We all know that US housing weakened in 2022 with inflation and The Fed’s counterattack. But what about equity real estate investment trusts (REITs) and commercial real estate (NCREIF)?
The NAREIT all equity REITs index is down -23.8% since the same date one year ago. Hey, that is better than Cathie Wood’s ARK fund (down -68.4% YoY). Oddly, the NCREIF commerical real estate index was up +9.4% through Q3. Interesting to see the NCREIF index (red line) rising with The Fed Funds Target rate (dashed yellow line).
And US home prices are still growing, but the trend looks like the WWII German battleship Tirpitz sinking.
US existing home sales in November collapsed by -38.6% YoY as M2 Money growth runs out of gas.
The above chart is similar to yesterday’s “Ski Slope” chart of US home prices YoY.
Unfortunately, pending home sales YoY are the worst in recorded history.
What will President Biden do about this dire situation? Our “Vacationer in Chief” is off on yet another vacation to St. Croix in the US Virgin Islands, so probably nothing. Now that Biden is sunbathing, what will his Treasury Secretary Janet Yellen do?
The market began downshifting earlier this year as the Federal Reserve started hiking its benchmark interest rate, with the goal of easing high inflation that’s been driven in part by skyrocketing housing costs.
Rates for 30-year, fixed mortgages reached 7.08% in October — and again in November — though they have since retreated, Freddie Mac data show. With borrowing costs roughly double where they were at the start of the year, and inflation leaving less savings to put toward a down payment, homebuyers have pulled back. Sellers are also reluctant to list their properties, yet houses that are on the market are lingering and getting discounted as demand slumps.
The Case-Shiller National Home Price Index “cooled” to 9.24% YoY growth as The Federal Reserve tightens its monetary noose.
Of the top twenty metro areas, both Miami and Tampa Florida were up over 20% YoY. Hot ‘Lanta, Charlotte and Dallas were over 10% YoY. Mordor on the Potomac was up “only” 6% and all other metro areas were under 10%.
But if we look at October/September changes, all metro areas are down (MoM) with San Francisco the worst.
Finally, The Federal Reserve’s massive balance sheet is still out in force.
Look at this chart of the Case-Shiller National home price index again The Fed’s balance sheet. Uh-oh.
Let’s look at San Francisco (my hometown) since The Federal Reserve began interest rate tightening.
One of the big problems with Federal goverment and Federal Reserve monetary stimulus is … it wears out. Just look at M2 Money growth.
US existing homes sales fell -7.70% in November to 4.09 million units SAAR. And since the same month last year, existing home sales are down -35.4% YoY.
Existing home sales were the lowest in November since 2010.
The good news? The median price of existing homes fell to 3.21% YoY. The bad news? The ark is really bad pointing to a bad December. Inventory for sale (orange line) remains below pre-Covid shutdown levels.
Like the Mel Gibson movie “Apocalypto!”, we are seeing the US middle class and low-wage workers being economically sacrificed by The Federal Reserve, the Biden Administration and Congress.
Despite the rhetoric that Fed stimulus (aka “Stimulypto!”) is being removed, the US remains plagued by NEGATIVE real 10-year Treasury yields, NEGATIVE real Fed Funds Target rate and NEGATIVE real average hourly earnings growth under Inflation Joe.
This chart demonstrates the Stimulytpo problem. Prior to Covid, US wage growth was consistently higher than headline inflation. But starting in March 2021, three months after Biden became President, headline inflation became higher than wage growth.
Even with all these negative REAL rates, the US economy is forecast to have almost no growth in 2023.
To quote Peggy Lee, Is That All There Is? Trillions in Federal spending and Fed monetary stimulus and all we get it 0.50% Real GDP??
Central bankers won’t ride to the rescue when growth slows in this new regime, contrary to what investors have come to expect. They are deliberately causing recessions by overtightening policy to try to rein in inflation. That makes recession foretold. We see central banks eventually backing off from rate hikes as the economic damage becomes reality. We expect inflation to cool but stay persistently higher than central bank targets of 2%.
For some investors, this year’s rout in high-flying technology stocks is more than a bear market: It’s the end of an era for a handful of giant companies such as Facebook parent Meta Platforms Inc. and Amazon.com Inc.
Those companies — known along with Apple Inc., Netflix Inc. and Google parent Alphabet Inc. as the FAANGs — led the move to a digital world and helped power a 13-year bull run. And FAANG drawdown have reached over $3 trillion.
FAANGs (Meta, Amazon, Apple, Alphabet, Netflix) are getting clobbered in 2022.
Typically, when The Fed prints too much money, such as 10% or higher (red line), inflation follows. Particularly when The Fed prints at 25% YoY in Q4 2020, it was followed by the highest inflation rate in 40 years. But if M2 Money continues to slow, inflation will likely slow, but not to The Fed’s target of 2%.
Despite what Minneapolis Fed’s Neal Kashkari said about The Fed having infinite printing resourses, The Fed is going to fight inflation THAT THEY HELPED CAUSE. Biden’s energy policies (did you see that Elon Musk has a car that uses plentiful hydrogen?), and excessive Federal spending by Biden/Pelosi/Schumer, are culprits in creating the supply chain problems facing America. BUT after the 25% surge in M2 Money in 2020 and 2021, we saw M2 Money VELOCITY crash and burn to its lowest level in history. Which means the “bang for the buck” for printing more money is negligible.
Of course, big tech firms got caught influencing the 2020 Presidential election (see Musk’s release of Twitter files) and engaged in restriction of the 1st Amendment (Freedom of Speech). How much will that impact FAANG stocks going foward?
And yes, the US Treasury yield curve is inverted pointing to a recession in 2023.
And yes, apparently Biden was complicit in the Twitter fiasco.
This will be the last time (Fed rate hikes) as the US economy is forecast to either go into a recession in 2023 or slow down to an anemic 1.20% Real GDP YoY. Even the Fed is forecasting 3.10% core inflation in 2023, still higher than their target rate of 2%.
One of the sectors that is suffering is commercial real estate.
Commercial mortgage bonds could get clobbered in the coming months, and investors are backing away from the securities.
Some $34 billion of the bonds come due in 2023, and refinancing property loans is difficult now. Property prices could fall 10% to 15% next year, according to JPMorgan Chase & Co. strategists. And some types of properties seem particularly vulnerable as, for example, city workers are slow to come back to their offices full time.
That may be why spreads on BBB commercial mortgage bonds have widened by about 2.7 percentage points this year through Thursday to around 6.6%, for the securities without government backing. They are now at their widest since January 2021. They’ve been getting hit particularly hard in the last few months, even as risk premiums on investment-grade and high-yield corporates have been shrinking on hopes the Federal Reserve will scale back its tightening campaign.
“For CMBS investors, there’s lots of uncertainty, especially around whether maturing loans are going to get refinanced or not, and if not, what the resolution will be,” said David Goodson, head of securitized credit at Voya Investment Management, in an interview. “Layering in risk from lower office utilization makes the assessment even tougher.”
The trouble that the bonds face won’t necessarily translate to a surge in defaults in the near term, which is part of why betting against them is so difficult. When property owners can’t refinance mortgages that have been bundled into bonds, noteholders have a difficult choice to make. They can seize the buildings and liquidate them, or they can extend the debt and accept repayment later. They usually go for the second option.
Extending maturities allows bondholders to kick the can down the road and potentially recover more later, said Stav Gaon, head of securitized products research at Academy Securities. The question is whether properties have permanently lost value as, for example, people reorder their lives after the pandemic, or whether declines may be more temporary because of higher rates.
“Foreclosing on a loan, rather than granting an extension, can be really messy — that’s a lesson that was learned during the great financial crisis,” said Gaon. “The lenders also recognize that today’s higher interest rates are a very sudden development that many high-quality borrowers need time to adjust to.”
Some investors that are still buying are focusing on higher-quality borrowers and properties, that are likelier to withstand any downturn in real estate prices without having to seek extensions on loans.
“We think trophy properties will fare better due to better access to the debt markets, lower potential property declines, and a continued tenant flight to quality,” said Zach Winters, senior credit analyst at USAA Investments.
He acknowledges that this strategy isn’t always popular now, even if it turns out to make sense.
“When we go out and bid on a bond tied to a trophy office building now, usually the number of buyers is significantly less than before,” Winters said.
After the Pandemic
The market for commercial mortgage bonds without government backing was about $670 billion as of the end of 2021, and although the securities soared in the second half of 2020 as the Fed opened the money spigots, they’re facing more difficulty now. With office occupancy still below 50% in many cities as more people work from home, corporate buildings may see their values drop. Retail space is similarly under pressure as consumers have grown used to buying more online. And while travel volume is rising, many hotels are struggling to reach 2019 levels for room charges.
A survey of institutional real estate market professionals in November found that firms expect office values to fall about 10% next year, and overall commercial property declines of 5%, according to the Pension Real Estate Association.
The $34 billion of bonds due next year includes mostly fixed-rate CMBS bonds sold without government backing. It’s a steep increase from the $24.4 billion of such bonds maturing this year, according to Academy Securities.
There’s another $103 billion of a type of CMBS known as single-asset single-borrower bonds maturing next year, according to Academy — although most of that debt pile has a built-in contractual ability to extend loans, meaning they’ll be able to seek extensions more easily.
Next year won’t be the first time that CMBS bondholders and servicers have faced tough choices about whether to allow en masse extensions to the underlying borrowers. After the 2008 financial crisis, commercial property values plummeted and many lenders chose to give owners of those properties more time to pay back their loans. As a result they ended up getting more money back than if they’d immediately foreclosed on the loans and liquidated the properties, said Jeff Berenbaum, head of CMBS and agency CMBS strategy at Citigroup.
In terms of watchlisted CMBS loans, currently most of the USA is in the green (good) except for San Francisco, New Orleans, Memphis and Chicago all have elevated commercial loans on the watchlist (loans being watched for going late and into default). Puerto Rico is also in the red (>25%) watchlisted commercial loans, so I expect AOC to be asking for a bailout.
On the office property front, we can see red (>25% of commercial loans watchlisted) pretty much across the board.
The leading metro area in terms of watchlisted office property loans is … Virginia Beach-Norfolk-Newport News VA-NC at 66.49% (that is pretty bad). Providence RI is second and San Juan Puerto Rico is third followed by Charlotte NC in fourth place. The only Ohio city in top 15 is Cincinnati, home of Skyline Chili and Montgomery Inn.
While most are calling for more rate hikes in 2023, I predicted that December’s likely 50 basis point hike with be the last one for a while as the US economy grinds to a halt. Or it’s all over now for Fed rate hikes.
While The Fed predicts slow growth, markets are pointing to recession. The Fed is out of touch with reality. As is the US Secretarty of Treasury, “Too low for too long” Janet Yellen.
The Federal Reserve is removing the massive punch bowl from the US economy and markets. And with the rising US mortgage rates, we got crashing buying conditions for housing.
The UMich consumer survey for buying conditions for house rose slightly in December to 36, well below 100 (the baseline).
Confounded Interest - Anthony B. Sanders 
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