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Fear That The Near Decade Long Bull Market Has Reversed

A weekend topic starting with the Wall Street Journal. “An important indicator in the U.S. commercial real-estate market is signaling that a decade long bull run is on shaky ground heading into the new year. The gap between long-term borrowing rates and what some types of commercial properties on average yield is the narrowest it has been since 2008, according to data firm Trepp LLC.”

“In the past, this tightening spread has often presaged a drop in property prices, sometimes with dire results. ‘In 2007, looking back, that was a real red flag,’ said David Steinbach, chief investment officer for Houston-based Hines.”

The Buffalo News in New York. “A lender for a Town of Tonawanda apartment complex whose owner is at the center of a federal mortgage fraud investigation wants to foreclose on the property after an auditor determined it also received false information.”

“‘Given the criminal conduct apparently at issue in this case, the loans are toxic,’ attorney John P. Doherty wrote in a legal memo on behalf of SteepRock Capital. Doherty said SteepRock has ‘unexpectedly had to deal with investor concerns and reputational risk, risk of senior lender enforcement actions that could wipe out its interest, and the Federal Bureau of Investigations’ because it made loans unaware of the ‘fraudulent scheme.'”

From PropertyShark on New York. ” To get a clearer picture of the post-election sentiment in the multifamily real estate market in NYC, PropertyShark posed questions to several leading industry professionals.”

“‘The slowdown in investment sales transactions has been a product of the perfect storm: rising interest rates, concern about new rent regulation laws, and fear that the near decade long bull market has reversed.’ – An Executive Managing Director at a leading investment firm.”

“The outlook for investors and landlords seems bleak, at least in the short-term. Multifamily properties went from trading at 15 times rents to around 12 times – a 20% decline almost overnight. Multifamily as an asset class has typically traded at lower cap rates relative to other asset classes because there was an inherent ‘vacate and increase rent’ methodology used by investors. ‘In past years when people bought a low cap rate deal, it was because they were counting on vacating a certain percentage of units, raising rents, and achieving a higher return.'”

From WAER on New York. “Anyone who’s been on University Hill lately has probably noticed three massive student housing projects. University Hill Corporation President Dave Mankiewicz is concerned that the influx of new student apartments is distorting and saturating the market.”

“‘So far what we’ve seen is that some of the older projects have been struggling, the ones that are a little further away have been struggling, and some of the units in the neighborhood have gone vacant longer or just haven’t been occupied,’ he said.”

From the Oregonian. “Portland built thousands of apartments in 2017, helping slow rent increases to levels not seen since 2011. Developers built some 7,300 homes during the year, most of them apartments. That’s more than any of the past 15 years — about 50 percent more than the year prior and double the number built during the typical year in the 2000s.”

“The glut of supply helped bring average rent increases to an annualized rate of 2 percent. That rate continued into 2018, the report said. Meanwhile, rent concessions — discounts or weeks of free rent — grew more common.”

“The city also had a banner year for residential construction permits, with 6,000 permits approved representing homes that could be built in coming years.”

The Modesto Bee in California. “RentCafe reported the average rent for a Modesto complex with at least 50 apartments was $781 in December 2012. That means rents increased by more than 50 percent in six years, with the average rent increasing by $412 a month over that time frame.”

“‘I think it’s going to plateau,’ said Ben Sweet, owner of Modesto-based Sweet Properties, which manages about 300 rental propertie. ‘We are starting to see the inventory creep up. … We are bumping up against the top of the wage base for our area. We’ve had all of these increases.'”

The Greenville News in South Carolina. “It’s no secret that the revitalization of downtown Greenville has sent property values to historic highs, creating unprecedented real estate wealth in an area virtually abandoned just a few decades ago.”

“Nowhere is the wealth created more evident than in the luxury apartments that are rising, one after the other, from increasingly scarce land — though a recent market analysis seems to show that there’s room for many more.”

“A market study found that downtown Greenville’s overall vacancy rate for apartments — at 13 percent currently — is relatively low considering how many multifamily developments are being built.”

“‘That’s considered stunning,’ Mayor Knox White said. ‘This is not the apartments of 20 years ago. It’s a different demographic, and it seems to be more sustainable than years past because people’s behaviors are changing. It’s not unique to Greenville. But what is a little unusual is our market seems to be surprisingly strong.'”

“In elections and public forums and opinion pieces over the past couple years, the idea that Greenville might be flooded with apartments to an unhealthy level has permeated. The overall vacancy rate, however, has remained within the range of 10 percent, except for a spike to 15 percent with the demolition of Scott Towers in 2013 and a rise to 20 percent last year when many apartments opened.”

“The downtown master plan market analysis, which found that 43 percent of renters downtown are considered to be overburdened by the share of income spent on rent. The analysis shows that a renter must earn about $50,000 per year to afford an average downtown rate, according to data gathered from 2011 to 2015.”

“The median income in the city of Greenville in 2016 was $45,400, according to the downtown master plan market analysis, and the median income downtown specifically was $35,400.”

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  1. More from the Buffalo News link:

    ‘The battle with SteepRock is the latest challenge for Morgan’s companies, which have amassed a portfolio of more than 36,000 apartments in 14 states, including more than 3,500 in the Buffalo area.’

    ‘But its financing methods began to draw the scrutiny of the FBI and the U.S. Attorney’s Office, which launched an investigation focused on the financial statements, rent rolls and other documents the companies provided to lenders to justify mortgages.’

    ‘The FBI raided Morgan Management offices in the Rochester suburb of Pittsford last May. And prosecutors that month issued fraud indictments against Kevin and Todd Morgan – Robert Morgan’s nephew and son – as well as against two mortgage brokers, Frank Giacobbe and Patrick Ogiony of Aurora Capital Advisors in Buffalo. The four were charged with 62 counts of bank and wire fraud for allegedly falsifying income data to obtain $167.5 million in loans on seven properties.’

    ‘In the court documents, Bucci identified Giacobbe as the broker who approached SteepRock on behalf of Morgan in 2013.’

    ‘As the investigation unfolded, Morgan’s companies then “began sending accurate financial statements that raised red flags, because they were considerably worse than previous financial statements,” Doherty wrote. Bucci confronted company executives, who “did not deny that all financial reporting to SteepRock prior to 2017 was false.”

  2. ‘Multifamily properties went from trading at 15 times rents to around 12 times – a 20% decline almost overnight’

    Apartment bubble, meet pin!

    2. If these loans are so highly rated by the big banks selling them, the real question is why are they selling them, then? The answer is because they’re toxic, subprime garbage that they’re trying to unload on bagholders.

  4. ‘A market study found that downtown Greenville’s overall vacancy rate for apartments — at 13 percent currently — is relatively low considering how many multifamily developments are being built’

    ‘That’s considered stunning,’ Mayor Knox White said. ‘This is not the apartments of 20 years ago. It’s a different demographic, and it seems to be more sustainable than years past because people’s behaviors are changing.’

    This Mayor is a ding dong. Note again that not one of these metros tapped the brakes in time:

    ‘The city also had a banner year for residential construction permits, with 6,000 permits approved representing homes that could be built in coming years’

  5. So why are they building without concern for the market? Because they plan to sell them to a greater fool:

    ‘Investors are still eager to buy apartment properties where they can raise the rents and achieve strong yields. “There is a vast amount of capital in the multifamily space targeting value-add apartment properties,” says Rick Hurd, chief investment officer for Waterton, a real estate investment and property management firm.’

    ‘Investors spent $31.9 billion to buy apartment properties in value-add transactions in the 12 months that ended in the third quarter of 2018, according to RCA. Overall, that has been roughly one-fifth of all the dollars spent to buy apartment properties over the past few years.’

  6. ‘The strong multifamily market is fueling competition in the lending environment, with an abundance of new players and extended services from life companies. Tower Capital’s Adam Finkel shares his views on the capital stack outlook for 2019, along with some predictions for the sector.’

    ‘Finkel: The multifamily landscape continues to be very robust, with a lot of capital seeking to be placed. An abundance of new alternative lenders consisting mostly of debt funds have made the bridge lending space especially competitive. Looking for additional yield, some life companies are now offering light bridge programs. The CMBS market seemed to regain its footing as a feasible source of financing. DUS lenders and Seller/Servicers have been expanding their market presence with additional offices and competition among the agency lenders is especially high. The agency lenders have become much more aggressive to win deals, often quoting terms based upon underwriting off of annualized T1 revenues. This creates greater risk that borrowers will be “retraded” on their loan proceeds by the time the loan is approved if the property does not perform as expected.’

    ‘What are your predictions for the industry in 2019?’

    ‘Finkel: Certain primary coastal markets are topping out and will see downward pressure on rents due to new supply. Secondary and tertiary markets will see continued activity from out-of-state investors chasing yield.’

  7. ‘As the real estate cycle winds down, investors view student housing as one of the few recession-resistant asset classes. “Many are waiting on the sidelines for the right deals to unload billions in capital within the near future,” says Dorothy L. Jackman, executive managing director of the national student housing group with real estate services firm Colliers International.’

    ‘Despite some worries about overbuilding, real estate investors remain drawn to the sector. Student housing continues to attract new investors. “We expect the number of investors targeting student housing as an asset class to further grow in 2019,” says Fred Pierce, president and CEO of Pierce Education Properties, an investment and development firm that specializes in student housing.’

    ‘On average, student housing properties still have few empty beds and rents continue to grow. However, the markets around several universities are challenged because too many new projects have opened. “There are markets that are overdeveloped, but overall there is very little distress,” says Fitts.’

  8. RE: Fear That The Near Decade Long Bull Market Has Reversed

    The credit cycle has turned. The Everything Bubble (includes CRE+RRE) is popping. Slowly at first, then all at once. The inevitable consequence of Keynesian economics as implemented by central banks.

    https://www.hussmanfunds.com/comment/mc181128/
    John P. Hussman, Ph.D.
    President, Hussman Investment Trust
    December 2018

    “Of all the delusions that have infected the minds of economists, central bankers, and the investing public in recent years, perhaps none is as short-sighted and pernicious as the idea that aggressively low interest rates are “good” for the economy and the financial markets.”

    “In the Federal Reserve’s attempt to bring the U.S. out of the crisis of its own making, the Fed has produced conditions that make another collapse inevitable. Unfortunately, the scale of the present bubble is far grander, and the consequences are likely to be more severe.”

    “After 8 years of Fed-induced yield-seeking speculation, financial valuations have been driven to the most offensive extremes in history, with the most reliable equity valuation measures recently matching or exceeding their 1929 and 2000 peaks.”

    “Put simply, the extraordinary and experimental policies of quantitative easing and zero interest rates have not been “good” except in the myopic sense of encouraging a short-term burst of very bad choices and misallocations of capital.”

    “Additional rounds of blame will be directed at whatever advances the agenda of the person talking. Republicans will blame Democrats. Democrats will blame Republicans. Dogs will blame cats. Cats will blame mice. Everyone on financial TV will blame Jay Powell at the Fed for the “policy mistake” of even trying to normalize interest rates. But the true object deserving of blame will be the thing that made a financial collapse inevitable in the first place: the yield- seeking carnival of speculation engineered by the Bernanke-Yellen Fed.”

    You Ain’t Seen Nothing Yet
    by Bachman-Turner Overdrive
    https://www.youtube.com/watch?v=7miRCLeFSJo

    I met a devil woman
    She took my heart away
    She said I had it coming to me
    But I wanted it that way

    I think that any lovin’s good lovin’
    So I took what I could get, mmm ooh ooh
    She looked at me with big brown eyes
    And said

    You ain’t seen nothing yet
    B-b-b-baby you just ain’t seen n-n-n-nothin’ yet
    Here’s somethin’ that you’re never gonna forget
    B-b-b-baby you just ain’t seen n-n-n-nothing yet

    1. And what pops up? Fraud. Like this giant apartment scandal and the near weekly reports out of Australia involving Chinese buyers.

      1. That explanation is unlikely, Ben. Would-be fraudsters have a well-founded fear of criminal prosecution by our ever-vigilant regulators and enforcers. Why, just look at how many gold-collar criminals who caused the implosion of Housing Bubble 1.0 and subsequent Great Financial Crash ended up serving lengthy prison terms.

        Oh, wait….

    2. Cats will blame mice. Mice will blame flea$. … But the true object de$erving of blame will be the thing that made a financial collap$e inevitable in the fir$t place:

      “Ea$y monie$ True.Believer$”

    3. ‘…fear that the near decade long bull market has reversed.’

      It’s funny to see the same headline repeated separately in reference to such a vast assortment of bubbles in all manner of risk assets, from stocks to corporate bonds to housing to commercial property to oil to cryptocurrency. All happy bubble speculators are alike; each unhappy bubble collapse victim is unhappy in his own way.

      3. Bonds News
        December 21, 2018 / 10:49 AM / a day ago
        U.S. junk bonds lower again after worst day since 2016
        Dan Burns

        NEW YORK, Dec 21 (Reuters) – A gauge of high-yield bond performance was trading close to its lowest since early 2016 on Friday, a day after the riskiest U.S. corporate bonds suffered their biggest daily drop in nearly three years and in sync with a broad pullback from stocks and other risky assets.

        The iShares Iboxx High Yield ETF was down around half a percent in early afternoon trading and has fallen 7.2 percent so far this quarter, putting it on pace for its poorest quarterly performance since 2011.
        …

      4. Like Bitcoin, the price of oil is almost low enough so further mining doesn’t pencil out.

        Oil prices are getting scary: Former Shell Oil president
        Julia Limitone
        Fox Business
        December 21, 2018, 9:37 AM PST

        The collapse in oil prices, now hovering around $45 per barrel in the U.S., is terrifying, according to former Shell Oil President John Hofmeister.

        “It’s getting to a scary point,” he said during an interview on FOX Business’ Varney & Co. “If we get below $40 we’ll see rapid stopping of drilling because the companies simply can’t afford it.”

        The drop in oil is also a warning sign for the global economy.
        …

      6. Bitcoin has plunged so far it’s now unprofitable to even mine it, JPMorgan says
        By Gregor Stuart Hunter
        Updated 19 Dec 2018 — 8:32 AM, first published at 8:30 AM

        Hong Kong | The prolonged digital-asset slump is scaring off institutional players, according to JPMorgan Chase & Co, suggesting a fulcrum for cryptocurrency markets is giving way.

        “Participation by financial institutions in Bitcoin trading appears to be fading,” analysts including Nikolaos Panigirtzoglou wrote in a research note. “Key flow metrics have downshifted dramatically,” including in futures markets and in average volumes, they said.

        While the surge of institutional interest a year ago was cheered by cryptocurrency enthusiasts as a signal the industry was here to stay, last December’s debut of Bitcoin futures – a key product for professionals – also coincided with Bitcoin’s apex.
        …

  9. 1) From the PropertyShark article:
    “Multifamily as an asset class has typically traded at lower cap rates relative to other asset classes because there was an inherent “vacate and increase rent” methodology used by investors. “In past years when people bought a low cap rate deal, it was because they were counting on vacating a certain percentage of units, raising rents, and achieving a higher return.”
    – a) Low cap rates means you’re overpaying. b) Well, that sounds like a sustainable business model…

    2) From the WAER article:
    “We think there’s a lot more room in the market for those more diverse groups that want to live in the center city to spread out.”
    and
    “In all, Mankiewicz says new projects completed, launched, or announced on the Hill this year alone total $683 million.”
    – When viewed through the lens of the higher edu. bubble, yet another economic bubble courtesy of gov’t. policies, the multifamily college town building mania fits right in. However, prospective students are wising up to the (sometimes negative) value add of huge student loan debt vs. wages in the gig economy. Do I hear the sound of declining (brick and mortar) enrollments? I think I do!
    https://www.jamesgmartin.center/2018/07/a-worrisome-trend-for-higher-education-declining-enrollments/
    The James G. Martin Center for Academic Renewal
    A Worrisome Trend for Higher Education: Declining Enrollments
    Jul 6, 2018 | Jane S. Shaw
    “A specter is haunting higher education—the specter of declining enrollments. University and college enrollment has fallen nearly 9 percent since 2011, according to the National Student Clearinghouse, and no one is exactly sure why. ”
    and
    https://www.nationalreview.com/corner/the-college-bubble-begins-to-deflate/
    The College Bubble Begins to Deflate
    By George Leef | July 6, 2018 5:01 PM
    “Not so long ago, the conventional wisdom in America was that just about everyone needed a college degree. Never mind that many students learned little of value and racked up big debts — unless you got a “college education,” your life would be nothing but drudgery.

    And then reality started to catch up on that conventional wisdom. Americans started doubting that college was such a great investment as they saw lots of people with degrees doing low-skill work and realized that the high cost of college could exceed the benefits by a wide margin. The upward march of college enrollments leveled off and began to decline. Since 2011, they’re down 9 percent.”
    – Uh-oh!

    3) U.S. Multifamily is overbuilt, and will continue down this path for a few more years as current projects will be completed, since they’re hard to stop in mid-stream. Another prime example of mis-allocation of capital due to false economic signals (i.e. low interest rates and easy credit) from the Fed. I’m sure that rents are only “plateauing”, as in The Modesto Bee article, and will not decline at all. Uh-huh! (/sarc)

    4) We won’t know the full extent of the fraud until rates and economic conditions start to cause real pain and expose where the problems really are. “You never know who’s swimming naked until the tide goes out.” – Warren Buffett. As I mentioned, the tide (credit) is now going out.

  10. All$ well that end$ well!, … foreca$t for tonight, dark. (G. Carlin)

    The network$ for financial contagion, should thing$ turn ugly, are already in place.

    … As was the case during the heyday of mortgage-backed securities, there is great investor demand for this debt, reminiscent of the “capital inflow problem” or the “bonanza” phase of the capital flow cycle. A recurring pattern across time and place is that the seeds of financial crises are sown during good times (when bad loans are made).

    These are good times, as the U.S. economy is at or near full employment.

    The record shows that capital-inflow surges often end badly.

    Any number of factors can shift the cycle from boom to bust. In the case of corporates, the odds of default rise with mounting debt levels, erosion in the value of collateral (for example, oil prices in the case of the U.S. shale industry), and falling equity prices.

    All three sources of default risk are now salient, and, lacking credible guarantees, the CLO market (like many others) is vulnerable to runs, because the main players are lightly regulated shadow banking institutions.

    And then there are the old and well-known concerns about shadow banking in general, which stress both its growing importance and the opaqueness of its links with other parts of the financial sector. Of course, we also hear that a virtue of financing debt through capital markets rather than banks is that the shock of an abrupt re-pricing or write-off will not impair the credit channel to the real economy to the degree that it did in 2008-2009.

    Moreover, compared to mortgage-backed securities (and the housing market in general), the scale of household balance sheets’ exposure to the corporate-debt market is a different order of magnitude.

    https://www.marketwatch.com/story/the-biggest-emerging-market-debt-problem-is-in-america-2018-12-21

      1. 🌞
        SUN WITH FACE
        Unicode: U+1F31E (U+D83C U+DF1E), UTF-8: F0 9F 8C 9E

        Pasted this in from wordpress emojis. Who knows what will show up? Anyway, hi jeff.

  11. The surprising thing to me is how long market distortions can carry on, particularly sky-high rents that have no basis in economic reality, in conjunction with sky-high vacancy rates. The shenanigans by the wealthy to maintain high asset prices using accounting gimmicks and other fraudulent tactics are remarkable, yet despicable.

  12. I happen to be a commercial leasing agent in LA and I can confirm, landlords with big mortgages are dealing with rent decreases, if they do not have reserves I am not sure how they will meet debt service, especially with rising rates.

    1. Just look at the prices. Until they start “sawin’ and slashin’,” ain’t nobody gonna rent that sheet!

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