Weekly Economic Update, July 13, 2020

Brad StevensUncategorized

A lot to cover this week.  I am a bit long winded, but the information is interesting.

Multifamily real estate is showing stress as renters are falling behind in making their payments.  So far most of this in the Midwest has been covered by the owners from their reserves so the payments on the bank loan are not yet impacted. Once the moratoriums on evictions sunsets, vacancy rates are bound to increase.  If you have an apartment loan in your portfolio you should check with the owners to get a rent roll which would show any late rents due.

What may be a sign of a major structural shift in rental housing came out Thursday.  Manhattan New York hit the highest vacancy rate ever in rental units.  There was an 85% rise in vacancy in that market in the last two months.  While rents in Manhattan are the highest in the nation for residential living, that does not seem to be the incentive to leave.  Most of those leaving indicated they were moving to the suburbs to escape crime, density and were no longer required to be in an office so commuting is not going to be an issue.  It will be interesting as we receive other reports from the central business districts around the nation if the same trend is found.

The Minneapolis Fed released some sobering numbers on Thursday this past week.  In the 9th District residential mortgages have reached a delinquency rate of 5.8%.  This is a 10 year high and one that is rivaling the numbers from the Great Recession.  What is interesting in the article is that non mortgage debt delinquency has actually decreased.  Credit card debt and auto loans are being paid.  Usage of credit card debt is not rising which is a good sign.  The thought is that the mortgage delinquency increase is related to the CARES Act limiting the actions of banks and mortgage holders while requiring forbearance agreements, which, even under an agreement are considered delinquent.  

Commercial Real Estate loans should be looked at in the same manner as apartments.  The rent rolls you currently have should be updated to determine which tenants are still in business and which have vacated.  Any tenant that is in food, retail, gym or medical industry, should be carefully watched.  By the time the owner misses a payment you are already too late.  Between the rising cap rates, lower occupancy and higher rental delinquent rents, the value as well as the cash flow coverage on investment real estate could be dropping fast.

The most concerning real estate numbers are coming from the Hotel sector.  When the Covid impact hit, hotels either closed up for the duration or saw occupancy rates drop to under 5% on average.  They catered to emergency travel if they were open at all.  The structure of financing in this market is unusual and could lead to either opportunities for your borrowers or disaster all the way around.  Hotels are highly risky since the lease duration of a room is 24 hours, not a year.  Many banks refuse the risk so the industry financing is split.  Over the past ten years I have seen more banks willing to take the risk and offer financing but keep the duration short.  Interest rates are also pretty high.  That is where the commercial mortgage backed securities market steps in.  They offer longer duration loans with lower interest rates.  If an issue arises, banks are pretty flexible in most cases to modify terms to try to assist in getting the owner through a rough patch.  From what I am hearing most all bank held hotel loans are in some sort of modification mode. Is it enough is the 800 pound elephant in the corner of the room.

The owners who accepted the securitized financing are finding that bond holders are not keen on modifications, forbearance agreements or payment deferrals.  Any renegotiation is going to be expensive legally and will require the bond holders/investors to agree.  Many owners are not in a position to make the required payments nor are they able to fund the very high legal fees.  This is going to devastate the industry.  If the owners fall into bankruptcy and foreclosure these properties will eventually be sold likely driving values of hotel properties down.  In the post covid era the industry may need to settled into a new, much lower occupancy rate as the normal.  While owners with cash might be able to expand their holdings at a discount, banks holding existing notes may be facing deeper trouble than expected.

Lastly, the ISM non-manufacturing report.  The non-manufacturing sector soared in June, moving from 45.4 all the way to 57.1 as the economy opened back up.  Customer demand is shown as strongly positive after two months of pent up demand was unleashed.  While the media plays up the fact that the covid numbers are still high, it certainly appears that consumers are saying enough and are trying to get back to a level of normalcy.  While they are willing to take precautions such as masks, remote working and other safety approaches, it is doubtful they are willing to abide another shutdown.

Have a great week.

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