HFF Research Update for July 12, 2016: Atlas

Tuesday, July 12, 2016

Weekly insights on current research in the commercial real estate industry from HFF Managing Director of Research Jimmy Hinton. View Daily Rates on the HFF website.

Atlas was the Titan god of endurance and astronomy. After Mount Olympus vanquished Atlas and his kin from an uprising, Zeus tested his skills by condemning him to hold up the heavens for eternity. Late last week, the Italian government announced a new private initiative designed to stop the skies from cratering on the country’s brittle banking industry, and it has been aptly named “Atlante.” Who says sixth grade history would never prove useful?

Is it enough? According to the Bank of Italy, the balance of debt already non-performing and/or written off stands at €360 billion. A very significant amount of private capital could be needed to offset the losses and/or to purchase the loans and assuage the banks from further value destruction. In the context of Atlante’s paltry €5 billion of equity, should we appeal to the heavens for more capital? Remember that a small amount of equity is sufficient to acquire a larger face value of non-performing loans. But the outlook of legality, of funding and of successful execution is quite opaque. If anything is transparent, the banks would rather move the non-performing loans from their balance sheet altogether than stand recapitalized.

Ad interim, stock markets around the globe seem indifferent. They are focused on developments elsewhere in Europe.

Theresa May is poised to assume the role of prime minister of the still-United-Kingdom when David Cameron officially ends his premiership tomorrow. The outcome was firmed as the S&P 500 hit a record value in Monday trading and extended it further this morning. The MSCI All-Country World Index of equities has now reached its highest value since the Brexit vote on June 23 and, for the first time in weeks, bond yields are moving higher in tandem with rising stock markets.

In other words, investors in both fixed income and equities are simultaneously signaling a “risk on” approach. Thankfully, we are seeing this take place in the commercial real estate industry as well, where investors are once again embracing central business district (CBD) office assets in the United States.

After a five-month decline, Moody’s and RCA’s co-authored Commercial Property Price Index (CPPI) shows that prices of CBD office assets rose in May 2016, arresting a troubling trend that accompanied a long-held mantra that those properties foretell the broader industry’s trajectory. As has been well documented, the pace of CBD offices’ recovery had been swift and steep, especially when taken against the recovery of its cousin, suburban office.

Below we provide a vision into the pace of each subtype’s respective recovery after peaking in late 2007/early 2008. It is apparent CBD office assets recovered their prior peak pricing in the shortest time, reflected in the number of months needed to index back to 100. CBD office assets needed 67 months to recover from the Great Financial Crisis, apartments needed 70 months, industrial required 94 months and retail needed 105 months, but suburban office is still recovering. 

Given CBD office’s recovery was more mature sequentially than other asset classes, its multi-month decline in pricing gave cause for caution throughout the industry. This is another reason we are thankful for the reversal in its decline. One month a trend does not make, so we will continue to monitor progress.

In the meantime, we sure could use Atlas.

In closing, below are a few bullet points of which to take note:

  • The equal-weight average of the 10-year A and 10-year BBB corporate bond is 3.26 percent, the lowest level I can find since the indices were first authored.
  • The spread the above yield represents relative to the 10-year UST is 173 basis points, the lowest corporate bond spread since June 3, 2015.
  • This suggests both corporate bond yields and related credit spreads have narrowed to year-plus lows.
  • SWAP spreads have expanded back to low-teen territory, currently ~ -12 basis points.

Sources: HFF Research, Financial Times, Moody’s, Real Capital Analytics, Bloomberg

About Jimmy Hinton

Jimmy Hinton serves as managing director of HFF and is responsible for the firm’s national research efforts. Mr. Hinton works with the executive management team to assist in investor relations and to inform both HFF staff and firm clients with in-depth analysis of economic, property and capital market trends. He is also responsible for providing extensive market reports, client presentations and deal-specific analysis for debt placement and investment sales assignments. Mr. Hinton’s responsibilities include substantial interaction with pension funds, life insurance companies, regional and CMBS lenders, REITs, foreign investors and private equity funds.

During his tenure at HFF, Mr. Hinton has supported the execution of more than 150 commercial real estate transactions totaling more than $4.5 billion in 20 states. Mr. Hinton has experience in fixed- and adjustable-rate debt, mezzanine debt, construction loans and joint venture executions on behalf of clients engaged in the acquisition, development and recapitalization of property types including multi-housing, industrial, office, retail, medical office and storage properties.

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