Insanity: The New Norm
- Dec 05, 2012
Insanity: doing the same thing over and over again and expecting different results.
By Kenneth P. Riggs, Jr., Chairman & President of Real Estate Research Corp.
We must be an insane lot. We’ve seen this play before, performed by the same actors, and for some reason, we think (perhaps “hope,” is more accurate) that this time, things will turn out differently.
But it shouldn’t take Einstein to tell us that it is unlikely we will see a different outcome during this fiscal crisis. Not only are we up against another debt ceiling, but we are also facing the “fiscal cliff” of automatic tax increases and cuts to domestic/defense spending, which this same administration and Congress concocted when they were unable to come to agreement about raising the debt ceiling last year. As a result of that debacle, Standard & Poor’s lowered the nation’s credit rating to AA+ (the first downgrade in our nation’s history), the stock market tanked, and investors were left holding the bag. This time, both Fitch and Moody’s have already stated that they will lower their credit outlooks for the U.S. if lawmakers do not take meaningful steps to reduce the nation’s debt burden. Meanwhile, the stock market leaps at any hint of success, and falters when the political commentary is less hopeful.
Although it is hard to believe that the administration and Congress will be so negligent again, some investors do not expect an outcome to this year’s fiscal crisis that will be any better than last year’s crisis. As a result, many investors are taking steps to reduce potential tax increases for 2013 while maintaining their positions for possible bull market returns in case an agreement is reached by year’s end. While some companies and investors are selling real estate and other holdings in 2012 before capital gains taxes increase, other companies are even borrowing money in order to issue large dividends to stockholders so companies can avoid the tax consequences as a result of the fiscal crisis and the twisted political environment that are due to take place in 2013 and beyond.
There is some sanity in this crazy world, however, as reflected by the relative steady returns that investors have been able to earn for commercial real estate compared to more volatile investments. Commercial real estate isn’t glamorous, but as shown in the accompanying graph, the spread between RERC’s required pre-tax yield rates for the “All Property Types Average” and 10-year Treasury continues to climb at a reasonable pace (see third quarter/fall 2012 RERC Real Estate Report), and commercial real estate is well on its way to recovering the peak performance earned in first quarter 2009.
As we recognize that the insanity in this crazy world is our new normal, the best investment advice RERC can give investors is to learn from the past. As such, our expectations for 2013 are:
- Economic growth will remain slow, despite the upward revision to GDP growth of 2.7 percent in third quarter 2012. (If lawmakers fail to reach some type of agreement or postponement to avert the fiscal cliff, 2013 growth is expected to contract.)
- Unemployment will remain uncomfortably high. More than 12 million people remain out of work, and if not for those leaving the workforce altogether, the unemployment rate would be much higher. The employment-population ratio is 58.7 percent, and the workforce participation rate fell to a three-decade low of only 63.6 percent, according to the BLS.
- Quantitative easing will be with us for a while. Federal Reserve Chairman Ben Bernanke issued QE3 in September, with the possibility of buying securities indefinitely. Although there is skepticism about the effectiveness of this policy over the long term, the intent is for the added liquidity to help the housing market gain traction and to encourage consumer spending.
- The slow global economy is beginning to negatively impact the U.S. economy. Exports were down in third quarter 2012, and the Institute for Supply Management-Chicago Business survey business barometer reading fell to 49.7 in September, the first time that business activity contracted in the past 3 years.
- Commercial real estate will continue to be a reasonable investment choice for investors seeking realistic returns and minimal volatility. This investment class received the highest investment rating of 6.6 on a scale of 1 to 10, with 10 being high, from RERC’s institutional investment survey respondents in third quarter 2012. (The rating for commercial real estate was higher than that for stocks, bonds, or cash.)
- Commercial real estate fundamentals are improving slowly. With the exception of the retail sector vacancy rate which remained unchanged, the national vacancy rate for each of the property types declined slightly during third quarter 2012, and expectations are for this trend to continue in 2013.
- RERC’s required pre-tax yield rates and required going-in cap held steady or compressed slightly for most property types during third quarter 2012, except for the regional mall sector and the hotel sector. RERC expects these rates to hold steady in 2013.
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