The commercial real estate market is impacted by many factors. The performance of the national and local economies are just some of the drivers. The availability of talent, the kind of talent that today’s modern companies want to hire is another. Availability of real estate supply is another factor. But today’s market is also impacted by the leadership of politicians in Washington, DC, who over the next few months may or may not be able to affect change and implement policies that were the hallmark of their political ascent and that may or may not create the jobs each one of them promised to deliver.
“President Trump certainly wasn’t the first person to speak about jobs as the number one issue,” said Spencer Levy, CBRE’s Americas head of research who held the stage at an event tonight in Seattle titled Curve Benders. The event took a comprehensive look into the factors impacting the commercial real estate industry and over layered a number of issues that may impact it in the coming years, or bend the proverbial industry curve in one direction or the other.
Levy’s view is that there are two camps of thought in that regard. One, which strongly believes that President Trump’s promises of lower taxes, less regulation and more infrastructure spending, to name a few of his initiatives, is going to grow the economy faster. According to Levy, the International Monetary Fund is in that camp. The organization even increased its expectation of growth in the US economy 50-75 basis points recently.
In the other camp are organizations like the Federal Reserve, which has not raised growth expectations for the US economy, and they believe that our growth for the foreseeable future will remain at a very low growth trajectory of roughly 2 percent a year. But whether one falls into the first camp or the second seems to be a sentimental choice, which despite its subjective perspective of reality does have real economic impact. The credibility of the president can impacted, and it has proven to be so in the months following the inauguration. The defeated healthcare repeal, for instance, set a tone of what the president is actually able to affect, and the result was a subsequent drop of 10-year Treasuries’ yields from 2.65 percent, where they were post-election, to 2.21, where they are today, said Levy.
But getting back to the jobs, one of the most important predictors of true demand in the real estate industry, Levy added, “Are you forming more jobs, and are you forming certain types of jobs. Higher paying jobs have a multiplier effect; for everybody that comes through the market that makes six figures makes two or three spillover jobs, but it also has something called ‘office using jobs.’” Those are the kinds of jobs that will drive the market, he said, and he thinks producing those types of employment opportunities will be very difficult. “I don’t believe that he can form the jobs in the way he is suggesting. And the reason is automation,” said Levy.
As evidence he presented a slide that showed a job hierarchy of sorts that listed service and high knowledge jobs on the top, while production, manufacturing, transportation and material moving jobs were on the bottom of the scale. The lower-end jobs, like the latter kind are in jeopardy of getting lost to automation, and unless the labor force does not expand into the service jobs, the economy may suffer. Service jobs is the future of every advanced economy, including China, which is shifting away from goods manufacturing, as well, he said.
What may also impacts the commercial real estate industry is capital flow. There is a perception of certain value associated with gateway markets, such as San Francisco and Seattle that draws investors despite the cities’ or regions’ ability to produce the necessary labor. “Capital flows going into markets like Seattle, Boston, Austin, San Francisco are so strong, that they will trump any reversion to the mean problem you may have with excess supply or rents getting too high,” he said.
Those are things they may be indirectly affecting the curve bending in one direction or the other, whereas regulation can have a direct impact on the industry across the board. Levy sees regional regulation having a much higher impact on the health of the local real estate market, based on his research, but one particular federal regulation is of keen interest to him, and that is the ability for people to get a home loan. “There’s one area of federal regulation that I’m watching closely, that has to do with the ability to get a single family home loan. The single family home loans is an enormously important economic driver,” Levy said.
At the peak of the market in 2006 and 2007, single family homes added nearly 6 per cent to national gross domestic output by themselves. The spillover effect was almost 15 percent impact on the GDP, according to Levy’s research, and now it is around 3.5 percent. “If we see the loosening of credit standards, this will be one of the biggest economic drivers moving forward,” he said.
Also playing into this is a large demographic shift of Millennials moving to the suburbs looking to buy homes, which will only continue to intensify.
In terms of industry trends in 2017, Levy and team saw a first quarter slow down in transactions, which may or may not spell a shift in the market. “We saw a big drop of transaction volume in the first quarter. Transaction volume in the fist quarter went down probably by 20 percent or so. Why? Because right now people are [evaluating if] there a repricing going on. I don’t think there is going to be a repricing, because what has happened is there is a tremendous amount of pent-up equity capital looking to get out now, and there is a scarcity of assets coming out and so those assets are going to get bid up. So, I expect a much better second quarter than first quarter, which came right after the interest rates spike,” Levy said.
The Chinese investors will have a smaller impact in the market going forward. “We saw in the first few months of this year capital controls put into place by the Chinese government,” he said, which will drop them from the top investor group in US commercial real estate. Most likely the German and Japanese investors will make up the difference, he added, since they are experiencing negative returns on their money locally and will look for places where even a low cap rate can replace that.
Immigration is another area that will have a large impact on the market. According to Levy’s research, there is a labor shortage, not just talented labor, but also labor that effectively left market during the Great Recession. As a result, some of CBRE’s clients are looking for solutions that can help to relocate labor to Canada where the immigration laws are more relaxed, he added. But another consequence of this could be felt in the multifamily market, which in some areas in large measure relies on immigrants as renters.
So, how much longer could this cycle go? “The dominant view is that cycle will be coming to an end in about two years, sometime in 2019.” Could it go longer? Sure, Levy said, it could go longer, but that scenario is unlikely. However, it could also be a lot shorter, which in large part will depend on President Trump and the sentiments around what he can actually do in Washington. Levy concluded by adding that if we don’t pass some major stimulative policy, be that in the form of tax policy, infrastructure spending or some other regulation in the next six months, the sentiment might be ripe to kick off the next recession.