Mark Bonner: 00:09

Okay. Welcome to First Draft Live. It's Friday, September 5. I'm Mark Bonner, business owner's editor in chief coming to you live from New York. Thank you to everyone for tuning in.

Mark Bonner: 00:19

So today, we're gonna get into the bond markets. They're throwing a tantrum again, and not just here in The United States. UK gilts cracked 5.6% this week, the highest since 1998. The last time that happened, The UK prime minister couldn't outlast a head of lettuce. And France is also seeing decade highs.

Mark Bonner: 00:38

But let's be real. The market that matters is ours. US treasuries brushed 5% this week, and everyone suddenly remembered what expensive money feels like. Why is this happening? Well, Washington's still running deficits north of $1,600,000,000,000 for the first ten months of the year to be exact.

Mark Bonner: 00:58

And labor, it's no bull market anymore. BLS data released this morning showed August leverage just 22,000 new jobs, far below forecast. Unemployment ticked up to 4.3%, and wage growth is slowing. All that means the Fed is juggling fire. Inflation is still hot.

Mark Bonner: 01:18

Labor is starting to crack. The good news today, if there is any, is that on September 17, the Fed will almost certainly cut rates for the first time since December 2024. But meanwhile, a wall of new treasury issuance is testing just how much debt investors are willing to swallow. For real estate, that's the punchline. Every refi takes more equity.

Mark Bonner: 01:41

Every loan comes at a coupon you'd rather forget, and valuations are getting yanked between higher cap rates and rent rolls that don't look as bulletproof in a hybrid world. Oh, and that yield curve, Totally bent. Short rates above 5%, long bonds climbing, the middle sagging. It's a roller coaster. Banks hate it.

Mark Bonner: 02:04

Spreads are tight. Borrowers are stuck making ugly choices. So that's the setup heading into the fall. More volatility, more repricing, and no easy answers. But all is not lost because Chris Stanley, senior director from Moody's Analytics, is here to help us make sense of it all, and maybe tell us if this storm passes or if we're living in a new normal.

Mark Bonner: 02:29

Send us your questions in the chat. We'll hit as many as we can. Chris, welcome to First Draft Live.

Chris Stanley: 02:35

It's great to be here. Thank you, Mark.

Mark Bonner: 02:38

So Chris, what do you make of all this? Tell us about the moment that we're in today when it comes to the bond market.

Chris Stanley: 02:45

Well, you know, I've always been told that in bond markets there is truth. And I think we're getting a very complex forward picture. And so a lot of really what needs to happen next for a lot of participants is, you know, start taking in an array or an ensemble of signals to try to reconcile what is this forward view of the world that's coming from the yield curve? And how do I make heads and tails of some of these headline indicators that you mentioned relative to the local markets that I'm operating in, you know, as a builder developer or property owner or banker, you know, no matter which side of that equation you're on.

Mark Bonner: 03:37

So everything we talked about, it basically boils down to higher operating costs, tenants negotiating harder and capital raising getting a little bit tougher. It already was tough, now it's a little bit harder. Do you think these overlapping pressures complicate the operating picture for landlords?

Chris Stanley: 03:54

Well, you know, I think when we're in a nervous economy like we're in right now, everybody immediately jumps to, you know, what kind of credit problems are there going to be? Are we on the edge of a bunch of defaults? And I think the picture that we're looking at is really, you know, is a part of it, but we're really playing a balance sheet management game. You know, whether you're a lender or a borrower or a landlord, it doesn't matter. We are looking at a complex picture where liquidity is going to matter.

Chris Stanley: 04:30

So, you know, making sure you've got a really solid picture of not just how much cash, but when it's going to be flowing in and out, what interest rates are going to be doing all along that yield curve are important to manage that cost of funds and expected returns and interest rate risk. If you give it enough time has a tendency to turn into credit risk. Keeping that, in in play as a part of a deep playbook for a lot of different futures is is going to be critical.

Mark Bonner: 05:04

Yeah, let's talk about credit. I mean, even with volatility, credit spreads are tight. Lenders are still competing for business. That means financing is available, but it's not cheap. For borrowers rolling off 3% debt into six or 7%, the spread isn't the problem.

Mark Bonner: 05:20

It's the absolute cost of money and the new equity gap. So if spreads are still tight, what do you think is really driving the squeeze for borrowers right now?

Chris Stanley: 05:30

Well, you know, think the tightness of the spread is something that you want to keep an eye on, right? That for at least for the moment, signaling that there's still a lot of competition. There's a lot of dollars out there competing to capture the loan demand that's available. But I think the, you know, it's really that kind of higher baseline, the entire yield curve has moved up considerably from where we were several years ago. And that's going to weigh not only on, you know, the NOI of your property, but also on its value, right?

Chris Stanley: 06:07

Cap rates are going to follow those benchmark rates with a little bit of a lag and it's tough to observe until there's

Mark Bonner: 06:14

a bunch

Chris Stanley: 06:15

of rates in the market, but you know, if you're facing a situation where the price you paid five years ago is really not a relevant measure of the value of the property today, and there's all this, you know, pressure on the expenses of operating the property, becomes a much different conversation about what is my forward view of if this property can pay for itself and if is returning enough to stay in my portfolio.

Mark Bonner: 06:45

So how do you balance the debt availability and that stress that's associated with that, with the new equity owners need to bring to the table right now?

Chris Stanley: 06:54

So that's where I think this balance sheet management game is so important. So much of the media commentary we see is ultimately around, you know, what is going to happen at the Fed's next meeting and hoping for cuts or focusing only on those short term rates really misses a big part of the picture when we think about the terms that we're investing in properties for and the maturities of debts on those properties out, as well as leases right out into the future. So thinking about this as a balance sheet management game, thinking about liquidity, thinking about leverage, thinking about interest rate risk and what that does to your NOI, as well as what's being communicated about future inflation expectations for what you need to be getting out of that property well into the future. That's the kind of game we got to have a bunch of plays and strategies for.

Mark Bonner: 08:01

So, I mean, you know, we we got this drop this morning from the BLS. Right? It was a weaker than normal jobs report, 22,000 jobs for August. There were some technical difficulties. I'm not gonna get into the of that, but, you know, the data is now up in there whether we can trust it or not, and we'll see what the revision might be in a month.

Mark Bonner: 08:18

But assuming that everything is hunky dory, it just turbocharged this idea that absolutely, almost certainly, on September 17 when the FOMC meeting happens, that we are going to get our first rate cut since December 2024 at least 25 basis points, maybe even up to 50 basis points. Does that change your thinking? Did that did that change anything for you today, Chris, when you saw that news on this front? Listen.

Chris Stanley: 08:47

I I like to keep myself anchored in what is most likely to happen, but you got to plan for an upside and a downside what if around that as well. I think J Powell is under tremendous pressure right now to lower rates. Part of the presentation, when you look at the six month or one year maturities on the yield curve is a lot of market expectation that there's going to be 25 to 50 basis points of cuts coming up. There's no guarantee that that will happen. And, know, I think particularly on the long end of the curve, some of the noise that we've seen around the last, series of Fed cuts, there's a lot of disagreement out there, in that market.

Chris Stanley: 09:38

So you got to do your best to put a confidence interval around a few different futures, have a plan or, you know, ability to act if information changes, but don't count on consensus being the only outcome that you're potentially up against.

Mark Bonner: 10:00

The curve is bent in some unusual ways right now. You know, short rates above 5%, long bonds pushing the same dip in the middle. For banks, that kills net interest margins. For commercial real estate, it's seemingly making financing tenor a tactical choice. And lenders can't just extend debt on yesterday's yields when today's coupons are double.

Mark Bonner: 10:24

How is the curve shaping, lenders willingness to revise properties at this moment, Chris? Well, and what do you do if you, if you're sitting here watching this, what's your best advice on how to deal with that dynamic?

Chris Stanley: 10:37

So staying on top of liquidity is going to be critical. I think, you know, the one of the things that has been very interesting to watch, particularly over, you know, the the span of of, you know, the last twenty years, right, is how the mix of lenders in the market has continued to evolve. I think, you know, at this point, there is a share of the market that is still with traditional bank lenders, but there's been tremendous growth in that non bank financing sources, as well as an evolution in composition, term structures, all those different things that you can be looking at. The curve shape that we've got means that, you know, you may not only be looking at replacing fixed rate debt with a floating rate because of the volatility and interest rate risk that your lenders are facing, but also a return of, you know, things like derivatives and other things to kind of manage the risk profile that you have, as well as that your lenders have as this volatility continues is something that I'm definitely, you know, anticipating. So not looking just to traditional banks as your only source of funds, being cognizant around, you know, debt service under a variety of different conditions, and honestly taking a hard look at your portfolio, and, and what, what does today's LTV, you know, really look like?

Chris Stanley: 12:22

And, and is that something that you foresee improvement in, to where you've got the right mix in your portfolio? Or are there conditions where you need to start to revisit, that strategy?

Mark Bonner: 12:37

Chris, when you look at the macro picture, looking at like that twenty to thirty year window here, I mean, historically, how does the yield curve resolve when it enters into a dynamic like the one we're in today?

Chris Stanley: 12:49

Well, the problem with the one that we're in today is we've got uncertainty in the middle. That's what's giving us that, that trough around some of those shorter maturities. We've got a disagreement between the long end and the short end policy rates. Normally when there are cuts, it helps to normalize the entire yield curve. Last September, when the Fed cut rates, inflation expectations, sovereign borrowing pressure that you mentioned at the top of the call, these are all reasons among who knows what other ones that there was an offsetting increase in some of the longer maturities on the yield curve.

Chris Stanley: 13:38

So there's a disagreement between market participants about what does tomorrow hold and the, you know, those current policy rates. In the times that this has happened before, one side or the other tends to be the one that kind of violently responds either because we go into a recession and policy rates get cut, or, you know, the long end of the curve kind of sorts itself out. But you know, this is where you gotta, you gotta be on the lookout and agile for a bunch of different possibilities.

Mark Bonner: 14:11

I mean, you said uncertainty in the middle, and I think we all know where that emanates from, right? And I can't recall another time in economic history where we had a word like that in the middle. And can you? I mean, is there any other point in history that you know of economically speaking, Chris, where there was uncertainty in the middle? I mean, you know, this is this really a very unique moment in history, or are there other moments in time in the past that maybe we've all forgotten about where there was also concurrent uncertainty when it came to these matters?

Chris Stanley: 14:48

You know, I guess the thing I would go to is how pernicious inflation is once it gets started. For a good number of the bankers and property owners and developers working today, we've spent a good portion of our careers where inflation just wasn't a problem. In fact, getting the economy to inflate enough, like getting up to that 2% target, was really the focus of a lot of monetary policy for much of our careers. That shaped hurdle rates on properties and other investments. It shaped expectations or kind of muscle memory that was or wasn't developed on balance sheet management strategies at banks.

Chris Stanley: 15:37

And so, you know, I would I think this is part of the reason we keep going back to the late 70s, early 80s, we had trouble in labor markets and with inflation, and kind of the dramatic things that need to happen sometimes to unwind those. Job losses are bad. Inflation on average, still the bigger problem. Has much more wide ranging effects, and I wouldn't rule out either side of that Fed mandate getting worse or both of them at once in the market that we're in. And that's where we need to really be considerate of volatility at, at multiple maturities of that yield curve and having a plan for things not working in unison or the way that we've seen them work, you know, in, in, in the recent past.

Mark Bonner: 16:39

If you're just tuning in, this is First Draft Live. We're digging into the bond markets warning signs for commercial real estate. We're sitting here with Chris Stanley, senior director of Moody's Analytics. Send your questions into the chat and we'll get to as many as we can. Chris, let's talk about the September effect.

Mark Bonner: 16:53

September has a little bit of a reputation, right? Over the past decade, long bonds have lost ground in most years. Part of it is seasonal, issuance, calendars are heavy, traders return, loss harvesting kicks in. But this September arrives with deficits and inflation that are still very live issues as you've already discussed. For commercial real estate, the noise and the signal both matter because uncertainty as we've discussed drives repricing just as much as hard rates.

Mark Bonner: 17:22

How do you separate the seasonal noise from the structural change in the bond market right now, Chris?

Chris Stanley: 17:27

So I think first of all, gotta zoom out, right? Day to day, we're seeing a ton of noise, tons of ups and downs in equity and bond markets. And so really kind of interpreting some of these moves in yield through a more of a multi year type of view, you know, to say, hey, are we seeing a persistent upward, persistent downward? How does that shape my forward expectation there? I think you got to start relying on a much broader ensemble of signals.

Chris Stanley: 18:06

You know, this is the kind of a market where we start to see participants pull back. You know, it can be dangerous to see, a national view and apply that everywhere. So, you know, really kind of looking at, Hey, what's the yield curve doing? What's inflation doing? What are labor markets like?

Chris Stanley: 18:30

Just nationally, but you know, how does some of those play out in, in the local markets where I've got properties? And then ultimately trying to filter some of that through the lens of a cause. Know, why do we see these moves? What do we, is it a Fed announcement? Is there some kind of change in government policy or some new economic report like today's jobs report or something that's, that's maybe causing some of those, those near term, you know, noises, but could also be a signal.

Mark Bonner: 19:06

Right, I mean, look, the other word of the year or the phrase of the year is wait and see. Wait and see, wait and see, wait and see. We're post Labor Day now, we're coming into the end of Q3. This is typically the time of year where commercial real estate gets back from the summer and does that hard March to the end of the year. It's where a lot of deal making occurs, lot of big transactions.

Mark Bonner: 19:25

So if you're a commercial real estate decision maker, like, you've gotta weigh this. And so what I meant my question to you, Chris, is what's the bigger risk in making a decision right now? Overreacting to volatility and all this noise and uncertainty or under reacting to it?

Chris Stanley: 19:42

I think the not thinking about how volatility is going to change liquidity, debt service or valuations into the future. You know, the thing I'm constantly trying to do as I'm working with bankers and other industry participants is to say, we have a short term bias in our vision. We want to look at with this new thing just happened today. How does that change dynamics of this property in this instant?

Mark Bonner: 20:15

But

Chris Stanley: 20:15

what that property looks like to the maturity of its current debts? You know, what it looks like at maturity, of its current debts, not just, you know, over that debt service life. That's really what you gotta be thinking about. So time boxing those cash flows from changes in rents, changes in, you know, vacancies, you know, thinking about some of those asset dynamics around your NOI, really focusing on putting some stress on forward view of debt service or LAV as some of these indicators come in and really keeping your eyes open to what other properties in the market are up to because strategic defaults or major rent concessions to fix some vacancy or other things. The what is the other guy gonna do factor in the face of these could be the unknown unknown that gets you in this kind of market.

Mark Bonner: 21:26

All right, let's go to a question from the audience. How much will the current pricing of bonds have an impact on discount rates? How much will the current pricing of bonds have on the impact of discount rates? Forgive me.

Chris Stanley: 21:43

That's a million dollar question. I think if I knew the exact answer, we'd, we'd, we'd need to go make some trades. But I, you know, I would say, I think the strategies that are most important at this point are based on adapting to the new world as we know it, not expecting a return to, you know, we're never going to see zero, you know, policy rates again. You know, the hurdle rate that you're up against today that's impacting today's property value or, you know, the refinancing cost of, of, you know, debt on the property. Let that set a new normal in, in your mind and adjust your portfolio accordingly.

Mark Bonner: 22:40

Yeah. And look, moving on, I mean, the industry is still trying to figure out where, what assets, what their assets are actually worth today, right? Coming off the pandemic, coming into this new economy. I mean, far along are we in true price discovery in the industry right now?

Chris Stanley: 22:57

I think it's only just started. You can see, I don't have a background, like yours, Mark, but, this isn't an office I'm calling in from, and I'll bet a bunch of the folks on the call are in a similar position, right? The way that we are using these properties has dramatically changed, and I don't think it's going to go back. Strategic defaults, you know, jingle mail to bankers, know, or foreclosures are still, know, not they're happening not that frequently yet, but you know, there are other things out there that can cause shocks, you know, beyond just moves in, in, you know, those hurdle rates, on, on price value and prices and values.

Mark Bonner: 23:49

I mean, do we, do you expect that we're going to see more distressed trades that might accelerate this process, or do you think it's going to be a slow grind like it sort of has been?

Chris Stanley: 23:58

If CMBS are any indicator, I think we're going to see some more distressed trades coming. There's there's quite a bit of delinquency that that has spiked out there. Office multifamily, you know, are kind of key property types to be keeping an eye on. But, you know, I also think some of those changes are offset again with credit spreads are still really tight. There's still a bunch of money that's out there competing, and I think the growth of some of these non bank sources of funding is going to change the way those defaults get handled or if they occur, you know, versus kind of pay some strategic, you know, takeouts of equity or debt, you know, by other interested parties that can do different things, with that property than, than a bank traditionally could.

Mark Bonner: 24:54

Let's go to another question from the audience. Since operating expenses are key to NOI, what do you see regarding the impact of tariffs and national economic policy on that element?

Chris Stanley: 25:06

I think it creates a need to stress whatever assumptions you have about operating expense on any properties you're holding. Immigration dynamics, tariff dynamics, these are part of why we continue to see, there are many factors obviously, but goods and services are both contributing to the inflation that remains above target. And so how that continues to play out is something that I would be really stressing in plans that I made around my portfolio.

Mark Bonner: 25:49

I mean, if anything, volatility has become a great teacher this past year. So knowing that, and we talked about uncertainty and we talked about wait and see, which are like sort of these buzzwords and phrases of the moment. What does winning look like for lenders and landlords in this environment?

Chris Stanley: 26:10

Everybody is getting a lesson in the fundamentals. The quicker that you get back there, absent these assumptions about a return to normal, you know, the sooner you can prepare for multiple states of the world, the sooner you're in a position to be agile and resilient, no matter what happens. Tomorrow is uncertain, so there's no solutions. There's only going to be trade offs. Organize yourself and your portfolio around the best set of trade offs possible given that future variability.

Mark Bonner: 26:48

Okay, we're running out of time, but I do want to finish up on one question from the audience. Chris, for investors, is passive indexing now a thing of the past? Do investors need to look for active bond traders or managers?

Chris Stanley: 27:03

I got to be careful. I can't give you investment advice, but I think that part of what I would be on the lookout for is the effect of the volume of passive investing that is out there and how that may be affecting some of these price signals. You know, it's tough to outperform the market, but it's even tougher when you've got kind of some of those signals that may be a little bit more muted because of the volume and extent of some of those index or other, you know, kind of passive investments out there. So maybe time to kind of consider some of that in, in some variability in your strategy.

Mark Bonner: 28:00

Okay. That's all the time we have today. Chris, thanks so much for joining us.

Chris Stanley: 28:06

Thank you so much for having me, Mark. It was it was a pleasure.

Mark Bonner: 28:10

If you missed part of today's show or wanna go back and catch any of our past conversations, you can find every episode of our show in your favorite podcast app. Just search First Draft Live. We'll be back next Friday with another conversation that puts commercial real estate right in the middle of the big picture. Until then, I'm Mark Bonner and this is First Draft Live. Have a great weekend y'all.