Perhaps it is a sign of uncertain times when top-level economists start talking about feelings. The current U.S. economy is “not quite as bad as it feels,” said JLL Americas managing director Ben Breslau, during a 2016 ULI Fall Meeting panel discussion. “Not that there’s no risk, but it’s not quite as bad as it feels.”
The discussion, moderated by Prudential Real Estate Investors principal Collette English Dixon, featured Breslau and Joshua Scoville, senior managing director of research for Hines.
Breslau and Scoville agreed that a disconnect exists between the market realities and what they called the “noise” in the world. The business world is buffeted by daily headlines fueling uncertainty, from economic turmoil in China and plummeting oil prices to Brexit and negative interest on sovereign bonds.
“There is a lot of noise that is, frankly, overly negative,” Breslau said. The result is a “herd mentality” toward the prevailing feeling of uncertainty, he said. “It’s a pretty scary concoction.”
But the headlines don’t tell the real story, Breslau argued. “My view is that none of this stuff matters,” he said. “It’s much more important to look at the fundamentals of where things are, where pricing is, where the underlying growth rates are.”
In the United States, the growth cycle should continue beyond 2018, Breslau said, even though many prognosticators suggest that the downturn is likely to hit by the end of 2017. From his perspective, slower economic growth in the United States suggests the current cycle will last longer.
“Our view is [that] this growth cycle is more likely to last three or four years than it is one to two,” Breslau said.
Global markets are all over the place in terms of their point in the economic cycle, Breslau and Scoville agreed. Markets like Houston and London may be experiencing a rough period, while cities like Amsterdam and Milan are clearly on the upswing.
“We tend to generalize about the market, and markets are all over the place,” Scoville said. “San Francisco is much, much later in cycle than, say, Milan.” To succeed, investors “must remain disciplined on how we view markets,” he said.
Most economists trying to predict the future of real estate are fundamentally looking at the wrong factors, Scoville argued. When a market hits the top of ULI’s Emerging Trends charts, it is almost too late for investors, he argued. The top markets historically show weaker price growth going forward, while markets performing below historic averages tend to post stronger future price growth, he said.
“It almost has to be that way,” Scoville said. “When capital markets and collective capital [are] interested in an individual market, that tends to increase competition, which drives prices up and suppresses future price growth.”
His research found no direct relationship between future price growth and such factors as job growth, vacancy rates, and rent growth. Trends in growth and vacancy rates are “neither good nor bad,” they are simply not a good metric for predicting future growth, he said.
The best measure to predict market growth for “tactical investment decisions” of three to five years is pricing, Scoville said. In markets around the world, pricing has been a better guidepost for growth than the traditional market data, he said.
Finding the best opportunities for future growth will grow more challenging, with the analysts agreeing that most markets are nearing the end of the cycle. Both said they are counseling clients that declines are likely in the next five years.
“If you’re looking at a five-year investment window, we’re going to have a turn in the cycle within that window, you don’t know when,” Breslau said.
Investors should either look to add value within the short term or find assets they want to own for ten years through the next cycle, Breslau said. “We’re not going to get to the end of the decade without another cycle,” he said. “But our view is it could go for a while before it turns. So, it’s too early to run for the gates.”
One myth that both panelists were eager to bust is the idea that rising interest rates could negatively affect the real estate industry. Interest rates are expected to rise, but at a very slow pace over the next few years.
Data show that rising interest rates usually occur in environments of rising rents and growth, Scoville noted. “Higher rates have coincided with better returns, historically,” he said.
Real estate markets, though cautious, have been “clawing their way forward, for the most part,” in recent years, Breslau said. “It’s been a jittery cycle,” he said.
But several factors will help provide a foundation for the industry in the years ahead, Breslau said. The United States is primarily a domestic economy, which means it will be resilient in the face of overseas turmoil. The economy is also getting a “pretty good tailwind” from the consumer side, with housing, jobs, and wages on the rise, he said.
The fundamentals of the real estate industry are nowhere near the crisis conditions pre-2008, Breslau noted. Inventory growth has been “muted” and development has been more “equity driven,” with less leverage in the system. He expects “more low and slow”—low interest rates and slow growth.
“Slow, steady growth and low interest rates are generally a pretty good thing for real estate,” Breslau said.
With many financial markets sluggish, the search for yield will continue to send investors into real estate and alternative investments, Breslau said. “There is a bit of a structural shift in a low-yield environment to real assets, to income-producing assets, and to diversification,” he said. “All those things, especially with uncertainty in the world, are good” for real estate.
Both panelists were asked where they saw opportunity. Scoville said that Hines is looking at markets like Calgary and Houston, where values are depressed. Breslau pointed to “structural shifts” around demographics and technology, primarily in markets “with some affordability.” “To me, if you have cash I think there will be opportunities around those trends,” Breslau said.
Whatever the deal, the key is to ignore the noise and focus on the specifics of the market, Breslau said. “The macro trends don’t always tell the story; the micro trends are critically important,” he said.
