Market Matters: Exploring Real Estate Investment Conditions & Trends

Welcome to the latest edition of “Market Matters”; a perspective of current Capital Markets themes from Cushman & Wakefield's research professionals. In this newsletter, we explore current conditions, short-term developments and long-term economic trends so you can better understand their impact on the real estate investing environment. 

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NOVEMBER 07 EDITION | SEPTEMBER 20 EDITION | AUGUST 31 EDITION | JULY 24 EDITION | JUNE 26 EDITION

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NOVEMBER 7 2024

QUICK BITES  

• On November 7th, the Fed loosened monetary policy further with a widely expected 25 bps cut, bringing target policy rates to a range of 4.5% to 4.75%. The Fed has now cut rates by a cumulative 75 bps from their peak (terminal) rate, demonstrating their strong commitment towards achieving both sides of its mandate.  
• In Chairman Jerome Powell’s press conference, he reiterated that the Presidential election results do not immediately influence their near-term monetary policy response, a statement which should hopefully reassure markets that the Fed does not intend to take a reactionary approach towards monetary policy in the wake of the election.
• Powell highlighted that economic conditions remain on relatively solid, resilient footing; GDP growth is trending at 2.8% (both in Q3 and Q2), the labor market has cooled from its previously overheated condition, yet unemployment remains historically low. Nominal wage growth has eased in recent months, but remains resilient thanks to productivity growth, the latter of which is helping to ensure that the labor market is not arising as a “source of inflationary pressures.” Powell also mentioned the substantial progress made towards their goal of reigning in inflation, which has fallen from a peak of 7% annual growth in PCE to a pace 2.1% y/y as of September.
• As has been the resounding case over the last two years, the Fed seeks to emphasize their patience, which implies their focus will remain on both sides of their policy mandate, as opposed to making premature assumptions on the path of fiscal and trade policy ahead.
• Whereas immigration policies and fiscal stimulus could eventually be more inflationary, Powell described tariffs as being a one-off level shift rather than a more stubborn inflationary force.
• Regardless of the election results, Powell reiterated that the Fed intends to be slow and careful given the recalibration and balancing underway throughout both sides of their policy mandate.

 

KEY THEMES

Dissecting the Outlook on Rates & Capital Flows

• Remaining Realistic: We expect the Fed to maintain a patient, data-dependent approach towards cutting rates. With financial markets now more focused on the implications of fiscal and trade policy of the new administration, inflation expectations remain grounded, though they are edging up to the upper band of comfort (RHS of Chart). Further escalation in inflation expectations would be concerning for the Fed and may force them to slow the rate cutting cycle.  This will be an important trend to watch going forward.
• Near-term: As of this writing, the Fed futures currently place a 68% probability of another 25-bps cut at the December meeting.  Whether they cut or not, the Fed will likely utilize the meeting to provide markets with additional forward guidance and reassurance of their intention to remain independent. The December ‘24 FOMC meeting will provide a fresh update to the Summary of Economic Projections (SEP), which provides a valuable, real-time lens into FOMC officials’ views of the path ahead for inflation, economic growth, and monetary policy. By providing such forward guidance, the Fed will have ample time to prepare the markets, thereby helping to reduce any potential bond market volatility that would come from near-term monetary policy. 

• Response:  The Fed’s 75 bps of cumulative cuts were already priced into the bond markets. Apart from some of the volatility from the election, US10Y has been trending between the high 3%’s and low 4%’s, which reflects a normalized range consistent with nominal GDP growth. More recently, the Presidential election added volatility, with the US10Y trending up 60 bps from where it stood at the end of October to 4.3% as of Friday November 8th.
• Implications of Government Policy: The long end of the curve is likely to feel upward pressure given the implications potential tariffs, higher deficit spending and immigration policy on inflation; but again, it’s early, and we should not jump to conclusions prematurely given that we do not know the degree or timing to which the new administration will adopt policy positions mentioned on the campaign trail.  If anything, potential changes to immigration and other fiscal policies are more likely to influence the Fed’s forward-looking view of the neutral policy rate, as opposed to influencing their near-term, immediate policy response. Indeed, the Fed’s view of neutral rates has been rising over the course of the year, from 2.5% to 2.9% as of September (See LHS of Chart). If inflation accelerates, the Fed will likely pause cuts in the back half of ’25.
• Outlook:The consensus has the Fed funds rate trending in the low-to-mid 4%’s at year-end, and with another approx ~100 bps of cuts throughout 2025, rates will end 2025 in the low-to-mid-3% range, which will allow for the yield curve to un-invert. Flattening and un-inversion will be a significant milestone, as the market will have taken nearly four years to regain a positively sloped yield curve (last was October 2021).
• Yield Curve Normalization Implications for CRE:As the yield curve continues to flatten and eventually un-inverts, capital will naturally and gradually start to shift out of the short-end of the curve and into longer-dated instruments in order to achieve better yield; this natural and logical rotation out of the short-end of the curve into the longer-end will help to ignite more demand for longer-term investments like CRE from both debt and equity providers, which underscores our view that the CRE capital markets will continue to gain traction not only as rate visibility improves, and not only as financial markets (and debt conditions) loosen, but also as the yield curve flattens and un-inverts.
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DIVING DEEPER

Debt & Equity Capital is Coming Off the Sidelines Gradually

Regardless of the volatility and uncertainty arising from the election, it is important to maintain a balanced perspective; the Fed’s two initial rate cuts have still infused much-needed optimism throughout the marketplace, helping to usher in the next phase of the capital markets recovery. Above and beyond the symbolic influence on sentiment, less restrictive monetary policy loosens broader financial market conditions by very definition, which supports better, more fluid conditions for both CRE leasing and capital markets. Prospects for a soft-landing are also still coming into focus, which implies a stronger outlook for NOI growth and improved conviction for businesses, investors, and lenders. 

Cost and availability of CRE debt capital has improved, though the run in treasuries over the last few days has curtailed momentum a bit. Yet, the contraction in base rates (pre-election) together with the stability/tightening in risk spreads have helped bring fixed-rate debt costs in anywhere from 125-150 bps from October ’23; post-election, that improvement has narrowed given the 50-60 bps expansion in base rates, but conditions are still improved relative to this time last year. The improvements in debt costs, alongside the adjustments to property values have also helped to generate neutral to slightly positive leverage conditions for select deals, which is drawing additional buyer interest. Lender sentiment has turned significantly more positive, as well. A growing spectrum of lenders are showing a mounting desire to selectively place debt capital, particularly for high-quality cash flowing properties. While non-bank lenders such as life cos, debt funds and mortgage REITs continue to fill the gap left by many of the regional and community banks, a select group of larger domestic money center and foreign banks have indicated a desire to lend on quality cash-flowing term loans as they strategically rebalance exposures to other assets classes within their CRE portfolios.

The commencement of the rate cutting cycle has also started to move equity capital gradually off the sidelines driven not only by greater conviction in the outlook for fundamentals and NOI, but also by a recognition of the fact that this window of relative opportunity on the equity capital markets side is fleeting (i.e. less buy-side competition from institutional and public-players, and still attractive pricing).

We’ve also seen a very important inflection in redemption queues, signaling that open-end, core and core-plus investors are feeling more confident about their capital remaining invested in existing CRE funds given the progress made in write-downs. Institutional property values continue to correct, with NCREIF ODCE Appreciation returns having registered 9 consecutive quarters of declines, bringing cumulative appreciation returns to -17.7% as of Q3 2024. Redemptions requests appear to have peaked in Q1 2024 at approximately 18-20% of Net Asset Value (NAV) and have trended lower in Q2.[1] Queues are expected to continue to decline going forward – a signal that investors are not only gaining confidence in where valuations stand, but also viewing this as an attractive entry point or vintage year for investment.

Implications:, With interest rate and cap rate compression dynamics more limited in the chapter, investment strategy will continue to tilt towards operational alpha strategies (i.e. strategies that can generate outsized income returns), and focus on the fundamentals will remain pronounced in this next chapter.

In addition to the meaningful inflections felt throughout the capital markets, CRE fundamentals have reached several meaningful inflection points:

• Overall, we expect to see inflections in vacancy for essentially every CRE sector this coming year.
• Demand has inflected meaningfully for Multifamily and is on track to record the second-best year on record. The resilient labor market, strong international immigration trends over the past few years, and a cost-prohibitive single-family market are collectively keeping renters renting longer, helping to generate these historically strong demand trends.
• The Industrial construction pipeline, which has thinned by 57% relative to the peak in Q3 2022, is trending at its lowest point since 2018. Despite the wave of supply working through the Industrial market, vacancy is at 6.4%, which is still commensurate with prior cycle lows (we expect it to peak at around 6.7% in ’25).
• Retail availability remains historically tight as the national vacancy rate for shopping centers held near a historic low of 5.4%. New construction remains subdued, and 2024 is on pace to be the weakest year for new construction on record. With only 11 msf currently under construction in a market of 4.3 billion square feet of inventory, there is virtually no supply risk.
• Office sublease availability has been flat for the past three quarters, and more than half of the markets Cushman & Wakefield tracks have seen their sublease pipeline shrink quarter-over-quarter (QOQ). Office occupancy increased QOQ in over one-fourth of markets, and half of U.S. markets registered improved absorption this quarter versus a year ago.

SEPTEMBER 20 EDITION  

FED PIVOTS: THE NEXT CHAPTER FOR CRE  

In lieu of a September edition, Cushman & Wakefield’s research team analyzed the September 18th announcement by the Federal Open Market Committee about their lowering of the federal funds rate by 50 basis points.

Read our analysis of this decision and what it means for the commercial real estate industry in this article.

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AUGUST 31 EDITION  

QUICK BITES  

The Time Has Come

• Inflation Pressures Are Fading: July’s CPI report confirmed that inflation continues to recede, solidifying likelihood of a Fed rate cut in September. Both headline and core consumer prices rose by 0.2% m/m in July, with the former largely meeting expectations and the latter edging slightly lower than expectations. Year-ago rates for both headline and core CPI measures improved as well, with headline declining from 3% to 2.9%, all as core year-over-year growth contracted from 3.3% to 3.2%. The three-month annualized rate of inflation for core CPI fell to 1.6% (notably below 2%), illustrating the encouraging recent deflationary progress made. Core goods remain in deflationary territory; however, core services continue to be pulled up by stubbornness in shelter inflation. While shelter inflation remains choppy, leading indicators of private market rent indices continue to slow, suggesting that housing inflation should follow in the months ahead.
• Awareness of Both Sides of Risk: the Fed has ensured the markets that they are aware of risks to both sides of either easing too slowly or too quickly; Powell has alluded to this awareness saying that the Committee is now more "attentive to risks to both sides of its dual mandate" (i.e., “price stability” and “full employment”) rather than only emphasizing “price stability.”
• Powell’s Jackson Hole Speech: Powell's speech will be remembered for its intentionally dovish tone signaling that officials have enough conviction to take decisive action in September. He made it clear that they “do not seek or welcome further cooling in labor conditions,” offering a strong signal that a September rate cut is imminent.
• Inflation Expectations Matter: Powell highlighted the “critically” important role that anchored longer-run inflation expectations have played (this cycle) in allowing the fed to wait for disinflation to progress without needing further slack to develop in the labor markets. For context, as inflation grew troublesome back in 2021 and 2022, concern over the de-anchoring of expectations introduced much of the Fed’s and the market’s initial view that disinflation would require “slack in the economy and specifically the labor market.” However, Powell now recognizes that the unique collision of pandemic-era distortions to demand alongside constrained supply-side conditions contributed to inflation. As a result of those unique underlying causes, he acknowledges that disinflation has been able to progress without creating more slack in the labor markets thanks to the unique combination of healing in pandemic-era distortions (on the supply side), together with the Fed’s efforts to curb demand through restrictive policy (on the demand side). Consistent anchored expectations have thus played a critical role in not making this fight harder for the Fed

 

KEY THEMES

The Path of Policy Ahead

• The Magnitude of the Fed’s Early Cutting Cycle: The magnitude of the Fed's cutting cycle will depend, in part, on the sense of urgency that the Fed may feel and the degree to which they feel they need to preempt further weakening in the labor market (“We do not seek or welcome further cooling in labor market conditions”). While they will rely upon July payrolls and the 2024 Benchmark Payroll revision report, their stance will also depend on the outcomes of both the August employment report (releasing September 6th) as well as the August CPI report (releasing September 11th).
• We Do Not Expect the Fed to Cut Rates Too Aggressively: Doing so would be unexpected and spook the markets; the Fed prefers not to surprise the financial markets. Chart 1 reflects the dispersion of target rate probabilities over time (captured following Powell’s Jackson Hole speech on Friday August 23rd). Based on the Fed’s prevailing signals, and on the data thus far, conservative views would expect the Fed to move at an approximate 25-bps/meeting clip, which would amount to 75 bps of cuts for the remainder of the year (between the September, November and December FOMC meetings), bringing bring target short-term policy rates to the high 4%’s. As per usual, the market expects more aggressive cuts, with the largest expectation for 100 bps worth of cuts through the remainder of the year.

• New Chapters for CRE Ahead: 
• The first Fed cut reflects a meaningful turning point within the CRE capital markets recovery. While the full macroeconomic outlook will, as always, remain uncertain, the commencement of the cutting cycle will help provide investors and lenders with a sense of direction and vision for the path ahead. So far, the market’s sensitivity to incoming data and the ambiguity in the outlook has made it difficult for lenders, owners, and investors to strategize and execute. Business and investor caution will remain (particularly during the hyper-sensitive election period); however, a new sense of optimism will still take hold as the short end of the curve comes in, and the yield curve flattens. While it is unrealistic to assume that financial market volatility will dissipate entirely, this new chapter will allow some space for the financial markets to stabilize and recalibrate to normalized interest rate levels; the long-end of the yield curve is expected to hover in the high 3%’s to low 4%-range. Contraction in the short-end, together with stabilization in the long-end will gradually provide buyers and lenders better clarity in underwriting yields, spreads, rent growth and cash flow assumptions; that very foundation defines this “next chapter.”
• An Attractive Entry Point Is Emerging: As businesses, lenders and buyers are gradually provided with better foundations upon which to make forward-looking investment decisions, CRE pricing and yields are also reaching an important milestone: Neutral to slightly positive CRE debt leverage conditions are emerging (as pricing adjusts and as base rates and spreads gradually improve), which is a huge step in restoring liquidity and momentum in the capital markets.
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DIVING DEEPER

Contextualizing and Reframing Recent Volatility

• The Backstory: Concerns over a slowing U.S. economy triggered a dramatic pull-back in global equities and U.S. bond yields as August kicked off. Such financial market and investor concerns were, in part, brought on by a reaction to the July employment payroll report, which showed that job formation is slowing all as unemployment edged up higher to 4.3%. The rise in unemployment also triggered the so-called Sahm rule, which historically has shown that anytime the 3 month moving average of the unemployment rate moves by more than 0.5% over twelve months, it points to a recession that’s already begun. The market’s acknowledgement of a slowing job market was also met with added concern when weekly initial unemployment claims jumped higher (before later pulling back), prompting many to worry that the economy was headed for a more significant slowdown in the face of higher policy rates.
• Softening Trends Were Indeed Already Evident in Labor Market Data, despite that the financial markets were arguably late to recognize that headline labor market figures masked underlying rebalancing trends. We've been highlighting the rebalancing occurring throughout the labor markets for months, citing leading indicators like the ongoing decline in temporary employment. Job openings have also been trending down and are far below their post-pandemic highs, all as the Quits rate had plunged over the last 3-4 months. Job gains have also been concentrated in less-cyclically sensitive sectors like government, health care and education. Meanwhile, longer-term unemployment claims had also been rising since this spring, which emerges as a leading indicator ignored by markets until a few weeks ago. Finally, as it relates to the Sahm rule, it is important to point out that this recession indicator may not be as powerful or instructive an alarm for this cycle because a large portion of the rise in unemployment has been driven by the denominator (i.e. in the rise in the labor supply, driven by immigration). Keep in mind, the theme is of moderation so far, not of widespread labor-market unraveling, and it is important not to overreact in either direction.
• The Larger Perspective to Keep in Mind: The market has (in my view) oversubscribed to this notion that the economy was going to skirt through this period of restrictive policy without seeing moderation percolate through to the labor markets or the economy more broadly. Soft-landing is very different from No-landing. By definition, Soft-landing still implies slowing or easing or rebalancing throughout key macroeconomic indicators. Ultimately, the transmission mechanism of restrictive rates takes time to filter through. In this case, that transmission mechanism has taken time because the economy had to work through pandemic-era conditions/excesses that distorted certain pockets of the market, all as fixed-rate debt structures have insulated certain borrowers and segments of the economy, thereby requiring more time to pass before outstanding debt is impacted.
• Near-Term Softness Provides Conviction for The Fed: The more evidence that restrictive policy rates are permeating the economy, ironically, the better for the Fed. While counterintuitive, short-term pain in the economy is, in one sense, a net positive for the CRE capital markets recovery because such softening ushers in the Fed’s rate-cutting cycle, which provides owners, investors, and lenders with greater visibility into the path ahead for both interest rates and macroeconomic growth.
• The Early-August Whipsaw in Yields and Spreads Has Since Calmed: In the wake of the July jobs report release, 10Y Treasury yields fell by upwards of 30 bps relative to trailing 5-day yields, reflecting a fear-driven flight to risk-free instruments. As risk-free rates contracted, spreads widened for credit instruments and corporate bond yields all as lenders took pause and financial market conditions tightened. AAA CMBS spreads widened around 10 bps before settling back into around 100 bps over swaps. This sharp contraction in the risk-free rate, alongside the expansion in risk-premium and spreads was temporary, though, and the markets have since taken the time to absorb the broader narrative. The hard truth remains that volatility in both equities, bond markets and financial market conditions is likely to continue in the near-term but spreads are holding very tight relative to historic standards.
• Stability Outweighs Isolated Windows of Interest Rate Fluctuations: While the recent volatility may have provided a few borrowers the opportunity to take advantage of the contraction in base rates, many lenders took to the sidelines to wait to see where spreads were headed; this mismatched dynamic highlights the often frustrating fact that stability throughout the financial markets and clarity on the macroeconomic outlook offsets isolated opportunities to time the market. Stability and clarity on the outlook will form more considerably as the Fed pivots this fall, ushering in the next phase of the CRE capital markets recovery.

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JULY 24 EDITION  

QUICK BITES  

Inflation

April's PCE and May's CPI reports show renewed cooling.

• The fight against inflation is on track: most recently evidenced by June’s CPI print. On a three-month annualized basis, core measures of inflation are now trending at 2.1% y/y for CPI and 2.7% for PCE. Headline PCE (widely considered the Fed’s preferred target) is now trending at 2.5% y/y, which is the slowest pace registered since August 2021 (nearly 3 years ago when inflation hadn’t started to accelerate yet).
• We’re also seeing easing on core services: While core goods remain in disinflationary territory, the easing in core services was helped by moderations in discretionary areas such as airfares, lodging away from home, and recreational services; indeed, the consumer is dialing back certain discretionary spending habits amid mounting price pressures.
• The much-anticipated lagged relationship for housing inflation still exists: The stubborn lag between spot-market measures of rent and those surveyed showed ongoing traction. Both owner’s equivalent rent and rent of primary residences eased, with the latter expected to contract more as the full effects of easing market-rent growth work their way through the survey data. 

KEY THEMES

Monetary Policy & CRE Fundamentals: Foundations of the Pyramid
 
Decidedly Dovish Shift from Powell
Just ahead of the June’s CPI release, Powell’s latest testimony to Congress also took a decidedly dovish tone. Not only did he acknowledge the progress made on inflation, but he also emphasized that they remain focused on the “balance of risks” facing the economy amid such restrictive policy. While they remain data dependent, and while he also emphasized the importance of central bank independence, Powell’s testimony suggested that he was comfortable signaling to the markets that they are paving the way or teeing up impending rate cuts.

Economy No Longer Viewed as Overheated
Powell also made specific and clear reference to his views of the labor markets in his testimony, emphasizing his view that “Labor markets have cooled considerably…” and that the “U.S. is no longer an overheated economy.” He emphasized that the “economy is more or less back by most measures to where it was before the pandemic,” and the trend prior to the pandemic featured a “strong labor market, but it wasn’t an overheated labor market.”

Don’t Overlook the Upside Surprises in CRE Demand This Quarter
While much of the attention has been placed on the pace of new construction in both Multifamily and Industrial, too little attention has been given to the robust demand formation for apartments. U.S. multifamily vacancies declined by 10 bps in the second quarter as absorption topped 138,000 units. With more than 500,000 jobs added in the second quarter, the resilient labor market remains supportive of new household formation as real wage growth remains positive. Year-to-date Multifamily absorption has nearly surpassed all of last year’s demand and is up 75% over the first half of 2023. Meanwhile, Industrial absorption more than doubled in Q2, and together with the easing in new sublease space, helped to ease some of the upward pressure on vacancy. With construction starts plummeting in both sectors, fundamentals should begin to recover in earnest in 2025-2026

Diving Deeper
 
What We’re Watching: The Power of Expectations & Influence on CRE Capital Markets

Market Expectations & Sentiment Have Shifted to the Upside
To appreciate the degree to which investor-oriented perceptions and financial market conditions have changed since the June CPI print, we can explore various high frequency indicators to monitor the undercurrents of investor sentiment. Chart 1 below reflects the forceful shift in expectations based on forward-looking expectations of monetary policy (shown in the form of probabilities for year-end target policy rates). The yellow series reflects the distribution of probabilities just ahead of the June CPI report (on July 10th). At that point, the market was assigning a 45% probability for 2 rate cuts by the end of the year. Yet, notice that more than 20% were still expecting just one cut. Meanwhile, the blue series reflects market-based probabilities following the latest June CPI print (as of July 12th); at that point, the market assigned upwards of 90% probability to the Fed executing a few rate cuts by year-end. Certainly, this can change based on incoming data, and markets tend to be poor predictors of Fed policy; however, the key message here relates to sentiment. Growing confidence around an impending rate cut meaningfully impacts business and investor psychology.

 

Real-time CRE insights Offer Green-Shoot Perspective
Just as market implied probabilities are a useful tool in monitory financial markets, public REIT pricing trends arise as a powerful barometer of CRE investor sentiment and trends in private performance ahead. Indeed, in the wake of the June CPI report posting, REITs had one of their best weeks since the rate hiking cycle began. As shown in the LHS of Chart 2, below, the All-Equity REIT index improved over 4% in a single week as shifting rate cut expectations catalyzed investors’ renewed focus on real estate. In connection to the improvements in REIT pricing, we’ve also been tracking a tightening in REIT-Implied Nominal Cap Rates.

Meanwhile, shown in the RHS of the chart, while REIT pricing still stands roughly 21% below its prior peak, the public markets are in recovery mode (even for office), as evidenced by the fact that all peak-to-current % changes in the RHS of Chart 2 are better than their peak-to-trough declines. Certainly, disparity exists by property type, but the key message is one of recovery. While the private markets are still in correction mode, in most cases, it is just that: a correction to the one-off adjustment to higher interest rate environment. The rebound in the public market underscores that recovery follows adjustment; investors are keenly aware of this fleeting window of opportunity, and our experts in the field continue to indicate rising buyer demand.

 

So, What Does a Fed Cut Really Mean for CRE?
Think of it in terms of three “C”s, starting with

1. Clarity on the path ahead: The first cut implies that the broad “soft-landing” narrative is holding, which gives consumers, businesses, investors, and lenders more clarity and confidence to make decisions. More business clarity begets more business growth and demand for credit/investment, which in turn supports demand for the built environment (a fortuitous cycle). More clarity also provides buyers and lenders with a more solid foundation upon which to underwrite NOI growth and forward-returns, which will inevitably help more deals pencil on the buy-side.
2. Curve Shifts: Fed cuts will gradually bring the short end of the curve in and will help generate some additional debt spread compression. With longer-dated Treasuries pegged to low 4%-equilibrium range, full un-inversion isn’t expected until the end of ’25 (at least assuming growth remains in a soft-landing scenario, underscoring the Fed’s patience). The eventual flattening and un-inversion of the yield curve naturally stimulates longer-term credit growth for lenders and borrowers.
3. Contraction in CRE Debt Costs: Fed cuts influence the short end of the curve, which certainly helps debt tied to floating rate instruments. We can also expect some spread compression as uncertainty fades, however, debt spreads have already been tightening, so the impact of rate cuts is likely to be felt more so in base rates with marginal spread compression to follow.

As Debt Costs Come In, Neutral/Positive Leverage Can Be Restored
Negative leverage conditions (i.e. when going-in cap rates are below debt costs) remain a significant hindrance to velocity. While some investors have stomached negative leverage over the last several years (with the intention of growing out of it with NOI growth), many have taken to the sidelines to wait for prices to correct enough such that cap rates become more amenable.

Chart 3 tackles a common question as it relates to timing – i.e. when can we expect positive or even just neutral leverage conditions to reemerge? Currently, fixed debt for higher quality (i.e. Top Quartile cap rates) are still negative (-70 bps for Residential, -25 bps Retail, -65 for Industrial, -87 for Office and -35 for Hotel). Fixed rate longer-term debt is poised to return to neutral/positive leverage conditions within a few quarters as base rates come in, yet keep in mind that longer-dated Treasuries are still expected to anchor around the mid-to-low 4%-range. Meanwhile, floating rate debt spreads to SOFR are more negative; assuming cap rates remain stable and spreads hold constant (for simplicity’s sake), it will take upwards of 5 to 6 rate cuts until floating rate debt returns to neutral or positive range. Of course, some spread compression and cap rate compression are likely to follow rate cuts, so the timing to restore neutral/positive leverage could shift ahead to 3-4 cuts, depending on product type and leverage utilization. As the CRE capital and debt markets near that neutral/positive leverage tipping point, liquidity conditions stand to significantly gain traction.

Looking Ahead
Fed cuts will translate to neutral/positive leverage conditions gradually (not immediately), so it is best to think of the capital markets recovery as sequential in nature, not necessarily as a flood-gate opening upon the first rate cut. Encouragingly though, fixed rate product is effectively at or very close to squeezing out neutral/positive leverage, signaling that more traction is expected to form in the quarter(s) to come. Such mounting momentum continues to be corroborated by our Debt and Capital Markets experts, who are noting robust deal pipelines and growing buyer interest.

 

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JUNE 26 EDITION  

QUICK BITES  

Disinflationary Trends Are Back on Track

April's PCE and May's CPI reports show renewed cooling.

• In April, core PCE maintained a 2.8% year-over-year pace, while the 3-month moving averages for Core PCE, Core-Ex Shelter PCE, and Super Core PCE (Core Services) each declined to 3.4%, 3.1%, and 3.6% y/y, respectively.
• May’s CPI report also showed positive signs, with some of the stickier portions of core services (including airfare, motor vehicle insurance, and lodging) easing over the month; Core CPI trended at 3.4% y/y in May, with the three-month moving average downshifting to 4.1% y/y, from 4.5% y/y in April.
• Ultimately, both the latest PCE and CPI reports reflect a downward trend in inflation. However, the FOMC still wants to observe more consistent disinflationary progress before pivoting their restrictive policy. Despite the Fed’s patient and data-dependent approach, the acceleration seen in Q1’s inflation data has reversed course and the critical cooling trend desired by the Fed is once again more evident.

Cracks Are Indeed Forming:

While topline macroeconomic figures continue to reflect a resilient economy, underlying data help to provide growing evidence that the weight of restrictive policy is curbing growth: the labor market is rebalancing, employees are feeling less optimistic about their prospects of employment, and the consumer has dialed back their confidence and spending amid dwindling post-pandemic savings and snowballing cost pressures.

• Delving into a few details: job openings were down significantly in March and April, the latter of which registered at 8 million (below forecast expectations of 8.4 million); while still trending higher than pre-pandemic norms, the prevailing figure is now well below the post-pandemic peak of 12 million registered in mid-’22.
• The ratio of job openings to unemployed persons has also returned to near pre-COVID levels, registering around 1.2 versus a peak of 2.0 in ’22.
• The JOLTs diffusion index has also broadened, meaning that the contraction in job openings has been growing more broad-based across all industries (Construction, Health Care and Social Assistance, Manufacturing).
• Meanwhile, the three-month moving average of the Atlanta Fed’s wage growth tracker is now at 4.7% in March, versus June ’22 peak of 6.7% y/y.
• While top-line non-farm payrolls increased in May, job growth has also been concentrated in sectors like Government, Education and Healthcare that generally tend to lag the economy’s broader job formation trends.

Alas, the transmission mechanism of restrictive policy takes time to permeate and flow through interest rate-sensitive segments of the economy, and we’ve seen some pockets of the economy, including manufacturing and CRE, more negatively impacted.

An Uncomfortable Soft-Landing:

While the economy remains resilient (a net positive foundation for CRE fundamentals), growth is still expected to generate what we have been referring to as a “Slow-cession” or an ‘uncomfortable soft-landing’ to distinguish the fact that soft-landing is very different than ‘no-landing’.

• For now, the growing evidence of rebalancing and easing throughout the economy should provide the Fed enough confidence to shift from observation-mode to cutting-mode in Q4, assuming the next several inflation reports show sustained progress.
• The slow and stubborn lag in housing disinflation should also continue to help measures of core inflation retreat closer to target (though elevated wage growth and stubborn services will costs will still keep some core inflation above-target for the immediate horizon).
• For more insights into the outlook, check out our latest U.S. Macro Outlook report, released last week, which features forecasts for both the economy and each CRE sector.

 

KEY THEMES

Deciphering the Dot Plot, Interest Rates & Capital Markets
 
As part of the FOMC’s June meeting, the committee released their quarterly Summary of Economic Projections, which serves as a valuable lens into the committee’s outlook for monetary policy, both in the immediate term (through year-end), medium term (next year) and longer-term (2026 and thereafter).

• The immediate-term policy view continues to shift and dial-back given stickier than expected inflation and resilient macroeconomic growth. As a result of this backdrop, FOMC officials raised their projections for the year-end ’24 policy rate from 4.625% to 5.125%, which implies that members of the committee expect only one 25 bps rate cut, as opposed to the few cuts assumed within the March ‘24 SEP. While expectations for cuts this year were dialed back, none of the participants signaled an expectation that rates would need to rise this year.
• For those looking for green shoots, there was a slight improvement in median rate cut expectations for 2025, as the median came in at 4.125% for 2025, indicating that participants expect 100 bps of cuts for ’25, versus 75 bps projected during the March ’24 SEP.
• While GDP projections remained steady, near-term inflation projections notched up slightly higher, the latter of which likely contributes to the noteworthy upward shift in longer-run policy rate projections. This latest SEP now shows the median long-run policy rate is projected at 2.75%, which is the highest long-run rate noted by the committee since 2019.
   

With increasing acceptance and recalibration towards a more normalized interest rate environment, CRE buyers and sellers are growing increasingly more open to act, though both sides remain cautious and selective in the near term.

• As participants increasingly recognize that longer-dated rates are not likely to resume their prior decades-long compression trend, investors will remain income-focused for the foreseeable future as existing debt slowly re-prices into the higher-rate environment.
• Fortunately for most asset classes, the NOI outlook is decent, if not robust, growing by 1.5% to 2% this year and next (in a diversified portfolio) before accelerating to the 4.5% to 7.5% range in the following years.
• Even though some measured cap rates will march upwards as credit spreads normalize off higher base rates, we forecast that total unlevered returns will again reach double-digits and high-single-digits in 2026 and beyond.
• Polarization from a cross-sector appreciation-returns-standpoint has narrowed over the last five quarters (see more on this in Deeper Dive section and Chart 1 below). Looking ahead, market- and property-level selection will play a more pronounced role in attribution as performance converges across sectors and managers (i.e. allocation effects grow relatively more measured amid narrowing appreciation returns). This underscores the relative value that manager-expertise, track record and asset management will bring to portfolio management in the future. Allocation strategies of simply riding sectoral tailwinds will only be a piece of the puzzle in the next chapter.

Diving Deeper
 
Generating Alpha in the Chapters Ahead (with a Lens into Employment Growth)

Tracking institutional returns (and appreciation returns in particular) provides a distilled view into the themes that will shape both this downcycle and the recovery ahead.

The NCREIF NPI recently recorded its 5th consecutive quarter of negative unlevered appreciation returns. Yet, there’s a lot more to unpack as to what it can tell us about performance looking ahead.

Chart 1 illustrates an important point on past polarization and recent convergence: notice that the Retail, Industrial and Apartment sectors' appreciation returns have converged more recently, while Office continues to pull back as an outlier. Prior polarization underscores the benefits of portfolio diversification, both from a downside protection and upside alpha-generation perspective. Yet, downturns tend to bring a convergence in performance, which is exactly what we’re witnessing right now.

Taking a historic view of such polarization demonstrates just how significant and unique the last 3 years have been. At the height of this last cycle, we were seeing double-digit spreads between Appreciation Returns across sectors. The divergence in appreciation returns contributed to significant alpha-generation in the prior chapter for investment managers that were proportionally weighted to Industrial or Multifamily, for example, before the post-pandemic upswing in values unfolded.

Importantly, polarization has narrowed over the last several quarters as the combination of ongoing macroeconomic uncertainty, together with the ongoing acceptance of the longer-term costs of capital, is causing a more broad-based pullback in appreciation returns and performance across even the most resilient of sectors.

As higher costs of capital cause a broad-based rightsizing in yield effects, cross-sector divergence in appreciation returns is not likely to be nearly as pronounced as it was over the last 3 years. The more that the current uncertain environment collectively places pressure on NOI growth assumptions and key valuation metrics (going-in yields and exit-caps), the more convergence we will likely see in ODCE investment manager performance. Looking ahead, selection-effects (i.e. market and property level selection) are set to impact returns in a more pronounced way as allocation effects converge.

Market-level returns were also polarized during the post-pandemic years, and they too have converged as the broader capital markets correction unfolds. Chart 2 depicts the average standard deviations of cross-market rolling four-quarter total returns for each sector over time.

While dispersion on a cross-market basis is not likely to return to the historically wide ranges witnessed post-pandemic, a reversion to a more typical distribution is emerging. Much of this expectation can be linked to the recognition that demand-side growth will not follow a uniform path across the country, as underscored by cross-market employment growth forecasts. Chart 3 ranks the top employment markets according to the cumulative growth rate projected between ’24-’28, and the nominal level of new employment is featured in the data labels. Just the top 28 of 102 MSAs with over 300K in employment as of Q1 ‘24 were included to give a glimpse of regional dispersion.

Indeed, most of the employment and population growth is going to occur in Sunbelt markets, throughout the West, Southeast and Southwest regions of the country. However, it’s also important to note that these are not just small markets experiencing strong growth due to smaller base effects. Several larger markets will arise as top-ranking employment growth markets in the near-term, including Las Vegas, Orlando, Phoenix, Austin, Houston, Miami and Dallas. Such market-level dispersion offers investors another avenue towards outperformance, apart from operational efficiency and income-optimization strategies that will help drive returns in the chapters ahead.

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MAY 21 EDITION  

QUICK BITES  

• Moment of Truth: While it is fair to say that every moment could be characterized as that proverbial “moment of truth,” the juncture we are at now is undeniably critical to the outlook. Coming into this year, inflation was trending steadily lower all as the economy was posting resilient growth, and the Fed made a clear dovish shift in messaging. The financial markets responded with eager anticipation, which allowed for some stability and momentum to form throughout the financial and treasury markets. Such optimism spread through the CRE capital markets, as risk spreads trended in.  
  
  
• Soft-Landing Is Different from No-Landing: Unfortunately, over the past few months, we’ve seen some of that progress unwind as the broader economy remains remarkably resilient. In some respects, more “bad” news in the macroeconomy counteractively spells good news for inflation and monetary policy. Indeed, there are signs that we’re on the path to reaching target inflation, but until inflation shows consistent and measurable progress towards slowing, we believe the Fed is unlikely to cut rates, perhaps only doing so once or twice this year. 
  
  
• It’s Called Restrictive for a Reason: The markets are actively recalibrating their expectations not only to a more gradual, delayed rate cutting cycle, but also to a more accepted view of what it means to normalize to higher interest rates. Quite simply, the stubbornness in inflation is a powerful reminder that a shift in the timing and magnitude of Fed rate cuts, on the margin, will not make or break the larger narrative that will unfold over the medium and longer-term. Restrictive monetary policy is intended to weigh on growth, and we continue to expect a slowdown; yet the foundations of both households and businesses remain solid, which will help CRE fundamentals weather a downturn relatively well. 
  
  
• Volatility --> Acceptance: Ultimately, the CRE market really doesn’t need to wait for the Fed to cut rates to accept the normalized interest rate regime. Fortunately, we’re seeing that acceptance process unfold even as inflation remains choppy and as the Fed remains patient. Such acceptance will continue to usher in more price discovery and transaction activity, all as property fundamentals outside of commodity office remain on healthy footing, poised for inflection in the coming years. 
  
  
• For more insights into the macro-picture, check out Cushman & Wakefield’s U.S. Macro Outlook update written by our Global Chief Economist, Kevin Thorpe. 

 

KEY THEMES

Key Capital Flows Themes 
 
After persevering through two years of a rate hiking cycle, both buyers and sellers are adjusting their business plans to the new environment, which doesn't necessarily mean sitting on the sidelines. While many sellers became holders throughout 2022 and 2023, they are now recognizing 2024 as a time to transact. Many owners are exhibiting a clear interest to trade some of their assets for various liquidity reasons, primarily driven from redemption needs from pension accounts or other LPs in their accounts. Other sellers are simply behind on their sales and portfolio management/rebalancing goals, and recognize they need to move product. 
 
An on-the-ground pulse continues to show a significant imbalance between the supply of quality offerings for sale relative to investor demand in 2024. And, value-add and opportunistic buyers hungry for blood-in-the water are still sitting on significant amounts of dry powder that ultimately needs to be deployed. Both sides, also recognize that timing a bottom is unrealistic, garnering this period before the elections and ahead of a Fed pivot as a unique window of opportunity to act. 
 
For more insights into how we see capital markets unfolding even amid this period of dislocation and volatility, check out our latest short report, “Following the Flows,” which features perspectives on the capital flow sources that are expected to drive the market.

Key Global Inflation and Monetary Policy Themes 
 
April’s CPI print provides the Fed (and financial markets) with some encouragement that inflation is downshifting from the pace registered in Q1. 

• Core CPI is trending at 3.6% y/y, while the 3-month annualized pace is still elevated at 4.1% y/y. Core Goods inflation continues to ease (trending at 1.2% y/y in April) and has returned to its pre-pandemic pace, however, some of the disinflationary influences of healing supply chains have nevertheless dissipated more recently. Ultimately, much of the focus on inflation still lies in the service sector, which continues to ease, but at a stubbornly slow pace. 
  
  
• Housing services (both OER and rent of primary residences) inflation continues to downshift, but also slowly.  

With housing inflation arising not only as influential to inflation, but also to CRE more broadly, a few reflections on multifamily rent growth help to frame the outlook. Oftentimes, when analyzing the progress towards reaching the Fed’s core inflation target, it may feel tempting to point to the well-known lag in shelter inflation as justification for saying that we’ve effectively reached target by stripping out Shelter inflation from Core (which in some sense is correct and is certainly not lost on the Fed). However, writing off Shelter from the inflation outlook altogether (such as looking at Core CPI ex-shelter) and concluding that the Fed has achieved its 2% inflation mandate would ignore a few important considerations. 

• First off, rent of primary residence (which draws in theory from multifamily rent growth, and which is recognized as filtering through with a lag) has indeed cooled from its 2021-2022 peak, however the pace is still trending at 1.5% y/y (which is certainly not 0%). In addition, Cushman & Wakefield manages 180,000 units across the country, which provide us a unique lens into rent growth trends. A recent deep dive into this data by our Head of Multifamily Insights, Sam Tenenbaum, highlights that new lease trade-outs are showing resilience, which naturally places upward pressure on overall trade-outs as well. 
  
  
• In addition to multifamily rent growth, the Owner’s Equivalent Rent component of shelter inflation also (indirectly) takes into account home prices and even hotel room costs, which are up 6.5% and 3% y/y, respectively. 

Shelter inflation is still expected to ease as the lag effect of the private rental market filters through, but its overall influence on inflation unlikely to drop to zero, as looking at CPI ex-shelter would imply. The Fed is no-doubt aware of this, which underscores their patient stance in wanting to see other elements of inflation consistently trend down before cutting. 
 
Meanwhile, taking a more global perspective, inflation throughout the U.S. has cooled more slowly than throughout Europe and the UK, a dynamic which positions both the ECB and the BOE to potentially cut their policy rates ahead of a pivot from the U.S. Federal Reserve Open Market Committee (“Fed”). 

• While global monetary policy has historically moved in coordination and largely followed the Fed’s tack, regional disparities in macroeconomic fundamentals and inflation dynamics are now initiating a divergence in those paths. 
  
  
• The U.S. macroeconomy has posted remarkable resilience against the weight of restrictive policy, whereas Europe and the UK have experienced economic stagnation with nearly non-existent consumer spending trends, sluggish investment, a softening labor market and slowing wage growth, which collectively contribute to more deflationary pressures. As a result, the ECB and BOE are now widely expected to cut before the Fed. 
  
  
• Improved liquidity and conviction among investors arises as a direct implication of an earlier potential cut (and even of the dovish positioning on part of the BOE and ECB). The window of relative opportunity before oncoming rate cuts also arises as a unique period of dislocation where many European investors will be keen to capitalize on both buy-and sell-side opportunities ahead of a full-swing capital markets recovery. 
  
  
• With monetary policy conditions slightly farther ahead in the ECB and the UK, yields in certain markets have already stabilized, particularly markets that have witnessed swifter yield adjustments offering attractive entry points. A potentially earlier ECB or BOE policy shift would also act as an example of the response that U.S. capital markets participants might have as the cutting cycle ensues. 
  
  
• For more insights into European and UK monetary policy, inflation and investment implications, check out our latest report The Opening Gambit for Central Banks: Unravelling the ‘Who Cuts First’ written by Sukhdeep Dillon, our Head of EMEA Forecasting. 

DIVING DEEPER

Cushman & Wakefield’s Investment Strategy Framework “CPR”

Over the last several months, we have finished building out an Investment Strategy framework that draws from several of the models I created while working for and/or consulting for several institutional private equity investment managers.  
 
The framework created for Cushman & Wakefield is aptly named the Cushman Pulse Report, or “CPR”, and it is aimed to serve as a tactical and strategic tool for the full spectrum of CRE capital markets participants (owners, portfolio managers, investors, lenders, brokers, developers etc.). 

The CPR is structured with the recognition that forward-looking investment strategy requires a systematic cross-sector and cross-market perspective of fundamentals and capital markets conditions and performance both currently, in the medium-term as well as in the longer-term. 

Chart 1 provides a perspective of each of the CPR’s four prongs, including Cyclical Positioning, Near-Term Growth Trajectory, Winds (i.e. Mega Trends), and Target-Market Matrices.

• The first prong, Cyclical Positioning, can be thought of as the foundation to the investment strategy pyramid, as it captures a view of cross-sector cyclicality and utilizes a full spectrum of fundamentals and capital markets indicators to identify key inflections within each sector’s respective indicators and unique cycles. Each of the cyclical phases align with key execution points for investment, and the positions allow for flexibility of interpretation given the wide audience: depending on the philosophy and risk appetite of a given investor, the current and future cyclical positioning can inform timing of execution (to either acquire, develop, hold or monetize/exit).  
  
  
• The second prong, i.e. Trajectory, accounts for the fact that two sectors may be in similar Cyclical Positions, but offer entirely unique growth trajectories. Therefore, we utilize our propriety forecasts to project near-term growth prospects for each sector. 
  
  
• The third prong, i.e. Winds, encompasses a comprehensive rubric to evaluate the influence that longer-term mega trends such as aging demographics, climate change, technology innovation, and geopolitical trends will have on each sector. By evaluating each sector against a consistent set of Winds, we are able to arrive at relative cross-sector Winds attractiveness scores that reflect the degree to which the collective Winds will either positively or negatively influence a sector over the longer-term. 
  
  
• We synthesize the first, second and third prongs into a “confluence view” of cross-sector conditions, which allows a comprehensive, consistent and data driven perspective of how the sectors’ compare for investment currently, in the near-term and across longer-term horizons. 
  
  
• In addition to the quantitative frameworks that comprise the sector-level prongs, we also provide thematic investment recommendations for each sector, which originate from our pulse of performance and investment trends. 
  
  
• The fourth prong, i.e. Target-Market Matrices, applies a similar conceptual and quantitative approach taken at the sector level, but at the market-level for each sector. Each investor holds unique philosophies, strategy and firm infrastructure that naturally provide for firm-level proprietary target-markets, however we sought to create a framework that allows for a quantitative, rigorous and consistent approach towards contextualizing how the markets stack up against one another, utilizing a spectrum of strategy profiles. 
   
• We share this investment strategy framework with key strategic clients. Please reach out to us to request access.