May 2024 - Fed Signals and Market Movements

The relationship between the Fed and the market is pretty funny when you think about it. The last hike was in July 2023, which was almost a year ago. In December, the Fed signaled they might cut, and everybody got too excited, so the Fed pivoted to saying that they weren't going to cut and that they might even increase rates.

In a certain way, it feels like a game of who can think the most steps ahead. The Fed doesn't want the market to get too hot, so it threatens to hike rates. But the market knows that's why the Fed is saying that, so they don't really believe the Fed, so they still assume cuts will come this year. But since the market still thinks cuts will come this year, the Fed maintains that they don't plan on cutting to keep the market lower. (It actually reminds me of this scene from Dodgeball)

And on and on it goes. At times like this, I'm just grateful for two things:

1. That I'm not a bond trader

2. That we use fixed rate debt

JUST CLOSED - RESIDENCES AT ST. GEORGE

As you may have seen, we successfully completed the acquisition of Residences at St. George on May 10th. This was our largest acquisition as the lead sponsor, and our first deal in Georgia.

Thank you to everybody who took the time to review this deal, and thanks especially to those who chose to invest. We are excited to work with you in the years to come.

WHAT WE ARE LOOKING FOR

No changes on this front. We are either looking for distressed properties like Cooper Bend (which we bought for the debt basis) or loan assumptions like Summers Run and Residences at St. George. The reasoning is fairly simple.

For distressed properties, we feel that the low basis provides a lot of security, even if the projected cash flow is low. After all, it's seemingly impossible to get cash flow if you're using new financing because the debt is so expensive (but we're working on it!).

For loan assumptions, the combination of lower interest rates and longer debt terms (7+ years) provides cash flow and security.

MARKET UPDATE

The month started off with a miss on the April jobs report, 175k versus expectations of 240k fueling the possibility of rate cuts at either of the summer Fed meetings. Wage growth also cooled, from 4.1% Y/Y in March to 3.9%. (It's worth noting that the jobs numbers are revised down almost every month, so that will be something to watch.)

Inflation followed suit and eased in April as well, with the CPI coming in at 3.4%, and Core CPI hitting 3.6%, the lowest rise since April 2021. We've come a long way from when inflation was over 9%, but the Fed seems to think that this last 1.5% will be the hardest.

The New York Fed released its consumer expectation survey for inflation a year from now, and the median came in at 3.3%, showing a lack of confidence in the Fed to hit its goal of sub 3% by year end, effectively predicting no change from today's 3.4%.

Real GDP for 1Q24 was adjusted down from 1.6% to 1.3% on the second estimate based predominantly on a downward revision to consumer spending.

Rounding out the macro news, the May Fed Beige Book points to "lower discretionary spending and heightened price sensitivity" across much of the country, which aligns with the downward adjustment to GDP. It also cites, "Rising Uncertainty and Greater Downside Risk", so we'll see what happens.

Over the last few Fed meetings, Jerome Powell has started to bring up employment, so that may be the signal for a pivot. (Hindsight might be 20/20, but people really seem to struggle when it comes to predicting the future.)

MARKET INSIGHTS

KKR is predicting opportunities to buy "high-quality properties below replacement cost, while achieving long-term yields". MSCI's capital trends report supports this forecast, as distressed CRE grew 3% to $88.6B in 1Q24. Potential distress hit $205B, with Southeast multifamily the lowest regionally at $9.4B vs. $29B in the Northeast. (I'm a broken record on this, but this is why we are trying to buy. If prices are down and demand is down, that's a good time to buy!)

JPMorgan concurred, saying there would be buying opportunities, expecting 2H24 to be positive for CRE, as did CBRE and Starwood, highlighting the likelihood of rent growth through 2024 and 2025.

Maybe the second half of the year will see the large players currently sidelined get back into acquisitions? Sales volume in 1Q24 was down 86% from its 4Q21 peak as MAA, AvalonBay, UDR, and Equity Residential all had zero activity, choosing instead to build up liquidity to prepare to re-enter the arena (MAA has since closed on an $81MM acquisition in Raleigh, NC).

In the interim, capital raising is still slow as investors aren't quite ready to bet on a soft landing and interest rate cuts. Preqin reported $28.5B raised in 1Q24, down 7.5%. Value-add investing was the preferred strategy, responsible for 47% of capital raised.

An interesting development on the distressed front is issuers buying back delinquent credit they issued to avoid losing out on fees if buyers sour on their CLO products. This, obviously, is a short-term fix and a doubling down on lender underwriting that objectively appears to be too optimistic. We'll be keeping an eye on this one.

Apartment occupancy posted the first M/M increase in nearly 2 years, ticking up 10 bp to 94.2%. This reflects a net 100k absorption nationwide.

Raleigh is now the 3rd fastest growing large (250k+) city, according to US Census Data. There are no signs of stopping, as companies are eyeing further development in the city.

A few tailwinds for multifamily investments:

- National median income required to buy a home is up 5.4% Y/Y, to $116k

- Boomers believe it's a better time to rent than buy, with preference at 80% versus 63% a year ago

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

Thank you,

Will Matheson