Puppy Dogs, Rainbows and Three Caps

A nation’s overall happiness is not necessarily based on the strength of its economy.

Take Japan, for example. Its economy hasn’t grown much in almost 30 years, but it has one of the highest standards of living in the world and, according to a recent study by the CATO Institute, is the third “least miserable” country on earth. The U.S. is the 28th least miserable out of 95 countries ranked by CATO, which derives the rankings by the sum of each nation’s unemployment, inflation and bank lending rates minus the percentage change in real GDP per capita.

As I turn 50 this year, I’ve begun to think a lot more about things money can’t buy: more time with my kids, a decent first baseman on the Baltimore Orioles and the pursuit of happiness. I also wonder what’s happiness worth? While happiness is great, it may be a bit overrated. Based on seven independent studies, happiness peaks at the ages of 16 to 18 and 86 to 88. Everyone else—and this means you—is pretty much at the nadir of miserable for most of their lives.    

So, what is happiness worth? The eternal sunshine of the spotless mind, ignorance is bliss and happiness is a warm gun (thank you John Lennon) all sound pretty good to me and sound even better as I get closer to my 86-year-old fountain of new happiness! And if happiness is measured by cheap stuff (i.e., a $500, 68-inch smart TV) and more free time, then 2019 is a good year. Technology and innovation have made all stuff cheaper (though services costs have skyrocketed) and many big employers are experimenting with four- and even three-day work weeks as knowledge-worker productivity has increased.

The problem is that the same forces that are increasing our happiness—particularly innovation that, due to efficiencies in things like electric cars, makes us use less stuff—are also slowing economic growth. These four forces are too much cheap money, cheap labor, cheap energy and innovation itself. So we may be happier, but we are in for slow growth, low inflation and low interest rates for a long time. Big deal you say, at least we are happy! Well, I like puppy dogs and rainbows as much as the next guy, but I can’t put them in my 401(k), which requires growth and cold hard cash.

The silver lining to lousy growth is lower cap rates for commercial real estate. In short, because growth has slowed globally, we are in a seemingly permanent environment of lower interest rates and inflation. This lowered cost of debt capital, combined with the increasingly lower cost of equity capital as both international investors and large U.S. domestic institutions increase their allocations to U.S. commercial real estate, means that cap rates can and likely will get lower. U.S. growth may be slowing, but the country’s relatively high-yielding (compared to bonds) commercial real estate is the cleanest dirty shirt in the global investment laundry.

“I can’t believe I’m paying a four cap.” Just wait. European inflation is falling, and the U.S. is following suit. EU cap rates are typically 50 to 100 basis points lower than U.S. cap rates for comparable assets because of lower inflation. Lower inflation ahead means lower cap rates are the latest luxury European export that will line the pockets of U.S. commercial real estate investors in the form of declining cap rates across the board in core markets like New York, Los Angeles, San Francisco and Washington, D.C.   Don’t be surprised when the three cap becomes the new four cap in the U.S.

Jamie Dimon, Alan Greenspan and a lot of other smart folks believe that the 10-year Treasury rate could go to zero to match the $17 trillion of zero or negative interest rate bonds globally. This means commercial real estate investors investors will do well in the years to come. With slower growth, my 401 (k) may be a disappointment in my golden years, but at least I’ll be happy (particularly if I buy a puppy)!

By Spencer Levy, Chairman, Americas Research & Senior Economic Advisor, CBRE.

What Does a Stronger Dollar Mean for CRE?

The direct effects of a stronger U.S. dollar on commercial real estate fundamentals are likely to be overall positive. Industrial and “bread –and-butter” retail (as opposed to luxury) assets will benefit the most as consumers flush with the “oil dividend”, take advantage of cheaper prices of goods.

There will be a modest downward effect on demand for luxury hotels in gateway markets. However, according to Jack Corgel, Cornell Professor of hospitality (and a senior leader of PKF, a CBRE company), any effect on luxury hotel demand from a rising dollar “is only the ‘icing on the cake’ and not the cake itself.”

Furthermore, U.S. manufacturing exports are going to be negatively affected, but this will prompt more capital investment in the already super-efficient U.S. manufacturing sector. Importantly, our research suggests that imports are a better indicator of industrial space demand than exports and, as we have noted, these will be boosted by the rising dollar.

A possible downside is that the rising dollar might choke off the capital flows from countries whose currencies have fallen. In some cases, these countries will be feeling the “double whammy” of both falling oil prices and depreciating currencies. However, as Chris Ludeman, CBRE’s Global President, Capital Markets,  notes, ‘domestic real estate capital is abundant at the present time.’

Diversity and Depth of Capital

According to Real Capital Analytics, the total volume of U.S. properties (over $2.5 million) sold over the last three years is approximately $1.1 trillion, and foreign investors accounted for only 10.9% of that total. This represents capital from 39 countries, and no country, except for Canada, accounts for as much as 10% of all foreign investments into U.S. commercial real estate. In short, foreign capital into the U.S. is deep and diverse, and while there may be some modest “winners and losers” from relative currency movements, the fact that the U.S. is the only growth story in town will mean that overseas investment interest will remain high.

Moreover, we think the “wall” of domestic capital, some of which has previously been priced out of the market, will more than make up for the shortfall. As a side note, one of the big “winners” is U.S. capital exported to foreign countries, which will also see a boost as assets priced in foreign country currencies will appear to be “on-sale” during this period.

We need to keep in mind that the world economy is, at the present time, subject to a savings “glut”. National savings (including both the private and public sectors) has been rising steadily since 2013.  In aggregate, several countries—China, Japan, Germany and other parts of Northern Europe—spend too little and save too much. They suffer from deficient demand, which is part of the problem the global economy faces today. However, it also means these countries have a need to export capital.

In the case of China, the capital outflow is only just beginning. This capital will be invested in bonds and real assets that is only now being unleashed, most notably in China, which is undergoing a transformation from an investment-based economy to a consumer-based economy. This savings glut will be tapped further by changes in laws in many of these countries (some of which we have already seen in China, Taiwan and, going back a few years, Israel), that  liberalize the ability to export capital overseas.

We believe that the “wall” of capital, both from domestic sources and non-petro-dependent foreign capital sources, is so deep that there will be no negative effect on U.S. commercial real estate from reduced capital flows.  In fact, the positive impact on fundamentals will make the U.S. look even more attractive than it already does. “Bread-and-butter retail” (as opposed to luxury) and industrial will be winners, and negative effects will largely be isolated to energy export-dependent markets.