Is The Yield Curve Foretelling a Downturn?

As we move deeper into the cycle, industry leaders are looking for potential signs of a recession, and one emerged: The 10-year/three-month yield curve has inverted. Historically, a yield curve inversion is one of the signs of an oncoming recession, and while it is only one metric, it is enough to encourage some developers to make strategic adjustments to hedge against a downturn.

“We are working to anticipate future changes in the market using a robust set of tools, and those tools are starting to give us some indication of market drift,” Scott Choppin, founder of Urban Pacific Group of Cos., tells GlobeSt.com. “We are just trying to be as effective as we can in the management of our real estate development, and we are looking for indicators that affect the multifamily market place. The tools facilitate the design of our strategy, and they include rent levels and rental demand, supply and the demand for that supply and the BaR Grid analysis, and the yield curve is one of the variables in this tool.”

While the yield curve inversion is a signal, it is following an atypical pattern. The 10-year/three-month yield curve has inverted while the 10-year/two-year yield curve has not. “That is an anomaly,” says Choppin. “These two ratios typically travel together, but this time, they are not. We don’t know what that means, but it informs me in a couple of ways. First, it is a general signal of the possibility of a recession, particularly when you look at the fact that we are in the longest expansion in US history. Our housing market in the US is also not in its normal condition, and in multifamily we are in the highest production rates historically. When you put those together, we feel that, while we can’t predict a recession, we have to move differently to insulate ourselves from a recession.”

While Choppin isn’t necessarily predicting a recession in the short-term or even when it might hit, he is acknowledging the increasing risk of a downturn and responding accordingly. However, that doesn’t mean he’ll stop building or even slow down. Instead, the company is shifting to hold for a longer term. “We are organizing our capital differently so that we are on a seven to 10 year hold, and if the recession comes, I am not indifferent, but I don’t have to sell during the recession,” says Choppin. “That is the real concern for developers that you can’t sell the product because the market is off. Then, all we have to do is worry about renting the property and finding permanent financing at the price we underwrote.”

In addition to this strategic change, Choppin believes the urban townhouse, the firm’s bread-and-butter product, will be a strong performer during the recession. “This is where the UTH model comes into play,” he says. “I like the story of UTH because of the demographic and the yields that we deliver, and it is a good recessionary product. I think that it performs better than other multifamily products during a recession.”