The Small Balance Intersection Update - November 8, 2024

Fun Facts of The Day:

Cappuccino Day: It’s National Cappuccino Day in the U.S., so coffee lovers celebrate by enjoying this delicious espresso-based drink.

IPO of the NYSE: On November 8, 2006, the New York Stock Exchange became a publicly traded company, merging with Archipelago Holdings and becoming NYSE Group, Inc.

General Electric (GE) Foundation: Founded on November 8, 1892, GE has been a powerhouse in innovation, originally producing electric lights and transformers before expanding into healthcare, aviation, and more.

Reduce Leasing Speed

Federal Lease Cuts Loom as Government Eyes Space Reduction

With Republicans now controlling both the legislative and executive branches, federal agencies may face pressure to cut costs, potentially reducing their office space usage. The federal government currently operates under 7,549 office leases totaling 174 million square feet, primarily managed by the General Services Administration (GSA). Recent legislation, the Telework Transparency Act of 2024, aims to increase reporting on remote work’s effects, a move that could influence future office space needs as telework trends persist. Notably, GSA holds 51.56 million square feet across Maryland, Virginia, and D.C., where 270 leases (worth $164.74 million annually) are set to expire this year, with another 821 leases expiring in 2025.

The GSA can terminate 552 leases this year, representing $284.49 million in annual rent. If these options are exercised, property owners could face significant financial losses; a full termination could reduce impacted buildings' net operating income (NOI) by an estimated $170.69 million, potentially lowering property values by $2.26 billion based on a 7.56% capitalization rate. Even a 50% termination rate could cause an NOI drop of $85.35 million, with property values declining by around $1.13 billion. As the government reassesses its office needs, owners of these properties may face steep devaluations, underscoring the economic impact of a leaner federal footprint on the commercial real estate market.

Read more from the GSA

Expect Delays: Housing Supply Tight

Addressing Housing Affordability: Supply Constraints and Policy

The Trepp report "The Housing Equation: Policy, Affordability, & Supply Constraints in the U.S." delves into the challenges of U.S. housing affordability through a supply-demand framework, emphasizing the role of supply inelasticity. Since the 2008 financial crisis, rent has grown faster than income, straining affordability, with urban areas experiencing the most pronounced rent-income gaps due to high demand and limited housing supply. Housing supply inelasticity—worsened by strict land-use regulations and rising construction costs—limits the market’s ability to respond to increased demand, driving up rents, especially in high-demand regions.

Supply-side subsidies, though commonly proposed, may offer only temporary relief. The report suggests that policies encouraging greater supply elasticity, such as regulatory reform to streamline construction, could address long-term affordability by enhancing housing responsiveness to demand shocks. However, challenges persist, including market concentration and a shift towards higher-end housing, which reduces the availability of affordable units. Demand-side solutions, like down-payment subsidies, could increase home prices if applied without expanding affordable supply.

For investors, the report highlights that markets with inelastic supply generally show lower cap rates and less price volatility, but policy-induced elasticity improvements could increase both metrics. The analysis underscores that housing policies impact not only market dynamics but also related sectors like commercial mortgage-backed securities (CMBS) and real estate lending.

Read the full Trepp report

Fed Way

Fed Eases Rates, December Decision Still Up for Debate

The Federal Reserve reduced the federal funds rate by 0.25% to a range of 4.50%-4.75%, responding to a softening labor market and ongoing inflation control efforts. This follows a more aggressive 0.50% cut in September, with officials signaling a gradual approach to future rate adjustments. The FOMC's statement acknowledged balanced risks to employment and inflation goals but pointed to economic uncertainties. Economic concerns have heightened post-election, with President-elect Donald Trump’s policies potentially increasing inflation, unemployment, and the federal debt, per several forecasts. Goldman Sachs projects Trump’s proposed tariffs could push inflation up to 2.75%-3% by mid-2026. Fed Chair Jay Powell indicated that the election would not immediately influence policy but noted a shift toward a "neutral" stance on rates. Market expectations for another cut in December have dropped slightly to 71%, with some analysts suggesting a pause if economic indicators continue improving. Longer-term, a rate-cutting cycle is expected to resume in 2025 as the labor market slows and inflation eases further. Read full report.

Concession Causeway

October Rental Market Softens as Vacancy and Concessions Hit New Highs

The U.S. rental market softened significantly in October 2024, with rent prices dropping more than typical for this season. Although average rents remain 3.3% higher year-over-year, metros like San Antonio and Austin actually saw annual declines, a rarity in the market. Multifamily unit completions hit a historic high, with 55,500 units added in September, resulting in a mild 2.3% increase in multifamily rents over the past year compared to a 4.3% rise in single-family rents. With Zillow’s Observed Renter Demand Index (ZORDI) at an all-time low, competition for rentals has decreased, pushing vacancy rates up to 6.9%, up from 6.6% pre-pandemic. Rent concessions are also at record levels, with 37.7% of listings offering incentives such as free parking or rent reductions. The share of rentals with concessions rose by 1.9 percentage points from September and 7.6 points year-over-year. Affordability remains a concern, with the median household spending nearly 29% of income on rent, reflecting the 32.4% increase in rent affordability burdens since pre-pandemic levels. Renters can anticipate favorable conditions through November, with continued high concession rates and low competition in many markets.

Read the full Zillow report here.