In the Bay Area fall can characteristically be marked by the San Francisco Giants’ winning the World Series, beautiful warm days, one large Apple product unveiling and Ken Rosen’s economic and real estate forecast. The 37th annual Real Estate & Economics Symposium is sponsored by the Fisher Center for Real Estate and Urban Economics at UC Berkeley and is traditionally held at The Westin St. Francis in Union Square. As he had done in the past, Mr. Rosen has prepared a thick deck of slides to guide his presentation and overview of the national economy and its impact on the Northern California real estate market.
The tone of the presentation was optimistic, which resulted from a number of positive things evolving in the national economy. Job creation is very strong—we have 2 million jobs more than in the previous peak. Auto sales, which came in around 16.5 million last week, are a positive indicator of consumer demand for durable goods. Interest rates remain at historic lows. The sharp drop in energy costs over the past three months came as an effective tax cut to the average American.
Yet, with all that good news, we know that reality for most people has resulted in somewhat muted excitement. This has been a very long recovery; it has taken us six and a half years to recover, longer than any recession in the past. Rosen called it a broken W pattern, characterized by choppy ups and downs in the economy, which by all accounts should continue.
“It took us a long time to get back, and a lot of people are not fully back, yet,” said Rosen, as he addressed a room of real estate professionals that filled the conference center last Monday. Job creation is one of those items that has not gotten as much attention in the media as it could have, according to him. “(The) unemployment rate has come down dramatically. It’s down to 5.9 percent…we’re almost fully employed based on that data,” Rosen said.
“There is now one job opening for every two people looking for a job, the best we’ve been since 2005,” Rosen said. His figures showed that to date the economy has gained 10.3 million jobs, compared to 8.8 million that were lost during the recession. The good news is that Rosen sees this growth expanding into 2015, even as job growth has not been equally distributed across the population.
The rosy labor market statistics apply mainly to those who have the appropriate education, he said. A number of the newly created jobs are not getting filled because we have a mismatch of skills. “A lot of people don’t have the education and the ability to work in this new economy,” Rosen added.
The topic on which Rosen seemed to spend the most time was the future movement of interest rates. With the economy growing 2.3 percent this year and a projected 2.5 percent in 2015, Rosen is anticipating a further tactical shift in Fed policy, which had already been announced when Chairwoman Yellen declared an end to its bond-buying program earlier this month. The program had increased the Fed’s balance sheet holdings of bonds by more than $3 trillion to nearly $4.5 trillion, ABC News reported. Rosen predicts that will start changing. “We think that sometime in the next year, they’ll start letting their balance sheet come down and try to get back to a more normalized situation,” Rosen said.
That process will not be an easy one. The 10-year bond, which just weeks ago carried 1.85 percent interest, is back to 2.36 percent today. When that figure spiked to 3 percent at the end of 2013, Rosen had predicted it would reach 3.7 percent during 2014. However, global forces have overwhelmed that upward movement and repressed its prospects further, according to Rosen. Part of that is caused by lower-than-expected inflation, slower global economic recovery as well as arbitrage. “People are rushing to put money in the 2.36 percent U.S. Treasury bond because the German Treasury bond is 0.82 percent,” he concluded.
The market’s new forecast is 2.61 percent by the end of 2014, surging to 3.46 by the end of 2018. Rosen sees those figures rising even higher, from today’s 2.36 percent to 2.90 percent by the end of this year and 4.80 by the end of 2018. His argument is that the anchor on the 10-year bond will be gone with the Fed’s bond purchases disappearing. The real rate, which has been artificially compressed for so long, will go back to 2 percent. And with a 3 percent inflation rate, his predicted 5 percent on a 10-year bond is achievable.
But the big question on everyone’s mind was what this means for the real estate industry. On a macro level, the major economic and labor drivers have been technology and energy. Almost every chart Rosen presented had cities immersed in those industries leading the economic recovery. “In terms of where we are in the cycle, the clock is moving, but still in the green zone for most property types. That means vacancy rates are falling, rents are rising,” Rosen said.
“On the investment sales volume, based on annualized third quarter numbers, we have the third strongest year in history,” Rosen added. Office construction is up somewhat, but we’re still near our 50-year low in new construction, way below the previous levels, according to his research.
“Job growth has been very strong in the office space sector, mainly in the tech area, but that has not translated into vacancy rate declines,” Rosen said. He attributed this to continued densification of office space and a general trend away from creating offices for employees. And while this has helped San Francisco rents rise, on a national basis, the appreciation has been much slower.
The strongest sector thus far has been rental apartments. While there has been a lot of construction in this sector, the vacancy rates are still at historic lows. “Vacancy rates have plunged. Nationally, they dropped to 4.4 percent, just about as low as they’ve ever been for Class A buildings. And B and C buildings, it’s the lowest in 30 years. So, this is a very tight apartment market,” Rosen said.
The main driver of this has been household formation, which is surging again. Job creation, which is very strong for the millennial generation, has helped pull a lot of people into the market. Rosen sees more of that unbundling (younger adults moving out of the parents’ homes) to come in the near term, which he sees positively affecting the apartment market in the years to come. “(The) apartment market is the strongest sector of the real estate market. We think it will continue to be that way for some time, because we’re not going to make it easy for people to buy homes,” he concluded.
As a result, “single-family recovery nationally has been pretty slow. We’re at 700,000 starts, up from 400,000, way below the previous numbers we saw, way below demographic demand,” Rosen said.
And while affordability has increased across most of the country, spare California, it is still not easy to get a loan. This results in first-time homebuyers decreasing to 29 percent of the market, whereas 40 percent to 45 percent would be more normal, according to Rosen.
In San Francisco, another market that is on an absolute tear is hotels. Rosen sees it as the “biggest boom in hotels we’ve ever seen: 85 percent occupancy,” he said. RevPAR growth is the best in the country, nearly 15 percent a year in the last 4 years, with occupancy above the 2007 peak, the impact of which will result in a pipeline of hotels coming online during 2015 and 2016.
Photo courtesy of UC Berkeley