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Inversion of the Yield Curve Ensures Commercial Real Estate Stability «The Investment Real Estate Research Blog : INVESTMENT

Inversion of the yield curve confirms stability of commercial real estate

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FINANCIAL MARKETS AUGUST 2019
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research assignment
Inversion of the yield curve confirms stability of commercial real estate
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Short inversion of the yield curve leads to volatility. The short-lived inversion of the 10-year and 2-year government bond yield curves triggered significant volatility in the financial markets as the closely monitored signs of impending recession triggered a warning. Despite the efforts of the Federal Reserve and generally strong economic indicators such as steady job creation, low inflation, above-average growth in retail sales, and increased confidence among small businesses, financial markets remain concerned about ongoing trade disputes with China. The uncertainty-driven flight to safety has raised the 10-year Treasury rate to 1.5 percent, within 20 bps from the record low of July 2016. The convergence of these factors has opened a unique window of opportunity for the commercial real estate investors.

The volatility of the financial markets underlines the security of real estate. Recent fluctuations in the financial markets confirm both the stability of commercial real estate and the attractive returns of the sector. In addition, the currently exceptionally low interest rates offer a high leveraged yield premium. The average combined cap rate for commercial real estate of 6.3 percent exceeds the 10-year Treasury by 480 basis points, which is one of the largest margins in this cycle. While this has the potential to attract additional capital to the sector, it also offers current investors an opportunity to reassess their existing portfolios. Given the risk of an impending recession, real estate owners may consider a more defensive asset allocation that favors single tenant net lending with strong credit ratings and sectors that generally perform well in times of economic downturn, such as health care properties. Diversification across markets with different economic drivers and across different real estate types will also become more important over the next business cycle. However, the window of opportunity could close quickly as a solution to the trade war could quickly remove much of the uncertainty and trigger a rapid increase in interest rates.

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Develop trends
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Job creation is steadily increasing. The US is well on its way to hiring 2 million new employees in 2019. Unemployment is in the upper range of 3 percent as the number of vacancies still exceeds 20 percent. Sustainable job creation remains a major driver of domestic growth and demand for real estate.

Expenditure picks up again as consumers remain optimistic. Revenue growth in retail increased by 4.2 percent year-on-year in July, after having risen 3.8 percent in three of the last four months. Increased consumer confidence and solid wage growth continue to support spending and put consumption above the historical average.

Stable economy keeps income levels on the rise. Disposable income remains at an all-time high, adjusted for inflation, reaching $ 45,600 per capita in June. Year-on-year growth continued to be in the mid-to-high range of 2 percent in 2019, confirming the fundamental strength of the economy.

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6.3%

Average CRE cap rate
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1.54%

10-year interest rate
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* Until the 16th of August
Sources: Marcus & Millichap Research Services; Labor Statistics Office; Federal Reserve Bank

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