Yield Curve is Rapidly Un-Inverting; Higher Borrowing Costs Ahead

Good morning,

Yield curve is rapidly un-inverting, higher borrowing costs ahead; debt funds struggle to raise capital; and select developers bet on office. Let’s delve into today’s topics.

📈 Market Update

⚠️ Yield Curve is Rapidly Un-Inverting; Higher Borrowing Costs Ahead

As central banks remain committed to taming inflation through high rates, yields on 10-year government debt from the US to Germany to Japan have surged to multi-year highs. This rising rate environment signals higher borrowing costs on the horizon, presenting challenges for property financing, acquisitions and development. While some see signs of a peak, most expect yields to rise further before stabilizing.

Rapidly Un-Inverting Yield Curve:
The yield curve is un-inverting via long term yields being higher; not by short term yields moving down. Expect rates to remain higher and a credit crunch incoming!

Prices Continue to Fall:
Softer commercial property pricing in August reflects rising Treasury yields, which were up 0.4-0.5% from July when many deals were likely negotiated. The supply-demand imbalance also weighed on prices, as new construction surged while tenant demand eroded. The value-weighted Composite Index fell 1.4% in August, down for the 10th straight month versus last year. Though the equal-weighted index was flat in August, it remains below peak levels. With interest rates expected to rise further, property prices will likely face ongoing headwinds.

💸 Debt Funds Struggle to Raise Capital

US real estate debt funds are on track to raise the lowest amount of new capital in seven years, with only $1.1B taken in through August 2023. The pullback in fundraising comes as property sales have declined significantly this year, reducing demand for short-term financing from developers. With plenty of dry powder still available from prior years, debt fund originations have plummeted 73% from last year.

🏗️ Select Developers Bet on Office

While the office sector faces widespread weakness, some major developers are still betting on select office projects, including Wells Fargo's $550M purchase and planned conversion of retail space at Hudson Yards and Two Tree Management's opening of a 460,000 sf Brooklyn office after switching plans from condos. In Chicago, Fulton Street Cos. secured $320M in financing for the city's first big new office development in over a year. Though office demand is declining broadly, these developers believe certain high-quality, well-located projects can still attract tenants and deliver returns, albeit with higher risk given current market challenges.

✍️ Further Reading

• Congress Averts US Government Shutdown Hours Before Deadline (BBG)

• A New Interest-Rate Regime Has Begun. These Are the Market’s Winners and Losers (WSJ)

• Student Loan Payments Are Back. What That Means for Millions of Borrowers (BBG)

• Loans for Two Shorenstein Office Buildings Run Into Trouble, Brookwood Misses Payoff on Portfolio, PennCap Seeks New Terms for 31 Properties (CS)

• SL Green, Pacific Retail Outline Plans for $2.5 Billion Redevelopment of Aged Westchester County Mall (CS)

• CRE Investment Sales Continue to Disappoint (GS)

• Sycamore Partners to Acquire Chico’s FAS for $1B (CPE)

📊 Chart of The Day