The Commercial Real Estate industry is progressing from the economic downturn post crisis. In the 3rd quarter, the largest capital investments were observed in the following sectors: apartment, high quality retail, and office space. Investors have looked towards CRE assets for enhanced returns, taking advantage of the low interest rates maintained by the Federal Reserve. Investor sentiment riddled with uncertainty and numerous small businesses searching for clarity on the US fiscal situation generated increased risk aversion causing a stalemate on employment. Businesses are also waiting for some type of clarity on taxation policies before further expansion. From March 2012 to August 2012, the US economy added an average of 96,670 jobs per month, well short of the 125,000 needed to keep the unemployment rate constant. Arizona unemployment increased 0.1% over the 2nd quarter to 8.3% while the US unemployment was reported at 7.8%, a 0.4% drop over the previous quarter. This national unemployment figure has raised the suspicious eye of several economists. Many are questioning the validity of data for employment numbers that largely beat forecasts. The unrest in Europe is a constant factor in US economy concerns as news fluctuates as to the stability in the region. Overall continued uncertainty, fueled by fear of the potential fiscal cliff and the results of the presidential election, has investors finding safety with lower risk assets.
The Federal Reserve elected to continue further quantitative easing (QE3) as of September 14th, 2012. The process will involve buying $40 billion worth of mortgage securities per month within an undisclosed timeframe. The stimulus measures are accommodative policies aimed at maintaining significantly low borrowing rates, sustaining a normal inflation rate, and improving labor markets. Markets immediately picked up, yet forecasts are mixed and some opinions point to the Fed’s decisions as irrational; unable to curb unemployment and encourage spending.
Those Fed measures did spark a temporary rally in the markets, and September was the third quarter’s best month. The Conference Board released the Consumer Confidence Index which rebounded in September and is approaching levels not seen since February of this year. The index increased to 70.3 in September, up from 61.3 in August and close to the 71.6 seen in mid-February. The level of consumers expecting business conditions to improve over the next six months increased to 18.2% from 16.7%. While public optimism improves, the Consumer Price Index (CPI) did increase 0.6% in August 2012, with a total increase for the third quarter of 1.7%. The majority of this increase is seen in heightened energy costs. There has been considerable debate about the false sense of confidence that was priced into the market due to QE3. There is a huge consensus that such “Fed easing,” offers a false sense of hope for the markets, and that the purchases may induce heightened activity in the housing market as mortgage rates plummet even lower.
Manufacturing has improved on a national scale. The Institute of Supply and Management released the ISM Report on Business, noting that the Purchasing Managers Index (PMI) rose to 51.5 in September 2012. The index is an indicator of manufacturing activity through the acquisition of goods and services. The increase of 1.9% from August 2012 proves that the manufacturing sector expanded in September, after three months of minimal contraction. In line with the ISM data, according to the Bureau of Economic Analysis, personal consumption expenditures increased 57.2 billion or 0.5% as disposable income increased 0.1%.
All core capitalization rates in the US for properties over $2.5 million stood at 6.97% at the end of August 2012. That number is up slightly from the 6.84% seen at the end of the 2nd quarter. The level of CMBS issuance, according to Pension Real Estate Association, was $167 billion in 2005 and increased to $229 billion in 2007. That level is down to $29 billion in 2012. In stark comparison, the level of CMBS delinquencies stood near $5 billion in 2005 through 2007. That level is now at $58.6 billion as of August 2012, totaling $706.9 billion in outstanding CMBS delinquencies. (Morningstar Credit Ratings)
The presidential elections and the fiscal cliff are the primary concerns for upcoming quarters. Most economists agree that compromise and changing policy in Washington are critical to the ability of our economy to improve and fully recover. Goldman Sachs predicted that if both tax increases and spending cuts take place, overall GDP would fall 4%. One major concern at the forefront of most professional’s minds is that the next President would implement policies that will curb the deficit, limit entitlements, enact tax reform and change impeding business regulation. Such tax policy could spur changes in the profitability of the real estate industry as tax burdens affect REITs. The carried interest that partners receive for investment profit could be taxed at a higher rate, not the capital gains tax rate presently in place. Nevertheless, the main upside in commercial real estate will be consumer confidence. After the elections take place the element of uncertainty will diminish.