Interest Rates Trend Lower As Fed Responds to Trade War Uncertainty

 



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FINANCIAL MARKETS JULY 2019
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Research Brief
Interest Rates Trend Lower As Fed Responds to Trade War Uncertainty
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Fed has increasingly accommodative stance as trade battles weigh on economy. At its latest meeting, the Federal Reserve showed a greater willingness to ease policy rates in the near term. Chairman Powell pointed to weaker inflation and economic data, together with uncertainty amid trade tensions between the United States and China. The Fed reinforced its willingness to let inflation rise above the 2 percent level going forward, a notable shift in its historical policy framework designed to increase future flexibility. Wall Street has begun to price in rate cuts as early as the July meeting, reflecting a rapid shift toward more dovish policy. Rate cuts during an ongoing expansion would echo similar steps taken during the mid-1990s, when Fed officials responded to softening data by trimming rates three times. The recent trade detente reached between Presidents Trump and Xi at the G20 meetings in Tokyo has eased market concerns in the near term, yet ongoing uncertainty and the potential for re-escalation of tensions remain key considerations of Fed officials moving forward.

Yield spread widening as global interest rates plummet. As the 10-Year Treasury yield hovers in the 2 percent range, borrowing costs have followed suit. This has widened the yield spread between cap rates and lending rates for investments, allowing buyers more aggressive underwriting. Primary markets are likely to be the key beneficiary of this trend due to the razor-thin yield spreads in many property types, particularly highly desired multifamily assets. Lower interest rates could potentially boost market liquidity, as many economic metrics including low unemployment and stable wage growth still favor additional acquisitions. However, risks to the economic outlook remain, particularly in manufacturing industries where tariffs have already caused notable weakness. The impact of previously announced tariffs on consumer goods in the coming months should be closely monitored for risks of slowing consumption and economic growth.

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Developing Trends
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Subdued inflation aiding relaxed Fed stance. While job growth and wage trends are positive, inflationary pressures remain muted. Core CPI recently printed 2 percent, yet the Fed’s preferred metric, Core PCE, trended down to 1.6 percent. Both metrics allow the Fed ample latitude to execute policy as necessary without significant concern of sparking a bout of increased inflationary pressure.

International central banks place downward pressure on interest rates. Within the last month, both the Federal Reserve and the European Central Bank reiterated their willingness to act amid risks of a broader economic slowdown. This has placed significant downward pressure on interest rates, pushing more than $12.5 trillion in sovereign bonds into negative yields. Extremely low and negative rates reinforce the competitive benefits of commercial real estate, where cap rates range from the 4 to 8 percent range.

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2.25%
Current Fed Funds Overnight Rate
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1.6%

Core PCE in May 2019
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* Through June
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; Federal Reserve Bank

 

Robust Job Growth Underscores Confidence in Apartment, Retail Sectors

 

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EMPLOYMENT JULY 2019
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Research Brief
Robust Job Growth Underscores Confidence in Apartment, Retail Sectors
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Recent hiring trends fall below pre-tax stimulus job growth. Employers created 224,000 jobs in June, bringing the total so far this year to 1.03 million. That is the lowest first-half sum since 2010, although comparable periods in 2016 and 2017 reported only slightly higher employment growth. The fiscal stimulus from tax reform encouraged greater hiring in 2018, but as those effects fade, staffs are expanding at a slower pace, further hindered by historically low unemployment.

Tight job market keeps Class C multifamily vacancy low. Greater employment and continued household formation are driving housing demand, particularly for rentals. Unemployment and apartment demand continue to move in sync as individuals with a range of experiences and education levels find opportunities. The correlation is especially strong for Class C units, which serve the broadest renter pool. The second quarter ended with a 3.7 percent unemployment rate and a Class C vacancy rate of 3.5 percent, a near-20-year low. High renter interest and limited availability are propelling effective rents up at a class-leading pace.

Higher earnings bolster discretionary spending, driving demand for retail services. Tight labor market conditions support an annual pace of wage growth above 3 percent, helping lift retail sales by a similar margin. Spending is improving at an even faster rate at restaurants and bars, up 3.6 percent year over year in May. Consumers continue to gravitate toward social experiences and the convenience of eating out, making dining an important driver of foot traffic for retail centers. Spending in grocery stores is also rising at a steady clip, prompting more store openings, especially for smaller format locations. Solid demand factors paired with subdued retail construction will contribute to one of the lowest vacancy rates in 20 years at the end of 2019 and rent growth above the cycle average.

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Developing Trends
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Labor market entrants decline amid hiring shortage. Total job openings continue to surpass the number of unemployed by about 20 percent. The strength of the labor market is empowering employees to change jobs more frequently, raising the number of people quitting their current position in favor of another. At the same time, the labor pool has tightened due to factors such as education. Labor force participation for people between the ages of 20 and 24 is lower compared with past cycles as more young people stay in school longer to obtain advanced degrees.

Higher earnings, trade tensions raise inflation risk. Stable wage growth aided by a labor shortage and the impact of existing tariffs may be behind the recent appreciation in consumer prices. Core CPI rose 0.3 percent in June, the highest monthly increase since January 2018, for a 2.1 percent annual gain. Inflation has been subdued this year despite upward economic pressures, which could begin to manifest in the near future.

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3.7%

June 2019 Unemployment Rate
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3.5%

2Q 2019 Class C Apartment Vacancy

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* Through 2Q
Sources: Marcus & Millichap Research Services; RealPage, Inc.; Bureau of Labor Statistics

 

Rental Demand Elevated in 2Q; Home Refinancing Intensifies as Rates Fall

 

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HOUSING JULY 2019
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Research Brief
Rental Demand Elevated in 2Q; Home Refinancing Intensifies as Rates Fall
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Mortgage rates falling but home sales still soft. Though mortgage rates have declined 80 basis points since they peaked last November, single-family home sales remain sluggish. An increased preference for rentals, the limited number of entry-level homes for sale and caution surrounding the economic outlook are restraining buyers. Move-up homebuyers are less active in the market than in previous cycles, while renters are choosing to remain in apartments. Rentals are also attracting some baby boomers who favor urban locations and amenity packages. This has weighed on the single-family housing market as a broad spectrum of households are showing signs of a transitional shift toward rental housing.

Low borrowing rates spark surge in refinancing. With the 30-year mortgage rate well below 4 percent, many owners are refinancing their loans. Refinances are up roughly 90 percent on an annual basis, while purchase originations are down 3.5 percent. With fewer people buying homes, apartment demand has remained strong, compressing vacancy 40 basis points year over year to 4.2 percent through the second quarter.

Consumer preferences support ongoing apartment performance trends. The ownership rate for people 35 and younger dropped 110 basis points to 35.4 percent during the first quarter as lifestyle changes and evolving preferences steered housing demand toward multifamily rentals. Strong job growth and tight unemployment have bolstered household creation, enabling more people to move out on their own. Robust demand and the slowing pace of inventory growth will support rent increases while keeping apartment vacancy low. At the end of the second quarter, the average effective rent increased 3 percent on an annual basis to $1,390 per month.

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Developing Trends
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Young people choose to start families later in life. The median age for marriage is nearing 30 years old, approximately three years older than the median age in 2000. This delay is impacting single-family home sales as first home purchases are commonly aligned with a transition to family life.

Home-related retail supported by refinancing activity. Homeowners are electing to stay put rather than swapping out for upgraded homes. Instead, owners are refinancing at low mortgage rates and are dedicating some of the savings to enhance their current homes.

Affordability gap highlights cost benefits of renting. While falling interest rates have decreased the mortgage payment of a median priced home, there is still a $248 difference between that and the average effective rent. This disparity paired with the limited flexibility of homeownership has many would-be buyers choosing to rent.

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$280,200

Median Price of Existing Single-Family Homes
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$1,390

Average Effective Rent
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* Through 2Q
Sources: Marcus & Millichap Research Services; Bureau of Labor Statistics; RealPage, Inc.; National Association of Home Builders; National Association of Realtors; U.S. Census Bureau

 

Growing Distribution Webs Boost Retailers’ Competitive Advantages

 

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RETAIL SALES JUNE 2019
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Research Brief
Growing Distribution Webs Boost Retailers’ Competitive Advantages
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Consumption underpinned by elevated consumer optimism. Retail sales remained steady in May, increasing 3.2 percent over the past year. Though this is slightly lower than the previous two months, spending appears to have further stabilized following heightened levels of consumption for much of 2018. Sustained economic optimism is supporting this trend as consumer confidence stays near historical highs.

Industrial properties reap rewards of transforming retail sector. Sound consumption was evident across several retail categories, headlined by bars and restaurants, which remain beneficiaries of increased discretionary spending. General merchandise vendors also performed well, outpacing historical averages as companies like Target and Walmart boost their omnichannel capabilities to improve overall sales. Both companies have ramped up shipping efforts to match Amazon’s rapid delivery services. Walmart also established pickup towers at many of its locations as well as introduced an in-home delivery service. The strengthening omnichannel concept across retail continues to benefit the industrial sector as retailers broaden their distribution networks. Asset appreciation among industrial properties has soared over the past five years, driving the nationwide average price per square foot up nearly 50 percent, substantially outmatching other property types.

Grocery stores evolve with consumers. The grocery sector maintained its steady performance as sales rose 2.1 percent on an annual basis. Changing store layouts and more experiential features have improved these assets’ ability to drive foot traffic, making them highly desired by investors. Many grocers are on track to significantly expand their footprints in the coming months, highlighted by an infusion of small-format stores. These layouts better align with many of today’s consumer shopping habits as customers shift to more frequent, shorter trips compared with large weekly hauls.

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Developing Trends
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Economy’s underlying strength overshadows potential challenges. Consumer confidence continued to rise in May, jumping 4 percent from April’s reading. While some economic headwinds and pending geopolitical issues persist, the economy’s foundation remains solid, fostering a positive outlook from consumers.

Walmart building out logistics nexus. Walmart recently added a supplementary component to its delivery service, which will allow customers to bypass per order fees through an annual subscription. This gives Walmart a bigger edge on many brick-and-mortar retailers as well as a more competitive stance against the robust distribution networks of online vendors.

Industrial sector sustains momentum. While yields for other property types have flattened, industrial returns remain on a downward trend. At the end of the first quarter, the national average cap rate tightened 10 basis points to 6.9 percent, with yields falling evenly across all market sizes.

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3.2%
Core Retail Sales Growth Y-O-Y
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2.9%

General Merchandise Growth Y-O-Y
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* Through May
Sources: Marcus & Millichap Research Services; The Conference Board; National Real Estate Investor; Real Capital Analytics; U.S. Census Bureau