Parkview Financial: Storm Watch

Hurricane season is here, and like many of you, I spent a big chunk of early September glued to coverage of Hurricane Dorian as it spread ruin across the Bahamas and worked its way up the East Coast. Especially in the storm’s early stages, the uncertainty of its path was especially disconcerting; Dorian repeatedly flummoxed the world’s most sophisticated forecasting models and seemed liable to change course from hour to hour.

That got me thinking about predictions. Far be it from me to seem to trivialize a catastrophic storm, let alone the humanitarian crisis it’s left in its wake. Having issued that disclaimer, I’d suggest that the challenges of forecasting a hurricane may offer a parable for an unsettled economic climate.

Weather forecasting models can tell us that something big is coming, how powerful it will probably get and where it’s generally headed. As Dorian showed, however, predictions are subject to change: where the storm will make landfall, when it will hit and how much damage it’s going to inflict. In a much different sphere, the same can be said about projecting real estate market conditions.

Since the emergence of the inverted yield curve in mid-August, the possibility of a recession has loomed larger than ever. For all the alarms it triggered, that turn of events came as no surprise to capital market-watchers. By May, Hugh Kelly, the distinguished real estate economist and CPE columnist, was already calling attention to the gap between yields on the three-month and 10-year Treasury bills, which had already shrunk from 197 basis points in early 2017 to a slender 11 basis points. “As history tells us, inverted yield curves presage liquidity squeezes, and that’s why inversion is considered an advance indicator of recessions,” Kelly wrote.

SORTING OUT THE SIGNALS

Sifting through a variety of expert views has been helping me grasp the outlines of what’s likely ahead. In a CPE guest column last month, Parkview Financial CEO Paul Rahimian cited lower yields on 10-year Treasuries, the inverted yield curve and the U.S. trade dispute with China among factors making investors uneasy.

Cushman & Wakefield noted in an August report that the historic lag time between a yield curve inversion and a recession is typically five to 18 months. Real estate fundamentals around the country are still generally sound, the report observes. The circumstances provide an opportune moment to refinance from short-term debt to longer-term, lower-cost debt, advised Ken McCarthy, the veteran Cushman & Wakefield economist and head of applied research for the Americas. “Plan for income, but not for capital appreciation,” McCarthy has said.

The state of the job market does much to explain why real estate fundamentals are still basically OK. At this writing, the latest report from the Bureau of Labor Statistics is still a few days away, but the baseline unemployment rate has hovered at around 3.6 or 3.7 percent for much of the year, and solid hiring continues among metros representing diversity of location and size.

Meanwhile, the investment market continues to fluctuate. After a slow first quarter, sales volume rallied through April, May and June, then hit the wall again in July. Sales volume dropped 21 percent year-over-year, and single-asset transactions plunged by 25 percent, Real Capital Analytics reported. Still, there’s more to the story. Year-to-date volume is basically keeping pace with 2018, and RCA’s pricing index rose 6.3 percent year-over-year in July. Major asset categories varied widely in strength, from a 12.8 percent gain posted by the industrial sector to the modest 1.8 percent bump for suburban office properties.

PREPARATION TIME

That brings me back, in a roundabout way, to hurricane season. As with a major hurricane, nobody can tell exactly which way the wind will turn. As Dorian changed course repeatedly, then stalled, its erratic path gave bonus preparation time to first responders and public officials and millions of residents. This time, the East Coast was spared the destruction suffered by Bahamians. But I’d argue that the time and effort devoted to preparation were well spent.

The same should be said of strategies for a possible market correction, no matter what its eventual timing or impact. Whatever the timing, nature and extent of the downturn, though, a few principles would seem to apply. It seems almost self-evident that investors who recently bought assets at or near the top of the market can’t expect to sit on them and ride out the downturn.

Active management to maximize efficiency and compete effectively for tenants will be essential. It goes without saying that deals must be underwritten rigorously. A recession has been predicted for years now, and if that long-expected downturn arrives in 2020, the long head start for readiness could make a big difference for investors.

The inverted yield curve could be the clearest sign yet that the long-awaited downturn is finally on the horizon. It could also be a false alarm, though that is starting to look unlikely. But whether market conditions by 2020 turn out to be stormy or calm, prudence is an attribute that’s always in season.

Via Commercial Property Executive