It’s an old argument, and it goes something like this: the newest federal regulations on commercial real estate lending standards in the wake of the 2008 financial crisis are too onerous for US banks to adapt to. Sarbanes-Oxley and Dodd-Frank regulatory packages taken together, the line of thinking goes, are strangling US banking and threatening efficient capital allocation by introducing piles of red tape. Too many commercial deals slow down and die waiting for capital, and it’s all thanks to these regulations, say many.
At its September meeting yesterday, the Federal Reserve Board noted one way and voted another. The Fed voted 7-3 to leave its Federal Funds interest rate untouched at its low level, suggesting the commercial real estate national markets will not have to worry about escalating cost of capital — at least for now.
In a press release following the vote, the Fed cited a strengthening labor market plus a picking up of economic activity in the second half of the year as a justification for the vote. Inflation fears were addressed by noting the level remains under the Board’s long-run goal of 2%.
The Federal Funds Rate’s target was allowed to stand between 1/4 and 1/2 of 1%, despite the “case for a [rate] increase [strengthening]”:
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
Prime Rates Primed To Stay Put
The Federal Funds rate is deeply tied to the prime rates each commercial bank offers to its least risky borrowers, prime rates tracking more or less consistently at 3 percentage points above the Federal Funds rate. The next Federal Open Market Committee (FOMC) meeting where the issue of interest rates will be again considered is scheduled for November 2.
The Federal Reserve’s Beige Book, the published-six-times-yearly compendium of anecdotes from every corner of the economy, issued its newest edition yesterday. Within, we learn the commercial real estate market, viewed from a national perspective, is showing good signs – expansion in transactions and construction plus rising rents characterize many of the Fed’s twelve districts.
The cost of money might not be going up after all. Signals from the Federal Reserve over the last quarter had been pointing to a raise in interest rates in September. But a new jobs report from the US Labor Department showed softer gains than were predicted. Now the signals point again to rates being left at their current low levels.
If, during the past twelve months, you’ve gone to the capital markets and suspected that banks aren’t playing ball quite as much as before, a key survey of loan officers says you’d be right.
This week, the Federal Reserve Bank released its Senior Loan Officer Opinion Survey. The project looks at changes to the terms of commercial loans, including loans for commercial real estate. 71 domestic banks and 23 branches of foreign banks were heard from in this year’s survey.
The wave of lending for commercial real estate development that arose after the 2008 financial meltdown is secured by offices, shopping centers, multifamily and industrial properties all over the US. But worries about regulatory pressure intended to tamp down systemic risk — risk of the same kind that caused 2008 — are sparking concerns that a wave of refinancing made necessary by closer looks at underwriting standards could cause a new crisis in lending.
Yesterday, the latest edition of the eight-times-annually published Federal Reserve Beige Book arrived (or, as the kids say, dropped). What lies within its muted brown pages and cream-tone cover*? Good news for the state of the commercial real estate industry.
Construction and Real Estate
Construction and real estate activity generally expanded in late February and March, and contacts across Districts maintained a positive outlook for the rest of the year. Residential real estate activity strengthened, on balance, with robust growth in San Francisco, Cleveland, and Boston, but more mixed reports from Dallas, Kansas City, and Atlanta. Several Districts credited a mild winter for stronger home sales, and the pace of home price increases picked up in a number of Districts. Multi-family construction remained strong in most Districts. Chicago, Cleveland, and St. Louis also noted some improvement in demand for single-family home construction, and a contact in San Francisco reported backlogs of more than six months for new single-family units. Commercial real estate activity generally increased, with leasing activity and rents rising in many Districts: particularly strong leasing was noted in retailing in Chicago and in the industrial sector in Dallas. Vacancy rates either moved lower or were unchanged in most Districts. Most Districts reporting on nonresidential construction said that demand increased. Contacts in Boston said the education, health care, hospitality, retail, and office sectors all contributed to its recent construction boom. Nonresidential contractors in Cleveland cited broad-based demand, with particular strength in education and healthcare projects, where several builders expressed concern about their capacity to take on additional projects. In contrast, Chicago noted continued weak demand for industrial construction, and Philadelphia reported fewer starts of new nonresidential projects.
The Federal Reserve Beige Book gathers anecdotal information on current economic conditions in its District through reports from Bank and Branch directors and interviews with key business contacts, economists, market experts, and other sources. The Beige Book summarizes this information by District and sector. An overall summary of the twelve district reports is prepared by a designated Federal Reserve Bank on a rotating basis.
* The Beige Book is not colored beige, nor is it a book.
Last week saw the publication of the latest Beige Book, the six-times-annually published economic activity report from the Federal Reserve Bank that looks at the whole country divided by Federal Reserve Districts. You can read the entire Fed Beige Book after the link. Below find the key takeaways for commercial real estate nationally:
Real Estate and Construction (Nationwide)
Most reporting Districts characterized nonresidential real estate activity as modest to moderate; Boston and New York indicated little change. Rental rates rose in more than half of the reporting Districts, and vacancy rates were mixed. Most Districts reported modest or moderate growth in commercial construction, and the Dallas District noted high levels of industrial construction in Dallas-Fort Worth. Contacts in the Atlanta District expect construction activity to increase slightly, while contacts in the Philadelphia, St. Louis, Minneapolis, and Richmond Districts expect overall commercial real estate activity to continue to strengthen at least modestly.
Banking and Finance (Nationwide)
Lending activity appears to have improved on net. Loan demand grew on balance in the Philadelphia, St. Louis, and San Francisco Districts. Cleveland, Richmond, and Kansas City reported stable credit demand, on balance, while Dallas noted some recent softening. Philadelphia reported the strongest loan growth for autos, commercial real estate, and commercial and industrial deals, while residential lending was flat to down.
Banking and Finance (Chicago District)
Financial conditions tightened slightly on balance over the reporting period. Financial market contacts noted greater illiquidity in the bond market. In addition, a contact in commercial real estate financing reported a decline in interest from institutional investors amid concern that the commercial real estate market was overheated.
Construction and Real Estate (Minneapolis District)
Commercial real estate activity was moderate to strong since the last report. Retail, office, and industrial vacancies in Minneapolis-St. Paul have been falling and rents have been rising, according to multiple industry reports. In northwestern Montana, commercial vacancies “have mostly disappeared,” with rates stabilizing at about 5 percent, said a local source, while the Rapid City market “has been extremely active these last couple of weeks of the year.” […]
What’s in the July Beige Book? The usual compilation of anecdotal economic reportage from the districts of the Federal Reserve system, of course. The specifics this time around include positive news for commercial construction activity across the US, with mixed-positive news on commercial real estate lending and other factors. Here are commercial real estate-related excerpts from each district: