March 2024: Decision Paralysis and Market Steadiness

We thought about putting this out last Monday, and our April Fool’s joke was going to be that the Fed had actually decided on what policy action to pursue.

While there were some interesting stories in March, it feels like it was just another wait and see month economically.

Is the Fed ready to cut?

Is inflation still an issue that needs to be addressed?

Can they at least tell us what they’re thinking of doing?

Maybe decision paralysis is why the press conferences are always a bit delayed, Powell is in the back and can’t make up his mind between the light blue tie and the dark red. Half Windsor? Four-in-hand? Prince Albert? Wake me up when he goes with a bowtie (Is that a dovish signal?).

MARKET UPDATE

What did happen? We got February PCE reports last week, showing that overall PCE was up 2.5% Y/y, and ex-food & energy rose 2.8%. This was in line with expectations but up from January. Odds of a June rate cut remained about a 60/40 proposition following the announcement. The Fed held rates steady and reiterated its projection of 3 rate cuts in 2024.

PORTFOLIO RECAP

At Cooper Bend, we've now completed 21 renovations since our acquisition, with 5 more currently underway. We're seeing a $139/mo. increase on renovated units, beating our forecast by over 5%.

At Summers Run, we completed 3 renovations in March, and have 4 more currently underway. We are achieving $163/mo. renovation uplift, exceeding pro forma expectations by about 3%.

As our investors who soft-committed know from last week's email, there is a delay with the lender around our Residences at St. George closing. We will communicate a broader update shortly.

IN THE MEDIA

We were thrilled to be the headline sponsor of the CRE Daily newsletter two more times in March. Links to those issues are below:

• 60% Of Office Vacancies Are in 10% Of Buildings (credaily.com)
• US Industrial Sees Lowest Q1 Absorption in 10 Years (credaily.com)‍

‍WHAT WE ARE LOOKING FOR

Is it April Fools or Groundhog Day? The Fed left rates unchanged, the economy is unchanged, our target acquisitions haven't changed. Deja vu...

Our focus continues to be on distressed assets or loan assumptions. Traditional acquisition financing for value-add deals is still challenging, so we'll continue to look for opportunistic buying opportunities to pay market rates for assumption loans, or target assets that were purchased at peak pricing where sellers are ready to exit at a loss.

MARKET INSIGHTS

Jobs

February jobs report beat expectations, reporting 275k new jobs, versus 198k forecast. We’ll see how that holds up to revisions, as January and December were revised down a combined 167k jobs in February. For any given month, there is seemingly an 80% chance the revision will be downward.

Many people in major legacy metros are looking around wondering, “Where are all these jobs?” They’re increasingly in new growth markets in the Southeast, at pay level increasingly closer to the markets that formerly dominated the high-skilled labor pool. If you click one link from this newsletter, make it this one, where the WSJ offers detailed coverage on labor supply shifting from the West coast and legacy Northeast metros to the Sunbelt, and the win-win-win proposal for companies, employees, and suburban areas that’s associated with the trend.

Forecast Uncertainty

Nobody likes uncertainty, especially not the institutional capital markets looking to make investment decisions that can play out over a decade or longer. Unlike the Fed, they do not have the luxury of endlessly punting to the next meeting, and we continue to see the impact of their unwillingness to commit substantial amounts of capital into illiquid, long-term projects without a clear signal of where the economy is.

Construction spending was down for the second straight month, and housing starts are down a whopping 36% Y/y, so don’t expect to see construction spending turning around anytime soon (new permits were also down 33%, so not likely to see starts recover quickly either). Developers are being pretty direct about the reason for the slowing, with the most recent NMHC survey citing economic uncertainty and economic unfeasibility as the top two reasons for construction delays.

Economic uncertainty is not only hurting development, but it is also causing new investment in existing properties to dry up, with apartment sales now down for 18 straight months and 35% Y/y in February according to MSCI. Portfolio transactions, typically representing the largest players in the space, were down 44%. On the pricing side, the decline slowed; prices were down 7% Y/y in February, a lower decline than preceding months.

With institutional investors on the sideline, there's been an opportunity for private investors, who have accounted for 60% of CRE transactions in the last 2 years, versus an average of 46% post-financial crisis.

Lending

Do you remember in the cartoon Road Runner when no matter how far off the cliff Wile E. Coyote ran, he never actually fell until he looked down?

That is the lending market today.

While developers and investors are reacting to the uncertainty by not deploying new capital, it’s a different story when lenders and sponsors are already heavily invested in the deal. Every lender is different, and more non-bank lenders with different strategies are entering the market, but your average lender doesn’t want to take your property from you. If something goes wrong with operations, rates rise, or the property has trouble repaying, the banks natural response is typically to work with the borrower, and last year lenders modified over $20B in commercial mortgages, s 150% increase from 2022. This policy is colloquially referred to as “extend and pretend,” and roughly translates to Wile E. Coyote thinking, “I’ve followed this Roadrunner (property owner) off the cliff, and now we’re both stuck, but if we don’t look down maybe I can keep going.” Well, gravity comes into play at some point, and we’ve all seen how it ends in the cartoon.

Gravity in this scenario comes in the form of the ratings agencies warning of exposure to multifamily loans being an ongoing risk factor for the banks. Fitch recently highlighted 10 banks with outsized exposure, and any potential credit downgrade could spell trouble for the lenders. Markets with the greatest exposure to loan maturities through 2029 include Atlanta, Dallas, Denver, Houston, and NYC.

Rents

While the lending space may be a headwind, some positive news is rents are moving up nationally for the second straight month, up 0.6%, after 6 straight months of declines. 81 of the top 100 markets saw rent increases in March, and the YTD growth of 0.9% outpaces the 2017-2019 average of 0.7%, a good sign as we enter leasing season.

As always, thanks for reading, and we hope you enjoyed this update.

Thank you,

Will Matheson