It is roughly 1,600 miles from both Los Angeles and New York, but Houston sits squarely in the middle of the country and at the epicenter of a soaring economy. With an unemployment rate of 3.7% (lowest in the nation), an economy that is diversifying beyond the traditional oil sector (energy is 26% GRP versus 52% eight years ago), and a business-friendly climate where 26 Fortune 500 companies make their home, Houston is enjoying a boom that is the envy of both coasts.
Continue reading ‘A Tale of Two Cities’
Words are powerful and no one understands that more than Fed Chairman Ben Bernanke. Among those who follow the actions of the Federal Reserve, many believe that the Fed will hold rates steady at its meeting this week. All eyes will be scrutinizing the phrasing of the statement in order to uncover clues to any future rate increases. This type of semantic analyses can impact the confidence of the market over the short term.
Continue reading ‘Precision Needed in Fed Comments’
The consumer price index increased 0.6% in May, the Labor Department noted last Friday. Excluding food and energy, it advanced a modest 0.2%. Wall Street economists had expected a 0.5% rise in the headline and 0.2% core increase.
The surprising strength of the retail market, which came in twice as high as economists predicted, reinforces the ongoing shift of financial market and policymaker attention toward inflation risks and away from the risk of an imminent downturn in the economy, a move I wrote about in last week’s blog.
The strong report helped to boost the dollar, which rallied against both the euro and yen. The U.S. Dollar Index, which tracks the currency’s value against a basket of six foreign denominations, recently rose 0.9%, or 0.66 point, at 73.90.
As a whole, these reports indicate a U.S. economy that is, at best, tentative. Our core economy continues to post modest gains, which is good news for business and industry and has enabled CRE to remain fundamentally strong.
Real estate fundamentals remain solid with vacancy rates near the set points and with workman-like rent growth. CRE delinquency rates – at 0.5% – remain at near-historic lows and reflect generally healthy occupancy and income growth. The unknown continues to be the uncertainty in the economy, which is creating some deterioration in selected markets across the country. Clearly there has been deceleration in the first quarter of 2008, which has resulted in negative net absorption – not seen since the last downturn.
Overall vacancies edged up slightly to 14.3% in the first quarter from a cyclical low of 13.6% at the end of last year. With an uncertain economy, business turned cautious more quickly. Companies planning relocation or expansion have tabled their plans temporarily. Others are watching and waiting to see if there is more downward pressure on rental rates. Companies, if they are able, are waiting on the sidelines.
One factor that differentiates 2008 from the previous downturn in the national office market is that there are fewer construction projects online across a majority of markets. Private nonresidential-construction spending in April was at a seasonally adjusted annual rate of $388 billion, up 1.6% from March 2008 and up 15.4% from April 2007. Most of this construction was earmarked in the lodging sector. This time the industry is not saddled with too much inventory; it is weighted down with an anchor of poorly managed and priced debt. Fortunately, this is a situation that can be cured more rapidly.
Regionally, the commercial office market remains solid, and in many cases is still growing, albeit more slowly. In Houston for example, the nation’s fifth largest office market with 183.05 msf of total office space, overall occupancy stood at 88.2% — 91.1% in the CBD—and Class A space was 92.4% leased.
In Dallas, the area’s office leasing market began strong in the first quarter of 2008 with 834,200 square feet of positive net absorption, which primarily was driven by the Class B sector. Overall vacancy rates remain stable, signaling that current availability is meeting demand. For the first quarter of 2008, rental rate growth inched up slightly from the fourth quarter of 2007.
At 412 million sf of office space, New York City still is seeing modest rent growth of about 8.8%. In the Midwest, Chicago posted a modest positive absorption of 70,000 sf in the CBD during the first quarter. Total vacancies in the CBD were at 13.3%.
Although there is core stability in the industry, transactions must be completed in order to generate solid growth. Clearly, the CMBS market, which may be the driving force behind the recent boom years in the real estate capital markets, has completely changed in the last nine months. The widening of spreads, combined with a low tolerance for risk, has resulted in an industry that has seen virtually no activity for those who rely on securitized mortgage products.
As a result, U.S., banks — constrained now because of weak balance sheets — will have to start lending again. The good news is that with their borrowing costs relatively low, banks can repair the damage relatively quickly. Over the remainder of 2008, cash buyers including institutional funds and foreign buyers, may be expected to increase their market share among all purchasers. And as often is the case, the market will trim and prune itself and the result will be a stronger industry.
In the last two weeks we saw mixed May economic releases, from an expanding non-manufacturing sector and improving chain store sales, to continued declines in payrolls and a surge in the unemployment rate. Together, they added up to a soft but still growing U.S. economy. The Fed has been very effective through its aggressive monetary policies to sustain economic growth and minimize harm from collapse of the sub-prime mortgage market. The Fed’s powerful doses of rate cuts that started last September along with the government’s $170 billion stimulus package, including rebates for people and tax breaks for business, have stalled a potential recession expectation and should bring about better economic conditions in the second half of this year.
Continue reading ‘Right Time to Focus on Inflation’
The GDP grew 1.2 % in the first quarter of 2008. Year-over-year inflation edged lower in April to 3.9 %. In April, core inflation – a more stable indicator because it factors out large monthly swings in food and energy prices – moved lower to 2.3 %. Stable core inflation may be the saving grace bolstering the sluggish U.S. economy, which has limited price increases outside the volatile food and energy sectors.
Unemployment edged down slightly to 5.0 % in April but the employment report did provide some optimism, revealing a manageable 20,000 job loss, a sign that the economy may face a shallow rather than severe recession. Some of the optimism stems from a sharp turnaround in the professional and business services sector. This sector is the largest component of the office-using segment.
Last week’s slight pullback on oil prices and better-than-expected GDP figures created positive momentum for real estate stocks, which were up 2.8% as they rallied with the NASDAQ (up 2.6%) and were ahead of the S&P 500 (1.7%) and S&P Utilities Index (1.5%).
Although the financial sector continues to drag down the broader markets, the office sector is maintaining some positive momentum. Last week, it marginally outperformed the WRESI, which gained 2.8 % during the past week. Year to date, the WRESI is up 9.4 %. For the week, office stocks moved up 2.9 %. SL Green Realty led the group by edging up 5.2 %.
For the quarter, office vacancies rose a less-than-expected 20 bps to 12.8 % nationally. Uncertainty in the economy has caused some tenants to delay large lease commitments and expansions. With that said, asking rents increased some 1.7 % in the first quarter. This occurred despite rising vacancies in certain challenged markets including South Florida, Orange County and Riverside-San Bernardino, Calif. Markets that experienced the most notable increases in rent growth included Boston, New York, Houston, and Dallas. Effective rents remain flat due to use of concessions. On a positive note however, sublease space is rising more slowly during this period, which is having less of an effect on office rents.
There continues to be bright spots on the horizon for the office sector. The national default rate on commercial mortgages is a slim 0.4%. Economists generally are in agreement that this downturn will be unlike previous events and most predict a shallow slowdown with a recovery beginning in the second half of 2008. During April, $4.9 billion of office investment transactions occurred, which was an increase from February, but still well below comparative levels in 2007.
Despite changes in the capital and debt markets, not all buyers are constrained by the debt markets or are waiting on the sidelines for prices to fall. Although many institutional investors have slowed their rate of investing, they actually have increased their share of all office acquisitions to 23% because so many other buyers are out of the market. It is anticipated that institutional buyers will help drive the recovery with offshore investors accounting for 12% of all recent office acquisitions.
We think the divergence with the debt markets reflects the reduction of hedges that were put in place earlier this year. As more banks sell off their commercial mortgages, the amount they need to hedge is reduced as well. This means that banks would be able to sell credit default swaps, buy REIT equities or purchase the CMBX index. What’s more, fund flows remain positive with $31 million flowing into domestic real estate funds and another $73 million into the global funds.
When the economy and credit markets have stabilized, we continue to believe that the Federal Reserve may shift gears and begin raising interest rates to combat inflation.
The financial conditions in the debt markets continue improving, causing yield curves to flatten and spread to narrow further. Indeed, cash and credit default swap spreads have broadly declined in the U.S. and in Europe, driven by receding risk aversion, more confidence in financial institutions (despite additional write-downs and fairly downbeat earning projections), and modestly better-than-expected economic data. Futures markets reflect a substantial shift in sentiment too, and indicate that U.S. and European central bank rate cuts are on hold for the balance of this year (inhibited partly by stubborn inflation pressures trending above mandated targets). Most economists have concurred and have modified their policy forecasts to reflect the same.
Continue reading ‘All Eyes Focused on Banking’
The bi-polar nature of the economy made itself known again late last week. Following weeks of dismal predictions and the prospect of an economic meltdown of cataclysmic proportions, according to former Fed Chairman Alan Greenspan, economists this week posited that perhaps the sky is not falling, according to last Wednesday’s article in the Wall Street Journal. Treasury Secretary Henry Paulson said last Friday that financial markets are “considerably calmer” now than they were two months ago and is suggesting that the economy will be rebounding by the second half of this year.
Economists are now re-thinking recession. The senior economist at Wachovia puts the prospect of a recession at 45% down from 90% in April, and Global Insight, a national forecasting firm, now believes that the government will re-adjust its assessment of GDP growth for the first quarter to a 1.2% annual rate. Even Moody’s chief economist said that recent labor market data and signs that the credit crunch is easing on Wall Street has made him “less gloomy” over the economy than he was a few months ago.
Why was there a herd mentality when it came to predicting recession? Was it because the explosive growth in GDP that we saw in early 2007 had been substantially reduced in the first quarter of 2008? Retail sales, a barometer of consumer confidence, likewise declined but remained in the positive category. In April, excluding autos, retail sales actually climbed 0.5%. Unemployment claims, which typically exceed 400,000 a week during a recession, have remained well below that watermark. What’s more, the economy is not losing jobs, which is typical of recession
It certainly is not secret that a faltering economy plays into the hands of many in the media and of politicians who can leverage bad news to sweep in change. Interestingly, billionaire George Soros, an outspoken critic of the Bush Administration and financier of Moveon.org, has argued that the U.S. economy was headed for a major crisis. Soros recently toned down his rhetoric saying that the “acute phase” of the crisis had passed.
On Friday of last week, Secretary Paulson delivered a cautiously optimistic message to business leaders saying that the economy was moving toward a rebound after months of malaise. Responding to the release of new housing data, Paulson said there will continue to be challenges, especially in housing, but “we are closer to the end of the market turmoil than the beginning.” The approximately $100 billion in stimulus payments to Americans over the next few months will certainly help fuel the economic engine.
So what’s next? Clearly there needs to be continuing pressure/stimulus from the central bank to encourage financial institutions to repair their balance sheets. At a conference this week in Chicago, Fed Chief Bernanke said he has been “encouraged” by financial institutions’ ability to raise capital and said that they need to build “generous” cushions. This, Bernanke believes, will stimulate the extension of new credit. Frankly, I believe the financial institutions can be doing more that what they have done and can resume responsible lending to power the economy, which will benefit them more than the rest of us.
Although there are numerous signs that the Fed’s aggressive actions are aiding financial institutions weather the crisis, investment banks have bid for just a fraction of the Treasury securities that the Fed auctioned in exchange for the firms’ riskier mortgage-backed debt. The latest offering drew just $7.24 billion in bids from securities firms after $25 billion was offered. Direct loans to securities firms — another Fed program launched in March — stood at $14.5 billion at the end of Wednesday, down from $16.3 billion a week earlier.
We would encourage lenders and investment banks to complete their ”spring cleaning” so they once again can get back to the business of fueling the growth of our economy, which in turn will power the world.
Lending to responsible borrowers is always good business regardless of the economic environment.
The GDP growth for the first quarter of 2008 will be revised later this week from 0.6% as reported earlier to 1.2% (hardly any sign of recession?).
Continue reading ‘Forward Thinking’
The Federal Reserve lowered its Federal funds rate target 25 basis points to 2 percent last week, while issuing a more even-handed policy statement that provides room for the central bank to pause and allow easing to impact the economy (smart move). The Fed acknowledged that economic growth is likely to remain weak over the next few quarters. The Fed Chairman remains worried about inflation, but he expects inflation to moderate with future monetary policy changes. Importantly, the FOMC altered key language in its policy paragraph, indicating that “further ease is no longer imminent.”
Continue reading ‘Shift in Fundamentals and Policy Changes’
Most economists (if not all) believe that the Fed will lower the discount rate by another 25 bps later this week when they meet. We think it is time for the Fed to pause and stay put.
Fed Chairman Ben Bernanke should halt the roaring commodities rally by keeping rates steady. He needs to wait to see the impact of his past short-term interest rate cuts before he takes more action. Unfortunately, the Chairman and his colleagues are unlikely to take rate cuts off the table entirely (lesson from the past, the Fed did that in October by saying weak growth and inflation were of equal concern. Within weeks, deteriorating market conditions forced the Fed to signal a resumption of rate cuts). However, while downside risks to the economy persist today (far less than 6 months ago), we remain very unsettled about inflation and its impact on the global economy. We worry that inflation is feeding the fall in the dollar and the rise in commodity prices, and that further rate cuts could aggravate inflation and reduce the world confidence and dependency on the U.S. dollar.
The Fed chief’s inflation-fighting credentials have been in doubt since he said in a 2002 speech that “central banks could prevent deflation by dropping money out of a helicopter.” This is more evident today by the Fed’s aggressive response to the current credit crunch and its six rate cuts in the last 7 months. Unlike his predecessor, the current Fed chief is far more concerned with recession than the possibility of growing inflation.
One could come to conclusion that the Fed is partly to blame for the spike in commodity prices since rate cut policies have helped to weaken the dollar (I never thought that I would be criticizing the Fed’s action). The rate of inflation growth (32 bps just in the last 6 months) has surpassed many economists’ forecasts and will significantly deteriorate the economy by slowing consumer spending. It also could send a powerful statement to global monetary policy makers that this Fed is letting inflation out of its sights. The Fed chief needs to restore the world confidence in the U.S. dollar and start stabilizing its value immediately before other governments start taking steps to unload their reserve dollars and replace it with more commodities, which could fuel the inflation and price increases.
The recent reports of food shortages and riots in developing nations and food rationing in developed nations (Costco and Sam’s club are rationing rice) should send a strong signal to the Fed Chairman and all governing bodies. The Fed has taken appropriate steps to rescue the financial systems, now it needs to do more to bolster the sagging US dollar.
The jobless claims dropped unexpectedly last week (economists predicated claims would rise by 3,000). The Labor Department’s report that claims for unemployment benefits declined by 33,000 last week to 342,000 and the notion that unemployment might be contained appeared to cap some concern about the economy. This is good news for the office market and we still see no significant increase in vacancy rates and steady increases in the rental rates. The only weakness in the Commercial Real Estate sector is lack of available debt financing that we think should resume by end of this quarter (banks will not make any money if they don’t lend).
We continue to favor investment in selected or Rising Markets such as Texas. The Houston and Dallas office markets continued with positive real estate indicators through the first quarter 2008 compared to other parts of the country. The rapid pace of decreasing vacancy and increasing rents is an excellent indicator of the resilience of this State’s fundamentals. Stronger job growth and very stable unemployment are major reasons why lenders should start lending in this market before they miss the opportunity.
Subscribe to RSS Feed
Recent Comments