Falling Treasury Yields May Signal Emerging Shift in Multifamily Lending Conditions

Yields on the benchmark U.S. 10-year Treasury note have taken a significant leg downward in recent weeks. What factors are behind the move and what are the implications for multifamily sponsors and investors? We look at the recent developments in this quick note.

Treasury yields fall more than 75 bps after softer inflation data, Fed moves

At the time of writing on December 15, the 10-year Treasury was yielding 3.45%, down more than 75 basis points (bps) from 4.23% in late October.

U.S. 10-year Treasury Yield, as of December 15, 2022

Markets are showing signs that investors believe the Federal Reserve (Fed) won’t need to raise interest rates as high, or keep them high for as long, compared to previous expectations. Factors underpinning this sentiment include:

·????????Fed actions and commentary – The Fed hiked interest rates by just 50 bps on December 14, scaling back after four straight increases of 75 bps. The move was widely expected and in line with Fed Chair Powell’s recent comments.

·????????Easing inflation – November CPI numbers showed inflation easing. The 7.1% year-over-year increase was the smallest since the period ending December 2021. Month-over-month inflation came in at just 0.1%. This follows a surprisingly low increase in consumer prices in October. The most recent report of the Fed’s favored inflation measure, the Personal Consumption Expenditures (PCE) Price Index, showed inflation rose 6% year-over-year, and 0.3% month-over-month. Together, the data provided evidence of stabilization in underlying price pressures.

·????????ISM Manufacturing Index – The November reading showed the U.S. manufacturing sector dipped into contraction after expanding for 29 straight months. The index level was the lowest since May 2020.

The downward trend in yields withstood a surprisingly strong employment report on December 2. Employers added 263,000 jobs in November and the unemployment rate held steady at 3.7%. After an initial pop in yields, investors seemingly returned their focus to Powell's remarks and other data that suggested a slower pace of rate hikes.

Similarly, yields seemed to be faring well as investors digested the Fed’s December projection that rates will ultimately reach 5.1% by the end of 2023, 50 bps higher than projected in September.

Lower yields may catalyze a positive shift in multifamily lending conditions

Movements in the U.S. 10-year Treasury yield are important for commercial real estate investors, given the benchmark rate’s influence on commercial mortgage rates. Most major lenders—including agency players Fannie Mae and Freddie Mac—consider (and quote) commercial real estate loans in relation to the 10-year note. The overall interest rate environment is also important: Rates impacts investor returns, carry costs, and loan proceeds.

Commercial real estate lenders have pumped the brakes for most of 2022, pulling back in response to uncertainty around the Fed’s hawkish stance to reduce inflation. Sponsors have faced relatively constrained capital markets, characterized by higher borrowing costs, more conservative underwriting, and lower loan closing volume.

Industry-wide lending metrics from CBRE show higher mortgage rates and loan constants contributed to lower loan-to-value ratios, while underwritten cap rates and debt yields increased in Q3 2022. Specific to multifamily, loan-to-value levels averaged 58.8% in Q3 2022, down 2.9 percentage points from Q2 2022 and 9 percentage points from a year ago.

If bond investors continue to believe inflation is decelerating and the Fed will ease up on rate hikes, then the current retreat in Treasury yields could show some staying power—which we expect would catalyze a positive shift in commercial real estate lending conditions.

As a best-in-class multifamily sponsor with experience in a variety of economic conditions, Trion has been active throughout the year—we haven’t been sitting on the sidelines due to financing or recession concerns—but more favorable lending conditions and a general thawing of capital markets would certainly be welcome.?