Martin Neil Baily (Brookings) - Economy and Policy Outlook

Baily was chairman of CEA during Clinton administration.

Recovery over next 3 quarters will be 3.5% to 4.5%, well above trend, but well below historical "recovery" rates of growth.

Why weaker? Consumers still being battered (but Zandi showed strong consumer growth?)

Commercial real estate loans will roll over, causing lingering weakness in banks.

Consumers are de-leveraging (revolving credit dropping by 5% annual rate)

23% loss in "net worth relative to disposable income"

Long run growth depends on aggregate supply. Growth rate of capacity depends on labor force supply and productivity growth. Labor force growth is diminishing: baby boomers retiring, women participating less in labor force

Productivity (article in todays WSJ if improvement is permanent). (numbers only include non-farm business, only one component of GDP growth) Surge in productivity is underway (3.9% in 2009, due to layoffs) Reluctance of employers to high means higher productivity growth.

Productivity growth model (productivity is not all IT based, new processes, new products/services) chart

Deficit projection (falls below 1 Tril in 2014 and 2015, but then rises again)... deficits will decline as a percentage of GDP. Can deficits be financed? 10-year is still very low, but could be because US situation looks better than Europe, emerging economies don't want the dollar to fall
Impact:

Accounting exercise for 2019 scenario: US can't have full employment AND low private savings with a budget deficit and still have trade flows balanced.

**Send out Scenarios showing budget deficits, savings rates and trade deficits**

Savings rate was at 7% until 1997, but fall through the 2000s

Only last simulation resolves deficit, high savings rate leads to trade flows balanced.

Folks worried about manufacturing employment ALSO want government spending on infrastructure and education etc. They can't have it both ways unless we save a LOT more.

Closing the budget deficit

Not smart in near term

Problem is Medicare: voters refuse to limit services and refuse to raise taxes. Need to make a more transparent link between the two. Dedicated Medicare tax at a level that covers expected payments. Would help to address spending side

Revenue: carbon tax (???)

Financial regulatory reform

Effective reform should create a mechanism for large institutions to fail without being bailed out or disrupting the whole system

"unholy alliance" between left and right: undermining independence of the Fed, too heavy focus on stopping future bailouts (alternative was another Great Depression)

Bailouts haven't been expensive, those to banks have been profitable (ignores the impact of risk

Independent consumer agency is likely to be created. Now has support of Shelby

Questions

Are we overestimating productivity growth (3.9% in 2009)? Probably

Economy.com Liveblog - Zandi's Economy Outlook

9:05 7 Questions to audience.

9:15 Recession was 2x (-4% vs. -2%) worse than average, recovery half as good as average.
Job losses were more than double the average. Unemployment increase was double average.
End of recession and pace of recovery is due to federal response.

9:23 US economic stimulus amounted to 7% of GDP; China's was 13% and truly "shovel ready", also huge monetary stimulus (?)
Fears of protectionism are proving unfounded.

9:25 Current outlook for 2010 growth has risen 1% (to 2.9%) from a year ago.
Why? Consumers spending more than forecasted.; top quintile spike in saving rate to >15%, but has fallen back below 5%. (top decile accounts for 23% of consumer spending)
Nest eggs being rebuilt (slide 6), driving new "wealth effect" among high end and "relief spending"
Normal rate of spending ahead will imply lower contribution to GDP later.
Spending among middle/lower brackets increasing also because of decline in delinquency below pre-recessionary level (bad stuff has already happened, credit standards have tightened.

higher spending growth somewhat due to people not paying their bills???

9:35 Shape of recovery
Avoid double-dip
2010 3%, 100k job growth
2011 4%, 200k
2012 5% 300k
Need 150k monthly job growth to bring down unemployment rate

End of 2011 8.5%
YE 2012 7%
full employment (5% or so) not until 2013

9:40 much stronger job growth later in 2010 (historical profit/job growth trend implies 350k, but many risks

Reasons for optimism

1. corporate balance sheets improving for big business: quick ratios (liquid assets to s.t. liabilities) improving sharply (highest on ratio), interest coverage ratios declining. productivity gains were huge (YOY productivity growth was >6%, close to highest ever), but compensation growth was very low. Bottom line is that US labor is very cheap relative to output...
2. Pent up demand (how does this square with higher than expending??) Pent up vehicle demand... GM "investment" will pay off. Housing inventory has peaked, household formation is around 800k (usually around 1.25mil). 1.5 mil in excess inventory, demand exceeds supply by 750k - 2 years until recovery. 2012 and 2013 will be very strong construction
3. US unit labor costs are low (germany is the only developed country lower), when currency changes are incorporated, the dollar weighted US unit labor cost is very competitive. Exports, especially manufactured exports will thrive
4. Low fed rates, if double-dip recession looms, federal action will likely be aggressive ("appropriate federal funds" rate = federal funds rate and other actions taken to push liquidity, now at -2%), interest rate raise not until 2011.
5. Congress will pass extension of unemployment benefits, aid for state and local governments (25-30 bil). failure to do it may result in much higher state and local taxes that could undermine economic growth.
6. 1 Trillion in stimulus when all told (should have gotten that a year ago).

9:55 Threats to outlook

Outlook expressed so far still very much a forecast. Hiring at a low (4 mil/mo, vs 5 mil/mo pre-recessionary average

1. Small businesses struggling to get credit (12-14% complaining), can't get cash to be able to hire. traditionally small business is a hiring machine (account for 2/3 of job creation after the last recession). Small business confidence is still very low (NFIB is the source, what happened to economy.com's business confidence survey?)
2. Foreclosure threat; close to 4.5 mil mortgages are >90 days delinquent or in foreclosure... negative equity and under employment, strategic default (able to make payments but won't because they are so far underwater they are better off defaulting...
3. house prices will fall by another 5%by 1Q2011 Biggest reason banks won't loan to small business is the threat of collateral losses
4. State and local government revenues collapse, expenses grow (to support people who have lost jobs)
5. Commercial RE prices (stabilized for now). Loan defaults ahead will hit banks, constrain credit expansion (short shrift given to this topic)
6. Structured finance is still dysfunctional. Only credit cards and auto loans are anywhere near '00-'07 average
7. Fiscal challenge is biggest challenge. Debt-to-GDP ratio has doubled with stimulus action, new budget is the first one that doesn't get back to "fiscal stability" Biggest assumption is that this chart will change, enabling interest rates to stay low. Catalyst will be a "greek-lite" event to push us to deficit reduction brink.

Self sustaining expansion begins in 1Q-2Q2011, fiscal "event at 4Q2011.

10:40 Questions

Dollar is appropriately valued (undervalued against the yuan). Chinese will revalue based on basic economic theory (rein in bubbles and hyperinflation) Beginning later in 2010, Chinese will revalue the yuan by 3-5%

New post recessionary economy? US consumers won't drive global growth. New potential GDP growth rate? Need improvement in investment spending. Though positive, growth is not enough to replenish the capital stock. (Zandi thinks potential is 2.75%, .75 is labor force growth, 2% is productivity growth)

What is the possibility that the European debt crisis could envelop us? Should be contained. EU bailout should last Greece 2 years to resolve their crisis. Doesn't seem to be enough, but there would probably be further action. ECB could try to inflate their way out, but it's a short-term solution and could have repercussions for debt availability for ALL Europe. European economic growth will definitely be weaker and might reduce demand for US goods. Could push dollar up against the Euro.

Yield curve will stay very wide for the next few years. "Flight to quality" will persist.

Industrial Recovery Is Underway

Looking at market fundamentals, the industrial real estate market appears to be in the deepest hole it's ever been in. CBRE-Econometric Associates (formerly TWR) states that the current warehouse vacancy rate was 14.5% at the end of 2009, an increase of 2.7 percentage points from the previous year. This level is by far the highest vacancy has ever reached. Tenants vacated (or more accurately, never occupied) large amounts of space that they leased in the 2005-2007 period. Since total occupied space peaked in 2007, net absorption has totaled -203.5 million square feet. Rents have fallen 11% from their peak and are expected to fall another 7%, as landlords cut rate to fill their space.

Notwithstanding the current gloom, there are signs of hope emerging. Most leading indicators that drive warehouse demand have turned positive, some in dramatic fashion. The two indicators that have the biggest impact on the industrial sector are trade and manufacturing output. January imports were 13.7% higher than they were a year earlier (though still 25% below the peak in mid 2008). In response to massive fiscal stimulus, GDP growth is responding as well, with growth in the past two quarters measuring 2.2% and 5.9% respectively.

Other indicators indicate that industrial demand will strengthen as well. The Institute for Supply Management's Purchasing Managers Index (now at 56.5) has been above 50 for 7 months. Values above 50 are consistent with a growing economy. Industrial production is also rising. February production was 1.7% stronger than in February last year.

There is still quite a bit of slack in the supply chain. Firms are underusing the space they are currently in. Consequently, the economic improvement won't translate into an immediate rise in industrial demand. Rather, we are likely to see a stabilization of demand in much of 2010. Negataive demand early in the year will be balanced by stronger demand in the second half.

A much stronger pace of industrial real estate demand growth will have to wait until 2012, however. Rents will stabilize this year and grow slightly in 2011. Rent growth will probably be in the 4-5% range in 2012 and 2013, as efficient distribution becomes more scarce.

Protectionism?

Today's WSJ has an article (subscription required) about the return of protectionist pressures in global commerce. Russia is considering almost 30 new tariffs. President Obama deflected "buy American" language in the stimulus bill, but the US and the EU are using accusations of dumping to curb Chinese imports. India may add further protections to its steel industry. While these examples have not resulted in new tariffs yet, they are indicative of a broad trend away from free trade. As the global downturn worsens, skepticism is mounting over the benefits of free trade.

World trade had been growing at a 6% annual rate, more than double the pace of global economic growth since the late 1990s. The WTO expects it to shrink by 2.1% this year. The IMF is expecting the decline to be even sharper, at around -3%. Most of this decline is driven by falling consumer spending in the US and Europe. As economic growth slows, labor movements in each country are blaming their woes on outside forces. Workers from the US to Europe to Africa to China are pushing for their governments to protect their jobs from competition. The unstated argument here is the belief that their domestic economy is strong enough to stand on its own.

The implications of a permanent downturn in global trade for the warehouse segment of industrial demand are huge. Tenant demand in the US and Europe has been predicated on continued growth in trade. The supply chain infrastructure (factory and warehouse locations) has assumed that goods will move from production facilities in Asia through major ports to points of consumption in the US and Europe. The return of trade barriers and reduced trade would likely reduce the demand for space in warehouses near ports of entry. Moreover long-distance rail lines would play less of a role in getting goods to markets, reducing warehouse demand near their terminals.

None of this is to say that we will ever return to the high protectionist trade regime of the 1920s. It is entirely likely that we may see some protectionist measures introduced, but maintain the overall goal of free trade... a sort of "free trade with guardrails". But the debate suggests that the future growth of international trade will be slower than it has been over the past decade. Consequently, the expectation of voracious demand for DC space in places like the Inland Empire, Dallas, and South Atlanta (and emerging IDC markets like Savannah and Houston) may have to be scaled back.

Any thoughts on the matter? Is this just a passing fad, driven by cyclical economic fears (closer to my view) or are we in a long-term retrenchment of attitudes toward global trade?

Here are some recent publications from Colliers and Cushman & Wakefield on logistics real estate. Neither mention protectionism as a potential threat to this model.

Introduction

Here we are in the depths of a recession. What better time to start an industrial real estate blog? :-) I'm hoping to use this site as a forum for trends people observe both in fundamentals and investment patterns. Discuss news items... debate policy impacts on the sector... call each other nasty names...

I'm also hoping people will feel free to discuss what they are seeing more candidly than they would if they are speaking for their company. While anonymity is great, one also sacrifices credibility. You decide how much to share.

Anyway, let's get the ball rolling:
Yesterday, Globe St. pubished some data from Grubb and Ellis's Investment Opportunity Monitor showing LA as the top industrial market through 2013. Way to go out on a limb there, guys. Here's one not on their list: Kansas City. We like a lot of things going on there demand-wise and prices never spiked there the way they did in the traditional hub markets.