Economic Growth Accelerates, Fueling Optimism of a Soft Landing

Good morning,

Economic growth accelerates, fueling optimism of a soft landing, CMBS delinquency rate climbs as CRE struggles, and Brookfield’s ever-shifting real estate empire. Lets delve into today’s topics.

📈 Market Update

💸 Economic Growth Accelerates, Fueling Optimism of a Soft Landing

The US economy showed signs of strength in Q2, with GDP growing at an annualized rate of 2.4%, up from 2.0% in Q1. This acceleration was driven by gains in consumer and business spending. The growth has led some economists to predict an increased possibility of a “soft landing,” where the economy continues expanding while inflation cools off.

Consumers keep spending despite headwinds: Consumers have remained resilient, with spending rising 0.4% in June, led by demand for autos, recreational vehicles, travel, and entertainment. Wage gains have helped sustain purchasing power.

This spending has occurred despite surging prices and rising borrowing costs. For example, auto sales jumped in Q2 even as car loan rates climbed. While rates may constrain demand going forward, pent-up demand remains strong for big ticket items.

Businesses ramp up investment: After slowing investment through early 2022, businesses have started to resume investment. Spending on equipment surged 10.8% while investment in structures grew 9.7%. Some of this can be attributed to legislation like the Inflation Reduction Act, which provides incentives for domestic manufacturing.

Headwinds remain: Risks obviously still lurk. Ongoing rate hikes have tightened credit availability, with many banks reporting tighter lending standards. Stocks have remained buoyant for now, but the effects of financial tightening could still emerge. The path to a soft landing is still narrow, albeit a little wider.

📉 CMBS Delinquency Rate Climbs as CRE Struggles

The CMBS delinquency rate rose to 4.4% in July, its highest level since December 2021. This marks a 51 bps monthly increase, and a 137 bps increase since the start of 2022. This rise reflects ongoing struggles in CRE as the overall economy improves. Four of the five major property types saw jumps in delinquent loans last month.

Office and hospitality see significant increases: Office delinquencies rose 46 bps to 4.96% in July, up 350 bps since 2022. Hotel delinquency rate also saw 50 bps jump to 5.85%. These property types have been hit hard by remote work and less business travel.

Potential further erosion: The headline delinquency rate would be even higher if loans past maturing but current on interest were included. These loans reflect borrowers foregoing extension options amid property struggles. Borrowers are straining under maturing debt, and fewer extensions point to more defaults forthcoming.

🛑 Brookfield’s Ever-Shifting Real Estate Empire

Brookfield is one of the largest real estate owners in the world, controlling high-profile properties like London’s Canary Wharf. But with a complex structure and penchant for opacity, the Canadian company makes it difficult to grasp the full picture of its holdings. After going private in 2021, Brookfield is even more selective on what it discloses to the public.

Cracks emerge: In 2022, Brookfield defaulted on over $1B in loans for its downtown LA office buildings as the markets softened. It has also walked away from other assets, including a dozen suburban offices in DC, and 10 retail properties.

Yet Brookfield maintains that these are just minor issues among its broader portfolio of top-quality assets. Brookfield owns $130B in real estate, and is launching another $15B real estate fund. The privatization, however, makes it hard to independently verify the strength of Brookfield’s overall holdings. Stay tuned!

✍️ Further Reading

• Here are the States That Are Attracting the High-Earners (GS)

• Banks Expect to Tighten Standards for CRE Loans Even More (GS)

• Regional Mall Values are Dropping More Than 70% (GS)

• America's Fiscal Time Bomb Ticks Even Louder (WSJ)

• Kilroy Forecasts Shortage of High-Quality Office Space as Construction Slows Nationally (CS)

• Cushman & Wakefield Plans More Cost Cuts as Earnings Drop 95% (CS)

• KKR Opens LA Office in Push for Commercial Real Estate Deals (BBG)

• 5 Things to Consider Before Assuming a Loan (CPE)

• Prologis Pays $87M for Bay Area Industrial Asset (CPE)

• European Market Update (TP)

• Steve Roth Says Offices Are Like Malls. Is That Good? (RD)

📊 Chart of The Day