August 16, 2013
RCLCO U.S. Real Estate Chart Book - Second Quarter 2013
By: Paige Mueller, Managing Director
RCLCO OUTLOOK - FROM THE GROUND UP
A 100 bp rise in U.S. 10-year treasury rates in May and June caused temporary disruption in the mortgage and sales markets in June as investors and lenders alike attempted to sort out where interest rates would land. There has since been some improvement in the public markets, including treasuries, CMBS spreads, and REIT prices (although volatility remains), indicating that we may at least temporarily be staying somewhere near 2.5% to 3% treasury rates with less drastic increases in mortgage rates and cap rates.
Longer-term, given expected inflation in the 2% to 2.5% range, 10-year treasury rates near 3.5% or higher are more likely as quantitative easing slows and the bond markets return to more normalized spreads. Fortunately, cap rates for most property types have already priced in higher bond rates and are still pricing at wide spreads to treasuries. Our fair value cap rate model indicates some upward, but not significant, pressure on cap rates (p. 40) as of Q2 2013. If treasuries start approaching 3.5% or higher, our analysis indicates upward pressure on cap rates of 25-50 bps with the most pressure on several apartment markets and prime CBD office that are already priced near peak rates and are experiencing a significant amount of new construction. Also watch for assets with characteristics that increase interest rate risk, such as low growth or unstable cash flows, high leverage, low debt service coverage ratios, short hold periods, variable rate financing, or near-term financing needs. See RCLCO's special publication, "Interest Rates and Real Estate Pricing Risk," for a more detailed analysis of this topic.
The good news is that property markets are generally improving, with positive momentum in both occupancy and rents. Occupancy gains are particularly strong in both local industrial markets (Austin, Boston, San Diego) and national distribution hubs such as Atlanta, Riverside, and Memphis, as well as several office markets, including Orange County, San Diego, and San Jose. Construction is picking up across all property types, with strong activity in many apartment markets and some prime CBD office markets, namely New York and the D.C. and San Francisco Bay regions.
The slow growth U.S. economic figures are masking significant regional growth in many areas. Goods producing jobs are being supported by significant improvements in the residential construction and energy sectors. Even manufacturing employment is up y-o-y in a number of regions as of June. In addition to several states in the Mountain Northwest, Michigan joins the ranks of top performers with manufacturing employment up by 2.5% y-o-y in June.
To view the chart book, please click on the PDF link above.