There has been several industry articles published recently suggesting very loudly the recovery of the commercial real estate market is finally at hand. These articles can only be deemed to be considered wishful thinking at best or a blatant disregard to the reality of the overall economic situation facing the USA and the World and its impact on commercial real estate.
For example, PricewaterhouseCoopers LLP published a report just in the last few weeks which stated the commercial real estate market will be improving due to increased sales of investment properties; this is a totally absurd conclusion. There are factors that cannot be avoided which put this prediction in direct conflict with the reality of what is happening in the USA and Globally. Commercial real estate does not operate in an economic vacuum.
The PWC report references the MIT Center for Commercial Real Estate Statistic which shows a 19% increase in commercial prices in 2010. So how does that square with the fact that Moody’s released their report in March which shows commercial real estate prices have decreased for the second consecutive month?
“Commercial property prices in the U.S. dropped 1.2% in January, marking the second straight month of decreases, according to Moody’s/REAL Commercial Property Price Index. Despite the drop, prices remain 4.2% higher than Augusts’ eight-year low.”
Why would you use a small number of transactions to base your statistical results? They have no choice since sales really haven’t picked-up to the point that anyone is really comfortable with what the sale comps are in the database. There is no doubt there have been some very eye popping sales lately. This supports the fact the market by all indicators is what the Data providers of the industry are calling a “Bifurcated” marketplace for investment sales. However, one has to take a very close look at the sales that have closed recently. Many of the sales were bought with foreign money, so what may look like a great price here, is actually a cheap deal for the foreign investor taking into account the currency exchange. And because the Fed has helped keep the Dollar low to other currencies there is overseas demand for buying a good yield with well tenanted long term leased Class “A” properties. The only properties being traded are the in the Major “Gateway” cities which are leased to high credit worth companies or Government agencies on long term leases. The investment community is chasing yield which is not a good thing since that is one of the main factors that helped create the last bubble and this is directly due to the Federal Reserve keeping interest rates artificially low on purpose. The main reason the Fed is doing this is to push investors into alternative investments beyond the safety of Government backed instruments. Does this sound familiar? These investors are not using financing as they are institutional investors paying all cash and are looking at their yields only.
CMBS delinquencies have not decreased except for this past month, and the change was practically a statistical anomaly. The rate continues to be over 9% which is not an acceptable level by any means. Banks are as fragile as ever, despite words to contrary by the Feds. “Commercial mortgage-backed securities are showing signs of recovery, but investors remain concerned about the quality of the securities. Many of the bonds are backed by shopping malls and office buildings, and the lack of diversity worries some investors. “That’s a concentration people may be concerned about because there has been no turnaround in this sector, said Darrell Wheeler, senior managing director of strategy at Amherst Securities” and further… “Moody’s: CMBS Loan Delinquencies Rise to 9.18%; The delinquency rate on loans included in commercial mortgage-backed securities (CMBS) conduit and fusion transactions increased 17 basis points in February to 9.18 percent, according to Moody’s Investors Service. Moody’s noted that while still rising, increases in CMBS delinquencies have been moderating since June 2010.
Therefore “moderating” is supposed to be deemed a good thing. I guess if things don’t get worse that’s considered a major improvement, which just shows how bad the economy is in reality. Banks have been allowed to “Kick the Can Down the Street” as a matter of policy (Extend and Pretend) hoping for a resurgence in asset prices, primarily in the commercial real estate sector. How long will this charade last is anybody’s guess.
The housing market is in another free fall, both new and existing home sales have plunged to new lows, the lowest in 9 years as a matter of fact as reported last March. There is a double dip occurring in the housing market which no one wants to talk about. The Case Schiller Index and reports have backed this up. And until the housing market recovers, which sadly is a long way off, do not expect any significant improvement in the overall state of the economy. I know several residential mortgage brokers, and what they are saying is only those homeowners with stellar credit, that have high amounts of equity built-up in their homes even taking into account the price reductions which have occurred over the past 3 years, are getting low interest rates for 15 & 30 year mortgages. With nearly 25% of the entire homeownership in the United States being underwater, meaning the value of their houses are less than the mortgages on the property, you then have to ask the question… how in the world can there be an economic recovery. The Federal Reserve is pushing the rock uphill and they have made a small amount of progress, this after a $1 Trillion stimulus, TARP, HAMP, and all the other measures which they have taken to date including this QE2 program which for the first time in its history is monetizing the Country’s debt. Most people don’t feel the so called wealth effect by virtue of their 401K’s or IRA’s which were also decimated during the financial crisis, whereby most of the population hasn’t yet seen their retirement portfolios recover. Most people feel their wealth via their home’s value. And if 25% of the population is underwater, how will that help their perceptions?
The unemployment problem is still a major drag on the economy and will continue to be so. There is excitement over the fact the unemployment rate dropped to 8.8%. Sorry but that is nothing to get giddy about. The real unemployment rate is still hovering around 17% as the Government statistics don’t take into account those that have left the workforce and/or who have stopped looking for work. The retiring Baby Boomers will be left out of the employment numbers, but they will be counted in the entitlement payment obligations column. Based upon the Government’s own statistics, the unemployment rate is basically static at best, as it is not keeping up with the increase of the United States’ population growth. Here is a quote from 4/14/2011 in the Atlantic On-line Magazine by Daniel Indiviglio “More job openings were reported in February than in any month since September 2008. During the month 3.1 million jobs were available, according to the Bureau of Labor Statistics. That might sound like great news — until you remember that over 20 million Americans want a job, but do not have one. While the trend of more openings is encouraging, the bigger picture for job seekers remains bleak.”
Now you have gas prices skyrocketing which is creating skyrocketing food prices. We all know that higher oil prices seep their way into almost every corner of the economy. Add to this the continuing fiscal irresponsibility of the Federal Government, the States and local governments slashing jobs due to their own budget woes, and you have a perfect mix for what, a recovering commercial real estate market? The Federal Reserve revised downward the last quarter’s GDP. The rate in which the unemployment rate is dropping is not enough to impact vacancy rates, and certainly not enough to make a dent in the overall economy. There is the Pink Elephant in the room which nobody wants to discuss never mind try and solve, and that is the unfunded pension liabilities and the Social Security entitlement obligations which are about to explode with the aging Baby Boomers.
Although just announced today, Retail sales increased by 0.4% less than the economists had expected, the fact of the matter retail sales can’t help but slow down taking into account the rapid escalation of gas prices and the subsequent effect this will have on everything related to oil, which just about covers all economic sectors. Consumer confidence is falling like a stone due to the higher gas prices which is the future barometer for retail sales activity but the media refuses to report reality. The trade deficit dropped last month, but that is not taken as a good omen, as it signals a slowdown in both our exports and Global economic demand. Today (4/13/11) Britain reported the largest drop in retail sales since 1995! It appears we are a few steps behind our cousins.
The ICSC (International Council of Shopping Centers) is pushing Congress to enact taxation for all states to charge sales taxes on internet purchases. This is their way of social engineering; by enacting Internet sales taxes, they feel it levels the playing field and it will push people back to shopping in brick and mortar stores…That is not going to happen, and the lack of sales taxes are just a small part of the reasons there has been an increased use of the Internet for retail purchases. Therefore more money will be taken out of the consumer’s pockets to go towards taxes; that will really help the economy don’t you think? If you think there has not been a major paradigm shift just take a look at what has happened with Border’s and Blockbuster. The Internet taxation issue is a red herring in this writer’s opinion.
Manufacturing is supposedly on the rise, the reality is this is due to a drop in inventories, and as soon as sales reflect lower demand, which they will, this sector will also slow down again. Auto sales have dropped significantly in March, as this accounts for much of the statistics affecting the manufacturing sector. Japan is closing plants in Europe due to parts shortages due to last month’s tragic event.
The Federal Reserve and several of the “so called” economists, you know the ones that the media always refer to by the name “many economists” think the Fed has created what is now being called a “self sustaining economic recovery”. When the Federal Reserve ends its QE2, which has kept interest rates artificially low, interest rates will once again increase. Inflation is already a factor. But the Federal Reserve and the “Economists” discount this because if you take out the volatile Fuel and Food items, inflation is relatively moderate so they say. Well folks, how can you disregard these two of the most important ingredients of the CPI? What do people purchase most often just to live and work, right Food and Fuel? That is like saying if we just stop breathing we can reduce the Carbon Dioxide levels in the atmosphere.
The problem with the type of reports which are being released by such firms as Pricewaterhouse Coopers LLC, E&Y, Jones Lang LaSalle and so forth, is the fact they are not reflecting reality. They are providing a very skewed and narrow view of the market. They are not reporting as to what is going on at the Street level of the commercial real estate industry. Investment sales are only a small part of the commercial real estate business. Leasing is one of the most important factors which is most times discussed in passing or overlooked altogether. Vacancy rates have all to do with leasing and the unemployment rate. Companies for the most part are changing the way they are conducting business. Productivity has significantly increased due to fewer workers doing more work that used to require more people, and technological advances. Telecommuting is being pushed and adopted big time which reduces the need for physical space to house those workers and it helps reduce a company’s carbon footprint. The office vacancy rate has dropped by not even 100 basis points nationally, except for in a few of the major ‘gateway” markets such as Washington DC. But that is about to change as well. As reported by the WSJ recently…” In Washington and elsewhere, government leasing has helped prop up demand in tough times. But now cash-strapped governments are moving to cut back on office space, even as commercial real estate struggles to recover. The Office of the Comptroller of …” What does this say about the commercial market? It says much more than a few high profile sales by large institutional investors.
Now add to all the above what has recently and tragically happened to Japan and the upheaval going on in the Middle East and you get more uncertainty which businesses just hate.
So how can the fundamentals be in place for a commercial real estate recovery of any sort? They aren’t in place is the short answer despite what the media, large advisory firms or large brokerage firms say otherwise. It is not in their best interest to tell it like it is. We all would like to see the economy get back on its feet, that being said, the amount of damage done by Wall Street, The Rating Agencies, the “Too Big To Fail Banks”, along with the complicity of the Federal Government and the Federal Reserve, has created a sum total of problems which are too great to expect any sort of quick recovery and by all evidence most people believe we are still in a deep recession. New York, Washington DC, Los Angeles, and San Francisco are NOT the indicators for the overall health of the commercial sector. They have the highest profile, and they are in the Media Rich markets so they gain almost all the attention.
What doesn’t get discussed or given any attention by the main stream media and or the large industry players is the small business sector. The small business sector has been the largest creator of jobs in the United States for the past 15 years. They are under attack and sorry to say retreating. This is not a good thing for the overall economy.
If there is anything to be worried about is not falling into a deeper recession, (as this writer does not agree with the folks who use “certain” stats to say the recession ended over a year ago) which is very possible given the problems outlined above. In Addition there are certain indicators or practices which are being promoted which totally neglect the economic events of the last three (3) years and history will indeed repeat itself and it won’t take twenty years to happen again.
I know this recession is the longest since the end of WWII and it will maybe take a few more years for the United States to get back to a fully functioning economy, and that is a big Maybe! But to say Commercial Real Estate is on the road to recovery is completely delusional. But I guess if enough people say that is case it must be true…at least that is what the main stream media and the large commercial real estate firms are trying to accomplish which is a false sense of well being.
Bob Canter Founder
Canter Center for Commercial Real Estate