The yield on the benchmark 10-year Treasury note dipped below the 2-year rate for a brief period on August 14 for the first time since 2007, causing fears of a looming recession. As of this morning, the yield on the 2-year Treasury was at 1.6 percent vs. a yield of approximately 1.59 percent on the 10-year notes. Yield curve inversions typically precede a recession by five to 18 months.
But continued economic growth and a healthy debt market are dividing real estate professionals and economists on if a recession is imminent, and whether the yield curve has grown unreliable as a forecasting tool.
“There is a lot of debate about precisely the nature of this signal. We don’t expect a recession,” says Richard Barkham, global chief economist with real estate services firm CBRE. “We expect the Federal Reserve to cut interest rates more to stimulate the economy and there is indeed more unconventional monetary policy that the U.S. Fed can do or central banks around the world can do.”
The growing spread between bond rates and cap rates will encourage investors to accept greater risk when looking at commercial real estate assets in order to get the extra returns, according to Barkham.
“The gap between the yields available on bonds and the yields available on real estate [is] very wide and very attractive,” he notes. “Investors that want to preserve their portfolio returns will probably switch out of bonds and into real estate because of the differential that’s opened up between the forward-looking returns on bonds and the forward-looking returns on real estate.”
Investment sales volume rose by 2 percent year-over-year in the second quarter of 2019, according to research firm Real Capital Analytics (RCA), to $127 billion. Commercial property prices over the same period rose by 6.5 percent. RCA reported that cap rates have stayed largely flat from the second quarter of 2018 to the second quarter of 2019. (In July, however, investment sales volume fell by a whopping 21 percent, to $32.8 billion, as overall market uncertainty resulted in a widening bid/sell gap.)
Meanwhile, loan origination volumes are near record levels, according to CBRE research, as the declining cost of debt has created attractive refinancing opportunities. The CBRE lending momentum index in June increased 20.8 percent above its June 2018 level.
A loan request at this time last year would have received a quote in the low 5.0 percent range, but now, that quote is 4.5 percent because of the decline in the 10-year Treasury, according to Rob Murphy, vice president of the structured finance group with real estate services firm Transwestern.
“There have been significant savings that a borrower can realize just due to the fact long-term rates have fallen,” says Murphy. “So, it wouldn’t be too far off the mark to say institutional quality real estate with strong ownership, can lock up money at 3.0 to 4.0 percent. So, it represents an excellent opportunity for borrowers to capitalize on historically low rates for a long duration.”
If the inflation rate spikes, properties will become “a lot more attractive to each buyer simply for the fact that they have existing long-term debt at below market rates,” he notes.
Still Murphy says financing deals will likely pause temporarily as balance sheet lenders try to get a sense of where the bottom might be before quoting rates on new deals. “They certainly want to have a better understanding and make sure that long term bonds don’t keep falling.”
And he adds that while debt and equity capital for real estate investment remains plentiful, investors should pay attention to the reasons the yields on government bonds are going down. Issues such as the China-U.S. trade war, Brexit and the protests in Hong Kong all have the potential to affect the global economy and trickle down to property-level performance. That is something to be aware of if you’re a real estate investor.”
For now, neither Murphy or Barkham seem particularly concerned about a looming global recession.
“We are certainly looking at an extended period of low growth,” says Barkham. “But that period of low growth with low interest rates actually is quite good for real estate. I see this opportunity being around probably for 18 to 24 months.”
By: Sebastian Obando (NREI)
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