Mid-Year Report Card: Economic Down-Shift and Recession?

By Dennis Kaiser

Connect Los Angeles brought together nearly 500 CRE leaders last week for an information-packed conference in DTLA. The second-annual event featured four panel discussions including a Mid-Year Economic Report Card.

The outlook that emerged from the conversation among two economists, a lender and an investment broker revealed a few opposing thoughts about where the economy is headed and its effects on commercial real estate. But make no mistake, there was a consistent concern about a recession given the length of the current recovery.

Newmark Grubb Knight Frank’s Kevin Shannon conceded we’re “in a choppy time” with the primary concern he’s hearing in the marketplace being that the 84 months of recovery has “gone on so long” it must be nearing the end of the cycle.

The two economists, SunTrust Bank’s KC Conway and UCLA Anderson School of Management’s Jerry Nickelsburg, PHD, held differing opinions about the road ahead. Conway believes a “mild recession” is in the works, while Nickelsburg is a bit more upbeat because he sees “nothing in the data today that suggests a recession in the next couple of years,” though he admits perils exist.

Nickelsburg notes that the current economic expansion is largely being driven by consumers. Thus, the concern is they could be spooked into closing their wallets or a trade war could break out.

A looming serious issue for CRE, pointed out by Conway, is the likely shut down of CMBS lending this summer as a result of new regulations. Banks must figure out how to manage the risk retention components on the loans they make, and until they better understand what they can do, that capital source will likely be shut off. It is not expected to be more fully understood and clarified until a new administration takes the White House.

Hunt Mortgage Group’s Paul Angle also noted that another aspect of the new regulations is that bank officers will be held personally liable if found they didn’t follow proper disclosure rules. That, he believes, will cause “tighter controls over their own product,” but will complicate things downstream if a loan is sold, since it is unclear if a bank will be completely off the hook.

Should the CMBS capital tap run dry, Shannon is confident other lenders will step up to fill the void. A point Angle agreed on, noting that large banks will likely hold loans on their balance sheets a bit longer until the CMBS situation is ironed out.

Conway believes the recovery could extend for years, especially since there’s strong demand for multifamily housing with plenty of room to expand. He believes housing is the strength of the economy.

One of the reasons Angle is optimistic is the fact that there’s not been an “overbuilding of housing.” In fact, since 2007, the country has gained eight million new renters and the homeownership rate has dropped by 1.8 million. This shift in households is expected to continue, which will cause multifamily “vacancy rates to drop in 2016.”

Ahead for the main asset sectors:

• The multifamily market is expected to continue being a strong performer.
• The industrial sector faces challenges as a result of ecommerce growth, though it is expected to continue experiencing strong demand and rapid absorption – especially as functionally obsolete space is converted into modern facilities.
• Retail faces significant challenges as physical stores must counter online sales by reinventing the mall experience, and incorporating more service-oriented tenants.
• The office sector has evolved into a largely value-add play, with the exception of a handful of markets like Miami, Los Angeles or Seattle, where development costs justify building new product.