What Will It Take To Close CRE’s Bid Ask Gap?
Technically buyers should be more enthusiastic with a yield spread that is among the widest it has ever been in the past decade.
WASHINGTON, DC—Yesterday the Federal Reserve cut rates by a quarter-percentage point for the third time this year and hinted they may now put monetary policy on hold, for one meeting at least.
An analysis by Marcus & Milichap suggests that the next decision on rate policy will largely be determined by the holiday retail season and ongoing trade talks. “Should a resolution to the trade war be achieved, the economy and interest rates will likely witness an upward bounce,” it said.
But will it be enough to close the bid ask gap that appears to be holding back commercial real estate investment sales/? To be sure there are a number of reasons for the diminished investment volumes, but a growing gap between buyer and seller expectations is chief among them.
Deal volumes were off slightly from 2018 with Q3 down 6.9% from the same quarter in 2018, according to PwC. The Jan-Sept 2019 numbers have also been drifting downward; they are now down 1.8% over the five year average for the same seasonal period.
Technically this should not be the case with a yield spread that is among the widest it has ever been in the past decade.
With the 10-year Treasury hovering between 1.5 to 1.8% in recent months, investors have been favored by strong levered yields, Marcus & Millichap notes. Meanwhile, the average combined commercial real estate cap rate remains in the low-6% range, delivering a 400- to 450-basis-point premium above the 10-year Treasury.
But buyers remain spooked by the prospect of a recession, even as the spread bolsters levered return prospects. Certainly there is plenty of evidence to support their concerns; also yesterday the Commerce Department reported that third quarter GDP dropped to 1.9% and ADP said that there had been 125,000 private sector jobs created for the month.
This is why buyers’ underwriting models continue to deliver more cautious valuations, Marcus & Millichap says. “Sellers, meanwhile, continue to cite strong performance metrics that support aggressive asking prices.”
There are good reasons to think that the Fed will continue to pause interest rate cuts.
In September, core retail sales rose by 4.5% year over year for the second consecutive month while consumer spending remains elevated, following the sluggish growth pace of 2.5% in February. “This points to a positive growth outlook for the holiday season,” Marcus & Millichap says. Also, “inflation will play a pivotal role for future rate policy as Chairman Powell noted the Fed’s preferred inflationary measure—core PCE—remained below the Fed’s 2 percent target in recent months.”
While these metrics bode well for the US economy, it is debatable whether they are enough to sway buyers if interest rates pause.