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National   /   April 6, 2021

Paul Bubny
By: Paul Bubny

Marcus & Millichap Webcast Featuring Federal Reserve Policy Advisor: Inflation, Interest Rates Unlikely to Disrupt CRE Recovery, Capital Flows Anytime Soon. Economic Recovery Building Momentum.

With distribution of COVID-19 vaccines becoming more widespread, consumer confidence and spending on the rise, and the $2-trillion stimulus package beginning to work its way through the system, the keyword for the current outlook is “promising,” Marcus & Millichap CEO Hessam Nadji said on the firm’s recent webcast with over 9,000 investors signed on, “Roaring ‘20s Revival or Fed-Induced Downer?”

As a case in point, Nadji noted an uptick in commercial property sales as 2021 progresses. “We’ve seen a steady improvement in the transaction marketplace since the bottoming in the second quarter of last year,” he said.

However, he pointed out, “there is a big question mark as to the rising tide of an overall strong recovery lifting all boats by property type and potential lingering structural issues.”

Helping to illuminate the landscape for 2021 and beyond during the hour-plus webcast were a pair of experts who brought both private- and public-sector perspective to the conversation. Brian Bailey, senior financial policy advisor at the Federal Reserve Bank of Atlanta since 2011, provided unique perspective about the latest data on the recovery, interest rates and inflation. He also brought a commercial real estate background to the session, having been in the business for 15 years prior to joining the Federal Reserve. Paul Lewis, national director of agency programs at Marcus & Millichap Capital Corporation, joined MMCC after nearly three decades at Fannie Mae. Lewis broke down the current lending environment and on-the-ground perspective by property type.

Specifically in terms of the prospects for more jobs, “I think the environment is optimistic as it relates to lender outlook on the economy,” said Lewis. He noted that lenders are taking a fresh look at underwriting that accounts for increasing distribution of the vaccine and accordingly foreseeing business reopenings, specifically among restaurants, fitness centers and hospitality.

A big question mark, though, hangs over the employment landscape, as Bailey pointed out. This pertains not only to the 9.5 million jobs the U.S. economy still needs to recover but also to the under-employment rate among millions of others in the workforce. While getting back to full employment requires more than recovering jobs lost to the pandemic, which will take more time, it also points to slack in the economy helping to keep inflation in check.

The panel noted that the run-up in the 10-year treasury yield this year has been steeper than expected, but at 1.77%, the yield is still below pre-COVID levels and well below 3.2%, the previous peak in recent years. “Low inflation should give the Fed flexibility, at least for a while,” said Nadji.

At the same time, Nadji noted that the release of pent-up demand should not be underestimated as savings deposits are an estimated $3.2 trillion higher than pre-Covid levels. Businesses and consumers returning to normal is expected to boost all job segments. Lenders are factoring this into their underwriting, Lewis said. Looking at hospitality, for example, he noted, “In some cases, they’re underwriting to pre-COVID occupancy and income levels.”

Asset performance during the pandemic has varied not only by property type, but also by location. The apartment sector didn’t experience anything comparable in terms of reductions in occupancy and NOI. “Multifamily has in some ways been the shining star,” said Lewis.

Asked how the Federal Reserve is looking at the current state of CRE loan performance, Bailey said the CARES Act gave banks a little more flexibility to work with their borrowers. However, he added, “I am expecting a little bit of a wave of distress to come through. You have implications with the foreclosure and forbearance moratorium.

In addition, “the court systems have been closed in many locales,” he continued. As the courts reopen, a little more distress will rise to the surface as a backlog of cases is worked through.

In the office sector, while suburban properties have long withstood higher vacancies than their CBD counterparts, now the opposite is true in many metro areas. Bailey noted that the Fed is studying office vacancies and in particular the rise of CBD sublease space.

From the lenders’ perspective, Lewis said they’re struggling in terms of underwriting on downtown office properties, particularly in situations with large tenancies on short-term leases. There are short-term challenges on the apartment side, too, given the exodus from big cities during COVID.

“They’re ratcheting down their leverage levels and requiring higher debt service coverages for the opportunities that are getting financed,” said Lewis. Bailey concurred, saying, “There are non-bank lenders that are pushing back the amount of leverage up into the low 70s.”

The latest in a series of webcasts Marcus & Millichap has sponsored since the pandemic began in March 2020, the March 31 conversation also examined interest rates, cap rate movement, investment trends and the longer-term outlook. On-demand replays are available by clicking here.

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Paul Bubny serves as Senior Content Director for Connect Commercial Real Estate, a role to which he brings 13-plus years’ experience covering the commercial real estate industry and 30-plus years in business-to-business journalism.
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