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the BRIEFING: August 2013

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The Briefing is a monthly piece by Transwestern that discusses the national economy, capital markets and real estate outlook at a glance. It is an aggregation by Tom McNearney, Transwestern's chief …

The Briefing is a monthly piece by Transwestern that discusses the national economy, capital markets and real estate outlook at a glance. It is an aggregation by Tom McNearney, Transwestern's chief investment officer, of other articles and reports.

Published in Business , Economy & Finance
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  • 1. THE NATIONAL ECONOMY AT A GLANCE AUGUST 2013 the BRIEFING www.transwestern.net
  • 2. www.transwestern.netFollow us | @Transwestern ƒƒ 2Q GDP grew 1.7%, easing concerns about a summer stall, but still tepid by historical standards ƒƒ 1Q revised down to 1.1% — both below average growth of 2.2% since 2009 and less than half of historical growth of 3.0%+ The capital markets have settled down after Bernanke’s talk of tapering. However, no matter how hard the Fed tries to convince the market that tapering isn’t tightening, the markets will continue to be confronted with the specter of the inevitable rising rate environment. THE ECONOMY 8,000Online merchants accept Bitcoin, the new virtual currency 2Amazon now offering grocery delivery to Los Angeles, the second city after Seattle 1Mantoloking, NJ is one of the first places were traditional phone lines are not being installed GET DIGITIZED! 30%of home owners now have no land line
  • 3. www.transwestern.net Follow us | @Transwestern ƒƒ Job growth slowed to 162,000 jobs in July and unemployment fell to 7.4%, but participation rate remains weak and many new jobs are in low wage industries ƒƒ Eurozone is showing some signs of healing with 2Q growth of 0.3% ƒƒ Business activity has shown a modest increase – eurozone PMI increased 1.2 points in August to 51.7 ƒƒ Germany’s PMI rose to seven-month high of 53.4 ƒƒ New home sales dipped 13.4% in July to seasonally adjusted annual rate of 394,000 – down from an annual rate of 455,000 in June but still 7% ahead for the 12 months ending in July ƒƒ Auto sales soared to 1.5 million vehicles in August, up 17% from a year ago Investors continue to cash out of bonds and remain tentative about plunging into stocks, preferring to park funds in money market mutual funds despite low returns. THE ECONOMY, cont.
  • 4. www.transwestern.net Follow us | @Transwestern ƒƒ Durable goods orders suffered steep decline of 7.3% in July as demand for commercial aircraft plummeted and businesses spent less on computers and electrical equipment ƒƒ Excluding the volatile transportation category, orders fell just 0.6%, first decline in three months ƒƒ Core capital goods down 3.3% after four months of gains ƒƒ Average household net worth now = $527,000 ƒƒ HOWEVER, median household net worth is approximately $61,000, or $50,600 short of 2007, reflecting a very uneven recovery ƒƒ 30-year home mortgage up to approximately 4.60%, approximately 100 bps increase THE ECONOMY, cont.
  • 5. www.transwestern.netFollow us | @Transwestern ƒƒ Signs of slowing earnings growth, job growth, new home sales and growth in China ƒƒ Despite growth above “stall speed,” further erosion or global shocks from Japan, China or emerging countries could reverse the Fed’s commitment to taper ƒƒ Chinese economic growth slid further to 7.7% in 1Q13 vs. 7.9% at year-end 2012 ƒƒ Experienced an unexpected slump in June exports ƒƒ China’s Rongsheng Heavy Industries Group, its largest ship builder, applied for government aid ƒƒ Central bank was forced to intervene due to ongoing interbank cash crunch ƒƒ Yet 14- and 21-day interbank market repurchase rates still between 8.0 to 9.0% ƒƒ China’s debt to GDP has ballooned to 157%, while cost of debt has mushroomed to nearly 35% of annual government expenditures Amid turbulence in the capital markets, economic indicators signal real but slow traction, including what seems to be a nascent recovery in the eurozone. THE HEADWINDS
  • 6. www.transwestern.netFollow us | @Transwestern ƒƒ There could be two fundamental reasons for interest rates to spike or rise. First, some sort of economic crisis or collapse ƒƒ Probably bad for more types of assets, CRE or otherwise. However, in times of great uncertainty, investors tend to flock to safety of hard assets ƒƒ Second and more common catalyst is during periods of economic growth and job expansion ƒƒ Same engines that drive space fundamentals and increase appetite for risk ƒƒ Unless substantial over-building offsets improving space fundamentals, property fundamentals should improve and act somewhat as a hedge to rising cap rates ƒƒ Previous period saw limited new construction, so not likely to be a concern Continues to provide an attractive return to both institutional and non-institutional investors. However, we are facing a period of rising interest rates, which will raise the cost and lower returns for leveraged buyers. COMMERCIAL REAL ESTATE
  • 7. www.transwestern.net Follow us | @Transwestern ƒƒ In the short run, rising rates can be disruptive “in a competitive bidding process, the highest bidder is likely to be most sensitive to changes in the cost of capital,” particularly a leveraged buyer ƒƒ CRE can pass on inflation risk of operating expenses to tenants through net leases or base year expense stops ƒƒ Unlike fixed coupons on bonds, cash flows on CRE can rise over time based on lease duration, contractual lease escalations and/or supply and demand characteristics ƒƒ Rising commodity prices and wages raise the cost of CRE and slow new construction until rental rates catch up ƒƒ Current cap rates for core assets are materially lower than the start of any of the six prior interest rate cycles, but the same is true of Treasury and corporate bond yields and core inflation ƒƒ New construction has been limited for the past five years, while a slow-growing economy has driven improving tenant demand, rental rates and vacancy rates in virtually all property types, positioning property owners to offset any cap rate deterioration with operating fundamental improvements COMMERCIAL REAL ESTATE, cont.
  • 8. www.transwestern.net Follow us | @Transwestern ƒƒ Three factors will determine how rising interest rates impact property values: ƒƒ Magnitude of interest rate increases ƒƒ Risk premium for private real estate ƒƒ Property income growth ƒƒ Average cap rate spreads for major property types in NPI since 1992 = 263 bps ƒƒ Apartments = 200 bps ƒƒ Industrial, office, retail = approx. 290 bps ƒƒ Based on average cap rate spreads, current average core cap rates still seem reasonable with the ten-year Treasury at 3.0 to 3.5% ƒƒ Vacancy rates continue to improve, there is little construction outside of apartments and improving tenant demand and rental rates in virtually all property types ƒƒ Rising interest rates may be disruptive to all asset types in the short run, but the historical evidence is the CRE outperforms in periods of rising interest rates COMMERCIAL REAL ESTATE, cont.
  • 9. the BRIEFING is an aggregation by Tom McNearney, Transwestern chief investment officer, of other articles and reports. Tom leads Transwestern’s capital market efforts for development and investment nationwide. Tom also serves on the firm’s investment committee and board of directors, and he directs the execution and expansion of the firm’s principal investment activities across the country. DISCLAIMER Copyright © 2013 Transwestern. All rights reserved. No part of this work may be reproduced or distributed to third parties without written permission of the copyright owner. The information contained in this report was gathered by Transwestern from various sources believed to be reliable. Transwestern, however, makes no representation concerning the accuracy or completeness of such information and expressly disclaims any responsibility for any inaccuracy contained herein. the BRIEFING THE NATIONAL ECONOMY AT A GLANCE www.transwestern.net