I don’t know anyone who will not be happy to see 2009 in the rear view mirror. To say it was a challenging year is an understatement. Before we take a look at what commercial real estate market participants should be watching in 2010, let’s take a look back at some key events which took place in 2009:
In January, Barack Obama is sworn into the office of president of the United States making him the first African-American president in U.S. history.
In February, the president signs an unprecedented $787 billion stimulus plan which is touted as being necessary to keep unemployment under 8%.
The unemployment rate climbs to 10.2% (the highest it has been in decades) and drops to 10% even after a net loss of 11,000 jobs in November, demonstrating that discouraged people continue to drop out of the job market. They are no longer counted as unemployed and, if counted and added to those working part-time who would rather be working full-time, the unemployment rate is more like 17%.
The country braces for the H1N1 flu epidemic.
As the economy deteriorates, several frauds are uncovered led by the king of Ponzi schemers, Bernard Madoff, who is sentenced to 150 in prison.
To try to stimulate the economy, the government rolls out the “Cash-for-Clunkers” program paying $3,500 to $4,500 for cars which, in many cases, are worth little more than several hundred dollars. The program burns through $1 billion in the first week causing congress to provide another $2 billion to the program. The result is 690,000 cars sold of which only an estimated 125,000 would not have been purchased without the program.
The housing market becomes so stressed that the U.S. reaches a record rate of a foreclosure every 13 seconds.
With Fannie Mae and Freddie Mac hemorrhaging losses, FHA comes to the “rescue” as a new subprime lender requiring down payments of 3.5% or less. Between Fannie, Freddie and FHA, the U.S. government now guarantees 92% of all home loans in the country.
The $8,000 first time home buyer’s tax credit is launched stimulating home sales. The program is subsequently expanded to include a broader group of purchasers. Based upon the average U.S. home price of $178,000, and a 3.5% FHA down payment requirement, the government is “paying” people to buy houses.
Several banks turn very profitable based upon the Fed’s monetary policy, allowing them to recapitalize resulting in many of them repaying TARP money.
Chrysler and GM go belly up and get bailed out by the government. The atypical bankruptcy processes leave many wondering why highly sophisticated bankruptcy law is cast aside (along with thousands of senior secured creditors) for political objectives. Chrysler is taken over by Fiat and GM emerges as a zombie with UAW control and unsustainable pension obligations which the taxpayers must swallow.
Based upon all of the government spending, the U.S. budget deficit triples in size to over $1.4 trillion.
Yes, it was an eventful year with many firsts and many unprecedented actions in response to uncharted territory. On the commercial real estate front, we saw the lowest volume of sales that we have seen, going back at least to 1984. We also saw prices tumble anywhere from “a lot” to “a real lot” depending on the property type in question. Volume appears to be on the upswing while prices continue to slide in tandem with increasing unemployment. To figure out where we are headed in 2010, we will be watching 10 key indicators. Let’s take a look at them (in no particular order):
1) Unemployment. For those of you who are regular StreetWise readers, you know that I believe there is no metric that more closely impacts the fundamentals of the residential and commercial real estate markets than unemployment. If people have lost a job or fear losing one, they are not likely to move from a 0ne-bedroom apartment to a two-bedroom and are not likely to move from a rental apartment to a purchased residence. When employers cut staff, they are not likely to be taking more office space and, if anything, may take less space at renewal time. Similarly, those who have lost jobs are less likely to travel, leaving hotel occupancy hurting and they are also less likely to spend freely in retail stores, stressing that sector.
As indicated above, the present official unemployment rate is 10%, down from 10.2% even after a net loss of jobs in November. This indicated that dejected job seekers are dropping out of their search and after 30 days, they are no longer counted as “unemployed”. Currently, the average length of unemployment for those who have lost jobs is in excess of 28 weeks, the longest period ever recorded going back to 1948.
If we add to these discouraged workers, those that work part-time that would like to be working full-time, the unemployment rate soars to about 17%. It is expected that the official unemployment rate will remain elevated throughout 2010 as discouraged workers begin to seek employment again as jobs are created. Over 7 million jobs have been lost during this recession. Add to this the fact that, simply based upon population trends, we need to add 1 million jobs per year and it is easy to guess that it may be some time before we get back to mid-single digit official rates. Net job creation will be a key towards a recovery in our fundamentals, particularly if it can be sustained.
On the positive side, we have seen productivity increases at typical “coming-out-of-recession” levels of 5%-6% which is, usually, a prelude to resumption in hiring. Similarly, temporary employment is also on the rise which also foreshadows permanent job creation.
2) Corporate Earnings. Corporate performance will be key to watch, especially on the top line. The stock market has rallied from a low in early March of about 6,600 to about 10,500 today. Much of this increase was caused by speculation and above-estimated earnings based upon companies slashing expenses (payroll being the largest of these cuts). While effective in the short run, reducing expenses is not a viable strategy for sustainable earnings growth. Top line revenue must increase and, thus far in the cycle, companies have not seen revenue growth in a tangible way.
3) Credit Markets. In order to make our commercial real estate markets function, we need available debt. In New York, we have been fortunate to have community banks and smaller regional banks that have been consistently lending since we started to feel the effects of the credit crisis in the summer of 2007. In many parts of the country, many of these smaller banks have tied up far too much of their capital in development and redevelopment projects which have been the property type hardest hit. This has resulted in 140 bank failures in 2009. We have not seen a meaningful number of large commercial banks or money center banks actively making commercial real estate loans and their re-emergence would be welcomed.
The TALF and the PPIP programs, did little in terms of direct activity, particularly compared to initial expectations, however, their mere existence brought credit spreads in appreciably. This dynamic could help rekindle the CMBS market which is so desperately needed by our marketplace. The shadow banking sector provided as much as 40% of lending in the bubble inflating period of 2005-2007. The present and near-term demand for refinancing proceeds is staggering. Unfortunately, even if the traditional banking sector and the insurance industry were both operating at full-throttle relative to real estate lending, they do not have the capacity to meet the demand.
Access to public capital is vital. In 2007, CMBS was a $230 billion market which eroded to $12 billion in 2008 (all of which was in the first six months). From July 2008 thru just weeks ago, the CMBS issuance had been zero. A couple of transactions have now closed and others are in process. We will be keeping a close watch on continued CMBS activity and also on REIT capital raising activity ($20 billion recently) and the newly formed mortgage REITs for signs that public capital is again flowing into our market.
For numbers 4 thru 10, stop back to StreetWise next week….