Recovery Prevailing, But Macro Problems Alive and Kicking
The U.S. debt downgrade and the bumpy road of attempted resolutions to the European debt crisis have cast a cloud of uncertainty on the global economy but failed to tip the U.S. recovery. Amid the clouds of fear and uncertainty, fundamental economic activity has proven to be quite resilient as evidenced by the string of better-than-expected economic readings since August’s onset of financial-market turmoil and the roller coaster ride in Europe.
Between August and October, private sector hiring, retail sales, manufacturing, corporate profits and Gross Domestic Product (GDP) beat expectations and were topped off by robust post-Thanksgiving retail sales gains. The key indicator of retail sales is moving at levels well beyond an economy stuck in neutral and more reminiscent of a real recovery. For example, even before the surprisingly strong 6.6 percent year-over-year rise in Black Friday sales and a 22 percent jump in Cyber Monday sales, retail sales were up 7.2 percent in October on a YOY basis and 6.1 percent for core retail (excluding auto and gasoline sales). The monthly average retail sales growth in August and September was 0.7 percent overall and 0.5 percent for core. On a macro level, it appears that European authorities are committed to saving the common currency and pursuing more systemic solutions, including the most recent measure to increase bank liquidity.
All of this positive news is encouraging, particularly the mounting evidence of a relatively strong underlying economic base in the United States. However, caution is still in order for several reasons. The European proposals to create more than a common currency and bring member countries closer together with more accountability, and execution of any new accords, are still likely to face multiple issues. Europe’s economic growth has slowed and may enter recession, which would negatively impact the United States since the continent accounts for about 20 percent of U.S. exports. The domestic political log jam 2.0 was clearly evident in the failure of the “Super Committee” to reach a new deficit-reduction plan. Uncertainty in Washington is likely to linger through 2012, perhaps longer depending on the election outcome. Clearly, the economic engine is clearly not firing on all cylinders as the for-sale housing market is accounting for a meager 2 percent of economic output in the United States, unlike virtually all past recoveries. In turn, this is keeping banks, which have reserves of approximately $2 trillion, risk-averse with limited lending to consumers and small businesses. Receding recession fears and renewed geo-political problems in the Middle East have pushed oil prices back up, eating into consumption and profit margins.
In balancing the positive developments with the negative factors, one can only conclude that an organic transition from a muted recovery to a robust expansion is being held back by major macro issues in the United States and globally, and that investors need not panic or overreact to Doomsday scenarios but be prepared to endure through an extended period of slow improvement economically and in property fundamentals. In 2012, the challenge will be to balance the “wait and see” approach and the traditional need for more clarity with the established fact that by the time the macro risks are truly reduced, property pricing will have already moved.
Therefore, this is the time for market selection, asset selection, a well-thought out value creation and exit strategy – all built on an astute leveraging of incredibly low interest rates. The top-flight, low-risk acquisition strategy of 2010-2011 will not pencil out as easily in 2012 thanks to recompressed cap rates and back-to-peak pricing for many top-tier properties. One clear trend is the favorable position of commercial real estate as an asset class by multiple measures, starting from going-in yields, to improving fundamentals, lack of new supply (across most product types), increased lending sources and of course, low interest rates.
Hessam Nadji is senior vice president and managing director of Marcus & Millichap Real Estate Investment Services. He is also the interim managing director of Institutional Property Advisors, Marcus & Millichap's special division designed to serve the unique needs of institutional and major private multifamily investors. Contact him at email@example.com.
About Marcus & Millichap Real Estate Investment Services
Since 1971, Marcus & Millichap Real Estate Investment Services has been the premier provider of investment real estate services. Through the depth of its local market knowledge, the firm has established itself as a leading investment real estate company with more than 1,200 agents nationwide. The firm recently formed Institutional Property Advisors (IPA), a multifamily brokerage division serving the unique needs of major private and institutional investors.