Fed Issues Third Rate Cut, Sustains Prospect of Continued Growth

 

 

I
FINANCIAL MARKETS OCTOBER 2019
I
Research Brief
Fed Issues Third Rate Cut, Sustains Prospect of Continued Growth
I
Fed remains accommodative. In an effort to lengthen the economic runway, the Federal Reserve on Oct. 30 cut the overnight rate by 25 basis points for the third time in 100 days. Domestic growth has been moderating this year, falling to 1.9 percent in the third quarter as the trade war with China curtailed exports and ebbed inventory investment. With tariffs on Chinese goods increasingly coming into play, the economy could face additional pressure, but the Fed has signaled that another rate cut in December will be dependent on incoming data. Several Fed members have argued against additional cuts, as both inflation and unemployment remain very low. A decision on rate policy will largely be determined by the holiday retail season and ongoing trade talks. Should a resolution to the trade war be achieved, the economy and interest rates will likely witness an upward bounce. The Fed’s commitment to short-term Treasury purchases remains another key factor, increasing liquidity in the overnight markets and reducing short-term interest rates. This has helped “uninvert” the yield curve as the three-month Treasury rate fell below the 10-year reading. Though this has reduced recession risk, many speculate that a recession could still be on the horizon.

Investor activity sluggish despite widened yield spreads. With the 10-year Treasury hovering between 1.5 to 1.8 percent in recent months, investors have been favored by strong levered yields. The average combined commercial real estate cap rate remains in the low-6 percent range, delivering a 400- to 450-basis-point premium above the 10-year Treasury, among the widest spreads witnessed in the past decade. While this has bolstered levered return prospects, many buyers remain wary of a potential economic slowdown and their underwriting models continue to deliver more cautious valuations. Sellers, meanwhile, continue to cite strong performance metrics that support aggressive asking prices. The resulting bid/ask spread has moderately slowed transaction activity for all commercial real estate property types excluding industrial assets. Though third quarter commercial real estate sales slowed relative to the same period last year, they are still quite strong compared with the long-term average.

I
Follow Us on Twitter @MMReis
Developing Trends
I
Job creation moderates yet retains stability. The national unemployment rate contracted to a record low in September at 3.5 percent. This has contributed to softened employment growth this year, adding an average of 161,000 jobs per month, relative to a monthly average of 223,000 jobs in 2018.

Retailers hopeful as consumption accelerates. In September, core retail sales rose by 4.5 percent year over year for the second consecutive month. Consumer spending remains elevated, demonstrating a strong recovery from the sluggish growth pace of 2.5 percent in February. This points to a positive growth outlook for the holiday season.

Fed using data-driven strategy. Inflation will play a pivotal role for future rate policy as Chairman Powell noted the Fed’s preferred inflationary measure — core PCE — remained below the Fed’s 2 percent target in recent months.

I
6.3%
Average CRE Cap Rate
I
1.77%

10-Year Treasury Rate
I
I
* Through Oct. 30
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; Federal Reserve Bank

 

Fed Delivers Third Rate Cut, Sustains Prospect of Continued Growth

 

I
FINANCIAL MARKETS OCTOBER 2019
I
Research Brief
Fed Delivers Third Rate Cut,
Sustains Prospect of Continued Growth
I
Fed remains accommodative. In an effort to lengthen the economic runway, the Federal Reserve on Oct. 30 cut the overnight rate by 25 basis points for the third time in 100 days. Domestic growth has been moderating this year, falling to 1.9 percent in the third quarter as the trade war with China curtailed exports and ebbed inventory investment. With tariffs on Chinese goods increasingly coming into play, the economy could face additional pressure, but the Fed has signaled that another rate cut in December will be dependent on incoming data. Several Fed members have argued against additional cuts, as both inflation and unemployment remain very low. A decision on rate policy will largely be determined by the holiday retail season and ongoing trade talks. Should a resolution to the trade war be achieved, the economy and interest rates will likely witness an upward bounce. The Fed’s commitment to short-term Treasury purchases remains another key factor, increasing liquidity in the overnight markets and reducing short-term interest rates. This has helped “uninvert” the yield curve as the three-month Treasury rate fell below the 10-year reading. Though this has reduced recession risk, many speculate that a recession could still be on the horizon.

Investor activity sluggish despite widened yield spreads. With the 10-year Treasury hovering between 1.5 to 1.8 percent in recent months, investors have been favored by strong levered yields. The average combined commercial real estate cap rate remains in the low-6 percent range, delivering a 400- to 450-basis-point premium above the 10-year Treasury, among the widest spreads witnessed in the past decade. While this has bolstered levered return prospects, many buyers remain wary of a potential economic slowdown and their underwriting models continue to deliver more cautious valuations. Sellers, meanwhile, continue to cite strong performance metrics that support aggressive asking prices. The resulting bid/ask spread has moderately slowed transaction activity for all commercial real estate property types excluding industrial assets. Though third quarter commercial real estate sales slowed relative to the same period last year, they are still quite strong compared with the long-term average.

I
Follow Us on Twitter @MMReis
Developing Trends
I
Job creation moderates yet retains stability. The national unemployment rate contracted to a record low in September at 3.5 percent. This has contributed to softened employment growth this year, adding an average of 161,000 jobs per month, relative to a monthly average of 223,000 jobs in 2018.

Retailers hopeful as consumption accelerates. In September, core retail sales rose by 4.5 percent year over year for the second consecutive month. Consumer spending remains elevated, demonstrating a strong recovery from the sluggish growth pace of 2.5 percent in February. This points to a positive growth outlook for the holiday season.

Fed using data-driven strategy. Inflation will play a pivotal role for future rate policy as Chairman Powell suggested the Fed’s preferred inflationary measure — core PCE — will have to significantly rise before another rate reduction is issued. Core PCE has remained in the upper-1 percent range in recent months.

I
6.3%
Average CRE Cap Rate
I
1.77%

10-Year Treasury Rate
I
I
* Through Oct. 30
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; Federal Reserve Bank

 

Retail Spending Strong, Growth Emerging From Diverse Sectors

 

I
RETAIL SALES OCTOBER 2019
I
Research Brief
Retail Spending Strong, Growth Emerging From Diverse Sectors
I
Consumer spending active in midst of uncertainty. For the second consecutive month, core retail sales generated 4.5 percent annual growth as the softening economic outlook had little effect on shopping habits. While spending has moderated relative to last year, consumption trends are gaining traction, setting the stage for a potentially strong holiday season.

New trends surface as retail sales build momentum. After dipping to just 2.5 percent growth in the first quarter, consumption has been revived. Bars, restaurants and pharmacies remain notable catalysts for increased spending, but new trends have begun to emerge. Grocery stores sales are witnessing a modest rejuvenation, with sales delivering consistent annualized growth in the upper-4 percent range in recent months. Expansions by Aldi, Lidl and Sprouts Farmers Market, along with significant reinvestment into current stores by a number of other chains, appear to have boosted grocery store performance. Spending at sporting goods retailers is also trending up, notching two straight months of substantial gains following 36 consecutive months of relative inactivity. Improved omnichannel capabilities of Dick’s Sporting Goods and REI are supporting this resurgence.

Apparel industry in transformation again.
The retail sector remains in transit to reinvention, with the clothing industry facing additional headwinds. Apparel stores continue to feel the brunt of retail’s revolution as companies including Charlotte Russe, Forever 21 and Gymboree recently filed for bankruptcy. While certain segments of the fashion sector remain strong, the often fickle consumer preferences have once again turned against recent favorites. Closed locations have provided investors with new opportunities, allowing them to retenant their properties with more sustainable retailers. Underwriters are beginning to put a much heavier emphasis on tenant mixes, in addition to preferring loan-to-value (LTV) ratios in the 60 to 70 percent range.

I
Follow Us on Twitter @MMReis
Developing Trends
I
Retailers benefiting from record-low joblessness. The national unemployment rate dropped to its lowest level in 50 years at 3.5 percent in September. Sustained job creation and rising wages have boosted disposable income to record levels, empowering increased consumption across all types of retail.

Bankruptcies offering investors new opportunities. Forever 21’s recent Chapter 11 bankruptcy filing includes the planned closings of nearly 180 stores, located in regional malls and retail centers. Revitalizing these locations will be crucial for owners as they retenant the space or leverage adaptive reuse strategies to reposition the assets.

Yield spreads revert to more stabilized state. The 10-year and three-month Treasurys recently uninverted after effectively remaining upended for five months dating back to late May. An inversion of these yields is often recognized as an indicator of an impending recession.

I
4.5%
Core Retail Sales Growth Y-O-Y
I
4.7%

Grocery Store Sales Growth Y-O-Y
I
I
* Through September
Sources: Marcus & Millichap Research Services; The Conference Board; CoStar Group, Inc.; U.S. Census Bureau

 

Record-Low Unemployment Propels Demand for Commercial Real Estate

 

I
EMPLOYMENT OCTOBER 2019
I
Research Brief
Record-Low Unemployment Propels Demand for Commercial Real Estate
I
Job growth continues at subdued but consistent pace. Organizations added about 136,000 positions in September, slightly down from the 168,000 roles filled in August. The more modest rate of employment growth nevertheless exceeded the number of new entrants into the workforce, sustaining the current labor shortage. Employers’ staffing needs will support the hiring of about 2 million personnel by year end. Potential economic headwinds, originating from trade tensions and other factors, create some risk of job creation falling below expectations.

Broad-spectrum employment growth heightens apartment demand. The ongoing surplus of job openings relative to job seekers is supporting continued hiring this year, helping reduce the national unemployment rate to 3.5 percent last month, on par with the lowest reading in 50 years. Joblessness decreased the most among construction workers and members of the financial activities sector. Unemployment also fell substantially within the trade, education, health services, leisure and hospitality sectors. New job opportunities across a wide range of income levels are creating additional demand for housing, including both high-end Class A apartments as well as more affordable Class B/C rentals. Strong summer and autumn leasing seasons have driven the national multifamily vacancy rate down to 3.7 percent at the end of September, breaking the 4 percent threshold for the first time since 2000 despite record new development.

Increase in household formation spurs spending. The tight labor market is boosting new household formation, lifting demand for retail space, particularly in walkable urban and suburban neighborhoods. At the same time, retail construction activity has been limited, with additions pacing at about a third of the level set during the last growth cycle. This has enabled multi-tenant retail vacancy to remain just under 6 percent for more than a year as consumer patterns at brick-and-mortar locations shift toward social and entertainment-oriented venues.

I
Follow Us on Twitter @MMReis
Developing Trends
I
Ongoing job creation supports greater consumer spending. Unemployment for adults without a high-school diploma fell to a record low of 4.8 percent in September. New opportunities for many people who traditionally have a harder time finding employment is boosting discretionary spending. Retail sales are up 44 percent compared with 2008 and have grown 4.2 percent since August of last year. These trends suggest strong retail demand going into the holiday season.

Labor shortage lifts wages in hospitality sector.
Average hourly earnings improved 3.7 percent over the past 12 months in the leisure and hospitality sector, compared with 2.9 percent for all non-farm workers. Hotel operators are mindful of these rising labor costs even as broad-based job and wage gains contribute to record high occupancy levels and RevPAR.
I
108
Consecutive Months of Employment Growth
I
1.45 million

Jobs Added Year to Date
I
I
* Through September
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics