Strong Q1 driven by multifamily and industrial
By Jamie Woodwell; Reggie Booker
June 29, 2018
The US economy continued its strong performance during Q1 of 2018. Real GDP grew at seasonally adjusted annual rate of 2.0 percent. The US added 176,000 jobs in January, 324,000 in February and 155,000 in March. Job growth has continued with an additional 159,000 in April and 223,000 in May, despite an unemployment rate that has fallen to 3.8 percent and the fact that there are now more job openings than there are unemployed. The tight labor market has pushed hourly wages up 2.7 percent over the last year, one of the highest readings since 2009.
Consumer spending has continued to grow, with retail sales excluding motor vehicle and parts dealers increasing 6.6 percent between May 2017 and May 2018. E-commerce accounted for 9.5 percent of total retail sales in Q1 2018, compared to 8.5 percent a year earlier.
The yield curve continues to flatten. The 10-year Treasury averaged 2.98 percent in May, up 68 basis points from a year earlier. The 2-year Treasury averaged 2.51 percent in May, up 121 basis points from a year earlier. During that period, the 10-year/2-year spread has narrowed from 100 basis points to 47 basis points. In late June the spread was 34 basis points.
Property vacancy rates ticked up slightly from last year's first quarter, but so did asking rents. Vacancy rates rose from 4.3 percent to 4.7 percent for apartment properties, from 16.3 percent to 16.5 percent for offices, and from 9.9 percent to 10.0 percent for retail. At the same time, asking rents rose by 4.4 percent for apartments between Q1 2017 and Q1 2018, by 2.2 percent for offices and by 1.9 percent for retail.
New construction activity remains robust. In April, the value of new construction put-in-place was 16 percent higher than a year earlier for lodging properties, 8 percent higher for health care, 6 percent higher for office and 5 percent higher for other commercial (generally retail) properties. The value put-in-place was 4 percent lower for both manufacturing and multifamily properties. The multifamily decline should be seen in the context of Census numbers showing that the first quarter saw seasonally adjusted annual rates of 368,000 multifamily units completed, 412,000 units started, and 442,000 multifamily building permits issued. The 600,000 multifamily units under construction remains at levels not seen since the mid-1970s.
After two years of declines, property sales transactions held firm in the first quarter. Total sales volume for the major property types rose three percent from Q1 2017 to Q1 2018. Total Q1 sales had fallen from $118 billion in 2015 to $104 billion in 2016 and $94 billion in 2017 before the slight rise to $96 billion in 2018. Sales were buoyed by increases in apartment (a 25 percent increase from $27 billion in Q1 2017 to $35 billion in Q1 2018) and industrial (a 34 percent increase from $16 billion in Q1 2017 to $21 billion in Q1 2018) properties. Sales of office properties fell by 12 percent and retail fell by 31 percent.
Commercial property capitalization rates, meanwhile, have generally been on the decline. Apartment cap rates held steady at 5.6 percent between Q4 2017 and Q1 2018, but are down from a year earlier. Investor interest has pushed industrial cap rates down to 6.4 percent, from 6.7 percent during Q4 2017 and 6.9 percent during Q1 2017. Retail cap rates came in at 6.5 percent during Q1 2018, flat from a year earlier and down 10 basis points from Q4 2017. And office cap rates were flat from both a year earlier and from Q4 - at 6.7 percent.
The drop in cap rates, coupled with NOI growth, has generally continued to push property values higher. The Real Capital Analytics property price index increased 1.6 percent during Q1 2018 and the NCREIF transaction-based index rose 3.1 percent. The Green Street Advisors price index, on the other hand, showed a decline for the quarter.
Borrowing and lending backed by commercial real estate is starting 2018 at roughly the same pace at which it started 2017. The property types drawing the most attention of late continued to follow different paths, with retail originations declining while multifamily and industrial increased. It was the strongest first quarter on record for originations of loans for life insurance companies and the GSEs, Fannie Mae and Freddie Mac.
A rise in originations for hotel, multifamily and industrial properties led the overall increase in commercial/multifamily lending volumes when compared to the first quarter of 2017. The first quarter saw a 54 percent year-over-year increase in the dollar volume of loans for hotel properties, an 18 percent increase for multifamily properties, a 14 percent increase for industrial properties, a one percent decrease for office properties, a 27 percent decrease in retail property loans, and a 39 percent decrease in health care property loans.
Among investor types, the dollar volume of loans originated for commercial mortgage backed securities (CMBS) increased by 12 percent year-over-year. Life insurance company loans increased 9 percent, Government Sponsored Enterprises (GSEs - Fannie Mae and Freddie Mac) increased 8 percent, and loans originated for commercial bank portfolios loans decreased 23 percent.
MORTGAGE DEBT OUTSTANDING
During the first three months of 2018, commercial and multifamily mortgage debt outstanding increased more than during any other Q1 since before the Great Recession. Interestingly, Q1 holdings grew more slowly this year than last among the three largest investor groups: banks, life insurance companies, and the GSEs. This year's increase was driven by the CMBS market, which added $6 billion of mortgages to its balances. This is a sharp contrast to the $21 billion decline over the same period in 2017. For the first time since 2007, CMBS has seen three straight quarters of increase.
The level of commercial/multifamily mortgage debt outstanding increased by $44.3 billion in the first quarter of 2018 as all four major investor groups increased their holdings. That is a 1.4 percent increase over the fourth quarter of 2017. Total commercial/multifamily debt outstanding rose to $3.21 trillion at the end of the first quarter. Multifamily mortgage debt outstanding rose to $1.3 trillion, an increase of $19.3 billion, or 1.5 percent, from the fourth of quarter of 2017.
Mortgages backed by commercial and multifamily properties continue to perform extremely well. Delinquency rates are at or near their all-time lows across most capital sources. This continues to be driven by strong property fundamentals, increasing property values, still-low mortgage rates and readily available financing. Based on the unpaid principal balance (UPB) of loans, delinquency rates for each group at the end of the first quarter were as follows:
• Banks and thrifts (90 or more days delinquent or in non-accrual): 0.51 percent, unchanged from the fourth quarter of 2017;
• Life company portfolios (60 or more days delinquent): 0.02 percent, a decrease of 0.01 percentage points from the fourth quarter of 2017;
• Fannie Mae (60 or more days delinquent): 0.13 percent, an increase of 0.02 percentage points from the fourth quarter of 2017;
• Freddie Mac (60 or more days delinquent): 0.02 percent, unchanged from the fourth quarter of 2017;
• CMBS (30 or more days delinquent or in REO): 3.93 percent, a decrease of 0.15 percentage points from the fourth quarter of 2017.