Commercial Real Estate Debt: Industrial Beats Residential in Q1

Increasing apartment supply and the strength of the industrial sector reshape market dynamics in 2017.

May 18, 2017

This Commercial Real Estate Debt sector report is excerpted from the Second Quarter 2017 Fixed-Income Outlook.

Only the industrial sector saw positive year-over-year property sales growth in the first quarter of 2017, up by 3 percent. This growth is being driven by an expanding economy, e-commerce company demand for large distribution properties, and a muted new construction pipeline. Meanwhile, sales of apartments were down 35 percent year over year in the first quarter—the worst since the first quarter of 2014, and standing in stark contrast to the 2014–2016 trend where year-over-year sales were up 20 percent, on average. Occupancy and rental growth in Class A apartments is turning negative in some of the more heavily supplied markets like New York, San Francisco, Miami, Denver, and Houston. We do not expect apartment sales growth to return to the torrid pace of the last two years, particularly given that 375,000 units are already scheduled for delivery in 2017.

Apartment Sales Fall to a Three-Year Low in Q1

Sales of apartments were down 35 percent year over year in the first quarter, indicating a shift by investors from this property type in 2017.

Apartment Sales Fall to a Three-Year Low in Q1

Source: Real Capital Analytics, Guggenheim Investments. Data as of 4.19.2017.

The first and second quarters usually see commercial real estate loan spreads tighten as lenders, flush with new allocations, are anxious to get new business on the books. The first quarter of 2017 was no exception, with life insurance companies tightening spreads by 10–15 basis points on seven- and 10-year term loans. They are currently pricing 160–170 basis points over 10-year Treasurys for 60–65 percent loan to value (LTV) for the four major property types.

Cap rates did not increase with the decline of sales in apartments, but we are cautious here, particularly amongst Class A properties. The industrial sector, where cap rates remain higher than apartments, looks attractive given that we believe the tailwinds are sustainable. Investors have also not been as aggressive in the purchase of industrial properties as in apartments. Elsewhere, we have kept an eye on the retail sector for a while and it seems negative headlines are gaining momentum in this space. Mall is a four-letter word, and lenders are wary of big-box retail power centers but still constructive on groceryanchored centers in good demographic locations. We typically do not see much value in retail relative to the risks. In terms of loan structure, we like floating-rate lending with spreads between 350–500 basis points over Libor, which tend to be in construction lending and bridge product. In particular, our focus is on shorter term five- and seven-year loans on the permanent product. We are also looking at loans with over 65 percent LTV given that the premiums for these loans are rising as CMBS lenders decrease leverage due to risk retention rules.

Apartment Cap Rates Did Not Increase with the Decline in Sales

The industrial sector, where cap rates have ticked up since mid-2016, looks attractive, while we are cautious on apartments. Elsewhere, we have kept an eye on the retail sector for a while and it seems negative headlines are gaining momentum in this space, and we do not see value relative to the risks.

Apartment Cap Rates Did Not Increase with the Decline in Sales

Source: Real Capital Analytics, Guggenheim Investments. Data as of 3.31.2017.

—William Bennett, Managing Director; David Cacciapaglia, Managing Director

Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management. ©2017, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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