Situs Newswatch 12/15/17

Federal Reserve Increases Rates for Third Time in 2017
On Wednesday, the Federal Reserve raised interest rates as the U.S. economy continues to grow.The rate hike, which is the third this year, will benchmark federal-funds rate to a range between 1.25 percent and 1.5 percent. This interest rate indicates that despite a change in leadership, the Fed is continuing to stick to its road map, which would call for three increases next year, and two increases each in 2019 and 2020.What is less clear is how this rate hike will affect the commercial real estate market.“The question of the effect of interest rate hikes on the CRE mortgage market is the most complicated we have seen in decades,” said Situs Executive Managing Director Warren Friend. “The Federal Reserve has struggled to explain the accelerating growth rate and lack of inflation and the continued low interest rates, along with a flattening yield curve. The only answer is that one of the ‘inputs’ to the federal reserve’s model is incorrect — and that input would be productivity. Productivity has not been a very reliable metric  used in the Federal Reserve’s rate-calculation model as it has been unable to measure the acceleration of the productivity of labor due to the hyper-advancing technological revolution.” The Wall Street Journal would appear to agree with Friend, publishing a piecelooking at the yield curve and historically what a flattened yield curve has meant for the economy and investors. The accelerated pace of flattening has encouraged some investors, but it has also unnerved a number of economists and investors.

Despite this, the overall outlook remains positive.

“Other market forces have created headwinds for CRE prices, resulting in slowed CRE transaction volume and downward pressure on prices. The Fed rate hikes will pour into the mix and create stronger headwinds,” according to Situs RERC President Ken Riggs. “These additional headwinds relate to whether future short-term rate hikes will result in long-term interest rate increases and what the timing of these rate increases will be. As long as rate increases are not aggressive and they are baked into the market calculus for CRE pricing, the markets will not overreact. CRE is a long-term investment strategy, and as long as the cost of money remains far below historical levels, the rate hikes are unlikely to shake investors.”

The hike is expected to give the U.S. economy a boost, and that could create a ripple effect across the globe, leading to favorable economic conditions in a number of countries.

“I think rate increases will have a positive effect on the economy both domestically and globally,” Friend says. “First, the rate increase will continue to pull deflation out of the rest of the industrialized world. Second, the rate increase will improve the profitability of the banking system. Third, the rate increases will improve the lot of the insurance industry, which is heavily dependent on the fixed-income markets. Fourth, economic activity on a global basis has accelerated to over 3.5 percent, which is a growth rate that can absorb well-staged interest rate increases. Fifth, the Federal Reserve will only have well-staged interest rate increases as it continues to be heavily ‘data dependent,’ and its biggest ‘data dependent point’ is the stock market as a proxy for higher asset prices. Sixth, the global deflation position will act as a governor to the effects of any absolute yield changes.”


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Republican Tax Bill in Final Sprint Across Finish Line
The day after suffering a political blow in the Alabama special Senate election, congressional Republicans sped forward with the most sweeping tax rewrite in decades, announcing an agreement on a final bill that would cut taxes for businesses and individuals and signal the party’s first major legislative achievement since assuming political control this year.

Party leaders in the House and Senate agreed in principle to bridge the yawning gaps between their competing versions of the $1.5 trillion tax bill, keeping Republicans on track for final votes next week with the aim of delivering a bill to President Trump’s desk by Christmas. The House and Senate versions of the tax bill started from the same core principles — sharply cutting taxes on businesses, while reducing rates and eliminating some breaks for individuals — but diverged on several crucial details.

In the end, more of the Senate bill appeared to be included in the final version, though lawmakers continued to make significant changes from the legislation that passed either the House or the Senate.

The changes included a slightly higher corporate tax rate of 21 percent, rather than the 20 percent in the legislation that passed both chambers, and a lower top individual tax rate of 37 percent for the wealthiest Americans, who currently pay 39.6 percent. But the bill will still scale back some popular tax breaks, including the state and local tax deduction and the deductibility of mortgage interest.

“If tax cuts are enacted, the economic, and more importantly, the psychological aspect of the changes will add significant fuel to the growth flames, and would add an interesting twist that economists and the market are not taking into account; a point that will have a substantive effect on the economic picture in the US. Specifically, that federal tax receipts will rise dramatically (and unexpectedly) as the stock market continues its major advance,” says Situs Executive Managing Director Warren Friend. “The US experienced this exact situation in 1996 to 2000. As markets advanced 20 percent-plus per year, people took profits and employees with restricted stock recognized large ordinary tax payments upon conversion (due to the higher prices). The effect was a $700 billion reduction in the deficit. This had two effects — less pressure on interest rates due to less need for government borrowing, and less government expenditures because of lower debt. And it ultimately created the federal surplus by 1998/1999. So if the tax legislation is passed, 2018 and 2019 may see significant stock market gains, which would have a tremendous effect on federal tax receipts and help prolong the ‘true’ economic recovery. This, of course, would be solid for the CRE markets.”

read more: NYT

U.S. Commercial, Multifamily Mortgage Debt Rises to $3.11 Trillion
According to the Mortgage bankers Association, the combined level of commercial and multifamily mortgage debt outstanding increased by $45.4 billion, or 1.5 percent, to $3.11 trillion in the third quarter of 2017 as all four major investor groups, including Commercial Mortgage Backed Securities (CMBS), increased their holdings over the second quarter.

“The third quarter marks a significant turning point for the CMBS market. With only a few exceptions, since 2008, the balance of commercial and multifamily mortgages held in CMBS has declined each quarter. That years-long trend ended this quarter,” said Jamie Woodwell, MBA’s Vice President of Commercial Real Estate Research. “With the so-called ‘wall of maturities’ behind us, and a vibrant market for new originations, we are once again seeing more new loans being originated for CMBS than we are seeing in old loans paying off and paying down. The result is the largest increase in outstanding CMBS mortgages since the end of 2007.”

Multifamily mortgage debt outstanding rose to $1.2 trillion, an increase of $24.9 billion, or 2.1 percent, from the second of quarter of 2017.

The four major investor groups are: bank and thrift; commercial mortgage backed securities (CMBS), collateralized debt obligation (CDO) and other asset backed securities (ABS) issues; federal agency and government sponsored enterprise (GSE) portfolios and mortgage backed securities (MBS);  and life insurance companies.

The analysis summarizes the holdings of loans or, if the loans are securitized, the form of the security. For example, many life insurance companies invest both in whole loans for which they hold the mortgage note (and that appear in this data under Life Insurance Companies) and in CMBS, CDOs and other ABS for which the security issuers and trustees hold the note.

Commercial banks continue to hold the largest share of commercial/multifamily mortgages, $1.3 trillion, or 40 percent of the total.

read more: World Property Journal

Has Multifamily Market Growth Been Stronger in Urban Areas or the Suburbs?
Much has been written on the explosion of the apartment market in recent years. Most of the focus of this expansion has been on the central business districts (CBD) or urban cores as so much of the growth in inventory has been concentrated in the heart of major cities — or has it? And what do “major cities” look like, anyway?

Indeed, there has been considerable confusion as to where the multifamily market growth has been concentrated, especially for those who look at the numbers. In fact, most of the growth has taken place in suburban submarkets. Why this is confusing is because most associate apartment living with urban settings, while the “suburbs” are seen as subdivisions of single-family homes. Few recognize that the bulk of the apartment inventory is located in suburban submarkets, either within the city limits or outside. A quick look at the numbers shows that the ratio of suburban to CBD apartment stock is nearly 6:1.

Another reason why this is puzzling is because many cities are structured as suburban enclaves. Older cities such as New York, Washington, D.C., Chicago and Philadelphia are more traditionally urban, with a concentration of skyscrapers and strong public transportation networks. But most of the other metros tracked are not as densely populated. Residents in these newer cities tend to drive to work more than rely on public transportation. This distinction makes them more suburban, giving them a higher suburban to CBD ratio.

In Atlanta, for example, the suburban to CBD ratio is 18:1, while in Los Angeles, the ratio is 12:1. In some big cities such as Phoenix, there are no CBD apartment submarkets. Thus, because suburban submarkets house the bulk of the apartment inventory, it is only natural that this bigger segment of the apartment market would add more units. From 2010 to 2016, suburban apartment inventory grew by 635,900 units, while CBD inventory grew by 233,250 units.

read more: NREI

Marcus & Millichap Report: Tax Reform’s CRE Impact Likely Limited
Tax reform legislation that is currently in the hands of the U.S. Congress is not quite in its final form yet; however, as is, the proposed changes are not expected to have any notable negative impact on investment in the commercial real estate industry, according to a new tax plan report by real estate investment services firm Marcus & Millichap. On the other hand, there is likely to be some upside.

“The most significant outcome of finalizing the tax plan would be a reduction of uncertainty,” John Chang, first vice president, research services with Marcus & Millichap, told Commercial Property Executive. “For the last year, commercial real estate investors have not had a firm grasp of what to expect from the tax plan, and as a result, several have held off significant business decisions. With greater clarity on what to expect, investors have some information upon which to base their commercial real estate investment decisions.”

Sometimes, no news is good news. Key findings of the report include the conclusion that there would be no fundamental alteration of investor-friendly 1031 tax-deferred exchanges, business interest deductibility or depreciation rules. Additionally, for real estate businesses, full deduction of interest on real estate would continue.

read more: Commercial Property Executive

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