Monday, 20 March 2017

Commercial real estate under Trumponomics

 

This cycle has seen a wave of institutional money going into a few areas, commercial real estate being one big beneficiary as institutions tried to capture yield versus liabilities.
Trumponomics aims to deliver a few key rebalancings:
  • Wages as a percent of GDP higher, in particular minimum wages higher
  • Imports lower, domestic production and exports higher, driven by BAT tax
This has to deliver higher medium term inflation and nominal GDP outside of temporary recessions. The Fed, Eurodollar futures and bond yields are starting to reflect this expectation of higher nominal GDP. Most people I speak to see US corporate defaults rising.

Under globalisation and neo-liberalism combined with several economic sectoral deficits, the corporate sector profits as a percent of GDP has only really been higher towards the end of the 1920s credit boom, while wages have never been lower:



The FIRE sectors (finance, real estate and insurance, none of which directly contribute to output) as a percentage of GDP have increased to over 20%:

https://www.linkedin.com/pulse/fire-economy-under-trumponomics-rob-hawcroft

And while debt to GDP has been growing at around $3 of debt for each $1 of GDP, the finance sector growth has stalled with ZIRP. As rates rise the finance sector in the short term could even increase as a percentage of GDP before it busts.

More generally as corporates get squeezed by rising wages, BAT-increased import costs and higher financing costs, they have to cut costs elsewhere. One way is to increase productivity (positive) and other is cut optional costs; which brings us to real estate.

Offices will see less demand due to remote working which is better enabled by improved internet access. There is a general hollowing out of the mid-market of many industries to a bar-belled low price or high value industry structure. Some areas related to consumer spending and domestic production and exports will benefit, but most areas of commercial real estate will suffer from falling rents and falling occupancy.

The worst area (as discussed here by Charles Hugh-Smith http://charleshughsmith.blogspot.co.uk/2017/03/the-next-domino-to-fall-commercial-real.html) is likely to be big box and shopping mall retail, some of which is seeing more or less zero recovery value as marginal assets become uneconomic to operate, similar to the rust belt industries in the 80s and 90s. These retail sectors apart from wages/ BAT taxes, are also being hit by the structural shift to online.

According to CBRE the typical cap rates for investable retail assets are 3-5% (http://www.us.jll.com/united-states/en-us/research/capital-markets/commercial-real-estate-investment-trends/retail)

What could be the trigger for committed selling from institutions, starting with marginal retail assets?
Duration losses from government and IG bonds as the market prices in 4-5% nominal Trump GDP growth triggering the need to raise liquidity might be one.

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