Economic and Real Estate Forecast 2014 Presented to: The IREM Forecast Breakfast Presented by: Mark J. Eppli Interim Keyes Dean and Bell Chair in Real Estate Marquette University January 9, 2014
Interest Rates and Inflation
Low inflation tests world s central banks.... Source: Wall Street Journal, December 18, 2013, A1.
.... and U.S. inflation has remained stubbornly low....
.... with ample labor, unit labor costs are wellbehaved....
.... and stable commodity prices...
.... which will keep interest rates in check. 12.00 Components of an Interest Rate 10.00 8.00 6.00 4.00 2.00 Nov 13 Jan 03 Jun 03 Nov 03 Apr 04 Sep 04 Feb 05 Jul 05 Dec 05 May 06 Oct 06 Mar 07 Aug 07 Jan 08 Jun 08 Nov 08 Apr 09 Sep 09 Feb 10 Jul 10 Dec 10 May 11 Oct 11 Mar 12 Aug 12 Jan 13 Jun 13 0.00 2.00 Real Rate of Return Inflation Premium BBB Risk Premium
GDP
GDP growth has been constrained....
.... GDP growth is also weak relative past economic expansions.... Source: WSJ, December 18, 2013, A1.
Personal Consumption Expenditures
....since the Great Recession, personal consumption expenditure growth has been strong....
.... The Case Shiller home price index is up 13.6%, the best since 2006, and the S&P 500 stock index had its best year since 1997 with a 31.9% total return increasing household wealth.... Source: WSJ, December 10, 2013, A2.
.... and household debt service as a percent of disposable income has fallen to historic lows....
.... as consumer sentiment strengthens, consumption expenditures should be solid with personal consumption expenditures expected to be in 2.75% range in 2014.
Business Spending and Investment
Business investment is back....
.... with corporate profits continuing to be very strong....
.... and the outlook very strong as well for 5% YOY growth business investment in 2014.
Residential Investment and Government Spending
While residential real estate is a small portion of GDP, it has swung wildly....
.... the excess supply of homes have been absorbed....
.... pent up household growth is not yet tapped.... Source: Joint Center for Housing Studies, State of the Nation s Housing: 2013.
.... housing units having room to grow to meet prospective household growth....
.... government expenditures are growing slowly....
Expect growth of 2.70% in 2014. GDP Component Expected Growth Component Size Contribution to Growth Personal consumption: 2.75% 71% 1.95% Business spending and investment 5.0% 10% 0.50% Residential investment 5.0% 2.4% 0.12% State and local government spending 2.0% 12% 0.24% Federal government spending 1.0% 8% 0.08% Expected GDP growth in 2014 about +/ 2.70%
Commercial Real Estate
Commercial real estate transaction volume is back to 2006 levels.... Mortgage Bankers Quarterly Databook.
.... commercial real estate bank lending is back as well....
.... more generally, multifamily and commercial real estate debt is expanding for the first time since 2008.... Multifamily and Commercial Real Estate Lending (billions per quarter)
Is the Midwest Property Market a good Value Proposition?
First, is real estate a good value proposition? Market Index Comparisons (through 2013Q3) 1 Year 3 Year 5 Year 10 Year 20 Year National Property Index 11.0% 12.7% 3.4% 8.7% 9.1% NAREIT 6.2% 12.8% 6.0% 9.7% 9.9% S&P 500 Index 19.3% 16.3% 10.0% 7.6% 8.8% Barclays Government Bond 2.0% 2.9% 5.7% 4.5% 5.7% CPI 1.1% 2.3% 1.3% 2.4% 2.4%
Second, which property type has outperformed? National Property Index Returns By Property Type (through 2013Q3) National Property Index Apartment Industrial Office Retail 1 Year 11.0% 10.8% 11.7% 9.7% 13.2% 3 Year 12.7% 13.7% 12.7% 11.6% 13.5% 5 Year 3.4% 4.3% 2.7% 1.9% 5.6% 10 Year 8.7% 8.4% 8.1% 8.2% 10.5% 20 Year 9.2% 10.0% 9.6% 8.9% 9.5%
Third, which region has outperformed? National Property Index Returns By Region (through 2013Q3) National Property Index East Midwest South West 1 Year 11.0% 9.2% 10.9% 12.6% 11.8% 3 Year 12.7% 11.9% 11.4% 12.7% 13.9% 5 Year 3.4% 2.7% 3.5% 4.2% 3.5% 10 Year 8.7% 8.8% 7.1% 8.5% 9.3% 20 Year 9.2% 10.3% 8.0% 8.7% 10.0%
Is the Midwest a value proposition or out of favor? U.S. Regional Type Quarterly Indices - Equal Weighted, Data through October of 2013 Midwest Composite Northeast Composite South Composite West Composite 225 200 175 Index Value (2000 Dec = 100) 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 CoStar Commercial Repeat Sales Price Index, December 2013.
Index Value (2000 Dec = 100) 180 160 140 120 100 80 60 40 20 Which property type provides the greatest opportunity? Midwest Property Type Quarterly Indices Equal Weighted Data through October 2013 Midwest Office Midwest Industrial Midwest Retail Midwest Multifamily 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 CoStar Commercial Repeat Sales Price Index, December 2013.
Property Markets
Apartments
Apartments in non prime markets are trading at a discount to prime markets.... Prime Multifamily and Non Prime Multifamily Market Equal Weighted Data through October 2013 250 225 Prime Multifamily Metros U.S. Multifamily Index Value (2000 Dec = 100) 200 175 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 CoStar Commercial Repeat Sales Price Index, December 2013.
....multifamily starts averaged 360,000 since 1956, a level we are now reaching....
....minorities and seniors will drive most all household growth in the coming decade.... Source: Joint Center for Housing Studies, State of the Nation s Housing: 2013.
Retail
Prime retail markets are trading at a significant premium to the non prime markets.... Prime Retail and Non Prime Retail Market Equal Weighted Data through October 2013 275 250 Prime Retail Metros U.S. Retail Index Value (2000 Dec = 100) 225 200 175 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 CoStar Commercial Repeat Sales Price Index, December 2013.
Real retail sales fundamentals are solid....
.... spending has shifted to durable goods, which signals consumer confidence.... Source: WSJ, August 16, 2013, page B1.
....multi channel retailing the new normal (internet sales/total sales for WalMart $7.7B/$473B and for Best Buy $3.3B/$48B).... Source: WSJ, August 28, 2013, page A1..
Office and Industrial
Prime office markets command a premium over non prime markets.... Prime Office and Non Prime Office Market Equal Weighted Data through October 2013 225 200 Prime Office Metros U.S. Office Index Value (2000 Dec = 100) 175 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 CoStar Commercial Repeat Sales Price Index, December 2013.
.... however, prime and non prime industrial market have seen similar levels of appreciation.... Prime Industrial and Non Prime Industrial Market Equal Weighted Data through October 2013 225 200 Prime Industrial Metros U.S. Industrial Index Value (2000 Dec = 100) 175 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 CoStar Commercial Repeat Sales Price Index, December 2013.
.... while Wisconsin manufacturing output has grown nicely, job growth has been modest.... Source: Milwaukee Journal Sentinel, December 8, 2013, A9.
.... capacity utilization remains solid, which is comforting to industrial space owners....
.... manufacturing hours worked provide a solid signal for industrial markets.... Source: WSJ, April 19, 2013, page A14.
Boston Consulting Group projects that U.S. Manufacturing will increase U.S. Exports by $70 115 billion annually by the 2020, creating 2.5 5.0 million jobs Source: WSJ, August 30, 2013, page B1.
.... however, Jones Lang LaSalle projects significant reductions in space per employee.... Source: ULI, What s Next?, page 46.
.... while office market fundamentals remain difficult, asking rents continue to rise.... Source: WSJ, January 6, 2014, A6.
Summary I. Macro Economy A. For interest rates, it is no longer about the taper, it is about low inflation markets B. Consumers want to spend again, and did so through the government shutdown; C. Business investment is well positioned for growth; D. Single family construction growth will moderate; and E. Expect solid, if not robust growth of +/ 2.70%. II. Capital and Space Markets A. Debt markets are back and with lenders easing underwriting standards; B. Encouraged by the stock and residential real estate markets, investors will move out the risk spectrum in earnest, making second tier market investment attractive.
Summary (continued) III. Property Markets A. Apartment market fundamentals remain very strong, but new construction will begin to moderate rent appreciation, Midwest apartments represent a good value; B. Retail market fundamentals are good with some concern over space format changes, but with limited new space coming on line, Midwest retail represents a good value; C. Industrial fundaments also remain solid but the value proposition for non prime market upside potential does not exist; and D. Office market fundaments remain weak.