Big-time landlords have begun surrendering office buildings and other struggling properties to lenders this year, when just a few years ago they were fetching sky-high values amid super-low rates.
Many consider it the start of a reckoning for the estimated $20.7 trillion commercial real-estate market, likely its biggest test of confidence since the 2007-2008 global financial crisis.
Brian Lane, the Well Fargo Investment Institute’s lead analyst for private credit, pointed to a $1 trillion “wall of worry” as a wave of commercial real-estate loans come due through the end of 2024 (see chart), in a Monday client note. The balance balloons to about $2.5 trillion through the end of 2027.
“Property owners are facing higher vacancy, reduced net operating income, falling prices and rising capitalization rates,” Lane wrote. “While valuations have started to decline in most property types, there is likely more downside.”
A recent McKinsey report pegged prices for office buildings as likely to fall as much as 42%,
Morgan Stanley analysts reiterated a call for overall commercial-property prices to drop 27.4% peak-to-trough through the end of 2024.
Lane expects many borrowers to resort to private-capital providers for loans, with banks and the commercial mortgage-backed securities market pulling back.
“We expect that private investors will be needed to provide debt financing, and that sponsors may be forced to infuse equity to protect holdings and right-size property deals.”
Furthermore, institutional investors in bonds haven’t given up on all commercial real estate.
Saira Malik, Nuveen’s chief investment officer, said that “nonoffice” commercial mortgage-backed securities that currently offer 10.6% yields look attractive relative to the roughly 5.5% yield on investment-grade corporate bonds and 3.87% 10-year Treasury yield
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,
in a Monday client note.
Despite regional-bank failures and ongoing challenges in the office sector, Malik pointed to climbing delinquency rates of about 2% on loans in bond deals as well below the 9% rate of the global financial crisis some 15 years ago.
She also said investors might consider commercial real estate for its higher yields and total returns, given a backdrop where the Federal Reserve is expected to soon end its most aggressive cycle of rate hikes in decades.
Read: Do Not Disturb: Tenants brace for more office landlords to go belly up on their property debts
Stocks rose on Monday, with the Dow Jones Industrial Average
DJIA
up for its 11th straight session, ending at its highest level since February 2022, according to FactSet. The S&P 500 index
SPX
closed 5% below its record close on Jan. 3, 2022.
The U.S. economy isn’t the only thing unwilling to capitulate despite sharply higher interest rates.
Commercial real-estate prices have been heading lower in the wake of the pandemic and the Federal Reserve’s inflation fight, but the bulk of the pain still looks poised to come, according to Morgan Stanley analysts.
Prices for apartment buildings, offices properties and retail centers were pegged at about 8%-14% lower in May from peak levels (see chart), or less than Morgan Stanley’s initial estimates (blue line).
But the worst for property owners looks yet to come, according to Morgan Stanley’s REIT research team led by Ronald Kamden. The team reiterated its call for a 27.4% peak-to-trough price drop for all commercial property types through the end of 2024.
That compares with a 34.9% drop roughly 15 years ago during the global financial crisis, but also a subsequent period in which prices rose nearly 150% through the pandemic, according to Morgan Stanley data.
Prices have been heading lower overall, but with retail, industrial and office properties in the suburbs and central business districts, still facing the majority of their anticipated price declines “as transaction activity and distressed sales rise,” the team wrote in a Monday client note.
Up to 42% price drop?
Half-empty office buildings in the heart of financial districts in major U.S. cities are expected to be hit particularly hard by hybrid work, tighter credit and higher interest rates.
See: San Francisco’s office market erases all gains since 2017 as prices sag nationally: chart
New York magazine recently wrote how big Manhattan office landlords are looking to shed buildings now worth less.
The hardest-hit cities could see demand for office buildings tumbling by as much as 38% from 2019 levels, according to a McKinsey Global Institute report from earlier in June. The report also pegged office prices as falling about 26% on average in a moderate scenario through 2023, but skidding 42% in a severe scenario.
BofA Global researchers led by Alan Todd also said that pressure in the office sector could “spill over” into other property types, including hotels and retail, by making refinancing more difficult.
“For example, to the extent airline costs remain elevated, flight cancellations remain a common problem, or corporate belt tightening limits fly-to in person meetings, we see it as a headwind for hotel revenues, which can fluctuate significantly with the public’s ability or willingness to travel,” Todd’s team wrote, in a weekly client note.
The Dow Jones Equity REIT index
DJDBK
was up 3.1% on the year through Monday, according to FactSet. Stocks have punched higher in 2023 in the wake of a resilient U.S. economy, despite the Fed already having raised rates by about 500 basis points to a range of 5%-5.25%.
Fed officials indicated that two more rate hikes could still be in store this year, likely with another 25 basis point rate increase expected later this month. The S&P 500 index
SPX
was up about 17.8% on the year through Monday, while the Dow Jones Industrial Average
DJIA
was 4.3% higher and the Nasdaq Composite Index
COMP
was up 36%, according to FactSet.
Related (February): Losing the trophy? A $45 billion mortgage bill is coming due for some of America’s signature commercial properties
Read next: Do Not Disturb: Tenants brace for more office landlords to go belly up on their property debts
Virgin Galactic’s first commercial spaceflight launched successfully on Thursday, taking a crew from the Italian Air Force and the National Research Council of Italy on a 75-minute trip to the edge of space.
The flight, dubbed Galactic 01, marks the start of commercial service for the space tourism pioneer after a series of delays.
Shares (ticker: SPCE) fell sharply on the news, declining roughly 13% to $4.13, after trading higher earlier in the day. The stock market often “buys the rumor and sells the news.” That’s what happened during the company’s last high-profile launch.
For comparison, the
and
were both higher in midday trading.
A double-hulled mother ship took the Galactic spacecraft to 44,500 feet before dropping it, according to a company press release. The craft, called Unity, then lighted its engine and accelerated to about Mach 2.88, or almost three times the speed of sound, traveling about 52.9 miles above the surface of the Earth. After passengers experienced weightlessness, the ship glided back to Spaceport America in New Mexico.
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It was an exciting event and investors were optimistic. A live stream of the flight went live at around 11 a.m. Eastern time.
Prior to the flight, shares had gained $1.28, or 37%, over the past month, as of the market close on Wednesday. A similar pattern emerged when Virgin Galactic founder Richard Branson went to the edge of space almost two years ago in July 2021.
Virgin Galactic shares rose 40%, from about $35 to $45 a share, the month headed into the flight, but that gain didn’t last. The stock closed below $35 just three days after the flight, the latest bit of evidence that the stock market is forward-looking and that good news can be reflected in prices ahead of an expected event.
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Virgin Galactic stock has declined around 90% since Branson flew. A series of regulatory and equipment-related delays pushed out the start of commercial service much further than expected. And higher interest rates, which make funding start-up companies more expensive, have sapped investors’ enthusiasm.
In the long run, earnings and cash flow will determine how Virgin Galactic stock trades. In the short run, investors should watch out for a stock dip, even with a successful first flight.
With the start of service, Wall Street projects about $12 million in 2023 revenue for the company. Positive earnings and free cash flow aren’t projected until the end of the decade when annual sales reach roughly $700 million. Analysts also project Virgin Galactic will spend roughly $1 billion between now and the end of the decade before the business becomes self-sustaining.
Write to Emily Dattilo at emily.dattilo@dowjones.com and Al Root at allen.root@dowjones.com
Cash-strapped landlords with maturing property debt aren’t being scared off by 12%-16% rates of interest, said Ben Miller, CEO of Fundrise, which recently launched a new $500 million credit fund to make property loans to borrowers in need of liquidity.
“We have been turning away deals. We have too many deals,” Miller told MarketWatch on Friday. “The problem is too any deals and not enough dollars in the world today. The team has been trying to prioritize what we think are deals with the lowest risk.”
Fundrise’s newly launched Opportunistic Credit Fund, or “OFC” for short, was seeded by the company’s roster of nearly two million small-time investors, Miller said, where investments can be as little as $10.
Its aim is to give clients a shot at profiting off commercial real estate in a down cycle, in ways typically reserved for banks, private-equity funds or other alternative lenders.
Specifically, it makes “bridge” or “mezzanine” loans on residential buildings, either finishing construction or stabilized, where borrowers need more funding in the year since the Federal Reserve started sharply increasing interest rates.
Related: Commercial real-estate’s debt machine is broken down
Green Street Advisor’s May Commercial Property Price Index shows prices fell 15% from a year ago. While the shortage of homes is expected to keep demand high for rentals, it’s unclear if rents can stay as elevated as they have been, or when property prices will bottom.
Fundrise is making average loans of $10 million to $30 million to commercial landlords, according to Miller. The fund targets the gap borrowers need to fill as property values drop from peak pandemic levels and as rates on senior commercial mortgage loans have climbed from lows of roughly 3.5%.
“We had 15 years of ZIRP,” Miller said, of the Fed’s nearly zero-interest-rate policy in recent years. “When there’s too much money and liquidity, the opposite is too little liquidity,” he said.
Miller pointed to stress evident among small-time syndicators in multifamily properties, as highlighted by The Wall Street Journal, as an example of fallout already hitting real estate as credit conditions tighten. “They are the first to get foreclosed on because they are less capitalized,” he said. “But institutions have the exact same problem.”
He expects the new fund to be fully deployed in the next 24 months.
Fundrise, which has about $3 billion in assets under management, got off the ground about 10 years ago as a way for individuals to more easily invest in real estate, private equity and pre-IPO stocks, often now through smartphones.
While redemptions at funds have picked up across the board since the Fed tightened financial conditions, Miller says they haven’t been problematic at Fundrise. “We were seeing more redemptions that we did before, but still more fundraising,” he said.
Read: Debt on trophy office buildings is starting to buckle as loans come due
Stocks closed higher Friday on progress in Washington around a U.S. debt-ceiling deal. The Dow Jones Industrial Average
DJIA
rose 1% Friday, but gave up 1% for the week, while the S&P 500 index
SPX
gained 0.3% and since Monday and the Nasdaq Composite Index
COMP
rose 2.5% for the week, according to FactSet.
Published: May 9, 2023 at 11:54 a.m. ET
That’s a warning from Scott Kleinman, co-president at Apollo Global Management, in remarks to the Financial Times published Tuesday. Kleinman noted that the private market hasn’t yet to started to heavily mark down commercial real estate.
But there are signs of stress.
Issuance of commercial mortgage-backed securities, or bonds sold by Wall…
That’s a warning from Scott Kleinman, co-president at Apollo Global Management, in remarks to the Financial Times published Tuesday. Kleinman noted that the private market hasn’t yet to started to heavily mark down commercial real estate.
But there are signs of stress.
Issuance of commercial mortgage-backed securities, or bonds sold by Wall Street banks to finance commercial buildings, has fallen by about 83% so far this year to $9 billion, according to Deutsche Bank research.
While these bonds finance only roughly a 11% slice of the estimated $20.7 trillion commercial property market, the sector has long served as a visible gauge of the financial health of hotels, office buildings, apartment buildings, shopping malls and other income-producing real estate, MarketWatch’s Joy Wiltermuth reported last week.
Worries around rising interest rates and office buildings left partially empty after the COVID-19 pandemic were already causing heartburn before the collapse of Silicon Valley Bank in March.
Related: Office property woes could be tip of iceberg if credit freezes up as $1 trillion bill comes due
Regional-banking stocks have fallen sharply following March’s volatility. The SPDR S&P Regional Banking ETF
KRE
remains down around 37% so far in 2023 after falling to its lowest since September 2020 last week.
The broader stock market has been relatively resilient in the face of banking woes, though some analysts contend that problems in the financial sector have been a weight on the S&P 500 index
SPX
,
capping rally potential.
U.S. stocks were flat to slightly lower on Tuesday, with the S&P 500 down 0.3%, while the Dow Jones Industrial Average
DJIA
was off less than 0.1% and the Nasdaq Composite
COMP
declined 0.6%.
Published: April 30, 2023 at 7:06 p.m. ET
That’s Charlie Munger, the 99-year-old vice chair of Berkshire Hathaway Inc. BRK.A BRK.B, in an interview with the Financial Times published Sunday, in which the newspaper said he warned that U.S. banks are “full of” bad loans on commercial property.
Munger observed that banks were already retreating from commercial property, telling the FT that “every bank in the country is way tighter on real-estate loans today than they were six months ago.”
Munger…
That’s Charlie Munger, the 99-year-old vice chair of Berkshire Hathaway Inc.
BRK.A
BRK.B
,
in an interview with the Financial Times published Sunday, in which the newspaper said he warned that U.S. banks are “full of” bad loans on commercial property.
Munger observed that banks were already retreating from commercial property, telling the FT that “every bank in the country is way tighter on real-estate loans today than they were six months ago.”
Munger will again appear with Berkshire Chairman and Chief Executive Warren Buffett at Berkshire’s annual meeting on Saturday,
Related: Why First American Trust’s chief investment officer sees no quick end to regional-bank turmoil
The failure of Silicon Valley Bank and Signature Bank in March sparked worries over the banking sector, particularly regional banks, as investors pulled deposits. SVB’s collapse put a spotlight on potentially painful losses lurking at banks from trillions of dollars in commercial-real-estate loans on their books.
Meanwhile, the focus over the weekend was on First Republic Bank
FRC
,
which has struggled to recover from a sharp drop in deposits. News reports said a winning bid for the bank could be accepted by the Federal Deposit Insurance Corp. as early as Sunday evening.
See: FDIC asks banks for final bids for First Republic by Sunday
Stock-market investors last week largely brushed off banking jitters. Major U.S. stock indexes
DJIA
rose Friday, while the Cboe Volatility Index
VIX
,
sometimes referred to as Wall Street’s fear gauge, ended at a nearly 18-month low.
U.S. stock-index futures ticked slightly lower Sunday evening. Futures for the S&P 500
ES00
,
Dow industrials
YM00
and Nasdaq-100
NQ00
were down 0.1%.
'We've seen this movie before,' says Waterfall Asset co-founder on trouble in commercial real estate
Tom Capasse, a veteran of distressed property investing, won’t say the sky is falling when it comes to a credit crunch bearing down on the estimated $21 trillion U.S. commercial real-estate market.
But Capasse does see a wave of distress unfolding in the coming months as more borrowers buckle under the weight of higher interest rates, tighter credit and other pandemic aftershocks.
“You are going to see strategic defaults,” said Capasse, CEO of Ready Capital Corp.
RC
and co-founder of Waterfall Asset Management, of landlords walking away from properties or handing the keys back to lenders. “You are going to see a lot more of that in the office sector.”
After an era of easy credit and low interest rates, property values are expected to fall, eroding the equity that borrowers have in properties and likely leading to climbing defaults. “The Fed is getting its way. It is going to have a traditional cyclical decline in real estate,” he said.
See: Fed needs to keep raising interest rates, Waller says
Ready Capital is externally managed by Waterfall Asset Management, an alternative investment manager with $11.6 billion in assets. Waterfall closed a new $485 million Atlas Fund this week to invest in commercial real estate, distressed loans and bonds.
Capasse had a front-row seat to four decades of past commercial real estate boom and bust cycles. Back in the 1980s, he was helping Merrill Lynch navigate the Resolution Trust Corporation (RTC), a sweeping federal program that purged problem assets from failed banks, but also built the early fortunes of real estate titans Barry Sternlicht and Thomas Barrack.
“People who say this is the new RTC, they are like Chicken Little,” Capasse told MarketWatch “That’s not going to happen.”
Instead, Capasse sees an more orderly process of loan sales from lenders able to better absorb some level of loss, rather than the flood of bank failures that led to the RTC and fire sale prices. But he also anticipates enough distress coming down the way to gear up Waterfall, and its small-balance loan affiliate Ready Capital, to seize the moment.
“We’ve seen this movie before,” Capasse said. “Our trading desk is definitely hearing more inquiries from potential sellers of select, target portfolios from smaller and midsize banks,” he said, adding that this activity picked up since the collapse of Silicon Valley Bank and Signature Bank in March.
Ready Capital has been one of the biggest buyers of distressed small-balance property loans, with some $5 billion of total purchases in past down cycles. It also is a lender in the sector, where banks have recently retrenched.
Concerns in this cycle have been centered on smaller banks will less than $250 billion in assets, which account for three-quarters of commercial-real estate bank lending. It’s an area the International Monetary Fund pointed to earlier this week as a potential source if financial instability.
“For now, it’s more of a fact-finding mission at this point,” Capasse said of buyers and sellers who aren’t yet agreeing on price. “That impasse is only going to be broken by distressed sales,” he said, pegging office properties as the first shoe to drop. “They are just starting to happen.”
U.S. stocks have rallied to start 2023, but REITs have yet to catch a break. The Dow Jones Equity REIT Index
DJDBK
was down almost 22% from a year ago, while other REITs were down closer to 25%, according to FactSet. The Dow Jones Industrial Average
was less than 2% lower from a year ago, while the S&P 500 was off by about 6%, through Friday.
While headwinds continue to gather for commercial real estate, banks’ balance sheets remain awash in “safe,” but underwater assets as the Federal Reserve has quickly jacked up rates to fight inflation, making older, lower coupon bonds worth less.
The Fed in March created an emergency program for banks to avoid forced sales of “safe” but rate-sensitive assets. Banks can pledge Treasurys and agency mortgage bonds, in exchange for liquidity, but not commercial real-estate loans.
“That’s part of where we will get our supply,” Capasse said.
Commercial real estate that appears “significantly overvalued” could tumble in price, as debt costs rise and lenders come under pressure, the International Monetary Fund warned on Tuesday.
Commercial real estate has begun to face significant pressures as global central banks tightened their monetary policy stance, the IMF said in its latest global financial stability report.
In the U.S., banks have been tightening lending standards, making it harder for landlords to secure funding, while funds that also lend in the commercial real estate sector are retrenching, the report said.
Stress in real-estate investment trusts (REITs) and in the commercial mortgage-backed securities (CMBS) market, both important sources of loans to landlords, also could add to the sector’s woes, the report said.
Read: Office property woes could be tip of iceberg if credit freezes up as $1 trillion bill comes due.
This could “exacerbate adverse shocks if the economy slows significantly,” according to the IMF, which warned of rising defaults and losses at lenders from falling property values and illiquid markets.
Smaller U.S. banks in focus
The IMF said, “a decade of very low interest rates boosted values in the run-up to the pandemic in 2020 beyond what was explained by fundamental factors.”
As a result, the agency sees risks of a “broader correction” in commercial real-estate values, even after U.S. listed REITs already fell almost 14% in value in the first quarter of 2023 from a year ago.
The IMF on Tuesday also projected the weakest global economic growth in more than 30 years.
See: High inflation and interest rates to hobble U.S. and global economies for several years, IMF says
U.S. Treasury Secretary Janet Yellen signaled a more upbeat tone though, saying Tuesday that it was important not to overdo the negativism in the outlook for the global economy, ahead of an annual IMF-World Bank summit.
Still, the collapse of Silicon Valley bank in March put a focus on the stability of smaller U.S. banks, with less than $250 billion in total assets, which account for three-quarters of all commercial real estate lending. Any “deterioration in asset quality would have significant repercussions both for their profitability and lending appetite,” the IMF stability report said.
Commercial real estate has been vulnerable to past booms and busts. Last year, commercial real-estate loan volumes touched a roughly 12% annual rate at U.S. banks, as a portion of their total lending activity, or the highest since 2006 (see chart).
Commercial-real estate bust?
Torsten Slok, chief economist at Apollo Global Management, estimated that a pullback in commercial real estate construction could result in a drag of around 0.75% to U.S. gross domestic product over the coming three years.
“In other words, with the commercial real estate bubble bursting, we are likely to enter three years with low growth, similar to what we saw after the housing bubble burst in 2008,” Slok said in a Tuesday client note.
He also expects the Federal Reserve to interest cut rates later this year, and to keep them low for several years, while also resuming large-scale asset purchases, or quantitative easing, in 2024.
U.S. stocks were mostly higher on Tuesday, with the Dow Jones Industrial Average
DJIA
up 150 points, or 0.5%, at last check, and the S&P 500 index
SPX
up 0.2%, according to FactSet.
Published: April 5, 2023 at 7:59 p.m. ET
A downward spiral of commercial property prices can hurt sectors beyond the real-estate industry, warns Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.
Morgan Stanley analysts think commercial property prices could tumble as much as 40%, nearing declines seen in the aftermath of the 2008 global financial crisis.
The…
A downward spiral of commercial property prices can hurt sectors beyond the real-estate industry, warns Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management.
Morgan Stanley analysts think commercial property prices could tumble as much as 40%, nearing declines seen in the aftermath of the 2008 global financial crisis.
The estimate comes as trillions of dollars of commercial mortgage debt is set to mature in the next few years, likely in a higher rate environment. But there is also worry of broader ripple effects from half-empty office buildings.
“These kinds of challenges can hurt not only the real-estate industry, but also entire business communities,” Shalett said in a weekly client note. She warned that recent resilience in the stock market to start 2023 “demonstrates that investors continue to ignore genuine risks to the economy and corporate earnings.”
San Francisco Mayor London Breed’s office said a week ago that it was projecting a $780 million budget shortfall in the coming two fiscal years through 2024, up $51.5 million from its projection in January.
Its revised forecast pointed to higher interest rates that make borrowing on residential and commercial real estate more difficult as a drag on the city’s finances, but also to the remote-work dynamic that “makes office space an unattractive investment.”
See: Office property woes could be tip of iceberg if credit freezes up as $1 trillion bill comes due
Beyond potential cracks in commercial real estate, Shalett at Morgan Stanley said other potential sources of stress could come from further pain in the venture-capital world and from private equity, despite its estimated $2.3 trillion capital on hand to deploy.
“The collapse of Silicon Valley Bank put a spotlight on the already-stressed VC industry,” she wrote, adding that venture capital-backed firms employ more than 5 million people and “continue to burn through their cash reserves.”
For private equity, she sees a “dimming economic outlook,” a multiyear slowdown in new fundraising and “markdown risks” at portfolio companies.
The S&P 500 index
SPX
was up 6.5% on the year through Wednesday, while the Dow Jones Industrial Average
DJIA
was 1% higher and the Nasdaq Composite Index
had advanced 14.6%, according to FactSet.
Published: March 29, 2023 at 3:16 p.m. ET
U.S. banks held an estimated $3.1 trillion of commercial mortgages to start the year, leaving the real-estate industry particularly vulnerable to a pullback in lending, according to a Goldman Sachs analysis.
The new report offers a glimpse into how important commercial mortgages and bank loans have been over the last 20 years, for banks and the U.S. economy (see chart), with the two segments accounting for about 24% of U.S. gross domestic product.
Debt…
U.S. banks held an estimated $3.1 trillion of commercial mortgages to start the year, leaving the real-estate industry particularly vulnerable to a pullback in lending, according to a Goldman Sachs analysis.
The new report offers a glimpse into how important commercial mortgages and bank loans have been over the last 20 years, for banks and the U.S. economy (see chart), with the two segments accounting for about 24% of U.S. gross domestic product.
Debt securities at banks, which often include Treasurys and agency mortgage bonds, totaled about $7.6 trillion, the chart shows.
Silicon Valley Bank’s sale of low-coupon, “risk-free” securities at a $1.8 billion loss by in early March helped hasten a run on the bank’s deposits, ultimately leading to its collapse.
A fear since early March has been of potential further instability at banks, particularly if a run on deposits were to force banks to sell low-coupon debt or loan holdings at a discount, realizing the loss. The Fed created a new facility in March for banks to tap, with the goal of averting forced asset sales.
See: ‘One or done’ scenarios seem likely for the Fed, economists say
While the 2-year Treasury yield
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was around 2.3% a year ago, it was closer to 4.1% on Wednesday, showing why older securities would be worth less given today’s yields.
Furthermore, Goldman economists looked at the loan books of seven regional banks and quarterly Federal Reserve data to get a better gauge of industry-specific loan activity.
They estimated that manufacturing and the real-estate industry were the top two exposures within bank loans, at a combined 30%, but pegged the share as increasing to 50% when including commercial real-estate investment across other industries.
“These large shares—coupled with the large share of capex by the manufacturing and real-estate sectors—imply that the coming tightening in bank credit availability will affect the economy in part through its impact on these two industries,” wrote a team of Goldman economists led by Jan Hatzius.
On the other hand, they said weaker demand for office and retails properties could cut construction lending. “If so, the incremental drag from tight credit on commercial real estate activity could be smaller in magnitude.”
Stocks were higher Wednesday, with the Dow Jones Industrial Average
DJIA
up 260 points, or 0.8, while the S&P 500 index
SPX
was 1.2% higher, according to FactSet. Investors have been focused on inflation data due Friday and easing of worries around the banking sector.
Read more: Office property woes could be tip of iceberg if credit freezes up as $1 trillion bill comes due