What we call things and how we describe things is very important in terms of their meaning and potential impact on future behavior.
Take the flags at a race track as an example. The green flag says go as fast as you can. The yellow flag signals trouble up ahead. Wave that yellow flag at a driver and you’re telling him the danger is in the next corner. Wave a red flag in the middle of a race and everyone heads for the pits. Cross the finish line first on the last lap and that waving checkered flag means someone just won the race.
Adherence to the flag rules makes racing safer and more predictable. The same goes for the rules of economics even if they are not as clear cut as those on a track. However, basic definitions of economic events do provide a great deal of guidance to business decision makers, and to varying degrees, are relied upon at a level that influences action. They need to know what macro-economic trends are in play to make good judgments on how those trends will influence their future revenue and expenses.
Macro metrics like GDP growth, interest rates, inflation, unemployment, wage growth, bond yields, cap rates and other economic markers shape general conditions. If the economy was a giant pool, each one would have some influence over the temperature of the water. Each business owner has his or her own temperature preference and will decide to take a swim accordingly. Put another way, economic conditions in their entirety have a different impact depending on the unique circumstances surrounding every business and its owners.
This is why the recent flap over whether or not the country is officially in a recession drew our attention. The R word invokes fear in some, enough perhaps to back out of a deal, delay a real estate decision or press forward with one with greater urgency. Last week, it became a matter of record that the US economy experienced a decline in GDP for the second consecutive quarter. Most people who follow economics at all will tell you that generally defines a recession, as every recession we’ve endured since 1955 included that metric. However, there are other factors to consider like employment, wage growth and consumer spending, among others. The federal government relies on the National Bureau of Economic Research (NBER), a private think tank that often takes months to forensically determine whether the country is or was in a recession during a given time period. Often, the economy is in and out of a recession before the NBER declares one.
So, those two quarters of decline in GDP, don’t conclusively tell us anything other than the fact that the economy is shrinking, generally not a good thing. However, employment and wage numbers are still looking good and indicate that many businesses are still expanding. Typically, symptoms of recession include a rise in unemployment and downward pressure on wages, neither of which is currently the case. But, on the flip side, the yield curve between the 2-year and 10-year treasury notes issued by the US Treasury has been inverted for over a month and the spread is increasing. This means the yield on the 10-year is lower than that of the 2-year, a phenomenon that has consistently manifested prior to nearly all the US recessions since WWII.
We let the politicians on both ends of the spectrum argue over the semantics and try to move the goal posts to gain advantage. Instead, we focus our attention on what we believe recent economic events, however they are labeled, could mean to our clients; commercial property owners and occupiers like you.
As far as the decline in GDP goes, there’s nothing good about it. Whether it means we are in a recession now is apparently open to interpretation, but the fact that the economy shrunk in the first half of the year is not. Even Amazon is losing money. We had to hear that a couple of times before we believed it. The fastest growing and most innovative e-commerce company on the planet has been significantly impacted by a decline in demand for goods, enough that it has decided to shed over 10 million square feet of fulfillment infrastructure. Who’d-a-thunk? Why is this important? Consumer spending accounts for 70% of GDP. So, when big e-commerce companies like Amazon, and big in-store retailers like Target and Walmart are issuing financial warnings of sluggish growth, the GDP decline should not be ignored.
Manufacturing is slowing back down again, as well, and oil prices have sagged of late in anticipation of a worldwide recession that would crimp demand. Even China’s growth has stalled and the country has some big problems to address like its sagging real estate market, aging population and low birth rate.
Whether we are officially in a recession or not, it doesn’t change the fact that things are slowing down around the world. We recommend that you, as a property and/or business owner, ask yourself at what point does a shrinking overall economy become a real problem for you based on your unique circumstances. And while you’re at it, don’t forget to think about what opportunities a recession could create for you. We know quite a few property owners who acquired significant portfolios by buying smart in struggling markets. It’s too early to tell whether or not we will even see a significant correction in the near term, but those with patience and dry powder are giving it a lot of thought.
Beside the economic slowdown, rampant inflation and the rise in the cost of capital that has occurred via efforts to get it under control, is what’s making us lose the most sleep. The Fed is on a tear right now, raising its Fed Funds Rate in big chunks to get a handle on the worst inflation we’ve seen since 1982. Mortgage rates for industrial properties have risen sharply, up 60%+ in just 5 months for owner/user SBA 504 loans. Investors are feeling the pinch, too, as the cost to borrow money now exceeds going-in cap rates, a dynamic that can’t continue. Either rates have to come back down or prices will have to fall, and that fact has definitely impacted demand, especially in the last two months. More users and investors are heading for the sidelines and adopting a wait-and-see attitude. We think this change in sentiment will show up in the numbers beginning in Q3.
Yet, even with the economic headwinds, good quality properties are still moving quickly at record prices. The current pool of buyers with the courage to transact in shifting conditions, are insisting on buying quality to mitigate future risk. Land deals at sky-high valuations have gone away and even the cash-rich institutions who are hired to spend other people’s money, are becoming more cautious.
So, we see things as iffy and becoming more so through the end of this year. Good quality product will move at or near current price levels, whether it be for sale or lease. But, lesser quality product will sit longer and inventory will accumulate over time. That will shift at least some of the momentum to buyers and tenants, a scenario we haven’t seen for a long time.
We will continue to update you as we learn more, but first, one last point. Your strategic action plan is not a one-size-fits-all affair. So, we recommend that you carefully monitor current events and evaluate their potential impact with your own circumstances in mind. Let us know how we can help.