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HFF Research Update for October 6, 2016 Part II: High-Yield Corporate Spreads Very Tight

Thursday, October 06, 2016

Weekly insights on current research in the commercial real estate industry from HFF Managing Director of Research Jimmy Hinton. View Daily Rates on the HFF website or access the HFF Daily Rates App in iTunes.

Effective yields on the 10-year UST have risen approximately 20 basis points over the past month to 1.73 percent. The corporate bond market has moved in lock-step, with yields rising but still representing very low thresholds. In the past, we have focused very acutely on the spread between the 10-year UST and 10-year A/BBB bonds, given they are excellent proxies for capitalization rates and credit spreads on commercial real estate mortgages. Below, we would like to address another spread differential we believe could have a favorable impact on an owner capitalizing real estate assets with non-investment grade tenancy.

Per the below table, corporate bonds with a B rating are deemed “highly speculative.” The compression in spreads between the 10-year AAA and 10-year B corporate bonds has resulted in the metric moving below its average since both before and after the Great Financial Crisis – and approaching all-time lows.

High Yield Corporate Spread Premium

Why is this relevant? Because lenders and buyers of real estate whose income is derived by non-investment grade tenants use public market credit spreads as a minimum risk premium in their own underwriting.

Said another way, it is very possible your non-investment grade tenant’s credit has never measured more favorably against an otherwise “risk free” tenant. We can help you determine the answer.

Said another way, even if the effective yield on such a tenant’s corporate bonds has moved higher in recent months, the relative pricing they could achieve through no improvement in credit profile could make the asset abnormally attractive. We can help you determine the answer.

As we have written extensively, global monetary policy has played a significant role in the above phenomenon. But we have not seen such an impact on non-investment grade credit since 2013, thus rendering the analysis particularly relevant.

Moody's, S&P, Fitch Ratings descriptions

Sources: HFF Research, Bloomberg, Barclays

About Jimmy Hinton

HFF Jimmy HintonJimmy Hinton serves as Managing Director of HFF, responsible for the firm’s national research efforts. Mr. Hinton works with the executive management team to assist in investor relations and to inform both HFF staff and firm clients with in-depth analysis of economic, property and capital market trends. He is also responsible for providing extensive market reports, client presentations and deal-specific analysis for debt placement and investment sales assignments. Mr. Hinton’s responsibilities include substantial interaction with pension funds, life insurance companies, regional and CMBS lenders, REITs, foreign investors and private equity funds.

During his tenure at HFF, Mr. Hinton has supported the execution of more than 150 commercial real estate transactions totaling more than $4.5 billion in 20 states. Mr. Hinton has experience in fixed- and adjustable-rate debt, mezzanine debt, construction loans and joint venture executions on behalf of clients engaged in the acquisition, development and recapitalization of property types including multi-housing, industrial, office, retail, medical office and storage properties.

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