Federal Reserve Chair Janet Yellen gave her semiannual testimony to the House financial services committee on Capitol Hill yesterday. She said modest GDP growth combined with gains in the job market are two of the reasons why the Fed will continue with it’s plans to sell off over $4 trillion in debt and mortgage-backed securities on its balance sheet. As you may recall, this debt was built up during the financial crisis.
She then shared her concerns about economic uncertainty due to the Trump administration, given it has not yet succeeded in cutting taxes, slashing regulations, renegotiating trade deals, or rebuilding American infrastructure.
At yesterday’s testimony, Yellen said “the federal funds rate would not have to rise all that much further to get to a neutral policy stance.” That statement may be what caused a bit of stock market rally as it appears there will be no rate hikes in September, and the odds for a December hike are about 50/50.
Optimistic stock market investors may not be questioning is what will happen once the Fed stops purchasing mortgage backed securities, and instead, starts selling them off.
Additionally, the markets rallied after last week’s jobs report showing 222,000 new jobs in June. Oddly enough, unemployment rose slightly to 4.4%. It appears more jobs are being created, but more people seem to be entering the job market as well. The labor force participation rate rose slightly to 62.8% from 62.7% in May.
All these headlines can be confusing. The central bank says its optimistic about the economy but concerned at the same time. The jobs report is strong, but wages are fairly flat and unemployment is up. Stock market valuations are reaching new highs, but the rally continues.
Some of the largest real estate private equity funds, limited partnerships, and other service providers gathered at IMN’s annual U.S. Real Estate Opportunity & Private Fund Investing Forum in Newport, Rhode Island to share their insights into commercial real estate and the state of the economy.
In addition to a discussion on the latest challenges and opportunities for commercial real estate, they also addressed many other topics, including “when the other shoe will drop” on a market that’s overdue for a correction. After all, it’s the ninth year of expansion, or as some would say the “ninth inning.”
Ninth Inning of Expansion
If the expansion continues for another year, it could become the longest period of U.S. economic expansion ever. The record so far is ten years. That took place after a mild recession that ended in 1991. The current cycle began in June of 2009, so we are at the 9-year mark right now. And, according to fund managers, jitters over the market seem to be offset by a willingness to sink more money into the market.
A publication called Chief Investment Officer cited one fund manager at the conference as saying: “Fundraising for us seems to be better than it should be.” Gary Jaye of CBRE Global Investors says: “We’re selling a story of lower returns, a potential recession coming… yet inflows seem to be very strong.”
The CIO publication reports that capital inflows have been “robust” over the last few months. It says there are 554 real estate funds in the global market that are managing $189 billion worth of capital. According to David Kessler of CohnReznick, that’s the highest level since 2009.
Kessler also notes that investment strategies differ somewhat from last year. He says the percent of funds going after core real estate strategies that increase cash flow have risen from 41% to 52%. But there’s no lack of risk taking as some investors choose strategies that are more opportunistic.
As reported by CIO, Sean Ruhmann at TA Realty says: “Some folks think it’s a better time to go higher in the risk spectrum… the more opportunistic funds.” He continues, “There’s nothing uniform in what we’re seeing, other than people having interest.”
Whatever the strategy, real estate is providing at least the semblance of a safe haven.
Glenn Mueller of Dividend Capital says: “Everyone is looking for a safer place to put money and real estate looks safer than the stock market and certainly safer than the bond market if you think interest rates are going up.”
All Eyes on Leading Indicators
What investors are watching out for are signs that the economic expansion is coming to an end. One red flag could come as the Fed raises short-term interest rate. If that happens and the long-term bond yields fall, there will be a flattening of the yield curve. If that turns negative, it could be a heads up about the next recession.
Fund managers and other economists are also worried about the success or failure of President Trump’s plan to grow the economy. He’s made big promises but, so far, not much has materialized. And there’s plenty of disagreement about what he is doing as well.
The CIO quoted Tim Wang of Clarion Partners as saying: “There’s a lot of expectation built in, especially from the stock market, businesses, and consumers about his tax reform.” He says if Congress and the Trump administration don’t get their act together he’s afraid: “The animal spirit will disappear and we will fall into a recession earlier than expected.”
Russell Appel of the Praedium Group says he’s nervous about Mister Trump’s comments on immigration. He says: “We need strong immigration for strong real estate demand.”
Affects of Technology
Technology is also representing a big wild card. The current “normal” is a constantly changing matrix of technological advances and disruptions. It won’t be long before the road is filled with driverless cars and deliveries made by drones. As we enjoy the benefits of technology, there will be negatives. Automation will take away jobs. The important thing to remember is to look or new opportunities.
Kevin Mogenroth of PIMCO identified an important real estate opportunities. He says: “Ecommerce retailers need about three times as much warehouse space as brick and mortar retailers. We have too many malls and not enough warehousing.”
Among the real estate sectors undergoing big changes because of technology:
1 – Healthcare. CIO writes that people are living longer because of technology. As a result, they are staying in their homes longer, and are not moving into senior housing facilities as soon as they used to.
2 – Student Housing. There are more opportunities to take courses online. As that gains popularity, demand for student housing could fluctuate.
3 – Parking Garages. As the sharing economy provides alternatives for private car ownership, garages are becoming unnecessary.
4 – Commercial Real Estate. More and more employees are working remotely which is reducing the demand for office space.
Although people are spending less time working face-to-face with colleagues in the office environment, CIO writes that employee groups tend to get together more for conferences.
It is tough to predict exactly how this will play out economically. Even the fund managers say they don’t know what will happen next. Tim Wang said: “One of our key responsibilities is forecasting, but this late-stage cycle forecasting is career suicide.”
Thinking Outside the Box
When so many factors are in play, you need to stay up to date on market conditions, and think outside the box on how it may or may not affect you. Be prepared to recognize an opportunity, and know enough about what “might” happen to avoid any risks.