Calm Before the Storm? Markets Underestimate Recession Risk

Good morning,

Calm before the storm? Markets underestimate recession risk, class B rents outperform as demand holds up, and Nightingale’s meltdown continues. Let’s delve into today’s topics.

📈 Market Update

⚠️ Calm Before the Storm? Markets Underestimate Recession Risk

Markets appear to be underestimating the growing risks of an economic downturn. Long-term bond yields have been steadily rising as traders expect interest rates to remain high to combat inflation. This signals potential trouble ahead for the economy. After years of being negative, real yields have now turned positive. This will significantly increase borrowing costs across the board as the cost of debt servicing rises markedly. Credit access will tighten and debtors will be hurt. So far, markets seem surprisingly resilient, but contrarian indicators like low credit spreads and lofty equity valuations suggest this optimism may be misguided.

🔍️ Outlook:
With real rates no longer negative, defaults are likely to increase as borrowers struggle with higher debt costs. Households will feel the pinch as mortgage rates hit their highest since 2002. Distress will also spread to regional banks and commercial real estate. While rate policy remains historically low for now, further hikes may push 10-year yields above 5% or more. Stocks also look overvalued, priced for perfection based on optimistic earnings assumptions that seem doubtful to last as the credit cycle turns. Recession still appears on the horizon for late 2023 despite current market optimism. Stay tuned!

🏘️ Class B Rents Outperform as Demand Holds Up

While rent growth in many markets has turned negative, Class B properties have emerged as a surprising area of resilience. With abundant shiny new supply catering to the top of the market across the Sun Belt, targeting the resilient middle segment may reveal hidden opportunities and diamonds in the rough amid broader negative trends. The data suggests demand remains steady for mid-tier apartments in select areas despite rising concessions and declines in the overall rental market.

🫢 Nightingale’s Meltdown Continues

Nightingale has defaulted on a $30M loan for an office building in Midtown East. This comes after a series of foreclosures for Nightingale, including $395M purchase of 111 Wall Street, an office and retail property at 300 Lafayette Street, the Whale Building in Brooklyn, and others in Philadelphia and Chicago. Elie Schwartz has also recently been accused of misappropriating funds raised from CrowdStreet.

✍️ Further Reading

• Zara Billionaire Ortega Buys Chicago Apartment Tower for $232 Million (BBG)

• Default "Imminent" on $384M Loan for NEMA San Francisco Tower (GS)

• SB Properties Swaps California for Texas (RD)

• Meta Platforms Calls Employees Back to Office…Or Else (RD)

• A Painful Evaluation of the Current State of CRE (GS)

• Mortgage Bankers Reduce Losses in Making Loans (CS)

• Charles Schwab Raising Debt After News of Job, Real Estate Cuts (BBG)

• LEGO to Play in Boston’s Back Bay (CPE)

• New Development Group To Bring Retail Edge to Mixed-Use Projects in Texas and US (CS)

• Goodbye Bathtub and Living Room. America’s Homes Are Shrinking (WSJ)

• Airbnb Hosts and Guests Scramble as New York Begins Crackdown (WSJ)

📊 Chart of The Day