U.S. Commercial Real Estate Outlook: January 2014 Hugh F. Kelly, PhD, CRE - Featured Economist
Market Spotlight: Déjà vu all over again?
In the Nov/Dec 2013 issue of the journal Foreign Affairs, former Fed Chairman Alan Greenspan published an essay, “Never Saw It Coming: Why the Financial Crisis Took Economists by Surprise.” Greenspan describes the financial crisis as “an existential crisis for economists” as state-of-the-art models at the Fed, at the International Monetary Fund, and at private institutions such JP Morgan Chase, all failed to predict the depth and duration of the most recent economic downturn. This is a continuation of Greenspan’s extended apologia about the asset bubble that led to the crisis and the blind spots in policy that helped exacerbate the damage.
Should the constellation of current indicators give us pause about a potential repeat of that bubble? Look at the year-end numbers for 2013. The stock market was up between 27% (DJIA) and 38% (Nasdaq). The Case-Shiller Housing Price Index is again rising at a double-digit pace (13.6% in the latest reading). For commercial real estate, the Real Capital Analytics’ Commercial Property Price Index (CPPI – a joint effort of RCA, Moodys, and MIT) was up 13.9%, and transaction volume was up 19% for the year to $355 billion. Cap rates are roughly at 2006 levels. Apartment and hotel price-per-unit averages are above 2007 levels, with office and retail approaching there prior peaks. Meanwhile, the bond market is starting to give way under the influence of gradually rising interest rates, as it did in 2005 – 2006 (albeit from a substantially lower starting point now). Is it time to worry about catastrophic history repeating itself?
The best answer might be, “Not yet. But don’t get complacent either.”
There are numerous key differences between 2013 – 2014 and 2007 – 2008. The so-called Niagara of Capital is no longer a factor, and the hunt for yield is still tempered. Institutional money funds now hold about $1.8 trillion in low-yielding capital, about 50% more than in the run- up to the bubble. Housing prices are no longer detached from income levels. The NAR Housing Affordability Index is about 165, indicating that the median household has ample income to service mortgage debt at current prices. ‘It was not the case in the bubble years. And for most commercial property types, construction relative to market size is at a multigenerational low. This means that the threat of overbuilding to the commercial real estate market is virtually non- existent.
Generalizations about the exceptionally large and diverse U.S. commercial property markets are bound to hide significant local differences. But the national statistics are starting to run in favor of the real estate asset class, and in a year where bonds may be under pressure as interest rates rise and the stock market can be expected to cool off, real property may be ready to head into the fast lane once again. Let’s just hope that this time the drivers remember to fasten their safety belts and watch out for the bumps in the road.
U.S. ECONOMIC DASHBOARD
Year-end 2013 Statistics Show “Surprises to the Upside”
High-performance automobiles boast about their initial acceleration, going “zero to sixty” in a matter of seconds. The acceleration of the U.S. economy since the trough of its recent deep recession has been anything but high performance. Like a Porsche stuck in second gear, America has struggled to establish consistent forward momentum.
The most recent GDP report for the 3rd Quarter 2013 showed annualized growth at 4.1%, the economy’s best performance since early 2011. Improved personal consumption contributed to the stronger growth. In the same report, the Bureau of Economic Analysis revised its 2nd Quarter GDP estimate upward from 1.7% to 2.5%. The labor markets continue to present mixed signals. December’s jobs figures were disappointing, at a mere 74,000 increase, bringing the 12-month job gain to 2,186,000, or 1.7%. Nevertheless, the headline unemployment rate dropped to 6.7%, approaching the Fed’s 6.5% target for monetary policy adjustment.
With Janet Yellin taking the helm, the Fed will be tapering the quantitative easing programs that have been pumping cash into the economy. The task may be compared to driving a standard- shift auto on the hills of San Francisco, requiring just the right touch in easing off the gas pedal, lightly tapping the brakes, all the while managing the clutch to avoid stalling or slipping backward. Even with optimal control, the yield curve should be rising and flattening in the months ahead
The outlook for 2014 is fairly promising, all things considered. GDP growth at a sustained 3% rate is expected in the second half of the year. Job growth should accelerate as the housing
rebound continues. A mild thaw in Washington’s partisan wars has brought some reasonable compromise into the budgeting process, and the economic drag due to the “sequester” fiscal austerity should be less in 2014 than in 2013, bolstering GDP. A third boost could come from business fixed investment, as corporations have de-levered significantly, have raised operating margins significantly, and are sitting on huge cash reserves. Though political, monetary, and event risks remain of concern, the headwinds buffeting the economy since 2009 have eased and a tailwind may at long last be discerned.
U.S. COMMERCIAL REAL ESTATE DASHBOARD
About the Featured Economist:
Hugh F. Kelly, PhD, CRE is a researcher and consultant who has worked in the commercial real estate field for 35 years.He worked for the prestigious consulting firm, Landauer Associates, from 1979 to 2001 and was its chief economist and author of the annual Landauer Real Estate Market Forecast.He is presently Clinical Professor of Real Estate at NYU's Schack Institute of Real Estate, where he began teaching as an Adjunct in 1984. He serves private clients through his consulting practice, Hugh F. Kelly Real Estate Economics. Hugh is the author of more than 300 articles for industry and academic publications, and has served as the editor for SIOR's Comparative Statistics of Industrial and Office Markets (1988 - 2003), the CCIM/Landauer Investment Trends Quarterly (1995 - 2004), and the CRE's journal Real Estate Issues (2002 - 2006). Hugh is the 2014 Chair of the international professional organization The Counselors of Real Estate. His doctoral dissertation at the University of Ulster (No. Ireland) investigated the subject "24-hour Cities and Commercial Real Estate Investment Performance."
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