Spring Update. This update is the latest in our series of periodic reports which take a closer look at macro factors impacting commercial real estate (CRE). As in all of our reports, we take a fact-based approached using independent research to produce an unbiased analysis of key developments from a CRE perspective. Fore more, go to http://www.YeskeyRealEstate.com.
Groundhog Day? One of the most notable surprises that emerged in spring 2012 is how closely trends are tracking 2011, which was marked by an early sense of economic optimism, and followed by subsequent shakiness in capital markets, culminating in severe stock market volatility in August and September. This chain of events – which appear to be repeating – ultimately contributed to a pause in the forward momentum of CRE fundamentals and transactions. Will 2012 end in another pause for CRE, or will the remainder of this year feature the resumption of recovery?
Macro Perspective. We view current trends as part of a larger cycle, where the Great Recession has led to a Great Debate over how much government intervention is appropriate, illuminating the need for a Great Strategy for how the U.S. will compete globally given the emergence of competing industrialized economies. These topics are discussed in reports posted on our site, and this pop quiz is designed to help show where you stand on this issue:
Repeating Patterns. The biggest surprise in 2012 may be how much it looks like 2011. This is significant, because 2011 featured a stock market meltdown in August and September, the impact of which has been underestimated. The extreme stock market volatility was a defining moment in 2011, leading to subdued economic growth and a loss of momentum in the recovery of CRE fundamentals and transactions. 2012 is an election year, but that hasn’t stopped it from looking like a repeat of 2011, with early optimism of the economy giving way to underwhelming results, and a strong stock market performance that has begun to falter. A closer look at comparative returns shows that stock market indices were negative in late 2011 before rebounding in March and April, and then weakening in May.
Repeat of 2011? The chart above includes some good news for CRE, which continues to outperform stocks and bonds. However, the days where developments in the economy and stock market impact CRE with a significant lag are over, and the window is closing. Last year, the stock market meltdown of August and September had an almost immediate impact on CRE, in terms of slowing momentum of recovery. The future is unknown, but the underlying factors remain, so another summer/fall stock market swoon remains a possibility.
Root Cause Persists. Analysts and pundits have blamed various factors for the extreme stock volatility in the summer/fall of 2011, including economic weakness, low job growth, and European Debt concerns. While these factors certainly contributed, we believe the root cause was lack of investor trust. Investors no longer trust capital markets and the financial system, and doubt the numbers they hear, all of which has been exacerbated by news items such as the MF Global Scandal, and the recent huge losses by JPMorgan Chase. Lack of trust and confidence by investors drove the stock downturn last year, and trust has continued to erode, raising concerns that further volatility could be in store in 2012, which could impede CRE.
Strength of Economy is Debatable. In what is becoming almost an annual tradition, several prognosticators once again forecasted 3-4 percent GDP growth for 2012, and were once again underwhelmed by lower than expected growth in the first quarter. For 1Q12, GDP growth was 2.2 percent, and the true surprise may be that growth in the 1-2 percent range continues to be viewed as a disappointment. Our view is that the U.S. is a very mature economy in the process of slowly emerging from an extreme crisis, and that 1-2 percent should be considered the norm rather than a negative surprise. Economic recovery remains very fragile, but remains on track. In fact, despite lack of investor confidence, and potential for further stock market volatility, the amount of positive factors currently appear to outnumber negatives.
Unsurprising Developments. In early 2012, we published a set of forecasts for the economy, capital markets, alternatives, and CRE, and several of our predictions have come true, including the following:
- Despite some watering-down and delays of Dodd-Frank and Volcker, government
oversight is having a major impact
- Slow economic recovery continues, with GDP growth in the 1-2 percent range, and
unemployment edging down
- Consumer spending remains weak, as deleveraging continues
- Housing recovery remains flat and unconvincing
- Capital markets strong in early 2012, but appear to be fluctuating, and potential for
extreme volatility remains
- For CRE, debt remains hard to come by, and closings remain subdued, despite ample
- CMBS is necessary, but issuance remains well below peak, and some restructuring is
- REITs continue to outperform stocks and bonds
- Global CRE investors continue to favor the U.S.
- Euro is declining, more talk of a real estate bubble developing in Asia
CONCLUSION: MORE SURPRISES AHEAD?
What’s Next? The big surprises, minor surprises, and non-surprises that emerged during the spring provide some clarification of what to expect for the remainder of 2012.
- Government Oversight: The JPMorgan Chase issue and the election have intensified
the debate about regulation, and Wall Street continues to fight, but all parties seem
to agree that some regulation is inevitable, and will impact the financial system and
availability of debt for CRE deals.
- Economy and Jobs: The economic and employment recovery remains slow and may
lose steam, but is expected to continue.
- Capital Markets: Investors remain highly distrustful and potential remains for another
period of stock market volatility, perhaps comparable to the August/September 2011
meltdown. REITs continue to outperform, but the trend could be threatened by volatility.
Bottom Line: For CRE, the expectation is for a continued slow recovery for fundamentals and transactions, unless there is a reversal of GDP growth or an increase in capital markets volatility in the capital markets, either of which could cause another pause in growth.
Dennis P. Yeskey