What’s the State of Our Economic Recovery?

By Rick Chichester, President & CEO, Faris Lee Investments: How to navigate the near-term economy relative to the real estate market.
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In the the ninth inning, with (maybe) an inning of overtime… the real estate investment market continues its strong performance, with demand outpacing supply, strengthened by a slowly improving economy, job growth, and historically low interest rates. But, inflation continues to be stubbornly low and now it is the Fed’s primary focus, as opposed to its initial concern for unemployment/underemployment. The government has spent well over $11 trillion to rescue the economy from the grips of the great recession of 2008 through such programs as: Troubled Asset Relief Program, Federal Reserve Rescue Efforts, Federal Reserve Stimulus, FDIC Bank Takeovers, Housing Initiatives to rescue the housing markets, as well as other financial initiatives designed to rescue the financial markets. And, all this, only to produce moderate economic expansion and anemic inflation growth. So what, really, is the state of our economic recovery and how do we best navigate the near-term relative to the real estate investment market?

Following are some high points of interest, which suggest to me that we are in the bottom of the ninth inning, but with (maybe) one extra inning of overtime:

  • NASDAQ hits an all-time high last week, but more stocks were down than up, meaning fewer stocks are leading the market.
  • Stock repurchases exceeded $700 billion in 2014 as cheap debt fueled company stock buybacks in an effort to bolster stock prices.
  • Low interest rates for too long are destroying savers.
  • S. fracking industry has slowed substantially and yet there is $600 billion in junk bonds and leveraged loans outstanding, Big Oil announces job layoffs, and, we are six years into a recovery.
  • Globally, China’s economic growth is slowing and its stock market is being propped up by the government through its artificial buying of stocks, the banning of pension funds from selling stocks, as well as, allowing many firms to simply halt trading. China’s real estate market is softening significantly and these realities are critical as the Chinese economy is principally supported by real estate ownership. In China, 75 percent of household wealth is attributed to real estate, as opposed to just 28 percent in the U.S. Add to this the challenges and fragile nature of the economies of Russia, Venezuela, Brazil, Italy, Puerto Rico, Greece, Spain, etc., all in all, it is a very fragile, in debt, global economy.

With the above as context, on a relative basis, the U.S. economy is doing well, and as such, remains the global risk-adjusted investment of choice. The dollar is the preferred currency and continues to strengthen as evidenced by the demand for the 10-year T bill. Therefore, the most significant issues for the Federal Reserve in the near term are balancing the challenges of lower than acceptable inflation; the risk of deflation; unemployment/underemployment; and the rationale of when and how to raise interest rates with limited disruption to the economy. But, as the Federal Reserve only controls short term rates and the demand for the U.S. Treasury continues to strengthen, the real effects on rates will be minimal. As such, expect the Fed to raise rates shortly. Low inflation and low interest rates will be the new normal.

With regard to the real estate market, it is proving to be stable and more predictable as there is not an oversupply of new development. Tenants have right-sized and improved their business strategies, aligning themselves to the new realities of customer-centric omni-channel distribution and service. With interest rates continuing to remain historically low, there should be limited impact on capitalization rates. In fact, as the U.S. economic recovery matures and begins to moderate and sourcing for longer term yields is at a premium, I expect to see cap rates continue to decline slightly for core assets and credit tenancies. There is some risk for the secondary and tertiary asset class, however, and in this asset class there is growing evidence of a divide between seller and buyer expectations. We are entering the later stages of the U.S. economic recovery, and although the stock market is at all-time highs, there is significant volatility and with the employment market improving, there are structural challenges for businesses to sustain real growth. As such, real estate is an excellent long-term investment class, providing stability, however, underwriting, pricing and operational expertise is at a premium. Not all real estate is created equal, and as pricing expands, the margin for error narrows. Therefore, discipline and rigor will be paramount, but if managed and executed with care, the risk-adjusted benefits remain excellent. As we enter the later stages of economic recovery, managing real estate investments accordingly becomes increasingly crucial. It is a good time for owners and investors to ask themselves: if the economy were to reset on the downside, what is the tolerance of our real estate to support its tenancies and debt obligations?