Limits On Value Growth

Economic data do not get much better than they are now. Reality is, the only reason GDP is not showing much faster growth is, there is nobody left to hire. No matter who I speak with, they say they could do much more business, and make more profit, if they could find anyone with skills to hire. There is nobody who wants to work and has any ability, who is not working today. It does not matter what industry or job position, there is simply nobody left looking for a job unless they are looking to make a change at more money, or they decided to come out of retirement or finished raising a kid. This is a particular issue in construction where real skills are required to be able to safely do the work. There are now construction companies running their own apprentice training programs, and they are hiring ex-cons and others who want to work in a job that pays well. It means construction costs will continue to rise as workers can demand higher wages, and as more training costs are incurred. Less skilled labor means projects take longer to complete and more mistakes happen that are costly to fix. Punch lists get longer and more costly. The bit of good news here is that there are not the workers to build as fast as new development might demand, so supply of all types of real estate assets will be constrained this cycle.

With white unemployment at 3.2%, and wages growing at 3.1%, it means consumers have money. Consumer confidence is at record highs. It is likely to rise further with the new jobs report. Savings rates have been high for the past several years, home prices are back where they had been ten years ago in many markets and most outstanding mortgages are at record low interest rates, so this time around, homeowners are not pressured. They have money to spend and they have high confidence that their job is secure and their wages will continue to rise. Thanks to the tax cuts, bonuses should be good this year. All of this will translate into a very strong Christmas season for retail. It should blow away all records. That will translate into tenants being stronger in your shopping centers and able to pay rents with no problem. It should also translate into landlords being able to raise rents. Brick and mortar retail has learned how to compete effectively with Amazon and Wal Mart online shopping, so there should be much more stability for centers in terms of tenants going out of business.  After this Christmas we will likely see the end of the string of bankruptcies and store closings. Any retailer not making it this Christmas will have to close, and we will likely see the final group of store closings, early in 2019.

Most center owners have by now figured out alternative uses for abandoned big box spaces and are already working to fill those spaces, in many cases with higher rent payers than the older anchor stores. Stability will return to retail in 2019.

The problem is interest rates, the high dollar, and the end of the flood of Chinese dollars into the US.  The high US dollar makes it very costly for investors from other parts of the world to afford our assets as investments. Not only are they having to pay up in their own currency values, but they are at real risk the US dollar will decline in relative value during the long term hold period, inflicting currency losses on the investor.  There is no question that the Fed will continue to raise rates at least through Q! in 2019, and likely more than that. The ten year will surely rise next year as the economy continues to grow, and the Fed raises rates. The uncertainty of how high rates go is a big unknown. If GDP continues to grow around 3.5% into Q1 and Q2 next year, the ten year will likely rise to over 3.5% at some point, and could possibly go higher. Cap rates will then have to move up.

So we have a material lessening of capital coming in from China and other places, combined with rising rates, and a bond and equity market that will be strongly competing for investment dollars. Equities will continue to rise if the economy continues to grow at 3% or better, which is likely into the first few quarters of 2019. Taking all of this into consideration, it is likely that CRE values will stay flat or maybe rise only a little next year. If rates do rise four times as the Fed predicts, CRE values could decline in spite of a strong economy.

The views expressed here are the author’s own and not that of ALM’s real estate media.