Capital Alert – Exuberance: Rational vs. Irrational

March 19, 2021

Exuberance: Rational vs. Irrational

We are seeing renewed exuberance over the business climate, with both rational and irrational aspects. First, $1.9 trillion in fiscal stimulus is now flowing into the economy, and more than 20 percent of Americans have received at least one dose of a COVID-19 vaccine. Amid easing restrictions, Goldman Sachs predicted an 8.1 percent jump in gross domestic product (GDP) this year – the largest economic spike since 1951. Unemployment would fall to 4 percent, the bank’s economists said, and inflation would remain muted at 2.1 percent.

The Federal Reserve offered a more cautious forecast for 2021 after its meeting Wednesday, projecting a rise of 6.5 percent in GDP, unemployment of 4.5 percent and inflation of 2.4 percent. The 18 officials at this week’s meeting expect short-term rates to remain near zero through 2023, but seven of them now say rates could begin to rise in 2022 or 2023, up from five in December. The yield on the 10-Year Treasury rose to 1.67 percent following the news.

Rational lending is beginning to accelerate, with capital flowing to grocery-anchored shopping centers, quick-service restaurants and other essential retail, as well as multifamily, self-storage and industrial assets, with strong competition for the latter. Hotels remain challenged. More than ever, lenders are focused on borrowers’ track records and performance of other properties in their portfolios. While financial strength is very important, lenders are specifically looking at how borrowers handled the pandemic. Especially in the retail and office sectors, lenders are seeking detailed information about requests for rent deferrals.

Institutions are taking a fine-tooth comb to rent rolls, scrutinizing valuations, and requiring significantly higher loan-to-value ratios to inoculate themselves against risk. Underscoring concerns in the office sector, Fitch Ratings is examining how the work-from-home revolution is impacting commercial mortgage-backed securities (CMBS) credit ratings.

While financial strength is very important, lenders are specifically looking at how borrowers handled the pandemic.

Meanwhile, irrational exuberance may be playing out on the beaches of Florida, where unmasked Spring breakers have apparently decided the pandemic is over. Travel is rebounding sharply, with Transportation Security Administration (TSA) passenger screenings hitting the highest level in almost a year on March 13. These trends, combined with a spike in infections in Europe, are raising concerns that new variants of the coronavirus could outpace herd immunity.

In the coming months, commercial real estate is likely to see enormous reimagination and experimentation. Malls could be redeveloped into mini downtowns, with a mixture of housing, schools, medical facilities and natural amenities — a throwback to the prototypes of the 1950s. Immersive outdoor schools may continue post-pandemic – even chilly Portland, Maine has added an “outdoor learning coordinator” to its public system. Offices are seeing technology innovations to improve health and safety. Meanwhile, a New York magazine headline asks readers if they’d be willing to live in a midtown office tower, as conversions to apartments grow in downtowns across the country. (Some analysts suggest apartment rents may be hitting bottom in big cities as young professionals eye more affordable digs.) High-end hotels have already seen some experimentation; market-maker Citadel Securities is moving out of the employee bubble and trading floor it created in the Four Seasons Resort Palm Beach.

Given the massive federal support intervention required to respond to COVID-19, we are keeping an eye on Washington, D.C., and the administration’s proposals to address the federal budget deficit. Is a wealth tax on the horizon? Stay tuned.