A Potential Silver Lining Amid the Crisis of Confidence

The shakeout continues through the aftermath of the U.S. debt downgrade and ongoing concerns regarding European sovereign debt. Making matters worse, discouraging domestic economic readings are mounting with the latest coming from manufacturing and for-sale housing. Accounting for the usual lag in vital economic indicators, these readings confirm that consumers and businesses began pulling back even before the mishandling of the U.S. debt-ceiling resolution and the downgrade of U.S. debt that sent equity markets around the world into a tailspin. The magnitude of the additional weight the current fear factor will place on economic activity will take time to assess, but real estate owners and investors need to be prepared for economic stagnation — if not a contraction — over the next several months. The good news is that all property types have stabilized over the past year and the sector is much better positioned than it was going into the 2008-2009 period.

As stated in my previous blog, the last thing an already fragile recovery needed was a new bout of fear and uncertainty. Unfortunately, that is what has been caused by Europe’s debt-problem patching and our government’s failure to implement a plan to shore up the recovery in the short term and regain fiscal balance in the long-term. Forecasting how we might get through this period warrants a look at the nature and causes of the current issues, and not bundling the reaction with what might have been appropriate during the 2008-2009 crisis. The current dynamics are more about the political paralysis in dealing with structural issues that erupted in 2008 than new problems with the global economy. The transfer of debt from the private sector to the public sector in the form of massive stimuli was necessary to stop the downward spiral that would have led to a depression three years ago, but the political fumbling of solutions to re-establish fiscal balance at the right pace was unnecessary and avoidable. Unlike three years ago, there is much less political will and room for large-scale stimuli, especially since the global focus has shifted toward reining in deficit spending. Given the Fed’s already-bloated balance sheet, it seems few if any tools are now available to stimulate the economy. Therefore, short-term moves to boost equity markets, at least temporarily, are less likely.

This may seem like a recipe for prolonged stagnation but some positive outcomes may emerge. To start, given the failure of the past government initiatives to act as a spark toward a sustainable, fundamentals-driven expansion, and with an election year around the corner, renewed chatter regarding further job-creation measures are bound to be less costly and more directly tied to actual hiring. There is also a chance that legitimate, value-creating initiatives such as infrastructure improvements — which only received 7 percent of the 2008 stimuli package — and R&D incentives will become higher priorities. The banks, previously well-capitalized with $1.62 trillion in excess reserves, are already starting to increase lending and are likely to be pressured to do even more. This has been one of the major obstacles hindering the velocity of capital and unleashing the benefits of historically low interest rates, a badly needed lubricant to any sustainable recovery. That is not to say lending should or will revert back to dangerously low underwriting standards but opening more financing options for small- to mid-sized companies and generally qualified consumers would help corporate expansion and the for-sale housing market. Energy prices have eased substantially over the past month in the wake of renewed slowdown concerns, diminishing a major drag on consumer spending and corporate margins. Last but not least, the current period of uncertainty and stagnation is creating some pent up demand, particularly by Corporate America which was on a relatively healthy expansion trend prior to the current stall. Even a small degree of improvement or direction from the political realm that may come from the work of the “super committee” assigned to address U.S. debt on a longer-term basis would go a long way to reduce uncertainty. After all, private-sector confidence and Corporate Americ'as tendency toward expansion are the most powerful drivers of economic growth and are what's being held back.

We cannot underestimate the heightened level of risk, particularly the global economy’s vulnerability at the moment to another unexpected shock. We could also see the situation worsen if the fear factor escalates beyond the recent rise, leading to a more defensive posture by companies and consumers. As I have stated many times, one way or another, we need to be prepared for below-potential growth rates for some time given the necessity to eventually raise taxes and lower spending. However, the CRE sector will enter a sustainable and gradual recovery even at average or slightly below average job growth, and does not necessarily need an all-out economic boom to see improving fundamentals. Capital flows into commercial real estate, which have already improved, are likely to increase further as investors opt out of an increasingly volatile stock market. I will address the outlook for commercial real estate in the next blog.

Hessam Nadji is managing director, research and advisory services, for Marcus & Millichap Real Estate Investment Services. Contact him at hessam.nadji@marcusmillichap.com.