In The Sweet Spot

The US economy is now entering the sweet spot it has not seen for decades. Unemployment is nearing record lows, U6 is headed toward a record low, low skilled workers are moving off the part time rolls into full time work. The number moving to full time was 457,000 in the past month. Black unemployment is nearing what was once considered full employment for all workers at 5.9% and dropping fast. Even felons who have served their time, are getting training for low skilled jobs. Home prices and 401K’s are at a historic high, and consumers are as confident as they have ever been. Capital spending by corporations is increasing materially.  The Fed under Powell seems to be very aware of needing to keep rates moderate to keep the boom going. All of this together means GDP in Q2 is likely to reach 3.5% and maybe even 4%, and to continue at those levels into Q3, and maybe longer. At those levels of growth, compared to around 1.5% on average under Obama and Democrats, it so is now very likely that the Republicans will hold the House and materially increase their Senate seats. It is the economy stupid.

For CRE there is a lot of good news in this. Retail sales will increase, and online is still just around 10-12% of total retail sales. Department stores may become obsolete, and malls may have to be reconfigured to add entertainment and medical office, etc, but overall retail is not going away. It is just being reconceptualized to meet a changing consumer mindset. The mix of tenants may be changing, but consumers are stepping up spending now, as the tax reform and rising wages become believable to 90% of workers who got some benefit either through wage increases or a combination of wage increase and lower taxes. Retail did not die, it just got disrupted and a makeover. Like all industries over time, things change, and the weak got obliterated, and the fast movers get success.

For hotels, the strong economy means more demand to soak up the fast growth in supply. The bad news for hotels is they employ a lot of low skill labor, and those wages are now growing much faster, and the supply of labor is declining quickly.  These workers now have the option of getting a factory, or other type job at materially higher pay, so since labor is around 80% of operating expenses, the net cash flow of hotels will be under increasing stress. The industry never publishes NOI numbers because they want to hide reality and just talk about Revpar growing, and not profits decreasing as wages and labor shortages increase.

Industrial and distribution will continue to be strong as the economy grows at strong rates. Demand for goods is increasing nicely in the current quarter and is likely to increase faster as the tax reform impact and rising wages combine to convince workers that they also got a big benefit from the tax bill and deregulation, despite all the negative statements by the Democrats and the mainstream media. Workers look at the weekly or monthly paycheck, and they now see they are ahead. They see overtime, and the easy opportunity to change jobs to higher pay. Small cities and towns are even paying people to move there to be able to staff local factories to keep the plant in town. This will be a real pressure point for companies as they find that small cites are unable to supply the labor they need and they move factories to more labor populated locations. That has a lot of implications on where not to develop factories and housing. Labor force size matters.

Office should also see opportunities for raising rents as the workforce grows by millions, and not  a lot of new space is added. Working remote will probably not be able to fill the need for more space.

Moving offshore is no longer a good option for many industries as tax reform and deregulation become imbedded here. US energy costs are well below the rest of the industrialized world and will remain so. The Fed is not likely to raise rates too fast.  In addition, the new canal has moved a lot of seaborne delivery to the east coast, creating new development opportunities in port cities.

In summary, the Trump policies are now working, and the tariff story will go away as the EU, China and Canada realize they have to negotiate and concede. The damage to the US is a fraction of what it is to those countries. They can say they will not negotiate under pressure, but they had a chance to do it over the past few months and refused, so now they will have to concede after all. They just did not believe Trump really would do what he said he would. Slow learners. The whole tariff issue will go away over the summer as deals are cut with the EU, Canada and Mexico. China is more complex and might take longer, but in the end Xi needs economic growth, and he will work it out. Just ignore all the hyperbole from affected companies and economists. The tariffs are temporary.

Transaction volume likely will remain muted as prices of assets remain high, but for owners, and lenders, it is a very good time.

The views expressed are the author’s own and not those of ALM’s Real Estate Media Group.