Strong economy flows through to CRE in Q2
By Jamie Woodwell; Reggie Booker
October 1, 2018
The US economy showed solid strength during the second quarter. Real gross domestic product grew at a seasonally adjusted annual rate of 4.2 percent during the quarter. The U.S. added a seasonally adjusted 175,000 jobs in April, 268,000 in May and 208,000 in June. At its most recent reading (in August) the unemployment rate was just 3.9 percent. And wage growth has begun to take hold, with average hourly earnings up 2.9 percent between August 2017 and August 2018.
There were 1.6 million more households during the second quarter of 2018 than there were a year earlier. And consumer spending remains strong, with August retail sales, excluding motor vehicle and parts dealers, up 6.8 percent from a year earlier.
COMMERCIAL REAL ESTATE PROPERTY FUNDAMENTALS
The strong economy continues to flow through to demand for commercial real estate, and even though vacancy rates ticked upward during the second quarter, so did asking rents. Apartment vacancy rates rose from 4.3 percent during the second quarter of 2017 to 4.8 percent during the second quarter of 2018. Vacancy rates for retail properties rose from 10.0 percent to 10.2 percent and for office properties from 16.4 to 16.6 percent. Over the same period asking rents rose by 4.5 percent for apartments, 1.8 percent for retail and 2.5 percent for office.
New construction activity has largely plateaued in recent months, but with differences across property types. The value of construction put-in-place increased 1.1 percent between July 2017 and 2018 for multifamily properties, 6.8 percent for office properties and 7.9 percent for lodging. It declined 1.9 percent for health care and 4.4 percent for manufacturing. The level of multifamily units under construction remains high at roughly 600,000.
Commercial real estate sales activity started the year strong. During the first half of 2018, sales volume was three percent higher than a year earlier, led by increases in multifamily (up 8 percent to $70 billion) and industrial (up 26 percent to $39 billion) properties. Sales of office properties declined by 13 percent (to $58 billion) while sales of retail properties were relatively flat at $34 billion.
Major property price indices show property values either continuing to climb (up 1.8 percent during the second quarter according to the RCA CPPI) or generally plateauing (down 0.5 percent during the second quarter according to the NCREIF TBI). The indexes agree that prices currently stand approximately 25 percent above the 2007 peak.
Capitalization rates have been mixed over the last year. Between Q2 2017 and Q2 2018, cap rates for apartment properties declined from 5.6 percent to 5.5 percent and for industrial fell from 6.5 percent to 6.4 percent. Office cap rates rose from 6.5 percent to 6.7 percent and retail held steady at 6.5 percent.
Commercial and multifamily real estate borrowing and lending continues to track with last year's level. Investor demand for multifamily properties and hotels are helping push originations higher, even as loan demand for retail properties is down. New loan demand continues to be supported by still-low long-term interest rates, growing property incomes and rising values.
The second quarter saw a 22 percent year-over-year increase in the dollar volume of loans for hotel properties, a 17 percent increase for multifamily properties, a one percent increase for retail properties, a four percent decrease for office properties, a 10 percent decrease in industrial property loans, and a 16 percent decrease in health care property loans.
Among investor types, the dollar volume of loans originated for the Government Sponsored Enterprises (GSEs - Fannie Mae and Freddie Mac) increased by 18 percent year-over-year. There was a six percent year-over-year increase for life insurance company loans, a one percent decrease in commercial bank portfolio loans, and an eight percent decrease in the dollar volume of commercial mortgage-backed securities (CMBS) loans.
MORTGAGE DEBT OUTSTANDING
The balance of mortgage debt on commercial and multifamily properties grew faster during the first half of 2018 than during any other first half since 2007. The four major investor groups all increased their holdings, and multifamily mortgage debt outstanding topped $1.3 trillion for the first time. Strong property fundamentals and values, coupled with still-low mortgage rates and strong loan performance, are all supporting the market.
In the second quarter of 2018, banks and thrifts saw the largest increase in dollar terms in their holdings of commercial/multifamily mortgage debt - an increase of $23.9 billion, or 1.9 percent. Agency and GSE portfolios and MBS increased their holdings by $14.5 billion, or 2.4 percent, life insurance companies increased their holdings by $10.6 billion, or 2.2 percent, and CMBS, CDO and other ABS issues increased their holdings by $5.7 billion, or 1.3 percent.
The $20.0 billion increase in multifamily mortgage debt outstanding between the first and second quarters of 2018 represents a 1.6 percent increase. In dollar terms, agency and GSE portfolios and MBS saw the largest increase in their holdings of multifamily mortgage debt, an increase of $14.5 billion, or 2.4 percent. Commercial banks increased their holdings of multifamily mortgage debt by $7.9 billion, or 1.9 percent. Life insurance companies increased by $1.7 billion, or 2.2 percent. State and local government saw the largest decline in their holdings of multifamily mortgage debt, by $1.7 billion, or down 1.9 percent.
It is hard to overstate how low commercial and multifamily mortgage delinquency rates are today. Only three-one-hundredths of one percent (0.03 percent) of the balance of commercial and multifamily mortgages held by life insurance companies is delinquent, as is one-one-hundredth of one percent (0.01 percent) of the balance of multifamily mortgages held by Freddie Mac. The delinquency rate for loans held on banks' balance sheets is the lowest in the series history. Strong property fundamentals and values, coupled with low interest rates and ample financing options, all continue to support commercial real estate owners and their abilities to repay their mortgages.
Based on the unpaid principal balance (UPB) of loans, delinquency rates for each group at the end of the second quarter were as follows:
- Banks and thrifts (90 or more days delinquent or in non-accrual): 0.50 percent, a decrease of 0.01 from the first quarter of 2018;
- Life company portfolios (60 or more days delinquent): 0.03 percent, an increase of 0.01 percentage points from the first quarter of 2018;
- Fannie Mae (60 or more days delinquent): 0.10 percent, a decrease of 0.03 percentage points from the first quarter of 2018;
- Freddie Mac (60 or more days delinquent): 0.01 percent, a decrease of 0.01 from the first quarter of 2018;
- CMBS (30 or more days delinquent or in REO): 3.52 percent, a decrease of 0.41 percentage points from the first quarter of 2018;
The analysis incorporates the measures used by each individual investor group to track the performance of their loans. Because each investor group tracks delinquencies in its own way, delinquency rates are not comparable from one group to another.