2020: Where are we in the cycle? A synopsis from the CREFC conference.

Disclaimer: This article explores my personal opinion and summary of the Real Estate market for the year 2020. The views expressed within are my own and do not represent the views of my employer or any entity I have been, am now or will be affiliated to.

“It is a borrower’s market” seems to be the underpinning theme for 2020. With abundance of capital chasing yield, momentum into 2020 is expected to remain strong. Real Estate fundamentals and underwriting standards continue to be resilient, the overall economy is healthy, and the low interest rate environment is here to stay, for now. With no imminent signs of a recession, industry leaders are wondering what might set off the next downturn. Volatility is top of mind, particularly in the wake of weaker projected growth in the EU, geopolitics and a looming U.S Presidential elections. Corporate Debt and the Overnight Repo market are also on the watch list. One thing is for certain, the Commercial Real Estate (CRE) industry has proven to be resilient.

The annual CREFC January conference kicked off on January 13th with approximately 1,890 registered attendees, a record turnout. Industry leaders and CRE executives gathered in sunny Miami to celebrate a successful 2019 and discuss sentiments and expectations for 2020. Key highlights of the conference included thoughts from industry leader Barry Sternlicht, Chairman and CEO of Starwood Capital Group, and American political commentator and former presidential adviser, David Gergen.

Reflecting on 2019, transaction volume for the CMBS market was north of $98 billion, including 83 Single Asset Single Borrower (SASB) deals, up 27% from 2018 with spreads averaging 89 basis points. The year started relatively slow with uncertainty and anticipated rate hikes. The first part of the year, volume was down as much as 20% compared to the previous year. The latter part however saw a shift in policy from the Federal Open Market Committee (FOMC) fueling a pickup in transactions and volume.

Looking ahead into 2020, participants are anticipating a strong and stable year with pockets of volatility anchored by the looming upcoming U.S presidential elections, casting a shadow of doubt. Record amount of dry capital, estimated at $350 billion, continues to be the biggest driver of demand. Global low yields are driving investors to Real Estate as the fundamentals continue to be strong. Investors no longer view real estate as an alternative investment. As a result, participants predict that pricing will be tighter, and spreads may compress.

Additionally, participants anticipate Real Estate values to remain stable although average capitalization rates, particularly in gateway cities, has compressed significantly, relative to the last cycle. Search for yield is top of mind as the space continues to be crowded with the emergence of non-bank lenders and debt like equity. Industrial and Multifamily are anticipated to remain the biggest beneficiaries in 2020 whereas Retail will continue to struggle.

During a conversation on fundamentals, panelist indicated that lenders are not underwriting pro-forma and that rating agencies are keeping CMBS underwriting in check. Concerns were raised around the increase of interest-only loans. This was echoed in multiple discussions, particularly the challenge of refinancing should values decrease. Albeit relatively small, lenders have taken notice of an increase in defaults in interest-only loans.

Furthermore, the year 2020 represent the start of a new decade and most importantly, updated BLS census numbers. Industry leaders are looking for major indicators in population migration and cohorts’ shifts in order to better assess housing demand and affordability, consumer spending as well as significant behavioral changes.

While fundamentals are considered strong, the transition from LIBOR to a new benchmark, global economic and geopolitical uncertainty are keeping participants awake at night. There was no consensus from participants on a recession trigger. However, two topics were discussed at length: Overnight Repo Market and Corporate Debt.

1.  The overnight repo market came under stress in September as demand for funds to settle Treasury purchases and pay corporate taxes overwhelmed loans available. Interest rates in U.S. money markets shot up to as high as 10% for some overnight loans, more than four times the Fed’s rate. Since September, the New York Federal Reserve has offered daily operations where it has injected more than $500 billion, helping to ensure banks, companies and investors have the liquidity to meet their daily operational needs. Questions remained unanswered particularly if this measure was a result of falling bank reserve and the impact it will have on the transition from LIBOR to SOFR.
2.  US Corporate Debt has ballooned to nearly $10 trillion or about 47% of overall economy which has forced experts sound the alarm. BBB- rated bonds, the lowest bracket of investment grade debt, accounted for more than 50% of the market compared to 17% in 2001. Panelist’s discussed how corporate leverage can amply shocks in times of volatility, particularly the impact to CRE and the office market.

Finally, legislation and regulations took center stage, especially with the upcoming U.S Presidential elections. Two areas were highlighted by panelists:

1. Ending the GSE conservatorship was highlighted as the biggest issue in 2020. Congress is unlikely to act in an election year, but reform has moved to the administrative sphere. The Secretary of the Treasury and the Director of the Federal Housing Finance Agency are aligned with a goal to end the conservatorship and are likely to make progress this year. Regulatory capital and Federal Home Loan Bank Membership were also topics of interest
2. California, New York and Oregon have all enacted new rent control regulation. This topic is anticipated to have a carry over effect on other states. Participants discussed the benefits and downside of these regulation in advancing the agenda of affordable housing.

2019’s biggest surprise: Federal Reserve’s reversal on interest rates

2019’s biggest disappointment: WeWork

2020’s biggest surprise: Change in the White House

2020’s biggest disappointment: No Change in the White House