‘Capital Insights’ with Jack Kern: The Springtime of My Discontent

“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it, if it keeps moving, regulate it, and if it stops moving, subsidize it.”
Ronald Reagan, 40th U.S. President, 1981 to 1989
 
I have become increasingly optimistic about the long term prospects for growth in the economy while at the same time becoming bearish on the newly reformatted democratic party’s view of economic popularism. It seems to me that the lack of accountability on the part of federal officials is beginning to rival the cowboy mentality that made Wall Street so fragile, except that the Street reacted to its own hubris and ultimately self-adjusted. Certainly it was a spectacular adjustment, but one borne out of necessity and the rational need to find equilibrium. I was reading an article the other day about some pundit who claimed the country is functionally bankrupt and that civil war and constant struggles for food, shelter and medicine were going to become the de-facto status quo for many of us. I seriously doubt this is anything but an attempt to sell a book or maybe get more people to buy canned goods, but no self-respecting economist is going to head down that track. While foreclosures continue at record levels and unemployment and job numbers are shockingly uneven, the greater capacity to re-balance is evident.

In a sense, we’re constantly looking for rapid solutions to long term problems and in the multifamily sector, it’s no different. Rent growth comes from the economic vitality, drawing employment into sectors that feed the kinds of jobs important to apartment owners. Job growth, frequently misquoted and even more poorly misunderstood by the trade press is a part of that analysis but is not the answer. We can expect to have a jobless recovery, in that strong growth in jobs in all sectors is going to be sporadic and not helpful initially. The vast amount of stimulus being spent, estimated by us to be about $14 trillion at last count, is for projects that create no long term employment but are simply expected to act as a catalyst to spur other kinds of activities. This ultimate multiplier effect will be helpful, but don’t presume there is pent up demand or a massive number of Gen Y kids waiting to move out of their parents homes. In all likelihood, the gain in demand will come about as the entire U.S. housing inventory situation is addressed and rents once again become competitive.

It would be easy to address the issue of rent gain dating by following the industry perception that the economy is going to recover quickly. The real situation is more likely to observe a stringent de-coupling from this folklore in favor of a more long-term trend. Plan on 2009 and 2010 being very slow in most markets. Expect that whatever is being underwritten as an optimistic forecast for later years is just that. Anticipate that economists, who are perennially wrong, will once again miss the cycle and this time call for a cessation of economic duress that will not materialize.

Some real forecasts for you:

The Stock Market, (NYSE mostly) will decline more as the reality of limited earnings and trade imbalances become more evident. TARP, TALF and other programs will have insufficient power to make a difference in the way the market moves and the investing public, tired of the shell game driven by major traders will continue to stay away in earnest. The suspension of disbelief, so obvious in the early part of the market’s decline is now much more acceptable to traders and novices alike. Allowing for the possibility that those on the Street have an economic incentive to be sure Wall Street runs, it will get worse, but not drop to extraordinary lows. Another major adjustment cycle is in the offing and the sails are out of air at this point. Look for another 1500-point decline in the Dow.

The commercial property markets will not collapse as has been mistakenly forecast, but will continue to struggle, with industrial showing flat to slightly down rents, retail showing increased vacancy and new concessions and multifamily continuing to exhibit weakness in all but a small number of markets. Obvious pockets of growth will appear in certain investment grade submarkets, but mostly the prospects for rent growth are bleak across the board. The re-emergence of CMBS is a positive sign, but it’s far from being a certainty in financial markets.

We are in one of those intra-cycle periods where patience and a calm demeanor along with steely nerves will get investors through the cycle. Pricing of assets won’t decline as much as the perception of loss of value would indicate and transactions will close in small numbers until the capacity to underwrite improves. Don’t be fooled by the tremendous publicity about distressed deals, because there are not many of them, relative to the size of the inventory in most sectors. There are just more of them than historically normal. The single best source I’ve seen for information on distressed deals is at Pierce-Eislen, and I encourage you to call Ron Brock Sr. over there and see what they’ve done. The lists are, to say the least, astounding.

(Jack Kern is the managing director of Kern Investment Research. He has been repeatedly voted the best real estate forecaster in the United States by his close relatives and some well meaning friends, but still can’t get on the A list for parties. He can be reached at 301-601-1900 or [email protected].)