By Jack Stubbs
“The black swan event that could change the economic outlook is asset bubbles that are caused by easy money. Tax cuts are being proposed in a full employment economy on a global scale…which leads to higher inflation. We have no excess resources, a shortage of labor, and higher construction costs,” said Kenneth T. Rosen. Rosen was highlighting one of the main domino effects that political legislature is having on the national economy generally and the commercial real estate market specifically.
On Monday, November 20th, Rosen, chairman of Fisher Center for Real Estate & Urban Economics at UC Berkeley, spoke at the 40th Annual Real Estate & Economics Symposium in San Francisco. Rosen was the keynote speaker for his panel, “The Real Estate and Economic Outlook: Peak Moment or Extra Innings?” which was moderated by Robert H. Edelstein, co-chair of the Fisher Center for Real Estate & Urban Economics at UC Berkeley.
Rosen covered a wide range of topics during the discussion, giving his perspective on the outlook for the commercial real estate market and the broader U.S. economy in light of the current political climate. Rosen discussed the impact of policy change at the micro- and macro-level, proposed legislative changes, and how these changes might impact the commercial real estate market—in both San Francisco and nationally—moving forward. Rosen also discussed trends in commercial and retail construction; factors driving and limiting job creation nationwide, and finally what, looking forward, he believes the outlook to be for the commercial and residential real estate markets locally and nationally.
Though they might seem a part of their own sphere, policy changes, foremost those relating to tax reform‚ in Washington have a direct and more tangential impact on the real estate market. Trump’s current legislative priorities—tax cuts and reform, immigration reform/DACA, and hurricane relief, among others—are having an impact on the macro real estate market, which ultimately boils down to a cutting of corporate taxes, according to Rosen. “Property taxes will either be eliminated or severely limited. There are also a number of provisions that will hurt housing, including property tax deduction limitation,” he said. Additionally, Rosen discussed several broader impacts that tax reform might have on the national economy, including the elimination of state and local tax deductions, the end of interest deductions on student loans for graduate students, and the end of deduction for medical expenses over 10 percent of one’s gross income.
In addition to tax reform, immigration and job growth are two areas in which the current administration has a direct hand. The state of the national economy is heavily influenced by the broader political climate; and the current administration’s America-centric mentality is at the forefront, according to Rosen. “The administration has adopted an America First Strategy, which is basically de-globalization. Restricting immigration and trade—these are policies which could affect the supply of labor,” he said. In the coming months and years, the Bay Area, in particular, might feel these effects especially prominently. “We’re going to bear the brunt of this in the Bay Area; we are the most globally-connected place in the country, and we’ll be affected negatively, especially in terms of the supply of labor,” Rosen added.
The nation’s current presence on the global stage also reflects a pressurized environment. Rosen highlighted the current state of NAFTA as one factor playing a significant role in the state of the national economy as well. “NAFTA negotiations are in near collapse. NAFTA has been a big positive for North America; supply pipelines from Canada and Mexico are critical to our car companies and other [industries].” Additionally, the nation’s central banks are being overloaded, which is having an impact on other central economic markets. “We have $13.5 trillion in bonds that have been purchased by central banks; they’ve loaded the system up in a way that’s distorting the central markets; this is a bubble at home and abroad,” he said. When that bubble becomes less pressurized, the real estate market will achieve more of an equilibrium. “When that normalizes, asset values, like stocks, commercial real estate, housing, will adjust,” Rosen added.
Currently, construction rates in the commercial and residential markets are one of the key metrics by which the health of those markets is gauged. Rosen discussed the current state of the retail market at the local and national level, suggesting that the retail landscape is in a period of transition. “We’re not building much, but a lot of stores are closing, and more will close in 2018,” he said. Of retail sales growth, Rosen thinks that although people are certainly buying, there’s an increasing emphasis on E-commerce, with less being bought through traditional channels, and department stores and warehouse superstores struggling. Amazon, the tech behemoth based in Seattle, has much to do with these shifts in retail. “There’s a big restructuring happening, and the cannibal lives in Seattle.”
Just as the retail sector is in a period of growth and transition, construction in the commercial office market has been on an upward curve in recent years. “We’re building a lot of office buildings. we’re up to 2007 levels, still nothing like in the 80s, but we’re in that direction,” Rosen said. On the national scale, relatively stable job growth and lower vacancy rates mean that developers are building enough to keep pace with demand. And while there is significant office construction occurring on a national scale, the local market in San Francisco is more constrained. “Job growth has slowed in San Francisco, we have a shortage of labor because people can’t afford to live or move here. We have a tight market here still,” Rosen added.
There are also prominent shifts occurring in preferences for renting versus buying in the housing market, and the current state of the residential sector is due in large part to generational trends. “Millennials are finally deciding to stop delaying things and move towards ownership. Multifamily rental housing production levels have peaked,” Rosen said.
And although the current status of the rental and housing market is healthy due to current demand, Rosen believes that the market might become over-saturated. “Vacancy rates are starting to go up, and the market is showing signs of over-building,” he said. National rental inflation peaked two to three years ago, but is also largely dependent on individual markets and the particular class of assets, according to Rosen. The hottest markets are growing at between 5 and 6 percent, while the rate in San Francisco currently stands at roughly one percent. Currently, the best-performing assets are B and C garden apartments, with rental rates for A assets also growing, according to Rosen.
While geographic locale and demographic factors play a role determining rental rates around the nation, regulations surrounding immigration—a topic heavily influenced by the political climate—remain a central factor. “Immigration is the key to the future of the apartment market,” Rosen said. “Immigration is 45 percent of all population growth. It’s the entity that fuels the economy and especially the apartment market.”
Immigration—and current political legislature restricting it—is heavily tied to employment growth throughout the nation. Job growth is a key metric with which the real estate market can be evaluated. According to Rosen, the outlook for national job growth moving forward looks positive. “This continues to look very good every month. This year, we averaged 162,000 new jobs per month; and we created 17.4 million jobs since the recession ended, this has been a big string of positive numbers; the labor market is red hot.”
And while the numbers suggest a healthy job market, there are certain obstacles that continue to challenge those looking for work. “Job creation is the key to success in the real estate market…the restrictions on immigration are also exacerbating this problem. We have people looking for work, but they often have the wrong educational qualifications; or are in the wrong geographical area,” Rosen said. Indeed, geography plays a big role in the relative strength of job markets and employment growth, according to Rosen, with Seattle, Dallas, Atlanta and Austin, among other cities, experiencing intense employment growth. “We think it’s mostly the coastal markets [experiencing job growth], but it’s also in the Midwest and Southeast.” Ultimately, though job growth is only one sector of the economy, one that continues to be influenced by policies surrounding immigration. “This is a widespread, full employment economy with widespread economic growth. But there’s a shortage of people; we need immigration,” Rosen added.
The health of the U.S. job market—and subsequent employment growth—has clear implications for the commercial real estate market across all asset types including apartments, office, industrial and retail. “The single most important thing is cap rates. They are at a low point in the cycle, the lowest we’re going to see, high 3 percent to low 4 percent,” Rosen said. According to Rosen, these cap rates move the most for retail assets and the least for apartments—and although certain markets are incredibly robust, Rosen doesn’t believe that things are yet at a tipping point in relation to years past. “Unlike the late 80s or early 2000s, where real estate was more expensive than anything else, we’re not at a point where real estate values will crash; we’ve got a larger spread now,” he said.
While influenced by national trends driving or encouraging job growth—rental inflation, and immigration policies—the commercial and residential real estate markets are dynamic and unpredictable by nature and can often be best assessed by looking at where they stand in the cycle at a precise moment in time. When asked about the fundamentals of the market, Rosen had the following to say of the market’s trajectory: “We’re in a growth cycle and rental rates are still rising and new construction is happening; we’re moving towards extra innings.” However, while encouraging, this upward growth is not sustainable in the long run, and capacity will eventually be reached, according to Rosen. “At some point, we’ll build too much and the market will slow down; it’s so unusual for real estate to be in an equilibrium—it doesn’t stay long.”