Commercial real estate folks are optimists by nature.
The glass is generally half full at our table. We see changes in market conditions as a new challenge rather than something to celebrate or lament.
Change is a constant in the world today, and the commercial property sector is no exception. So, it’s wise to keep current on economic factors shaping real estate trends that could impact your business.
With that in mind, let’s take a look at what’s going on out there and see if we can give you some forward guidance on your next real estate decision.
The Global Economy
We like to start at high altitude and work our way down.
First, the global economy. Not good.
Global growth has slowed to a crawl, emerging economies are swimming in debt due to a slowdown in manufacturing and a collapse in the price of raw materials like oil, natural gas and copper.
Currencies around the world continue to lose value against the US dollar and sovereign bond debt is being downgraded, making it more expensive. Central banks have resorted to negative interest rates in some countries to stimulate economic activity. Even Saudi Arabia is issuing its own T-bills to fund a budget shortfall.
Enough already, you say.
Okay, there’s more, but our point is clear enough.
The US Economy
Let’s compare the global goings-on to what we are experiencing here at home.
All things considered, it’s good to be in America.
Our national economy is in much better shape than just about every other country around the globe, but that’s a fairly low hurdle these days.
The last US recession ended nearly six years ago, but the recovery has been sluggish at best and polls show that many Americans still “feel” mired in recession. How can that be when the statistics clearly show steady employment and GDP growth, the key indices of economic health?
The answer, at least in part, lies in the type and quality of jobs being created and the rate of growth in real wages that help people feel like they’re not just running in place.
Job gains have been running close to 200,000 new positions per month for the past two years and the unemployment rate through February stands at 4.9% after another 242,000 jobs were added during the year’s shortest month. That sounds pretty good until you take into account that a substantial portion of jobs created are part time, and many full time jobs offered are lower-skilled positions that pay poorly.
Often, these are jobs that can be easily eliminated, like those in the restaurant and drinking establishment sector. So, even those who get a new full-time job are wary of losing it on short notice, which has contributed to sluggish consumer spending in general, and retail sales in particular.
All that aside, the US economy still expanded by 2.4% in 2015.
It remains to be seen if that pace can be sustained, as global economic woes begin to show up in US statistics. One just needs to look at the energy sector in the US to understand how global factors can impact local economies here at home. Texas, Oklahoma, North Dakota and other states with a large energy component to their economies, are feeling the pinch.
Layoffs of highly-paid, full-time energy workers have become commonplace, and many believe that the fallout from the collapse of oil prices is just beginning. Houston’s office market, for example, has seen a rapid rise in sublease inventory, which has the vacancy rate on the rise and is keeping new development projects on the drawing boards.
Enough already, you say.
Okay, there’s more, but another point is made.
How Commercial Real Estate Fits In
When we look at commercial real estate metrics on this economic backdrop, things seem to be out of whack.
Absorption in 2015 for retail, office and industrial properties across the country was robust. Rents rose steadily in all three product types and vacancy rates continued to move down.
So, does that mean we are insulated from global economic challenges? The answer is yes and no.
Much of our growth is internally generated.
We produce, buy and sell enough products and services to keep our economy going, but we are also becoming more dependent on commerce with the rest of the world to generate strong growth. Many of our largest corporations like Apple, Johnson & Johnson and Caterpillar, generate more revenue abroad than they do at home.
With foreign currencies losing value against our dollar, that is not good for international business and recent earnings reports from companies with high levels of foreign sales, have made clear the challenge of the global slowdown. That will eventually impact net absorption for commercial real estate here, as companies reduce expenses to maintain profitability. Announcements of workforce reductions are becoming more common and this is a trend that is very likely to continue in 2016.
If absorption slows, rent growth will slow with it and vacancy declines will moderate. Developers will have to re-sharpen their pencils and lenders will most likely resort to more cautious underwriting. Add in the potential of higher interest rates that result from action by the Fed, and even the eternal optimists out there will start to hedge on their predictions.
If all that comes to pass, is it necessarily bad news? We think not. In fact, in many markets, a rebalancing of supply and demand would be welcome.
In Central Los Angeles, industrial vacancy could triple and the vacancy rate would still be under 7%.
For growing companies around the country who are hungry for good quality expansion space, there may be more than one building on the search list if demand became less intense. The “sticker shock” being felt by businesses that last signed a lease four or five years ago, will be mitigated, and owner-users may not have to pay as much of a premium to be the winning bidder.
Moderating occupancy costs would free up more capital for revenue-generating activities that will, in turn, boost GDP and employment growth. Like seismologists who prefer more frequent small earthquakes that reduce the chances of a big one, we would rather see smaller, more frequent market corrections that reduce the chances of another catastrophic economic event like the one we all experienced in 2008.
One interesting point, commercial real estate metrics reflect decisions that were based on conditions six months to as many as three years ago.
If you put that in perspective, it’s important to project the potential impact that current events and economic conditions will have on real estate metrics six months to three years hence.
With things changing as fast as they are, it’s a good idea to track changes in your local market and update your facilities plan accordingly.