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.

Are Trade Tensions Good for the Global Economy?

Despite global trade tensions, the global economy reached an estimated growth rate of 3.8% in the first half of 2018, the fastest since 2011, driven by growing consumer spending and massive fiscal stimulus enacted in the U.S. We might even argue that trade tensions have been good for the global economy, pushing China into additional economic stimulus.

Nevertheless, in the area of trade relations, the re-positioning of the U.S. continues. Tensions between the U.S. and EU have eased but continued to rise between the U.S. and China. Prospects brightened on regional trade agreements such as NAFTA (at least with Mexico) and a potential APAC deal later this year.

Despite trade uncertainties, income growth and capital appreciation in real estate generally kept up the positive momentum in line with positive economic growth. CBRE’s rent and capital value indices recorded year-over-year growth across all property types and all regions in Q2 2018, an all-around growth the market hasn’t seen since Q1 2016. Quarter-over-quarter growth prevailed in office and industrial sectors, while retail rent and capital value dropped in EMEA slightly.

The spread of real estate prime yields and government bond rates continues to narrow slowly. Capital growth has been resistant against the near-term pressure from rising interest rates. Income growth has increasingly become the return driver, particularly in the APAC office and industrial sectors.

The highly cyclical office sector started to experience more volatility in capital value growth, except for the APAC region, which remained in its delayed yet ongoing phase of accelerating office capital appreciation, reaching an annual growth rate of 9.6%. This is mainly due to the rising co-working space demand in East Asia, and has led to a construction surge in Southeast Asia. APAC office rental growth, 4.7% year-over-year, was the highest rental growth rate across the board in Q2 2018.

The Americas office rent and capital value growth was relatively slower, reflecting reduced labor availability and moderate but increased levels of supply. The U.S. office market is nicely balanced on occupier and investor terms.

The EMEA office market moderated after years of outstanding growth, whereas emerging markets, led by South Africa and the Nordics, gained solid footing in an office boom thanks to international business outsourcing and expansions. Both rent and capital value boasted double-digit growth in these markets throughout the first half of 2018.

Americas industrial continued to crown global capital value growth with 10.3% year-over-year growth, boosted by Canada’s improved logistics network and high-growth areas in the U.S. such as the San Antonio-Austin corridor, Louisville and Fort Worth. Rental growth decelerated but still appeared robust at 4.1% year-over-year. The industrial sector has shown cycle-defying resilience due to the secular shift to e-commerce in the region.

APAC industrial rent and capital value growth also showed momentum, on top of the previous e-commerce boom in the 2010 to 2014 period. This was mainly due to a drop in new completions in Q2 2018. Looking forward, the manufacturing subsector in a number of Asian economies is subject to the negative impacts of trade tensions, but growing consumer spending will help offset some of the loss.

Steady and relatively small growth persisted in the EMEA. Netherlands, Russia and South West England were the major rent and capital value growth drivers in Q2 2018. We expect the trend to continue whilst geopolitics poses a risk.

Slumping in the Americas retail rents came to an end. Year-over-year rent change entered the positive domain from -4.0% in Q2 2017 to 0.03% in Q2 2018. Many retailers beat second-quarter earnings expectations as structural shifts and changing business models gradually made an impact. Similarly, the APAC retail indices moved up slightly.

However, EMEA retail, which had been outperforming, saw rent and capital value growth soften as industry competition intensified, especially in the U.K., Nordics and U.A.E. We expect retail businesses continue to evolve their business models using brick-and-mortar space to connect with consumers, moving beyond merely selling.

Risk lies at the center of investment decisions, but our data suggests that trade conflict does not pose a significant threat to real estate. Positive economics and innovation are driving growth, with industrial real estate the clear leader.

By Professor Richard Barkham, Global Chief Economist & Wei Luo, Senior Research Analyst, CBRE.

Extended Cycle? Extended Slow Growth

Last time the U.S. unemployment rate fell below 4% was 2000. At the time, annual growth of office rents had exceeded 5% for five consecutive years, arriving at a high mark of 11%. Construction had burgeoned in a robust economy until, as we know, the music stopped. We have discussed the key role central banks’ key role in economic cycles, but that is not to say businesses and consumers are off the center stage.

As the job market tightens, occupier demand increases and rental growth accelerates, investors, lenders, and developers collectively do more business, take on more risk and drive up supply to match the rising demand. This heats up the economy, and inflation urges the central bank to raise interest rates. Demand usually softens after that, while supply growth moves on with overbuilding and overtaking, which trigger a recession.

But we may find ourselves in an unusual case this time: eight years and ten months have passed since October 2009 when the unemployment rate peaked at 10%. By comparison, it took seven years and ten months for unemployment to move from peak to trough in the longest cycle recorded in the U.S. history, which lasted 11 years. We are on track to break the longest-cycle record.

For the past four months, the unemployment rate has remained at 4% or less. Inflation has been steadily rising. The Federal Reserve has raised interest rates seven times in the past three years. The consensus is that we are late in the cycle. However, rental growth has lagged core inflation. Supply growth has yet to pick up its pace (Figure 1). We expect the office stock to grow 1.7% in 2018, but even then, the rate is nowhere near the previous high. Considering the soft rental growth against upward movements in borrowing and construction costs, investors are not highly incentivized to increase supply.

Why hasn’t rental growth climbed higher during this economic expansion? In 2012, office-using job growth surpassed that of 2005 and rent growth was at comparable levels (Figure 2). Nonetheless, investors stayed risk-averse. The 10-year Treasury yield hit a bottom low of 1.4%. In September 2012, the Fed initiated an open-ended Quantitative Easing (QE), attempting to boost market confidence and stabilize growth.

We won’t address the QE impacts in detail here, but the Fed’s move largely encouraged prudence in the market. The confidence, however, did not seem to rise as quickly as the Fed’s balance sheet. The market reacted badly in 2013 when the Fed stated its intent to scale back bond purchases. As soon as supply gained momentum, rental growth moderated.

Fiscal policy is not the only unique character of this cycle. Digitization has also played a significant role. Since 2010, financial companies and governments have been consolidating their physical space while up-investing in technology. More businesses began to think about workplace strategies that create a more collaborative, secure and efficient office environment. This trend continues, in sync with the rise of co-working space.

We think the slow growth of rent and supply will continue in the extended cycle. Without over-expansion, we don’t expect to see the national imbalances that investors saw during the last two recessions.

By Wei Luo, Senior Research Analyst, CBRE and Alex Krasikov, Economist, CBRE Econometric Advisors.