From a small northwestern observatory…

Following up on my previous post, Marcus & Millichap’s Hospitality report also hit my desk this week. They would posit that, “In fact, a recovery in the sector has already begun.” The projected nationwide occupancy of 51.6% in the 1st quarter topped 1Q-2009, but is still lower than the 57.7% 1st quarter average from 2005 – 2009. The primary drivers? Strengthening of the labor market and other key economic measures.

Hotel investments, however, are still waiting to mend. Sales of branded full-service hotels have declined 60% in the past 12 months, and sales of chain-affiliated, limited-service hotels are down 48%. The flight-to-quality which is evident in other sectors has yet to catch on in hospitality. Well capitalized buyers appear to be ready, but there is a gap between buyer and seller expectations. Room revenues continue to improve, but the physical condition of some assets (a result of deferred maintenance during the downturn) is problematic.

For more information, visit the Marcus and Millichap website.

Marcus and Millichap just released their Office Markets Report and their Hospitality Report this week. I’ll comment on the former today, and the latter later.

To quote, they believe the recovery will be “…muted and choppy…”, which is a departure from prior recession recoveries. They note that in the second half of this year, the business sector will need to step up to the plate and replace the government as the primary driver of economic recovery. Is the business sector up to the challenge?

Specific to the office sector, the rise in unemployment really masked the overbuilding in the office sector. As a result, while the overall vacancy rate has not yet peaked, the rate of increase in vacancies has slowed and should turn around later this year, with gradual recovery in 2011. Above-average job growth in 2012 and 2013 should fuel the slow recovery in the office sector.

Office investment hit a near-standstill in 2009, but they now see it picking up somewhat. (At Greenfield, we’ve noted that there is a fair argument for bargain hunting, particularly among choice properties which are on the market.) However, credit markets are still tight, keeping a lid on investment activity.

For the full report — which runs 66 pages — you’ll need to visit the Marcus and Millichap website and “join” as a client.

The February issue of the Dallas Fed’s Economic Letter hit my desk this week. The economic research staffs at various Federal Reserve Banks don’t directly compete with one another, but instead take very different slices of the same issues. As such, I try to glance at most of them from time to time. Dallas does a great job at the nuts-and-bolts of what makes up the economy.

The focus this month is on the way the world-wide recession has hit global trade, particularly durable goods. I won’t bore you with the whole thing — look it up yourself at http://www.dallasfed.org. However, they DO tend to assume that the reader is fully versed on how things work, and as such leave out a few details we would normally need to explain to Econ 101.

From an average persons perspective, world trade begins — and ends — with consumption. People want to buy stuff, and so other people somewhere else make it and ship it to them. If demand falls off, so does supply. Since one person’s consumption is another person’s income, a fall-off in demand creates a downward spiral that needs to be kick-started. It’s one reason why the Chinese are so apoplectic right now — they tend to be in the “supply” biz and Americans and Europeans are in the “consumption” biz. Ergo, if things get really bad, Chinese workers have too much spare time on their hands. Very few things frighten the Chinese leadership more than that.

And yes, trade REALLY got hit hard by this recession. On an annualized basis, U.S. imports fell about 15% in 4Q08 and another 35% in 1Q09 (U.S. exports fell by comparable percentages). Those are huge, but mild compare this to Japan’s experience. Remember — Japan is very much a trading hub. They import a huge share of their food and consumption and make a big chunk of their income by exporting stuff. Japan’s exports fell at an annual rate of about 45% in 4Q08 and a whopping 60% in 1Q09. Their imports fell as well, but not as badly because, let’s face it, if they don’t import stuff, they starve. (If the U.S. doesn’t import food, we end up having to eat domestic lettuce rather than Chilean arugula. It’s just not the same.)

Two things are missing from this equation, though, and need to be understood for a fuller appreciation of the trade problems. First, even if demand picks up (or for that matter, never fell off in the first place), world trade was going to get hit badly due to the almost total collapse of trade capital. Banks in free-fall were cutting lines of credit, and since import/export activities are among the riskiest (and require hedging, which was also in a tailspin), those lines got cut badly. If you were a major player, like Boeing or GE, you could finance yourself. However, if you were Joe’s Apple Orchard, you were out of business.

Second, this is interesting to the real estate community because the huge array of trade means a huge array of logistics — transportation, storage, port facilities, and associated properties dedicated to moving and storing stuff. If arugula needs to be imported from Chile, then consider all of the real estate devoted to getting a serving of it from the farm to a salad plate in middle-America.

Until credit is restored, the import-export game will continue to suffer, and the real estate devoted to serving that game will be “on hold”.

Sorry about the lack of posts. Things have been terrifically busy around Greenfield, and I’ve been traveling almost constantly.

Two quick pieces of news, then on to my regularly scheduled prattle. First, the May issue of The Greenfield Advisor just went to press. If you’re not on the e-mailing list, please let me know. We just send out an e-mail once per month with a link to the .pdf file, which you can read on-line or download and print. The newsletter format allows us a little more lattitude than a blog for including graphics, etc.

Second, I’ll be speaking at the Chinese Drywall litigation conference in New Orleans on June 18th. If you’d like more information, either e-mail us here at Greenfield or check out the Litigation Conferences website.

You’ve probably heard today’s jobs report by now — unemployment is up to 9.4% but the rate of job decline is slowing. The stock market is reading this as relatively good news (the 9.4% was already discounted in the market, and the slow-down of decline is good news). In our most recent Greenfield Advisor, we present a more detailed analysis from the Philadelphia FED, along with the implications for real estate. The current consensus thinking is that umemployment will get worse (up to 9.8%), but it will get from here to there slowly, probably peaking in early 2010.

In general, the residential real estate market has probably already bottomed, but we’ll need the credit markets to straighten out before we see strong price growth again. A LOT of personal wealth was wiped out with the market declines, and until this is restored — which could be a few years — we won’t see sales volumes like we saw at the recent peak.

The commercial market is a mixed bag. Some parts have already bottomed, and will slowly recover as the market comes around. Some parts — notably retail (except existing community shopping centers) — will be dark for quite some time.

Anyway, that’s it for today. If you have any questions, don’t hesitate to contact me.

The past two weeks have been busier than usual due to a pair of expert-witness trial testimonies in Kansas City. (Congrats to our clients, by the way, who prevailed with flying colors!). This coming week is slightly relaxed, then I’m off to the races again for a couple of weeks, including a trip to Louisiana and some other projects here in Seattle.

In the meantime, our monthly newsletter, The Greenfield Advisor, is slated to come out this month. We had planned to unveil our new trophy property index this month, but now I believe we’ll defer that for a couple of months. This month, our newsletter will summarize our economic forecast for the 1st quarter, with emphasis (of course) on the implications for real estate. I’ll unveil this forecast at a luncheon presentation to Seattle’s “Belden Club” at the Seattle Yacht Club on Tuesday.

The crux of the forecast depends on which of two economic theories you buy into — is this recession “normal” (albeit far deeper and longer than usual) or are we looking at a real structural shift in the economy?

It’s hard to point to specific phenomenon and say, “Aha! We have a structural shift on our hands!” because these events are so rare and ideosyncratic. Recessions are easy to spot, at least in the rear-view mirror. String together a couple of quarters of negative GDP growth, and you have, definitionally, a recession. However, once a recession is over, people go back to their jobs, asset markets make-up for lost time, and generally all of the trend lines are back where they were before the recession began.

There’s a lot to suggest that this time will be different. The obvious one is the housing price bubble — Moody’s Economy.com in a report released last month predicts that the Case-Shiller Index will retreat a total of 36% before it bottoms-out in the 4th quarter of 2009. That’s not only unprecidented, it also implies a massive loss in household wealth which will take many years to re-coup. Unfortunately for many families, time is not on their side, since the crest of the baby-boom — currently in their 50’s — were looking at this accumulated equity as a major source of retirement cushion. Coupled this with the declines in the stock market — household wealth buried in the equity market (either directly or indirectly) was another significant source of retirement cushion.

Some economists think the real clincher is the pay-down in household debt, which began last year and will probably accelerate this year. There’s a double-whammy there — much (most?) of the pay-down is being done by the most credit-worth households, leaving credit card companies seeing a real shift in the aggregate credit-worthiness of their borrowers. This is happeneing at the very time when the credit card companies themselves are seeing significant retrenchment in their lines of credit. Credit card companies are left with no choice but to curtail credit limits, thus forcing less credit-worth households to either pay-down or default. Since many households were already running permanent balances, and using the monthly pay-down as their revolving purchase line, the impact on household consumption is obviously severely negative.

If we ARE in a structural shift, then the impacts will be felt differently in the U.S. and abroad. Domestically, we’ll look a lot more like the 1970’s but without the inflation. The stock market will trade in a narrow band, and without inflation, bonds will look better than equities. Younger workers coming into the job market will see stagnating expectations, with older workers deferring retirement and an economy that won’t sustain significant job growth.

Abroad — Asia and Europe will be basket cases. The more conservative oil countries (Saudi Arabia comes to mind) will fare well enough, but the economies that bet the whole farm on $100 oil (Venezuela comes to mind) will quickly go into downward spirals. Don’t even start talking about sub-Sahara Africa. Japan — already suffering — from an aging population and a stagnant economy, will face political turmoil. China may be the worst hit — they’re more than happy today to loan us whatever money it takes to get the U.S. economy rolling again, since we are the engine that pulls their 8+% GDP growth. The U.S. could face two choices — either fund our domestic recovery with severe devaluation of the dollar (a distinct possibility) or hunker-down with protectionist legislation (anyone read what a good idea this was in the 1930’s?). Either case leaves China headed back to subsistence rice farming. A significant structural shift in the U.S. away from a consumption-driven economy basically puts us and China in the same position anyway, albeit indirectly rather than directly.

I’m personally leaning 60-40 in favor of a believing in a structural shift. The Obama Administration, at its core, believes in stronger domestic-spending by the U.S. government on things like education, health care, and domestic infrastructure. All of this shifts money away from consumption and toward government expenditures. GDP grows, but the mix of components that gets us there is lower consumption (or at least lower growth in consumption), higher growth in government spending, and a dampening of the import/export red ink.

What are the implications for real estate? More on that in my next post.