July 31, 2019
Enough Already! Congress’s inability to accomplish much beyond more record spending to avoid a default on U.S. debt obligations; the Federal Reserve thinking it is a fourth branch of government and adding a third role to its responsibilities with the most over-telegraphed rate cut ever this Wednesday; financial institutions failing to defend against massive data breaches like this latest Capital One Data Breach impacting an estimated 100 million; cries that housing is falling because builders won’t overbuild while politicians can’t figure out how to stimulate affordable housing; the appraisal industry not understanding why the bank regulatory community and NCUA are raising the threshold for when an appraisal is required (NCUA the latest to raise - $1.0 million - as they don’t see a value proposition in appraisals like they once did); and secondary schools starting earlier and earlier every year with no better outcomes. These are just some of the items behind this week’s “Enough Already” theme. As I had to surface from summer research and vacation to re-engage with work travel, industry presentations, and a bank regulatory briefing this past week, I so wanted to go back on vacation after reflecting on some of the aforementioned for my preparation to brief the bank regulators at the FDIC this past Monday (July 29). So why are these items relevant to this week’s WIN and commercial real estate?
First: Uncontrolled government deficit spending affects the cost and availability of capital for industries like commercial real estate that now rely on $4.1 trillion of that capital (banks once again holding the largest portion).
Second: The Federal Reserve is no longer following the market by studying the data and responding accordingly; rather, it is driving the market. Would just a single reporter please ask the Fed chair at Wednesday’s press conference to list five metrics it is data dependent on (GDP, Jobs, NFIB Small Business Optimism, ISM, Home Prices, Unemployment, Spread between the 2-year and 10-Year Treasury, Stock Market prices, the Tooth Fairy Inflation Index, etc.)? How is the market to take the Fed seriously with its “Data Dependent” statement when they won’t give tangible guidance around what data they are dependent upon? It sure isn’t anything about the U.S. economy if they cut rates as expected Wednesday.
Third: Cybersecurity and data breaches are the single greatest threat to our election process, financial system, and institutions, and e-commerce. In 2017 we had Equifax impacting nearly 150 million Americans that will now get $125 or free credit monitoring for a year. This week we learn of a 100 million impacted in a March 2019 data breach at Capital One. If we don’t get cyber security right, capitalism and this shift to an “online order and deliver to me” economy won’t function so well. Attention Congress and the Fed … pay attention here and think before you let social media manage a digital currency like Libra.
Fourth and Finally: Commercial real estate is as healthy as I have seen it in my 35-year career, but that can be short-lived if the fundamentals are overlooked. We can high-five more home price appreciation, 120 months of economic recovery (longest on record), a rising commercial property price index (CPPI) by RCA or Green Street Advisors, stellar multifamily and warehouse property performance despite additions to new inventory, but “bleep” happens and disrupts markets relatively quickly. What kind of disruptions you ask – as did the bank regulators this week in DC?
I have been warning about items like Lease-Accounting, over-investment in Opportunity Zones driven more by tax benefits than market and feasibility fundamentals, a lack of affordable housing, population and wealth migration away from high-tax states potentially creating a domino effect on unfunded pension liabilities and funding of vital infrastructure in high-cost states like NY, NJ, California, etc. 2020 and 2021 are the time frame when many of these risks mature and get decided by our election process. Start paying attention to how your portfolio is positioned, what markets you plan to expand into, and the “what-if” scenarios around property valuations and feasibility of new construction with rising construction costs. “Replacement Cost” and “Highest & Best Use” are two CRE tools to brush up on and consider with every new debt or equity real estate investment in 2H19 and 2020.
Legacy Featured Revisited - Uncontrolled Federal Deficit Spending: Congress and the White House reached a budget deal this past week to avoid a default on our U.S. debt obligations; however, it came at a price. That price is $320 billion more in spending. Recall this year started off with the longest-ever government shutdown over funding for a border wall. So much for fiscal restraint, and I can only conclude that those long TSA wait lines back in January were for nothing. Both parties have thrown fiscal responsibility out the window, and our fiscal priorities are all out of whack. Why is this a real estate issue? If you have been reading my WINs, or following my presentations covering the $13 trillion in negative yielding debt, the Federal Reserve, and the U.S. debt clock, you know the answer is eventually it impacts interest rates, availability of capital for things other than servicing debt and asset prices. We are a FIAT currency (nothing tangible backing its value) and we are an out-of-control spender demanding the world finance us. Typically, FIAT currencies that debase the value of their currency end badly (Rome, China in 1040 AD and Germany post WWI). On this point I want to present again the Congressional Budget Office latest summary report on receipts (tax collections) and spending through June 2019 and nine months of the current government fiscal year. Yes, we are growing revenues between 2.5%-3.0%, but we spend more than we take-in. Although receipts/revenues are up +2.7% for the October 2018 through June 2019 portion of the current government fiscal year, spending is up 6.6% (and that is before the latest budget deal that will add another $320 billion). And what is the spending line item with the most growth? That would be Net Interest to service our Public Debt. It is growing at 16.1%.
Economic and Real Estate Industry News of the Week: It was a good week. The first read on Q2 GDP came in at +2.1% (less than the 2.5% I had guided towards). The strength was in consumer spending. Tariffs are taking a bite out of the economy and inventories have been drawn down. That means they need to be rebuilt here in Q3 for the peak holiday retail season and for manufacturers to avoid supply-chain disruptions in 2H19. Next, earnings have continued to beat expectations. Approximately 170 companies report this week and over 60% of S&P 500 companies will have reported out earnings by the end of this week with mainly auto manufacturers and retailers to come. Another star was Procter & Gamble. Over the last four quarters, the company has surpassed consensus EPS estimates all four times and Procter & Gamble is not having difficulty managing in a tariffs environment by adjusting supply-chain, increasing some pricing across all lines, and enhancing efficiency. When multinational consumer products like Procter & Gamble, J&J last week and Walmart and Target to come are delivering strong earnings results and reporting health by the consumer, we are not anywhere close to this recovery ending. Follow the corporate earnings is a data dependent metric the Fed should follow. It’s where the rubber of the real economy meets the pavement. And with these kinds of earnings result, commercial real estate will continue to perform as well. The best most recent report out on this point is by Colliers International with their Q2 Industrial Outlook.
What did it say?
It said that:
- Q2 net absorption was up nearly 50% over Q1 to 60.9msf.
- It noted that warehouse asking rents reached a record high of just over $6.00/sf.
- And, it highlighted that the overall vacancy rate fell below 5% to a record low of 4.9%.
- And the result was record new construction activity of 306msf.
Don’t fret over the record new supply underway, we are only in the first or second inning or physical retail moving online with grocery, autos, and everything else we consume to come. The new “Big-Box” in retail is an e-commerce warehouse box.
This new macro look at industrial real estate by Colliers concluded with the following statement and four spot-on graphics that I concur with:
“Despite a drop in activity compared with the previous year, fundamentals for industrial real estate remain solid with record low vacancies and record high asking rents and product under construction.”
Q2 GDP was OK but still above 2%. It is slowing, but GDP is buoyed by consumer spending. Q2 earnings season is almost two-thirds done - and overall is beating expectations. Recall that Bloomberg piece prior to the 4th of July calling for dire disappointing earnings and my July 10th WIN calling BBQ-sauce on that Bloomberg forecast? We now have three consecutive quarters of corporate earnings beat expectations and managing through tariffs with a combination of supply-chain adjustments, modest price increases, and efficiency improvements to mitigate the full cost impact from tariffs. China is feeling it and I refer you to the following Bloomberg and Industry Week articles to understand the devastating impact tariffs are having on China’s economy. My LinkedIn post stated the following:
“So you don't think the tariffs are impacting China? Think again. Great piece by Bloomberg from earlier this month. And these Supply-chain moves/adjustments won't reverse so quickly if a Trade deal is reached. This may be one time China's gamble to wait out US elections does permanent Economic damage. This trade war and fight for intellectual property rights is working and worth some patience."
Next up is the over-telegraphed Fed rate cut Wednesday. It will be the first believe it or not in a decade. The Fed will end the 9-rate hike cycle that started in 2015 and take us backward to ending the QE experiment. Then we get the July jobs numbers – first by ADP on Wednesday July 31 and then the BLS on Friday August 2nd. We will see a number in the range of the 165-175k per month experienced in 1H2019.
Have a good week! And remember you can find all my industry presentations on the ACRE website!
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