volume of further stimulus from Washington. More stimulus = more dollars, more treasuries, and economic growth. Also, oil prices are over $50 a barrel, the highest since last February as major producers are limiting output. As normalcy returns, pent up demand for travel and other economic activities are expected to push prices up further. Could we see the return of “classic” inflation for the first time in over a decade? Will the Fed allow the economy to “run hot” in excess of its 2.00% target without raising rates? Will investors once again view commercial real estate as an “inflation hedge”, again?
Interest Rates: Due to ultra accommodative Fed policy, 2020 saw borrowers taking advantage of all time low fixed rate financings from Fannie/Freddie, CMBS, Life Companies and Banks. Rates in the 3.00% range for full leverage loans (with some IO) were available for the right properties (typically apartments, industrial, self-storage and selected office). 2021 is starting out with a jump in Treasury yields as the 10 year spiked from 0.84% to 1.15% in three weeks, before settling at 1.09%. The anticipated recovery should result in a steeper yield curve. Already, hedge funds are engaged in the “steepening trade” – buying short term treasuries and selling long term. Residential mortgage applications jumped 20% last week as borrowers rush to lock in low rates. Will commercial real estate borrowers and buyers join them? Will the Fed step in with “yield curve control” and buy longer term treasuries to keep those rates in check? Or, will the Fed turn hawkish, “declare victory” and ease up on bond purchases, allowing rates to rise?
By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 6, 2021
A sell-off in treasuries today spiked the yield on the 10 year Treasury to 1.03%, the highest level since the March 2020 Covid meltdown. After the Georgia run off results became apparent, expectations are for more stimulus, further expansion of the Fed balance sheet, and (possibly) inflation. After hitting 1.00%, the next key levels are in the 1.25% to 1.50% range. The most recent “normal” treasury levels from late 2019 (pre-Covid) were about 1.75%. US Dollar value indices are dropping as the supply of our currency increases significantly each month. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
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