August 14, 2019

Executive Summary

  • With the 10-year Treasury yielding less than both two-year and three-month bonds (a “yield-curve inversion”), fears of an oncoming recession have risen sharply despite robust consumer confidence, reasonable economic growth and a strong real estate market.
  • The drop in the 10-year Treasury yield (more than 150 bps since November)—the backdrop to today’s yield-curve inversion—reflects ever deeper worries about U.S./China trade tensions, a hard Brexit and the deepening trade conflict between Japan and South Korea.
  • The Federal Reserve lowered interest rates in July for the first time since 2008. However, escalating trade tensions have caused investors to seek sanctuary in the long-dated U.S. Treasuries, resulting in an inversion.
  • Despite this, U.S. commercial real estate sales volume, including entity-level deals, was up by 3.4% year-over-year in Q2 to $121.5 billion. Loan origination volumes are near record levels, with the rapidly declining cost of debt creating attractive refinancing opportunities.
  • We see further cuts by the Federal Reserve, alongside continued consumer confidence, providing enough momentum to further support the economy and real estate markets.

Uncertainty Remains

Part of the yield curve—three-month vs. 10-year Treasuries—started to invert at various points since March 2019, raising concerns about an impending recession. More recently, this concern intensified as yields on the 10-year Treasury began plummeting in late July. That slide led to the 10-year yield falling below the two-year yield today, inverting another closely watched portion of the curve. The U.S. isn’t alone. Some estimates put the amount of negative-yielding government debt at $15 trillion globally. In Japan, Germany, Sweden, Belgium, Denmark, Switzerland and France, yields are negative as far out as 15 years. In Germany, the entire yield curve is below zero.

Figure 1: Spread, 10-Year vs. Three-Month Treasury (bps)

Yield-Curve Inversion-08142019-F1

Source: Federal Reserve Bank of St. Louis. CBRE Research, Q3 2019.

Escalating trade tensions between the U.S. and China amid a slowing global economy are making investors nervous. This nervousness was heightened today with news that German GDP growth turned negative in Q2 2019 due to lower exports. Meanwhile in China, industrial production grew at its lowest level in 17 years. These events are causing notable swings in bond and equity markets.

With all of this in mind, businesses are becoming increasingly cautious, pulling in the reins on capital spending. Business investment in the U.S. fell by 5.5% in the second quarter.

Silver Lining

Even amid a slowing global economy and heightened uncertainty, the U.S. economy grew by a respectable 2.1% in Q2 2019. Additionally, the U.S. labor market remains very strong with job creation far exceeding the number of new entrants to the workforce, which is drawing more people back into the labor market and pushing unemployment down to multi-decade lows. This strength is showing up in consumer sentiment, which remains at very high levels—an important economic indicator since consumer spending accounts for approximately two-thirds of U.S. and other developed economy GDP.

Figure 2: Business Confidence vs. Consumer Confidence

Yield-Curve Inversion-08142019-F2

Source: Federal Reserve Bank of St. Louis. University of Michigan. Business Roundtable. August 2019.

The Fed’s recent interest rate cut also should further support economic growth. This loosening of monetary policy underpins expectations that although growth is slowing, the U.S. expansion will continue for the near term. With consumers propelling the economy, real estate fundamentals should be broadly supported.

Figure 3: U.S. GDP & Interest Rate Forecast

Yield-Curve Inversion-08142019-F3

Source: CBRE Research.

Business as Usual in Real Estate

U.S. investment volumes remain healthy. After the 2008 recession, investment volumes steadily increased and stabilized at relatively high levels in early 2015. Even amid trade tensions and elevated uncertainty, annual real estate investment volumes have remained remarkably resilient and are above the average since 2015.

Figure 4: U.S. Investment Volumes

Yield-Curve Inversion-08142019-F4

Source: Real Capital Analytics. CBRE Research, Q2 2019.

Debt and structured finance opportunities have increased as many borrowers are refinancing at lower rates for longer terms than they have in years to capture the benefits of a low-cost, highly liquid debt environment.

Various factors will continue to support capital flowing into real estate. Lower hedging costs and the resilience of the U.S. economy will keep foreign capital flows into the country strong. Additionally, investors searching for higher yields will continue to turn to commercial real estate.

In short, economic and property market resilience, along with a lower cost of capital, provide a reasonably positive mix for capital deployment in real estate. Although various risks will continue to weigh on growth and the outlook, CBRE expects the U.S. economy to continue its growth and present real estate investors with good opportunities in the near term.

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