Bloomberg News has joined Mort Zuckerman of US News and Noam Sheiber of The New Republic in endorsing the Shulmaven view of fast-tracking environmental approvals and waiving the prevailing wage requirements of the Davis-Bacon Act for new infrastructure projects. Their editorial calls for a $100 billion program. Hopefully President Obama will see the light.
Full url: http://www.bloomberg.com/news/2011-08-23/a-public-works-spending-deal-even-the-republican-party-can-embrace-view.html
Tuesday, August 23, 2011
Sunday, August 21, 2011
An Open Letter to President Obama on Jobs
Dear Mr. President:
I hope you are enjoying your working vacation in Martha's Vinyard. You sure could use a break from Washington and the emerging bear market on Wall Street. You told us that you will address the nation on the need to create jobs after Labor Day. I hope you come up with some good ideas in the clean ocean air. We surely can use them because we have a real employment emergency that is draining both the economy and the spirit of our nation.
Given the emergency, I assume that you are open to a few new and some old ideas about job creation. All the ideas you mentioned on your midwest tour such as ratifying the free trade agreements, passing the new patent law, extending the social security tax cut and extending unemployment benefits are mostly helpful, but they really won't do a whole lot in the short run.
So here are a few ideas that might move the dial.
1. We need an all out domestic energy program. That means more offshore drilling, establishing clear rules and best practices for hydraulic fracturing drilling technolgy that has the real potential to limit our dependence on foreign oil and approving the privately financed Keystone XL Pipeline that will bring Canadian oil to our gulf coast. Note that all of the above does not involve tax dollars. On the public side keep up and step up the research into energy alternatives, but have no illusions about all of the "green" jobs it will create.
2. Spend big on infrastucture. The $50 billion infrastructure bank is small potatoes and may take awhile to launch. Spend $200 billion, but fast track or eliminate the environmental approval process and waive the prevailing wage requirements of the Davis-Bacon Act. With very low interest rates and high unemployment, now is the time to borrow and spend for worthy projects.
3. Give employers a 5% tax credit for increasing their wage bill subject to FICA employment taxes. I think this would work far better than your current payroll tax cut.
4. Have Treasury sit down with the business lobbies and cut a deal on corporate tax reform to present to the Congress. I fear the normal process might take forever.
5. Fund the above with a combination of a one-time lower tax rate for repatriating foreign sourced corporate earnings that are idling overseas, a higher gasoline tax and a down payment on entitlement reform. By the way, if you can get it, going big on a grand bargain for reducing our structural deficit is good idea, but you have to convince yourself and your friends in Congress that the real heavy lifting has to be on the spending side.
None of this will be easy, but when you are President all the easy stuff gets decided before it gets to you. Enjoy your vacation and come back with a real program.
Sincerely,
David Shulman
I hope you are enjoying your working vacation in Martha's Vinyard. You sure could use a break from Washington and the emerging bear market on Wall Street. You told us that you will address the nation on the need to create jobs after Labor Day. I hope you come up with some good ideas in the clean ocean air. We surely can use them because we have a real employment emergency that is draining both the economy and the spirit of our nation.
Given the emergency, I assume that you are open to a few new and some old ideas about job creation. All the ideas you mentioned on your midwest tour such as ratifying the free trade agreements, passing the new patent law, extending the social security tax cut and extending unemployment benefits are mostly helpful, but they really won't do a whole lot in the short run.
So here are a few ideas that might move the dial.
1. We need an all out domestic energy program. That means more offshore drilling, establishing clear rules and best practices for hydraulic fracturing drilling technolgy that has the real potential to limit our dependence on foreign oil and approving the privately financed Keystone XL Pipeline that will bring Canadian oil to our gulf coast. Note that all of the above does not involve tax dollars. On the public side keep up and step up the research into energy alternatives, but have no illusions about all of the "green" jobs it will create.
2. Spend big on infrastucture. The $50 billion infrastructure bank is small potatoes and may take awhile to launch. Spend $200 billion, but fast track or eliminate the environmental approval process and waive the prevailing wage requirements of the Davis-Bacon Act. With very low interest rates and high unemployment, now is the time to borrow and spend for worthy projects.
3. Give employers a 5% tax credit for increasing their wage bill subject to FICA employment taxes. I think this would work far better than your current payroll tax cut.
4. Have Treasury sit down with the business lobbies and cut a deal on corporate tax reform to present to the Congress. I fear the normal process might take forever.
5. Fund the above with a combination of a one-time lower tax rate for repatriating foreign sourced corporate earnings that are idling overseas, a higher gasoline tax and a down payment on entitlement reform. By the way, if you can get it, going big on a grand bargain for reducing our structural deficit is good idea, but you have to convince yourself and your friends in Congress that the real heavy lifting has to be on the spending side.
None of this will be easy, but when you are President all the easy stuff gets decided before it gets to you. Enjoy your vacation and come back with a real program.
Sincerely,
David Shulman
Tuesday, August 2, 2011
The Debt Ceiling Deal: Looking for Cuts in All of the Wrong Places
At last the debt ceiling deal is done. Our nation won't default and there will be about $2.2 trillion in cuts,although there maybe some tax increases included in that number. However $2.2 trillion represents a small downpayment on the $8 trillion that will ultimately be required. Yes, $8 trillion. The much discussed $4 trillion grand bargain was also only a downpayment on what is needed. Moreover with the economy softening much of the $2.2 trillion will be washed away with lower tax collections and higher automatic spending. Thus don't be surprised if we see both tax cuts and spending back on the agenda in the Fall.
The real problem with the deal is that the cuts are in the wrong places. Too be sure much Nancy Pelosi's stimulus package of two years ago had to be undone, but our nation still needs infrastructure, research and yes, defense spending. In my opinion we will come to regret the steep cuts in the defense budget.
What should have been cut are the three big drivers of the longer term deficit: medicare, medicaid and social security. The Republicans made a huge mistake in not offering up some tax increases to achieve cuts in these areas. Unfortunately we will have to wait until 2013 until painful cuts have to made in the major entitlement programs. What I am writing about is not politics, but rather arithmetic. Bluntly put, medicare, medicaid and social security are not sustainable. Indeed it is likely that in a few years we will say the same thing about Obamacare.
As an aside an elegant deficit reduction plan would have kept the taxes embedded in Obamacare and delayed implementation of the spending for three years. But the President and the Democrats really don't care about deficit reduction, just as the refusal of the Republicans to to accept modest tax increases demonstrate that, they too, do not care about deficit reduction either. The Simpson-Bowles Commission had it right and President Obama's biggest political mistake was his failure to endorse the their recomendations.
The real problem with the deal is that the cuts are in the wrong places. Too be sure much Nancy Pelosi's stimulus package of two years ago had to be undone, but our nation still needs infrastructure, research and yes, defense spending. In my opinion we will come to regret the steep cuts in the defense budget.
What should have been cut are the three big drivers of the longer term deficit: medicare, medicaid and social security. The Republicans made a huge mistake in not offering up some tax increases to achieve cuts in these areas. Unfortunately we will have to wait until 2013 until painful cuts have to made in the major entitlement programs. What I am writing about is not politics, but rather arithmetic. Bluntly put, medicare, medicaid and social security are not sustainable. Indeed it is likely that in a few years we will say the same thing about Obamacare.
As an aside an elegant deficit reduction plan would have kept the taxes embedded in Obamacare and delayed implementation of the spending for three years. But the President and the Democrats really don't care about deficit reduction, just as the refusal of the Republicans to to accept modest tax increases demonstrate that, they too, do not care about deficit reduction either. The Simpson-Bowles Commission had it right and President Obama's biggest political mistake was his failure to endorse the their recomendations.
Thursday, July 14, 2011
Letter to The Wall Street Journal, July 14, 2011
Your front-page article "Canada Has Plenty of Oil, But Does the U.S. Want It?" (July 8) highlights the fact that the U.S. environmental lobby and its helpers in Congress are truly the "party of no."
It seems that the environmental lobby is against developing the Canadian oil sands, drilling offshore, drilling in the Alaskan wilderness, hydraulic fracturing, mountain-top coal mining, electric transmission lines connecting solar power to the grid in the California desert and nuclear power.
To be sure, there are and always have been environmental issues associated with energy development, but I wonder where the environmental lobby is going to get the power to air-condition its plush offices in Washington, D.C. We may just as well mail in the keys to our nation to Saudi Arabia if we are going to say "no" to all energy development.
Full url - http://online.wsj.com/public/page/letters.html?mod=WSJ_topnav_na_opinion
It seems that the environmental lobby is against developing the Canadian oil sands, drilling offshore, drilling in the Alaskan wilderness, hydraulic fracturing, mountain-top coal mining, electric transmission lines connecting solar power to the grid in the California desert and nuclear power.
To be sure, there are and always have been environmental issues associated with energy development, but I wonder where the environmental lobby is going to get the power to air-condition its plush offices in Washington, D.C. We may just as well mail in the keys to our nation to Saudi Arabia if we are going to say "no" to all energy development.
Full url - http://online.wsj.com/public/page/letters.html?mod=WSJ_topnav_na_opinion
Saturday, July 9, 2011
The End of a Dream
As a child of the space age I am especially saddened that with the final voyage of the space shuttle Atlantis we are witnessing the end of the manned space program. I vividly remember watching the first moon landing on a grainy black and white TV in my Fort Bragg orderly room on a hot July night in 1969. If you asked me then what the future would bring, I would most certainly have said that by 2011 we would be launching star fleets to Mars and Venus. We dreamed big things back then. Now our dreams seem pitifully small and we can't even do little things like fixing roads and bridges.
I think the political process grossly underestimates the need a society has for heroes and big projects. I was at astronaut John Glenn's ticker tape parade in 1962 after he returned from space. Glen was a real hero. Although President Kennedy was not as popular when he was in office than he is today, the space program was among his most popular efforts.
It was the space program that inspired millions of students to become scientists and engineers and we have been living off of that legacy for decades. The astronauts were far better roll models for kids to look up to than the reality television of today.
I know that latter thought proves that I am a curmudgeon, but trust me, with this last flight, we are losing something real.
I think the political process grossly underestimates the need a society has for heroes and big projects. I was at astronaut John Glenn's ticker tape parade in 1962 after he returned from space. Glen was a real hero. Although President Kennedy was not as popular when he was in office than he is today, the space program was among his most popular efforts.
It was the space program that inspired millions of students to become scientists and engineers and we have been living off of that legacy for decades. The astronauts were far better roll models for kids to look up to than the reality television of today.
I know that latter thought proves that I am a curmudgeon, but trust me, with this last flight, we are losing something real.
Wednesday, June 29, 2011
Hiding in Plain Sight: Mass Unemployment
Last night I attended the annual Loeb Awards dinner sponsored by the UCLA Anderson School which honors the best that business journalism has to offer. You can call it the Pulitzer Prizes for business journalism. All of the main characters from The Wall Street Journal, The New York Times, The Washington Post, Bloomberg, CNBC, etc were there.
To be sure all of the awards were relevant and they honored stories, among others, on the BP blowout in the Gulf, the scandal at Remington Firearms, and a significant book on hedge funds, but just like last year there was nary a mention on the unemployment crisis facing America. We are now in the third year of the worst unemployment crisis since the 1930s and nobody seems to care.
It seems that politicians of both parties and the journalists who cover them are in a conspiracy of silence. Maybe no one has any real solutions or maybe too many of the unemployed are out of sight and out of the minds of the policy elites, but make no mistake our country is being destroyed worker by worker. Unless there will be a dramatic change, this is one story that will end very badly.
To be sure all of the awards were relevant and they honored stories, among others, on the BP blowout in the Gulf, the scandal at Remington Firearms, and a significant book on hedge funds, but just like last year there was nary a mention on the unemployment crisis facing America. We are now in the third year of the worst unemployment crisis since the 1930s and nobody seems to care.
It seems that politicians of both parties and the journalists who cover them are in a conspiracy of silence. Maybe no one has any real solutions or maybe too many of the unemployed are out of sight and out of the minds of the policy elites, but make no mistake our country is being destroyed worker by worker. Unless there will be a dramatic change, this is one story that will end very badly.
Thursday, June 16, 2011
The Outlook for Commercial Estate: Asset Prices Ahead of Fundamentals, UCLA Anderson Forecast, June 2011
The bull market psychology of the mid-2000s has returned to commercial real estate with prices for quality properties just 13% below their bubble peak in 2006. (See Figure 1) Near record low cap rates (the cash yield before capital expenses for real estate) of below 5% for quality office buildings in Manhattan and Washington, D.C. and for Class A apartments in broader geographies are becoming more the rule than the exception. In contrast assets in less than desirable markets are trading at 7-9% cap rates. Indeed the Manhattan office market has become so frothy that developers are now talking about starting 25 million square feet of space this decade, the highest level since the 1980s.
Similarly, though still well below their 2007 peak, the publicly traded real estate investment trusts (REITs) have tripled off their financial crisis lows of March 2009. (See Figure 2) Moreover, bankers who as recently as twelve months ago were shunning real estate loans have aggressively returned to the market. Simply put a near zero federal funds rate and 3% 10-Year U.S. Treasury yields have lit a fire underneath the high quality end of the real estate market.
Figure 1. Green Street Advisors Commercial Property Index, Dec 97 – April 11
Source: Green Street Advisors
Figure 2. Dow jones Real Estate index, I-Shares, June 2006 –27 May 2011, Weekly Data
Source: BigCharts.com
Indeed the long moribund commercial mortgage backed securities (CMBS) market is showing signs of recovery. Although issuance remains low, spreads for existing securities have dropped enough to enable new securities to be created. (See Figure 3) However, the Dodd-Frank financial reform legislation requirement for issuers to retain an interest in the securitization may limit a full revival of this sector of the market.
Figure 3. CMBS Issuance, 1999-2011E, In $billions
Source: FBR Capital Markets and UCLA Anderson Forecast
Despite the ebullience discussed above, all is not well in the commercial real estate capital market. When you go beyond “A-List” properties regional and community banks are probably sitting on about $200 billion in 20% or more “under-water” real estate loans. The nation remains littered with vacant office buildings, warehouses, hotels and strip centers in fringe locations. Indeed even higher quality assets in what are perceived to be second and third tier cities find it difficult to attract a bid from institutional investors. Of course the longer interest rates remain abnormally low the likelihood increases that the search for yield will ultimately find its way to assets that the institutional investor community are currently shunning.
Thus as long as the interest rate environment remains benign, commercial real estate capital markets will continue to do well. At least until the over-leveraging excesses of a few years ago return. However, the very low interest rate environment is not likely to remain with us for long. After all that environment is a result of the emergency conditions of the financial crisis. As we mention elsewhere in this forecast report, we expect both long and short term interest rates to raise, with 10-Year U.S. Treasury yields approaching 5% in 2013 and with that the very low cap rates of today will give way to a pricing correction.
Figure 4. Federal Funds vs. 10 Year U.S. Treasury Yields, 2000Q1 – 2013Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast
Lack of Supply Underpins Fundamentals
The financial crisis of 2007-2009, for all practical purposes, halted commercial construction. (See Figures 5 and 6) Since the 2007 peak total commercial construction declined by 64%, new starts by 80% and multi-family housing starts also suffered a peak to trough decline of 80%. To be sure, the collapse in demand coupled with the completion of starts occurring during the boom, sent vacancy rates soaring. (See Figure 6) But with no new supply, even modest increases in demand will work to gradually lower vacancy rates over time and with that rents will increase and in the case of apartments, because of some very special factors, rents are already rising noticeably.
Figure 5. Real Commercial Construction Spending, 2000Q1 – 2013Q13F
Source: IHS Global Insight and UCLA Anderson Forecast
Figure 6. Multifamily Housing Starts, 2000Q1 – 2013Q4F
Sources: U.S. Department of Commerce, and UCLA Anderson Forecast
But Weak Demand is the Problem
Although supply is not a problem; demand is. Simply put the economy is growing far too slowly to meaningfully reduce vacancy rates for all product types (especially office buildings), with the exception of apartments. (See figure 7) Even with employment increasing at a rate of 200,000-250,000 jobs a month; it will take a few years to return to the peak achieved in late 2006. (See Figure 8) And the all-important financial activities sector for the office sector, employment in 2013 will still be well off the prior peak. (See figure 9) This is hardly an environment for robust rent increases, especially for the suburban office market which is still suffering from the collapse of the single family home market. Remember all too many suburban office buildings are tenanted by financial service companies tied to housing (e.g. real estate brokers, title companies, mortgage brokers, lawyers, architects and banks).
Furthermore the on-going restructuring of the legal services business will weigh on demand for prestigious central business district office space. (See Figure 10) Simply put the business model of the legal profession is facing challenges from computerized document searches, outsourcing to India and a corporate rebellion against the “billable hour. Indeed several large law firms have created a non-partnership track for lawyers and have set up satellite locations in low cost locations such a Wheeling, West Virginia and Dayton, Ohio.
Figure 7. National office Vacancy Rate, 1991Q1 -2010Q1
Source: REIS
Figure 8. Nonagricultural Employment, 2000Q1 – 2013Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 9. Financial Activities Employment, 2000Q1 -2013Q4, SAAR
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 10. Legal Services Employment, 1990-Apr 2011, Monthly Data, In Thousands.
Source: Saint Louis Fed
The bright side of commercial real estate is the apartment market where the shock of dramatically lower prices has altered consumer psychology with respect to single family home purchases. (See Figure 11) A rush to buy has been replaced by a reluctance to buy and that reluctance is being reinforced by tighter credit standards. As a result the homeownership rate is falling to the benefit of rental apartments with the national apartment vacancy rate dropping from 8% to 6.2% over the past year. (See Figure 12) Moreover with much of the single family home vacancies sitting in the exurbs, the glut of vacant single family homes make them far less competitive with closer-in apartments.
According to a recent national survey net effective rents on move-ins and renewals are rising 4-4.5%, well above the 1% increase reported by the official consumer price index. It is because of the combination rising rents and low cap rates; we are forecasting a doubling multi-family starts from early 2011 to late 2013. As actual rental rates get reflected in the official consumer price index, the rate of increase in the so-called core CPI will vault above the Fed’s informal 2% target thereby inducing a tighter monetary policy. It is ironic that the seeds for higher cap rates will have its origins in rising residential rents.
Indeed with house prices at near record affordability levels and after a few years of rising real rents, consumers will once again learn the virtues of homeownership. In response ownership housing starts will return to more normalized levels and full apartment buildings will face a decline in occupancy rates.
Figure 11. S&P Case-Shiller 20 City Home Price Index, Jan. 2000 – March 2011, Jan. 2000=100
Source: Standard & Poor’s
Figure 12. Home Ownership Rate, 1997 -2010Q1, Percent
Source: U.S. Census Bureau and The New York Times
The demand for retail oriented real estate can be characterized as a tale of two consumers. The higher end consumer, benefiting from rising stock prices and employment stability is back while the lower end consumer is being ravaged by high unemployment, high gas prices and weak home prices. After all, 5% of the households account for 40% of aggregate household income. Simply put the Nordstrom shopper is spending while the Wal-Mart shopper isn’t.
Although retail sales have recovered, the growth rate in sales is well off the path of the mid-2000s. (See Figure 13) Consumers are still in a retrenching mode as the savings rate normalizes from the near zero level of five years ago. (See Figure 14) In addition e-commerce inexorably gains share over store-based retailing year after year. Witness the bankruptcies of Blockbuster and Borders as prime examples of the impact of e-commerce on store-based retailing. As a result, retail real estate which was the investment “darling” of the last decade faces a far more difficult future going forward.
Figure 13. Retail & Food Service Sales, Ex Autos, 1992-Apr 2011, Monthly Data, In $ billion.
Sources: Federal Reserve Bank of Saint Louis
Figure 14. Personal Savings Rate, 2000Q1 – 2013Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Reflecting a weaker than normal rebound in consumption, warehouse demand is slowly recovering from the massive inventory liquidation that took place during the recession.(See Figure 15) Inventories are now rising and will likely receive an impetus from the tragic tsunami/earthquake in Japan. Why? One of the many lessons coming out of Japan was the realization how fragile the global supply chain is. While “just-in-time” inventory control is still the order of the day, there will be a role for “just-in-case” supply management with a resultant increase in the level of inventories.
Figure 15. Real Business Inventories, 2000Q1 – 2013Q4
Source: U.S. Department of Commerce and UCLA Anderson Forecast
Furthermore, because much of what is held in storage is imported, the rise in imports is an encouraging signs. (See Figure 16) Real imports have recovered all of the lost ground that occurred during the recession and are now making new highs. This factor certainly augers well for coastal-based warehouse-distribution facilities.
Figure 16. Real Imports, 2000Q1 – 2013Q4F, Quarterly Data
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Nevertheless the widening of the Panama Canal in 2014 has the potential to remake corporate logistical maps. No longer will Asian exporters be forced to use a ship-to-rail-link through west coast ports to reach the consumer markets of the Midwest and East. New competition for west coast ports will arise in Houston, Texas; Savannah, Georgia; and Charleston, South Carolina as shippers diversify their alternatives. Simply put, the west coast ports will lose their pricing flexibility.
Conclusion
It’s a happy time for quality commercial real estate in major markets and for apartments in general. As long as interest rates remain low investors will continue to pay historically high prices for those types of real estate. However, because demand growth remains tepid, market prices are increasingly vulnerable to even a modest rise in interest rates. In the meantime with the exception of rental housing new construction will remain muted over, at least, the next eighteen months. Thereafter a modest rebound in the other sectors of commercial real estate will likely occur.
Similarly, though still well below their 2007 peak, the publicly traded real estate investment trusts (REITs) have tripled off their financial crisis lows of March 2009. (See Figure 2) Moreover, bankers who as recently as twelve months ago were shunning real estate loans have aggressively returned to the market. Simply put a near zero federal funds rate and 3% 10-Year U.S. Treasury yields have lit a fire underneath the high quality end of the real estate market.
Figure 1. Green Street Advisors Commercial Property Index, Dec 97 – April 11
Source: Green Street Advisors
Figure 2. Dow jones Real Estate index, I-Shares, June 2006 –27 May 2011, Weekly Data
Source: BigCharts.com
Indeed the long moribund commercial mortgage backed securities (CMBS) market is showing signs of recovery. Although issuance remains low, spreads for existing securities have dropped enough to enable new securities to be created. (See Figure 3) However, the Dodd-Frank financial reform legislation requirement for issuers to retain an interest in the securitization may limit a full revival of this sector of the market.
Figure 3. CMBS Issuance, 1999-2011E, In $billions
Source: FBR Capital Markets and UCLA Anderson Forecast
Despite the ebullience discussed above, all is not well in the commercial real estate capital market. When you go beyond “A-List” properties regional and community banks are probably sitting on about $200 billion in 20% or more “under-water” real estate loans. The nation remains littered with vacant office buildings, warehouses, hotels and strip centers in fringe locations. Indeed even higher quality assets in what are perceived to be second and third tier cities find it difficult to attract a bid from institutional investors. Of course the longer interest rates remain abnormally low the likelihood increases that the search for yield will ultimately find its way to assets that the institutional investor community are currently shunning.
Thus as long as the interest rate environment remains benign, commercial real estate capital markets will continue to do well. At least until the over-leveraging excesses of a few years ago return. However, the very low interest rate environment is not likely to remain with us for long. After all that environment is a result of the emergency conditions of the financial crisis. As we mention elsewhere in this forecast report, we expect both long and short term interest rates to raise, with 10-Year U.S. Treasury yields approaching 5% in 2013 and with that the very low cap rates of today will give way to a pricing correction.
Figure 4. Federal Funds vs. 10 Year U.S. Treasury Yields, 2000Q1 – 2013Q4F
Sources: Federal Reserve Board and UCLA Anderson Forecast
Lack of Supply Underpins Fundamentals
The financial crisis of 2007-2009, for all practical purposes, halted commercial construction. (See Figures 5 and 6) Since the 2007 peak total commercial construction declined by 64%, new starts by 80% and multi-family housing starts also suffered a peak to trough decline of 80%. To be sure, the collapse in demand coupled with the completion of starts occurring during the boom, sent vacancy rates soaring. (See Figure 6) But with no new supply, even modest increases in demand will work to gradually lower vacancy rates over time and with that rents will increase and in the case of apartments, because of some very special factors, rents are already rising noticeably.
Figure 5. Real Commercial Construction Spending, 2000Q1 – 2013Q13F
Source: IHS Global Insight and UCLA Anderson Forecast
Figure 6. Multifamily Housing Starts, 2000Q1 – 2013Q4F
Sources: U.S. Department of Commerce, and UCLA Anderson Forecast
But Weak Demand is the Problem
Although supply is not a problem; demand is. Simply put the economy is growing far too slowly to meaningfully reduce vacancy rates for all product types (especially office buildings), with the exception of apartments. (See figure 7) Even with employment increasing at a rate of 200,000-250,000 jobs a month; it will take a few years to return to the peak achieved in late 2006. (See Figure 8) And the all-important financial activities sector for the office sector, employment in 2013 will still be well off the prior peak. (See figure 9) This is hardly an environment for robust rent increases, especially for the suburban office market which is still suffering from the collapse of the single family home market. Remember all too many suburban office buildings are tenanted by financial service companies tied to housing (e.g. real estate brokers, title companies, mortgage brokers, lawyers, architects and banks).
Furthermore the on-going restructuring of the legal services business will weigh on demand for prestigious central business district office space. (See Figure 10) Simply put the business model of the legal profession is facing challenges from computerized document searches, outsourcing to India and a corporate rebellion against the “billable hour. Indeed several large law firms have created a non-partnership track for lawyers and have set up satellite locations in low cost locations such a Wheeling, West Virginia and Dayton, Ohio.
Figure 7. National office Vacancy Rate, 1991Q1 -2010Q1
Source: REIS
Figure 8. Nonagricultural Employment, 2000Q1 – 2013Q4F
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 9. Financial Activities Employment, 2000Q1 -2013Q4, SAAR
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast
Figure 10. Legal Services Employment, 1990-Apr 2011, Monthly Data, In Thousands.
Source: Saint Louis Fed
The bright side of commercial real estate is the apartment market where the shock of dramatically lower prices has altered consumer psychology with respect to single family home purchases. (See Figure 11) A rush to buy has been replaced by a reluctance to buy and that reluctance is being reinforced by tighter credit standards. As a result the homeownership rate is falling to the benefit of rental apartments with the national apartment vacancy rate dropping from 8% to 6.2% over the past year. (See Figure 12) Moreover with much of the single family home vacancies sitting in the exurbs, the glut of vacant single family homes make them far less competitive with closer-in apartments.
According to a recent national survey net effective rents on move-ins and renewals are rising 4-4.5%, well above the 1% increase reported by the official consumer price index. It is because of the combination rising rents and low cap rates; we are forecasting a doubling multi-family starts from early 2011 to late 2013. As actual rental rates get reflected in the official consumer price index, the rate of increase in the so-called core CPI will vault above the Fed’s informal 2% target thereby inducing a tighter monetary policy. It is ironic that the seeds for higher cap rates will have its origins in rising residential rents.
Indeed with house prices at near record affordability levels and after a few years of rising real rents, consumers will once again learn the virtues of homeownership. In response ownership housing starts will return to more normalized levels and full apartment buildings will face a decline in occupancy rates.
Figure 11. S&P Case-Shiller 20 City Home Price Index, Jan. 2000 – March 2011, Jan. 2000=100
Source: Standard & Poor’s
Figure 12. Home Ownership Rate, 1997 -2010Q1, Percent
Source: U.S. Census Bureau and The New York Times
The demand for retail oriented real estate can be characterized as a tale of two consumers. The higher end consumer, benefiting from rising stock prices and employment stability is back while the lower end consumer is being ravaged by high unemployment, high gas prices and weak home prices. After all, 5% of the households account for 40% of aggregate household income. Simply put the Nordstrom shopper is spending while the Wal-Mart shopper isn’t.
Although retail sales have recovered, the growth rate in sales is well off the path of the mid-2000s. (See Figure 13) Consumers are still in a retrenching mode as the savings rate normalizes from the near zero level of five years ago. (See Figure 14) In addition e-commerce inexorably gains share over store-based retailing year after year. Witness the bankruptcies of Blockbuster and Borders as prime examples of the impact of e-commerce on store-based retailing. As a result, retail real estate which was the investment “darling” of the last decade faces a far more difficult future going forward.
Figure 13. Retail & Food Service Sales, Ex Autos, 1992-Apr 2011, Monthly Data, In $ billion.
Sources: Federal Reserve Bank of Saint Louis
Figure 14. Personal Savings Rate, 2000Q1 – 2013Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Reflecting a weaker than normal rebound in consumption, warehouse demand is slowly recovering from the massive inventory liquidation that took place during the recession.(See Figure 15) Inventories are now rising and will likely receive an impetus from the tragic tsunami/earthquake in Japan. Why? One of the many lessons coming out of Japan was the realization how fragile the global supply chain is. While “just-in-time” inventory control is still the order of the day, there will be a role for “just-in-case” supply management with a resultant increase in the level of inventories.
Figure 15. Real Business Inventories, 2000Q1 – 2013Q4
Source: U.S. Department of Commerce and UCLA Anderson Forecast
Furthermore, because much of what is held in storage is imported, the rise in imports is an encouraging signs. (See Figure 16) Real imports have recovered all of the lost ground that occurred during the recession and are now making new highs. This factor certainly augers well for coastal-based warehouse-distribution facilities.
Figure 16. Real Imports, 2000Q1 – 2013Q4F, Quarterly Data
Sources: U.S. Department of Commerce and UCLA Anderson Forecast
Nevertheless the widening of the Panama Canal in 2014 has the potential to remake corporate logistical maps. No longer will Asian exporters be forced to use a ship-to-rail-link through west coast ports to reach the consumer markets of the Midwest and East. New competition for west coast ports will arise in Houston, Texas; Savannah, Georgia; and Charleston, South Carolina as shippers diversify their alternatives. Simply put, the west coast ports will lose their pricing flexibility.
Conclusion
It’s a happy time for quality commercial real estate in major markets and for apartments in general. As long as interest rates remain low investors will continue to pay historically high prices for those types of real estate. However, because demand growth remains tepid, market prices are increasingly vulnerable to even a modest rise in interest rates. In the meantime with the exception of rental housing new construction will remain muted over, at least, the next eighteen months. Thereafter a modest rebound in the other sectors of commercial real estate will likely occur.
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