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Positive Economic Signs Suggest Continued Good Times for Commercial Real Estate

Posted by Rocky Mackintosh on December 07, 2017 Leave a comment

But is the apparent strong foundation resting on thin ice?

GOOD TIMES AHEAD 120717-1-1.jpgIt appears that the local legal office of Miles and Stockbridge is establishing a December tradition of booking one of the nation’s most knowledgeable and entertaining economists to speak to its client base here in Frederick County for a “Breakfast Briefing.”  

Anirban Basu, Chairman and CEO of the Sage Policy Group, has been quoted numerous times in the MacRo Report Blog over the years.  His economic insight is sought out from all corners of the country (including, as he would say, some obscure crossroads in the Mid-West). Directly from his website, Basu “has twice been recognized as one of Maryland’s 50 most influential people,” as well as being “...named one of the Baltimore region’s 20 most powerful business leaders.”

Basu laid out a case for why the nation as a whole, and Frederick among other counties clustered around the Washington and Baltimore metro area, will likely continue to benefit from an economy that seems to have shifted into a higher gear since the outcome of 2016 Presidential election. Basu did not speculate as to whether this is as a result of the person who won the White House, but he did state that “the consumer is more confident than it has been in the last 17 years.”

Job Market

One good sign is that over 2 million jobs were created nationally during the twelve months following October 2016. The top four employment segments that have benefited are Professional and Business services (536K), Education and Healthcare (464K), Leisure and Hospitality (284K) and Construction with 156,000 jobs created. In the case of the latter, with strong demand, Basu stated that it is the lack of the availability of skilled labor that has kept this industry from adding more jobs.

Surprisingly, during that same period, Maryland outpaced Virginia in job growth by creating over 54,000 new jobs and ranking 9th nationally with a 2.0% increase, while our neighbor south of the Potomac River ranked 33rd with a mere 0.9% increase in its labor force.

Locally, Frederick County has been enjoying a 3.1% rate of unemployment, just a bit higher than a handful of counties immediately to our eastern borders. As of September 2017, 3,901 more Frederick County residents had jobs than they did one year earlier.

Basu stated that another factor that should bring “great economic development to Frederick County” is the fact that Montgomery County just put a $15.00 per hour minimum wage into effect, which could cause some businesses to migrate our way over the course of the next few years.

The Price of Consumer Confidence

With consumer confidence growing, that means that consumers are spending more than they have in the last decade; so, it is fair to say that we are experiencing a “Consumer Lead Economy.”  

But Basu warns that while retail sales are popping along at a more than healthly pace, US household savings rates have fallen to around 3.1%, which is only slightly above pre-financial crisis levels. As an example he noted that millions of Americans are now more than 90 days past dues on auto loans, and the highest percentage of new auto loans are going to individuals with credit scores below 620.  In light of this, many of these fall into the category of subprime loans with interest rates at 15% to 20%.  

Could this be deja vu all over again?

Will Business Expansion Come to the Rescue?

Basu made it very clear that while the consumer is the key to keeping this economic recovery growing, it can’t keep taking on more debt.  

Another source of economic growth is required. It will likely not be via exports, and likely not through government spending. Where the current administration in Washington sees it is in the arena of business expansion and growth.  

With a Dow Industrial Average that has been steadly reaching one new high after another and quarterly growth in GPD surpassing 3%, Basu says that the business community has high hopes that all the talk about Congress passing a new tax bill will become a reality.  

If the law passes, he expects that business will respond accordingly, bringing an additional positive boost to the economy. Among other things, we can expect that part of this pent-up excitement to be business investment in new construction and existing commercial real estate facilities, which is often a core factor in building lasting economic growth.

The Ups and Downs of Nonresidential Construction Spending

During the 3-year period ending in September 2017, nonresidential construction spending in the development of commercial real estate projects grew nationally by $68.3 billion or 10.8% -- positive, to say the least. The lodging segment of the market spent 70.5% more than it did in past years, with (believe it or not) the office building segment surpassing 40% of where it was. Close behind in percentage in descending amounts were increases in amusement, recreation, communication, commercial and education construction. But it has been the public sector’s lack of spending in infrastructure (public safety, water supply, sewage and waste disposal) that have all spent as much as 18% less over that period.  

Do we really need more spending on hotels, apartments and office buildings versus public infrastructure?

Basu says that offshore investment dollars are gravitating to US primary real estate markets, because investors have more confidence in the US than elsewhere around the globe. Consider that foreign investment jumped by 85% from 2014 to 2015 and remains at levels of more than $50 billion each year in the multifamily sector alone.  

In major markets such as New York’s Manhattan, overseas dollars have made up over 78% of the total investment capital in multifamily construction. To a lesser degree, hotel and office construction have benefited from similar financial influxes. The net effect is that per unit sales prices have escalated as buyers are willing to purchase at capitalization rates as low as 4%.  

Basu noted that industry wide the looming over building in these sectors is starting to show … with hotel rates in major markets trending downward.  

From experience, those of us in the commercial real estate business should know by now what an emerging bubble looks like! While many do … it’s safe to say others don’t remember.

Retail Sales Versus Retail Real Estate Trends

It’s more than obvious to any consumer that a lot of retail transactions are taking place over the internet. I need not say it, but the phrase “The Amazon Effect,” may even become a trite phase soon. While retail sales are booming along and look bright for the 2017 holiday season, those located in shopping malls, strip and big box centers are getting worried. Most retail merchandise sold via such outlets has experienced increases in sales as the economy has grown, but the increases grow in many cases at decreasing rates.  

The top four winners over the last twelve months ending in October 2017 have been: building material & garden supplies dealers (+8.8%), gasoline stations (+7.5%), internet, etc. retailers (+6.8%) and motor vehicle & parts dealers (+5.6%).   

During the same period the bottom four sectors should not surprise anyone: electronics & appliance stores (+2.0%), clothing & clothing accessories stores (+1.8%), miscellaneous store retailers (+1.3%) and sporting goods, hobby, book & music stores (-2.5%).

Keeping this in mind this trend will surely continue as retail center owners are beginning to take notice.

Parting Points to Ponder

Basu summed up his talk with the following closing comments:

  1. Overall, the global economy remains weak.
  2. For this reason foreign investment in US business, industry and real estate will continue to be strong as it seeks “yield and safety” as compared to other less stable economies.
  3. The pressures on inflation are rising, including interest rates, which could squeeze asset prices in the coming years. This could influence a reversal of fortunes for many and negatively impact the current high level of consumer confidence.
  4. With mini-bubbles forming within certain sectors of the nonresidential and commercial real estate market, unchecked inflation could burst at magnitudes that we are all too familiar with.
  5. Longer term structural issues loom large on the horizon. Consider such things as the growing national debt and the pending insolvencies of Medicare and Social Security. These burdens will continue to deteriorate even as the economy improves.
  6. The economic momentum in the market should continue through the coming year, but somewhere between 2019 and 2020, the pressures of a tightening monetary policy and “political intrigue” could bring the longest economic recovery in modern times to a halt.

So let’s all make hay while the sun shines. Economic cycles are inevitable, and I liken them to the chorus line in one of the songs of the legendary country music group, The Highwaymen: The road goes on forever and the party never ends! 

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Rocky Mackintosh, President, MacRo, Ltd., a Land and Commercial Real Estate firm based in Frederick, Maryland. He has been an active member of the Frederick, Maryland community for over four decades. He has served as chairman of the board of Frederick Memorial Hospital and as a member of the Frederick County Charter Board from 2010 to 2012.  He currently serves as chairman of the board of Frederick Mutual Insurance Company. Established in 1843, it is one of the longest enduring businesses in Frederick County.

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Topics: Commercial and Industrial Real Estate Ashleigh's Fields Notes