Commercial Real Estate, plus financials, home prices, M&A, and social media financial advice
The Sandbox Daily (3.21.2023)
Welcome, Sandbox friends.
Today’s Daily discusses:
Commercial Real Estate (CRE) positions for a challenging backdrop
Financials worst week since the GFC
Home prices break decade-long streak
M&A deal flow remains muted
Sourcing financial advice from social media
Tomorrow, the Federal Reserve is expected to announce another rate hike – the market is pricing an 87.1% probability that the FOMC takes the Fed Funds Rate up by 25 bps to a target range of 4.75%-5.00%. Buckle up, it should be a fun session.
Let’s dig in.
Markets in review
EQUITIES: Russell 2000 +1.88% | Nasdaq 100 +1.42% | S&P 500 +1.30% | Dow +0.98%
FIXED INCOME: Barclays Agg Bond -0.30% | High Yield +1.09% | 2yr UST 4.173% | 10yr UST 3.607%
COMMODITIES: Brent Crude +1.94% to $75.22/barrel. Gold -1.95% to $1,960.8/oz.
BITCOIN: +0.88% to $28,187
US DOLLAR INDEX: -0.05% to 103.227
CBOE EQUITY PUT/CALL RATIO: 0.50
VIX: -11.47% to 21.38
Quote of the day
“Value works. Growth works. Momentum works. Quality works. They just don’t all work at the same time.”
- Cam Hui, Humble Student of the Markets
Commercial Real Estate (CRE) positions for a challenging backdrop
The recent stress in the banking sector has fueled growing concerns about spillover effects on the commercial real estate (CRE) industry.
The commercial real estate market is naturally dependent on leverage, giving banks an instrumental role in facilitating transactions. With over half of the $5.6 trillion of outstanding commercial loan stock sitting on bank balance sheets, banks remain the primary source of lending to commercial properties; this is particularly the case for small banks which capture the lion’s share of lending.
In fact, Goldman Sachs estimates that small- and medium-sized banks (institutions under $250 billion) account for 80% of all commercial real estate lending.
One area of particular concern has been the office property sector where regional banks have an outsized exposure to office loans. In addition to its heavy reliance on the bank lending channel, the sector continues to face a confluence of post-pandemic headwinds, including declining occupancy rates, falling appraisal values, and more recently rising defaults. Coupled with higher funding costs, elevated funding needs, and tighter lending standards, this implies a challenging fundamental backdrop in upcoming months.
55% of the stock of mortgage loans backed by these properties sit on bank balance sheets, including 23% specifically on regional or local bank balance sheets.
The combination of higher interest rates and the risk of dwindling credit availability is forcing office landlords to reckon with a pre-existing occupancy problem. As office utilization has shrunk by approximately 50% since the onset of the COVID-19 pandemic (per data from Kastle Systems), the vacancy rate of office properties is rising and no end appears to be in sight.
Source: Goldman Sachs Global Investment Research
Financials worst week since the GFC
The financial sector has been gripped by volatility in recent weeks as weakness from regional banks trickles into other markets and asset classes. After all, three U.S. banks failed and the Swiss National Bank brokered a deal forcing UBS into buying its embattled rival, Credit Suisse.
Last week, the Financial Sector ETF (XLF) registered its worst week since the global financial crisis (GFC) relative to the S&P 500 index.
Source: All Star Charts
Home prices break decade-long streak
The median price of a U.S. home was lower this February than it was in February 2022, ending more than a decade of year-over-year increases, the longest on record (131 consecutive months!). The median existing home price fell -0.2% YoY to $363,000 – the data series 1st YoY decline since February 2012 – as higher mortgage rates have been cooling the housing market since early 2022.
Lawrence Yun, Chief Economist for the National Association of Realtors, reported “This is not the bottom for prices. We expect a continuing price correction, but we are not expecting prices to crash.”
Sales of previously owned homes rose +14.5% in February compared with January, the 1st monthly gain in 12 months and the largest increase since July 2020, just after the start of the Covid-19 pandemic. On a YoY basis, sales were -22.6% lower than they were in February 2022.
Source: National Association of Realtors, Ned Davis Research, Bloomberg, Calculated Risk
M&A deal flow remains muted
U.S. Mergers & Acquisitions activity remains subdued, dropping -23% MoM with 1,066 announcements in February compared to 1,385 in January. Using a 3-month average to better track the trend and any underlying changes, 19 of the 21 sectors monitored by FactSet saw a decrease in M&A deal activity relative to the same 3-month period one year ago.
Topping the list of the largest deals announced in February: Newmont Corp.'s proposal to acquire Newcrest Mining Ltd. for $16.9 billion; Public Storage's bid to acquire Life Storage Inc., for $10.9 billion; and CVS Health Corp.'s agreement to acquire Oak Street Health for $9.5 billion.
Many expected M&A activity to remain somewhat muted in the beginning of 2023 – consistent with the environment in 2H22 – before accelerating in the back half of the year driven by a host of factors: well-capitalized companies making acquisitions to boost their core business during the slowdown of the economic cycle, financial sponsors deploying capital after holding record amounts of cash (see chart below), uneven performance among companies stoking shareholder activism (i.e. Salesforce), and cross-border M&A reverting back to the mean.
Source: FactSet, Morgan Stanley
Sourcing financial advice from social media
The explosive reliance on social media for information is spilling over into the realms of financial advice, an arena that was traditionally reserved for established media and news organizations as well as large blue-blood investment managers.
79% of Americans representing Millennials (born 1980-1996) and Gen Z (born 1997-2012) report to have received financial advice from social media, according to a January report from Forbes Advisor.
The downstream effects are massive and still unfolding: lack of oversight and editors to ensure reliability and integrity of the information and data, the gamification of trading, the ability to perpetuate bad actors by instilling trust through fun and engaging content, the ease of exploitation and fraud, engaging users under the age of 18 for which financial decisions are not appropriate, and on and on.
Source: Investment News
That’s all for today.
Blake
Welcome to The Sandbox Daily, a daily curation of relevant research at the intersection of markets, economics, and lifestyle. We are committed to delivering high-quality and timely content to help investors make sense of capital markets.
Blake Millard is the Director of Investments at Sandbox Financial Partners, a Registered Investment Advisor. All opinions expressed here are solely his opinion and do not express or reflect the opinion of Sandbox Financial Partners. This Substack channel is for informational purposes only and should not be construed as investment advice. Clients of Sandbox Financial Partners may maintain positions in the markets, indexes, corporations, and/or securities discussed within The Sandbox Daily.