Trend Czar

Get that sinking feeling?

What a whirlwind. So the Fed cut rates by another 50 basis points right after painful fourth quarter (barely any) growth data is announced. McCain races ahead for the Republicans and Edwards drops out of the Dems contest. Super Tuesday looms and the President and Congress struggle to enact legislation that won't inject any money into the economy until May at the earliest.

In polls voters become increasingly concerned about the economy ahead of Iraq and terrorism, but as noted before Republicans in the end will choose a tough guy candidate who will use fear tactics to get elected. With Rudy vanquished that leaves McCain, who readily admits the economy is not his strong suit. Fighting Islamofascists is and so that's why McCain leads the Republican field. Romney hangs around for now adopting all the long-in-the-tooth Reaganomics formulas (tax cuts, tax cuts, tax cuts) which are unsustainable particularly when the government has been spilling red ink for the past seven years and pins hopes on overleveraged consumers to keep spending. And no matter how hard Mitt tries, he can't muster the "don't-mess-with-me-I'll-blow-your-head-off" bluster that most Republicans crave. McCain may be over 70, but he'll defend the homeland better than anyone else. Go surge go.   

Edwards, the anti-poverty candidate, faced a dwindling campaign war chest among other hurdles. Hillary and Obama basically have the same Robin Hood platform, which will raise taxes on the rich and both look to get out of the Iraq mess, which has cost $500 billion plus and counting. Most Americans have come to calculate that all that money would have been better spent at home. And worse yet, we all have to pay future interest on the huge war deficit.

Bush and Congress plotz around looking for short-term stimulus, while the panicky Fed dances to Wall Street's tune after assuring us until a couple of months ago that the economy was okay even though the housing market was collapsing.

In October, I was on a panel and predicted recession.  Another panelist disagreed, contending that couldn't happen in an election year -- the politicians wouldn't let the economy stall out, she said. Given what's going on in Washington and the election, should anyone be surprised? 

© Miller Ryan LLC 2008

Call to Action; No Further Rate Cuts

Ken Rosen, the real estate guru (Chairman for the Fisher Center for Real Estate and Urban Economics at the University of California at Berkeley, and a leading REIT fund manager), today takes a pointed position on possible further rate cuts by the Federal Reserve. I thought I'd share his commentary:

"The Federal Reserve Board is deliberating over the state of the economy, and on Wednesday afternoon will announce its decision on changing the federal funds rate. It is widely believed by financial markets that the FED will cut the federal funds rate by an additional 50 basis points. This expected large cut would come just one week after the extraordinarily large 75 basis point emergency cut. The cut of a week ago was widely believed to have replaced the "Greenspan put" with the "Bernanke put"—that is, the FED rides to the rescue when there is a sharp correction in financial markets. The logic of the FED is that these stock market corrections impact the real economy through consumer confidence and wealth effects, and so it contends that it was not trying to bail out financial markets, but just trying to keep the economy on an even keel.The logic for an additional 25 or 50 basis point cut on Wednesday is not apparent. Before the cut last week, the market was expecting a 50 basis point cut on January 30th. The market got that and more last week or the FED to make an additional cut on January 30th would be a huge mistake. Economic data coming in for the last two weeks shows a large drop in first-time unemployment claims, a surge in durable goods orders and steady consumer confidence. Yes, the housing data continues to show a weakening housing market.... but that data represents the continuing unwinding of the speculative bubble in housing that will take several more years to play out."   

"If the FED cuts again so soon without good cause, it would seriously compromise its credibility. The right move for the FED would be to hold rates constant and in its statement, talk about its large move last week, and say that any future interest rate changes will depend on future economic and financial market conditions. The FED should JUST SAY NO to the ever-rising demands of financial markets; the FED should not let itself be bullied by speculators."

So that's Ken's take. My guess is the Fed will split the difference with a 25 point cut. While apparently cowed by market jawboning, the governors don't want to appear to be caving in totally. If they go for a 50 point cut, the economy must be worse than we think. Let's see what happens.

© Miller Ryan LLC 2008

The Birds Come Back -- Before Spring Arrives

Since the late 1990s, opportunity-vulture fund investors have had slim pickings in the U.S. Core and value add funds crowded them out in relatively distress-free markets with ample capital flows pushing up prices in frenzied bidding. Opportunity funds, managed by big investment banks and global financial giants, turned tail, targeting emerging Asian markets and Europe where higher risk development projects could score outsized returns.

Well, the birds are back, circling in the sky, waiting for action. We have talked about problems surfacing among recent buyers who overpaid and overleveraged. Near-term rents won't cover debt service for many of these deals and many borrowers who counted on refinancing on more favorable terms come to terms with the capital crunch. Some small REITs struggle with lower share prices, public company costs, and deteriorating markets. Homebuilders sell inventoried land at cents on the dollar, trying to hang on -- no one anticipates demand to pick up for new housing anytime soon. Condo projects crater in Florida and southern California. And who knows what will happen to all those loosely underwritten loans in all those recent vintage CMBS and CDOs?

Ironically, several major fund managers launch money-raising for new opportunity vehicles just as problems surface in their core and value add funds. Well, they overpaid and overleveraged too, trying to push out all the money investors were pouring into their kitties during the frantic 2004-2007 binge. Of course, don't be surprised to see familiar players joining forces or buying from one another as they lick wounds in the decline.  Just as all their trading with each other helped escalate prices on the way up, they will look to take advantage of each other on the way down, and probably temper the downside slide.   

© Miller Ryan LLC 2008 

Lower Rates and Tax Rebates

Back in the Fall, some market observers argued against the Fed lowering interest rates and bailing out the bad behavior of speculators and investors who overleveraged with cheap debt and bid up prices on various assets, including commercial real estate, to unsustainable levels. Well, it turned out bad behavior was so rampant and destructive spurred by licentious lending by the major financial institutions, the Fed couldn't help itself and has lowered rates beyond what might have been expected just a few months ago.

While lowering the Fed funds rate may buoy Wall Street in the short term and shore up battered banks, will it help average Joe on Main Street and end the dire consequences of the housing skid? And will Washington's $600 tax rebate keep consumers spending? A few hundred bucks doesn't take you very far these days especially when a lot of folks have mounting bills. That rebate won't suddenly improve most people's credit ratings or give them enough equity to start house hunting when banks will insist on more money down.

State and local governments, meanwhile, struggle with forecasts for lower tax receipts as property values drop and store sales turn sluggish. Anticipated government hiring freezes will shut down a major source of employment and reduced funding to myriad programs spells heaps of trouble for various contractors and other organizations supported by taxpayer largesse. Several not-for-profits, I work with, confront potential layoffs if various forms of state and city funding doesn't materialize in the next six months.      

The stock market has taken a good beating. And stock pros say that stock prices actually stabilize or rise during most recessions. It's the impact on Main Street yet to fully play out that real estate investors need to fear. And while housing values have dropped, commercial real estate repricing still needs to run its course. 

© Miller Ryan LLC 2008 

   

It's All About Jobs

Everybody in real estate should keep an eye on the unemployment rate. The jobs picture will determine how bad the real estate markets get.  If companies keep up modest hiring and avoid layoffs, real estate can skate through the rough patch, and recent economic weakness will turn out to be relatively benign. But if companies start announcing hiring freezes and layoffs pick up, watch out. That's when office markets suffer retrenchments, business travelers cut back on hotels, and consumers really shut down at the mall.  Only recently have employment numbers shown signs of deteriorating.

Expect all the gloom and doom talk, including recent grudging admissions about economic distress from the Administration, to coax business managers into play-it-safe rentrenchment mode. For any remaining Pollyannas out there, Tuesday's huge rate cut certainly signals that there are problems to confront. For most companies, this is no time to launch new initiatives unless you're in businesses that take advantage of potential distress. 

As we have noted before,  real estate asset managers and workout artists certainly will be in more demand. And a notable survey recently completed by Bill Ferguson and FPL Advisory finds lingering optimism among real estate executives, despite some caution. The FPL report says a majority of firms plan to add staff and increase compensation in 2008 with a focus on asset and portfolio management talents. 

According to Ferguson, FPL’s co-Chairman and co-CEO, two-thirds of senior U.S. real estate executives responding to his firm’s annual hiring and compensation survey expect to add staff in 2008. And while double-digit compensation increases will become less common, the vast majority of respondents do expect pay levels to increase at least moderately across the industry.

Ferguson says: “Given the well-publicized problems in the debt markets and generalized concern over the health of the economy, these results seem counterintuitive. We haven’t seen a precipitous drop in demand for talent. Rather, strong underlying fundamentals and the continued availability of large amounts of equity capital have resulted in a hiring environment that is much more robust than the markets may indicate. One of our clients has seen their stock price drop 40% in the last two months, but the underlying business is still good. They’re still hiring.” The full survey report is available at http://www.fpladvisorygroup.com.

Particularly surprising is the finding that nearly half of all commercial mortgage firms surveyed intend to hire new staff even despite the recent slowdown in lending. “Certainly, originations activity has slowed dramatically, and there has been a decrease in demand for underwriting professionals as a whole,” explained Ferguson. “However, the best and brightest of this group are in greater demand than ever as companies – particularly direct lenders who are getting into the game now that the conduits have fallen back – seek underwriting talent with the knowledge and skills necessary to be successful in an environment of tighter underwriting standards. Furthermore, as many companies move away from originations, there’s burgeoning demand for experts in servicing as well as in workouts and restructuring, as lenders focus on identifying and managing under-performing loans.”

Commercial real estate performance tends to lag the rest of the economy. It's my hunch real estate honchos will be less upbeat in a few months. But there is no doubt about it--asset managers and trouble shooters, you're time has come.

(Miller Ryan LLC has a business alliance with FPL Advisory)

© Miller Ryan LLC 2008    

 

No more free ride

What does President Bush in Saudi Arabia have to do with New Jersey Governor Corzine campaigning to raise highway tolls? And why should we care, especially if we never take the Jersey turnpike anyway?

It's pretty simple:  driving costs in the United States will be increasing dramatically in the future. And that will impact where people will want to work and live.

Part of the President's Middle East mission was to jawbone the Saudi royals to keep oil prices from rising too high too fast, because high energy bills in the US are not only inflationary they also hit consumers and help push the country into recession.  The President argues if you crater our economy we cannot buy as much oil from you and your revenues will go down.  But places like China and India escalate demand. Unless a global recession occurs, the Saudis have plenty of customers. And that will keep gasoline (and heating oil) prices headed up.

Gov. Corzine, meanwhile, faces a yawning $32 billion state budget deficit and aging highway system in a totally car dependant state. New Jersey has low gas taxes and the Federal government has been cutting road funding for years--the Federal Highway Trust Fund goes insolvent next year, because Congress has refused to raise the federal fuel tax since 1993. Adjusted for inflation, the federal gas tax is half its 1960 level. As part of the "no new taxes" mantra, the Federal government also has pushed more of the burden on maintaining interstates onto the states. So the governor proposes increasing tolls by five times current tolls over the next 15 years. Obviously, drivers (everybody in the state) are up in arms, but Jersey voters have also rebelled at some of the highest local property taxes in the nation. And they don't want the state gas tax raised either, especially when gas pump prices are up over $1 a gallon since last year. But the state has to pay its bills and fix its roads.

Corzine won't get his gigantic toll increase, but he'll get part. And don't be surprised if the state gas tax goes up to make up part of the difference.

And as for you in other states, New Jersey's problem is also your problem. Your roads are aging too and congestion just keeps getting worse. Bills are coming due and infrastructure needs require big bucks. Tolls and congestion pricing schemes are coming to roads near you.  The Federal gas tax will get hiked too to preserve the Trust Fund, and pump prices will just keep increasing. And if terrorists hit Saudi oil fields all bets are off.

There will be no more free ride. Living out in the burbs, needing three cars to get the family around, may not pencil out the way it once did.
© Miller Ryan LLC 2008    

More Trouble Lies Ahead

Last week was rough. Amid various corporate writedowns (Citibank, Merrill Lynch, American Express) and Bernanke's admission that the economy is tanking, the headline that grabbed me was McGraw Hill layoffs over worries that S&P will have fewer offerings to rate this year. While no surprise, rating agency ennui underscores the emerging fallout for companies that live off of transaction volumes (bankers, brokers, investment managers, etc.). Numbers will be down, down, down in 2008. The next shoe to drop--more layoffs and a higher unemployment rate. And that's when office markets really start to feel the pinch on NOI growth. New York has some cushion, but won't be immune, especially as the Wall Street powerhouses scale back after digesting their losses and assessing forecasts.
Weak Christmas sales portend consumer capitulation. Fed rate cuts are designed to encourage more borrowing and spending to keep consumers in the game. But that's the problem in this country. We spend and borrow too much and save too little. People realize their homes are no longer piggy banks and credit card debt taps them out--Amex problems stem from cardholders cutting back spending out of necessity and rising delinquencies. Household debt stands at 136% of disposable income. Our government red ink, meanwhile, makes us the the world's biggest debtor nation. And we should all go further into hock?
Michigan votes this week. Romney talks about restoring the state's moribund economy by helping the car companies out. McCain rightly points out that car company jobs aren't coming back, and talks about providing job training programs to help restore the state. Memo to Michigan and the candidates: Get with reality, unless the Detroit carmakers develop, engineer and market a car for the 21st century--one that doesn't operate on gasoline and look like a tank, they're not just in the hospital bed, they're dead. If car makers ever get with reality, those new vehicles probably won't be built in Michigan anyway. The factories are old, the climate is too cold, and manufacturers will operate in cheaper, warmer right-to-work states or outside the U.S. all-together. And job training for what--low paid Wal-Mart clerks? Well that fits our economy. Our number one industry becomes spending at the mall as long as we have something left in our bank accounts or more importantly on credit lines.
Rent the video--"Who killed the Electric Car?" It will help you understand why Detroit is in so much trouble and why our country remains so dependent on Middle East oil.
© Miller Ryan LLC 2008             

Flight to Quality Begins

As the real estate cycle dips in the midst of the credit crunch, expect investors to pull back from secondary and tertiary markets and continue to focus on the handful of global gateways. Values will hold up better in New York, Washington, D.C., San Francisco, West LA, and Seattle where capital has been concentrating. These markets boast diversified tenant bases with international reach.

When the economy slows, hot growth markets -- Atlanta, Dallas, Phoenix, Denver -- tend to cool off more quickly, getting caught with oversupply as demand shrinks. The OC and much of Florida, meanwhile, feel the side-effects of slumping housing and condo markets. Midwest manufacturing centers appear most vulnerable -- already hurting in good times, most capital red lines these markets in bad.

Capital will also gravitate to infill properties, especially apartments and neighborhood shopping centers, and shy away from development especially in fringe areas. Institutional money continues to seek distribution/warehouses near major ports and dominant international airports.  Suburban office and limited service hotels look more dicey. The further away from vibrant metro centers, the less interest from buyers and lenders.

Money players will also start to avoid smaller office markets with few major tenants and limited employer diversification. They worry that a major headshot -- like a city's dominant company forced into large layoffs -- would upend market equilibrium and cause property net operating incomes to plummet. But state capitals find some cushion from ample government jobs... at least for now. We need to watch whether states and cities tighten their belts in the next year as tax revenues decline.

In short, market bifurcation starts to occur in a flight to quality. The receding capital wave now forces greater upward cap rate adjustments on weaker properties in weaker markets.  Investors who paid a higher price per pound in Manhattan or downtown Washington rest easier than owners in the Jersey suburbs or Northern Virginia.  Capital starts to think about the meaning of risk adjusted returns again.

© Miller Ryan LLC 2008

Political Headwinds -- Wall Street in the Cross Hairs

Iowa caucus results increase nervousness among establishment financial types, who favor former private equity whiz Mitt Romney on the Republican side and Hillary on the Democratic ticket. Al Gore and John Kerry got absolutely no traction talking about raising taxes on the rich, but the early 2008 winners -- Obama, Huckabee, and even John Edwards -- make hay by implicitly countering Wall Street dogma for making permanent Bush style tax cuts and cutting corporate taxes further. People in the downtrodden heartland at least raise hackles over the growing inequity between payouts to private equity barons/corporate chieftains and the rank and file. Stoked by the Huckabees and Edwards, voters finally wake up to the idea that the deck may be stacked against them, especially in the souring economy. It wouldn't surprise if John McCain starts reminding people that initially he had voted against Bush tax cuts.

Stalwart Reagan blue-bloods (like CNBC's windy Larry Kudlow) relentlessly talk up free market, lower taxes, less regulation mantra in the face of a housing debacle precipitated by free market licentiousness. And lets not forget earlier iterations of similar out-of-hand market disasters -- the junk bond scandals, the S&L crisis, the internet meltdown and Enron, all in the last 20 years. The market will self correct, the Wall Street establishment says, don't snuff out the nation's entrepreneurial spirit and give us lots of cheap money so we can continue to play (lower interest rates). But self correction seems to mean that fired CEOs walk away with vast fortunes, while little guy borrowers lose homes and ordinary workers need to worry about layoffs.  Gasoline pump prices and heating bills now really start to bite when mortgage payments ratchet up. This environment gets ugly for any politician looking to support economic policies that appear to favor well-heeled, wheeler dealers.

With their economic playbook looking like the single wing, the eventual Republican winner will gravitate to tried-and-true politics of fear campaign themes -- Islamofacistas are poised to invade and immigrants are a threat to our borders. Tough guys like McCain and Rudy should gain ground on likable Huckabee, who seems fuzzy not only about international matters, but also on crossing picket line etiquette ("I thought Jay Leno had settled with his writers"). The Democrats, meanwhile, will dance to "change" lines and more populist "It's the economy stupid" themes. "You've been stupid if you think trickle down will get to you." Fat cats will be in their cross hairs. And voters are primed to listen. After eight years of George Bush, the Reagan Era may be ending, because a majority of Americans come to realize they are not better off after all.    

© Miller Ryan LLC 2007