Forward Thinking

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?).

The smaller-than-expected trade deficit in March reflects continued import weakness and will add about 0.6% to estimated Q1 GDP growth. The Commerce Department reported a March trade deficit of $58.4 billion, a sharp $3.6 billion decline from February and well below the $61.2 billion median of analysts’ forecasts. The huge import decline shrinks the March trade deficit (one of the wonders of a de-valued dollar). Imports fell almost 3.2% in the month, despite a 9.1% jump in imported petroleum prices. This is a positive sign for our economy in general and manufacturing in particular.

Unemployment edged lower from 5.1% to 5.0%. The Institute for Supply Management’s April non-manufacturing index advanced above 50 for the first time in 2008. Many retailers reported same-store-sales figures for April that were both better than expected and stronger than they have been in months. The U.S. is leading the international effort to put a floor under the falling dollar, which could stabilize oil and other commodity prices (Europeans are worried that the mighty euro is making their companies less competitive – what took them so long – and they no longer can control the euro valuation thru their monetary policies).

The effect of the contraction of the U.S. economy, which began in September of last year, has commenced weakening the office fundamentals. But we feel the impact to be shallow as overall unemployment has not edged up significantly and the demand for office space has not changed as expected. Also there is positive news for real estate in the face of a prolonged credit market freeze and economic contraction. All property types are relatively healthy with generally low vacancy rates and still-rising rental rates. New supply levels have been much lower than those that characterized previous boom-bust cycles. We believe this downturn is effectively managed with the appropriate and timely policy stimulus; the economy will mount a rebound in the late 2nd half of the year as we predicted earlier and real estate could emerge relatively unscathed.

Nationally, office vacancies rose only 20 bps during the first quarter to 12.8% (not that significant considering the impact in the rest of our economy). The increase is somewhat consistent with normal drops we have experienced over the past 10 years during the first quarter. Economic uncertainty pushed many tenants to delay large lease commitments and expansions during the first quarter of 2008 as the financial services sector registered a decline of 22,800 jobs, bringing the total job losses to 103,500 positions since the crisis began last year. However, asking rents increased 1.7% in the first quarter despite rising vacancies and despite effective rents, which were flat due to the re-emergence of concessions. Boston, New York, Houston, Dallas and Seattle posted some of the largest rent growth during the first quarter while decreases were recorded in Las Vegas, Austin, Orange County, Sacramento, Los Angeles, Detroit and Denver.

The transaction CAP rate in primary markets increased only by 10 bps during the first quarter to 6%. The largest impact was noted on the transaction side where we noticed a 70% drop from one year earlier mainly due to lack of available financing and tightening of underwriting requirements (the average DCR increased from 1.1% to 1.2% during the first quarter).

The issue still remains with lenders, who continue to tighten lending standards and falling housing activity, which will continue to weaken the economy. The tightened credit conditions are likely to have a dampening impact on corporate expansions and business investment over the remainder of the year. While the tightening of standards is an expected and prudent response to falling credit quality, we feel there is a serious danger that lending standards, which swung excessively in one direction during the housing boom, could now overshoot in the other direction and exaggerate the restraint on housing activity and consumer spending.

Lenders need to find a more appropriate balance in their lending practices in this changing environment.