Recently I heard a humorous quip that is appropriate for the moment we are in: “If you are not confused, it’s because you haven’t been paying attention.” In preparation for writing this blog post I’ve read several 2017 forecasts from well-meaning and well-qualified economists and political commentators. Their opinions vary widely as to what this year is going to bring, much more so than you normally see. Economists usually succumb to the herd mentality. They don’t want to be wrong so they more or less follow what everyone else is saying. Not this year. There are many contradictory opinions about 2017.
Before I give you my thoughts, let me start by saying that the most important events of 2016 were not anticipated. No one predicted that:
- The United Kingdom would vote last June to the leave the European Union.
- Donald Trump would be the Republican presidential nominee, let alone win the presidential election.
And I’m confident there will be other important events in 2017 that no one, not the most seasoned prognosticators, will anticipate. That said, there are really two questions that need to be answered in order to make accurate predictions about commercial real estate in 2017.
- What is the health of the U.S. economy?
- What phase is the real estate market cycle currently in?
Answering these two questions will go a long way in predicting the health of the commercial real estate market in the Pacific Northwest and beyond.
To help understand where the U.S. economy is headed four questions need to be addressed.
- What impact will Trump economic policies have on the U.S. economy?
- Will the U.S. dollar continue to appreciate?
- Where is the stock market headed?
- Will U.S. bond yields move permanently above 3.0%?
What impact will Trump economic policies have on the U.S. economy?
Many economists will tell you that Trump economic policies will stimulate the economy but also have the potential for generating huge budget deficits (related article: 3 Likely Outcomes of a Trump Administration on Commercial Real Estate) Let’s for the moment accept this is as true. This assumes two things: 1) that the Trump administration is going to successfully pass through Congress their economic policies without any changes; and 2) that if passed that it will positively influence the U.S. economy this year. I believe both assumptions are wrong. Any legislation that passes this year will be watered down either by deficit hawk Republicans or Democrats that team up with Republicans on policies that are deemed to favor the rich at the expense of the poor. More importantly, even if the Trump economic policies are enacted into law it will take months, possibly years, to feel the positive impact of those policies on the U.S. economy. It doesn’t happen overnight.
Will the U.S. dollar continue to appreciate?
The short answer is yes. There are too many global influences coalescing together to stop the appreciation of the dollar. Is this a good or bad for the U.S. economy? It generally is a bad thing. U.S. exports become less and less competitive compared to their foreign competitors as U.S. products become more expensive. It’s a good thing for U.S. consumers who buy foreign goods that are imported into the U.S. And if you like traveling abroad this is great news. Travel costs are becoming much less expensive.
Where is the stock market headed?
My track record predicting where the stock market is heading is abysmal. It’s embarrassingly bad. So doing the opposite of what I say will likely have a higher probability of being right. Markets have rallied since November on the expectations that Trump and the Republicans will quickly enact a growth-oriented economic agenda, including tax cuts, regulatory relief and targeted economic stimulus projects. If my 2017 forecast is right, that Trump economic policies, even if enacted, will have no positive influence on the economy this year, then the strong stock market rally that we’ve experienced since November is unwarranted.
And if you believe that the Price/Earnings ratio is an accurate indicator for valuing the stock market then you have to believe the stock market is overpriced. Since 2014, the S&P 500 P/E ratio has been increasing at an accelerated rate at a time when company revenues have been declining. It defies logic. This recent run up in the stock market only exacerbates this disparity (related article: A Bubble in Search of a Pin – The Unintended Consequences of Low Interest Rates).
Will U.S. bond yields move above 3.0%?
The ten-year bond yields jumped overnight with the election of Donald Trump. Yields jumped from 1.79% on election day to 2.60% by mid-December. They have since moderated to 2.34% but they are still well above were they were on election day. The rationale is that Trump’s economic policies will jump start the American economy allowing The Federal Reserve to raise short term interest rates leading to higher inflation. That may be a correct interpretation of a Trump election but I’m skeptical.
The world has been fighting disinflation for several years and is losing the battle as evidenced by the negative interest rates in Japan and Europe. I don’t believe one man can reverse this trend. My 2017 forecast predicts that once the market realizes this to be true treasury yields will slowly subside. Treasury rates may not return to where they were pre-Trump but they should trend down this year.
What will be the health of the American economy in 2017?
If my 2017 forecast is correct then I think it is likely that the economy will limp along like it has for the past several years with one exception: The stock market is heading for a correction. When? It’s hard to say. Can I tell you emphatically that 2017 will be the year? Heck no. No one has that ability. At a day and time unknown to all, some event will occur that will send a tremor through the economy (think Lehman Brothers in 2008).
This event will trigger a series of cataclysmic shock waves resulting in the stock market turning over night. It won’t be gradual. It will turn on a dime. And when that happens the economy will likely dip into a recession as well. But if there is no adverse triggering event in 2017 we should skate along with the economy continuing as it has for the past several years.
Where are we on the real estate market cycle?
The Pacific Northwest has experienced a strong rental market since coming out of the Great Recession. The chart below shows the four phases of the real estate market cycle.
My 2017 forecast for commercial real estate
So where do you think we are on this chart? I believe that rent growth for 2017 will begin to moderate. Instead of the strong rental growth of the past two or three years we will begin to see rental rates that are much more modest. If true, then the real estate market cycle is at the beginning of Phase III – the Hypersupply Phase. And as more product comes on line, vacancy rates will gradually increase.
So how should we respond? First of all, there is no need to panic. The world is not coming to an end. I believe a future economic slowdown is likely but it may be a year or two away. I believe the real estate market will continue to be strong although at a more moderate pace. And if treasury rates decrease as predicted then interest rates will continue to foster a healthy commercial real estate market. While the real estate market is still doing well, now is the time to prepare for a future slowdown in the economy.
3 steps to prepare for an economic slowdown
- If my 2017 forecast is right, now’s the time to sell that property you don’t want to get stuck with during the next economic cycle. You know the property. In spite of a hot real estate market, for whatever reason, it’s not really performing as well as it should be. It’s time to unload that albatross around your neck. I believe in the Greater Fool Theory. Sell that loser of a property to an investor who is a greater fool than you are.J Now’s the time. Prices are fantastic.
- If you haven’t done so already, it’s time to refinance your properties with modestly leveraged debt at a good interest rate. Call me today (503) 614-1808 for a free no-obligation loan quote.
- And finally, if my 2017 forecast is right now’s the time to sock away some additional cash to help you through the slowdown. Cash in the bank solves all sorts of problems and makes life a whole lot easier.
Sources: 5 Trends That Will Impact Your Real Estate Investments, by Doug Marshall, Marshall Commercial Funding, May 16, 2016; A Bubble in Search of a Pine – The Unintended Consequences of Low Interest Rates by Doug Marshall, Marshall Commercial Funding, October 31, 2016; Toronto Real Estate Forum: The Ying and the Yang?, by Robin White, blog.avisonyoung.com, December 29, 2016; Forecasting with Friends, by John Mauldin, Thoughts from the Frontline, January 14, 2017; 2017 Forecast: Skeptically Optimistic by John Mauldin, Thoughts from the Frontline, January 8, 2017