Healthy Corporate Profits Counter Global Unrest

Corporate profits are soaring. They started climbing in the fourth quarter of 2009 and continued to grow throughout 2010. In 2010, corporate profits climbed by 37%, for the biggest gain since 1950, according to the Bureau of Economic Analysis. This is very good news for both the economy and the commercial real estate market.

While thus far it has been accompanied by only moderate growth in demand for new employees and for CRE space, that relationship cannot continue for long. Productivity per worker is at historically high levels, and there is not much more that can be squeezed out of the American worker. Space utilization is also high. Underutilized space began to be reoccupied last year; and by July, it will be largely burned off. Until recently, firms have been reluctant to hire and/or take on more space until they were certain that the economic recovery was solid, and the risk to future corporate profits was minimal. While some doubts will linger (in particular due to uncertainty in the Middle East and Japan), nothing helps business confidence more than five consecutive quarters of profit.

Which sectors? Corporate profits in computers and electronic products were up an exceptional 295% on a year-over-year basis. This implies that there will be a resurgence in hiring and additional demand for office and R&D space in high-tech centers that have emerged throughout the nation, particularly in the Silicon Valley and San Francisco, Washington D.C., Boston, Austin and Seattle.

In petroleum and coal products, corporate profits were up 115%, which is good news for all CRE property types in energy-production metros, including Houston, Dallas and Denver.

Manufacturing corporate profits were up 72%, including 110% in machinery. This is positive news for the Rust Belt, as well a number of Sunbelt manufacturing centers, including Los Angeles. It also has direct positive implications for industrial space. 

Profits among financial services firms grew by 50% in 2010, which will likely stimulate hiring and absorption of office space in financial centers, including New York, Chicago, Boston and San Francisco.

Retail-trade corporations witnessed growth in profits of 26%. While not as dramatic an increase as in the aforementioned sectors of the economy, it still should be more than enough to justify expansion by retailers throughout the nation. Retailers also slashed inventory very quickly after the crisis and their inventory-to-sale ratio has been the healthiest in several years.

How will soaring corporate profits and unparalleled productivity impact commercial real estate investments? Healthy profits are a critical counterbalance to the negative global news as related to corporate confidence, which is the key to the next phase of the economic recovery. If companies spend and hire, a fundamentals-based recovery for commercial real estate and eventually, U.S. consumers will take hold. This will also provide the foundation of a sustainable housing recovery starting in 2012. Barring the escalation of current global issues into an all-out crisis, improved corporate confidence will also boost CRE investor confidence. We are already seeing private and institutional capital pursue more Class B and secondary market opportunities as confidence improves, and this pattern should continue.

Profit growth rates in the 30% to 300% range cannot continue much longer. That level is simply unsustainable; in part because the base is growing (corporate profits were low in 2009, enabling very high percentage gains in 2010). However, it also appears likely that absolute corporate profit growth will continue through 2011 and 2012, reinforcing business confidence and enabling accelerated job growth and demand for CRE space.