Archives for March 2023

The economic projections from the Federal Reserve and the Federal Reserve Bank presidents have taken a turn downward and it’s looking like a tacit admission of recession without using the R-word.

In December, the Fed and its bank presidents, “under their individual assumptions of projected appropriate monetary policy,” expected a median 0.5% change in real GDP (beyond inflation) in 2022, 2023, up to 1.6% in 2024, and 1.8% in 2025. The September projections were 0.2% in 2022, 1.2% in 2023, 1.7% in 2024, and 1.8% in 2025. In each, “in the longer run,” the number was 1.8%.

Unemployment? September’s projection was 3.8% in 2022, 4.4% in 2023 and 2024, and then 4.3% in in 2025 with the longer run number of 4.0%. The December projection kept the long run but went with 3.7% in 2022, 4.6% in 2023 and 2024, then edging down to 4.5% in 2025.

The projection released on March 22, 2023, went as follows for real GDP: 0.4% in 2023, 1.2% in 2024, and 1.9% in 2025, with long-term 1.8%. Unemployment projections were 4.5% in 2023, 4.6% in 2024 and 2025, and keeping the long-term 4.0%.

The same signs of slowdown came into personal consumption expenditures (PCE) inflation. December saw things going from 5.6% in 2022 to 3.1% in 2023, 2.5% in 2024, and 2.1% in 2025, with 2% long-term, which is the Fed’s magic target number.

Now the numbers are 3.3% this year, 2.5% in 2024, and 2.1% in 2025.

As Bloomberg pointed out, the changes seem small, but the economy has been strong so far in the first quarter of 2023. Simple arithmetic tells you that the Fed expects the brakes to really hit hard in order to get the median numbers they’re looking for. Unemployment is 3.6% right now. To get 4.4%, you have to jump well over 5% for things to average out. Historically, that isn’t an outrageous number and used to be close to what people considered “normal,” but in comparison to recent times, it is a big shift.

As for real GDP growth, Q4 of 2022 came in at 2.7%. The figures for the current quarter aren’t available—we’re not even past March—but, again, to get to the new figure, assuming Q1 hasn’t already crashed, and that seems unlikely, you probably need recessional levels in Q3 through Q4 to bring the average down sufficiently.

One other seeming oddity in the projections is how the long-term results don’t shift. Typically, when making future estimations, significant changes in where things are and where you thought they might be become reasons to reconsider the future. The Fed’s ongoing estimates seem more like targets that will happen by force of will. It smacks a bit of an organization that is trying to adjust the short term to argue for the eventual desired results. This will become a bigger question over the next few quarters with further reports from the Fed and a look at whether their extended estimates ever change.

Source: “Federal Reserve Sees a Colder Economic Wind Coming“

People in CRE have been wondering when the impact of macroeconomics and financial realities would mark the arrival of distressed properties.

An analysis by CRED iQ of the close to 400 metropolitan statistical areas in the US, with more than $900 billion in outstanding CRE debt, suggests that the answer is now.

Distress became more prevalent in a majority of primary markets during February 2023,” the firm wrote. “Of the 50 largest MSAs tracked by CRED iQ, 34 of those markets exhibited comparatively higher levels of distress in commercial real estate loans than one month prior. The average month-over-month increase in distressed rates for these 34 markets was approximately 21 basis points. The Birmingham, AL MSA (+1.0%) exhibited the highest month-over-month increase in distress. Other notable markets with increased levels of distress this month included Pittsburgh (+0.8%), Memphis (+0.7%), and Los Angeles (+0.7%).”

There were 16 MSAs that showed better month-over-month distressed conditions, including Portland (a 2.4% reduction), Cleveland (-2.3%), and San Francisco (-1.7%).

Office was one of the driving factors for distress, as anyone who has been monitoring the CRE markets and property types might have guessed. Three areas hit particularly hard by month-over-month were Birmingham, AL (+4.6%), Columbus, OH (+4.3%), and Memphis (+4.1%). Birmingham, for example, saw a loan secured by the 211,257-square foot Chase Corporate Center go into default and then a transfer into special servicing status. “Refinancing efforts may have been hindered by the relatively short remaining lease term of the property’s largest tenant, Cigna, which accounts for 34% of the property’s GLA,” said CRED iQ. “Cigna’s lease is scheduled to expire in November 2024, less than two years after loan maturity.”

Hotels also weighted heavily on markets, as five of the top 10 increases in distress were associated with the property type. “The lodging sector for Birmingham, AL exhibited the sharpest increase (+9.2%) in February following the special servicing transfer of a $10.4 million loan secured by Hotel Indigo Birmingham due to imminent monetary default,” the report said. “Additionally, two Virginia Beach hotel loans with the same sponsor, totaling $22.2 million, became 30 days delinquent in February. The delinquencies contributed to the distressed rate for the Virginia Beach hotel market increasing by 5.0%.”

Still, distress in one place does not mean equal problematic conditions in another. The highest overall distressed rate was 20.7% in Minneapolis. Rounding out the top five were Birmingham (11.4%), Milwaukee (8.9%), Cleveland (8.4%), and Charlotte (7.9%).

On the other hand, Salt Lake City had the lowest percentage of distress, at 0.1%, followed by Sacramento (0.3%), Dallas (0.6%), and Boston (0.6%).

Source: “The Delinquencies and Distress Are Here“

Investors seeking higher cap rates are finding them in industrial spaces that serve manufacturing, according to a new report from CBRE.

Although e-commerce-fueled bulk logistics space is the darling of the current cycle, manufacturing stimulates industrial space demand for both factories and warehouses.

CBRE pointed to Austin, Phoenix, and Reno as areas that benefit from new factories and capital stock capable of building high-value goods.

“Interestingly, high-cost California has expanded its manufacturing as it retains a competitive edge in producing aerospace, chemicals, computing equipment, and other extremely high-value goods,” according to its report.

Los Angeles is a notable outlier, it said, reflecting its heavy exposure to lower-value sectors, such as garment making.

The Midwest accounts for just over one-third of U.S. manufacturing employment, just ahead of the South.

Manufacturing Tenants More Imbedded in the Property

Rob Gemerchak, vice president, investment sales, Northmarq, tells GlobeSt.com that net-leased industrial manufacturing properties remain a very popular asset class among experienced investors – particularly those whose underwriting considers the tenant’s use of the facility, their industry, the property’s infrastructure, and regional labor.

“As opposed to some other asset classes, manufacturing tenants tend to be more embedded in the property due to their investment in process machinery and equipment, production lines, and use of a trained workforce,” Gemerchak said. “A successful manufacturing tenant is often more likely to renew a lease vs. relocate – due to the time, expense, and production challenges involved in a relocation.”

Considering manufacturing facilities’ unique infrastructure that may include cranes, heavy power, reinforced floors, etc. – there is economic value in these systems which support and enhance the real estate investment, he said.

“The tenant’s industry is also a factor that investors consider, as firms who are supplying growth industries such as computer and electronics, chemicals, pharmaceuticals, and automotive provide the strongest security,” according to Gemerchak.

“Finally, the regional workforce that supplies the tenant’s operation is an important variable that investors consider. As onshoring and reshoring of the manufacturing base continue, industrial properties located in strong regional labor markets will continue to be considered very attractive as a long-term investment.”

Economic Turbulence Might Have Inflated Cap Rates

Shanti Ryle, CREXi senior content marketing manager, tells GlobeSt.com that overall, while the total sales comps for manufacturing buildings are trending down year-over-year (given overall pauses in activity due to rising interest rate/economic factors), valuations and transaction volume for manufacturing industrial properties are still on the rise.

“There may be some pause in transaction velocity following pandemic-era construction delays and economic turbulence, and the delivery of multiple properties at the same time may have inflated cap rates, lowering total sales value in 2022,” Ryle said.

Arizona, Texas, I-85 Corridor Ideal for Manufacturing Expansion

Adrian Ponsen, national director of U.S. industrial analytics at CoStar Group, tells GlobeSt.com that labor shortages have been gripping most sectors of the U.S. economy since 2019, but because of an aging workforce, and a prevailing skills gap, manufacturing is one of the industries struggling most to grow and retain its headcount.

“As a result, US regions doing best to attract both foreign and domestic in-migration including Arizona, Texas, and the I-85 corridor stretching through Georgia and the Carolinas, have had a huge leg up securing the largest manufacturing expansions in recent years, particularly those tied to electric vehicle and semiconductor assembly,” Ponsen said.

“These are the locations where manufacturers feel most confident that local labor force growth will be strong enough to support staffing up new operations at scale.”

Source: “Industrial Space Serving Manufacturing Gets a Closer Look“

Federal Reserve Chair Jerome Powell and his colleagues are expecting a sharp dropoff in economic activity through the rest of 2023 — at least, that’s the implication from new economic projections they published this week.

The figures show policymakers now expect the US to eke out a 0.4% expansion this year, down from the 0.5% growth rate they penciled in at the last forecast round in December.

That might not seem like a big downgrade at first blush. But it’s important to consider that number in light of the economy’s surprising strength in the first quarter so far, as Robin Brooks, the chief economist at the International Institute of Finance in Washington, points out.

In January, the Atlanta Fed’s GDPNow tracker forecast first-quarter gross domestic product would rise 0.7% at an annualized rate. By March 16, that estimate had risen to 3.2%.

Fed policymakers don’t release official projections for quarterly growth. But taking the latest estimates from private forecasters and Fed economists into account, the new projections imply Fed officials see a sharper downward trajectory for quarters two through four.

As Brooks put it, “The Fed is bracing for recession.”

Based on current first-quarter forecasts, the Fed’s latest projections imply GDP will shrink by 0.2% on average per quarter through the rest of the year, Jason Furman, a former top White House economist, said on Twitter. That’s compared with the 0.5% average growth over those three quarters implied by the Fed’s December forecast.

To make matters worse, nearly all Fed officials saw risks to that already-downgraded forecast as tilted to the downside. And they’ve never been in greater agreement on that point, according to data compiled by Bloomberg that stretches back to 2007.

Source: “New Fed Forecasts Suggest Central Bank Is Bracing for Recession“