Written by Peter Strauss of Iconic Investments
UCLA ECONOMIC FORECAST
Iconic attended the March 2019 UCLA Economic Forecast. The topic of this forecast was Technology and the Business of Entertainment, although the forecast did not directly relate this topic to real estate it does have some significance. This article will focus on the global economy, US economic forecasts, the likelihood of a recession and the sentiment of today’s buyer.
“The world is caught up in something – the global economy is experiencing a slow down.”
David Shulman, Senior Economist, UCLA Ziman Center for Real Estate
David Shulman – US Forecast
Mr. Shulman began his forecast describing the healthy GDP expansion most countries have enjoyed over the last 18 months. Today, however, many nations are seeing their economies going in reverse. The Eurozone is predicted to have GDP growth of 1.2% in 2019. Germany, Europe’s powerhouse economy is expected to lead growth with 1.3%, while Italy is expected to the laggard with only 0.6% growth. These numbers contrast strongly with China’s estimated government reported growth rate of 6.2%, which declined from last year’s 6.6%. Most economists believe China’s GDP numbers are inflated and that actual growth will be in the range of 4.2%.
Shulman predicts that US GDP will grow by 1.7% in 2019 and 1.1% in 2020, a steep drop from the 3.1% growth experienced in 2018. Unemployment is anticipated to remain strong in 2019 while it dips to 3.6%, before rising above 4.2%, which is still considered full employment. Job creation is expected to decline from month-over-month growth of 150,000 jobs down to 50,000 per month, by the end of 2020.
The elephant in the room amongst the panel of economists, Shulman included, is the annual federal deficit of $1 Trillion – which they expect will continue into the foreseeable future. Generation Y and the millennials will pay the price, as the debt service on the deficit will continue to grow over time.
As a result of the impending global economic slowdown, Shulman predicts the Fed will only increase interest rates once in 2019. Currently the 10-year treasury in the US sits at 2.65%, in sharp contrast to rates in Germany (0.09%) and France (0.52%). Rates in other nations’ 10-year debt must increase before the US can continue to raise rates higher.
Inflation is currently around 2.5%, and is projected to remain at this level through 2020. The inflation rate will remain stable so long as oil remains in the $60 per barrel range.
Jerry Nickelsburg – California Forecast
The California Forecast focused on “Trains and Houses.” Jerry discussed Governor Newsom’s decision to cancel the highspeed rail, which Nickelsburg believes would have had no more than a marginal impact on economic growth in California. The high-speed rail would have had a positive impact on the housing affordability solution, as it may have allowed people to commute from California’s rural center into densely populated areas.
California’s unemployment rate is currently at 4.2%, driven by continued strength of the logistics and construction sectors. The state unemployment rate is expected to remain steady at 4.3% through 2021.
Home prices in most California cities are experiencing a sharp decline. Case Shiller Home Price Indices reports that over the last six months, year-over-year home prices in San Francisco declined by 7.3%, San Diego 5.1%, and 1.5% in Los Angeles. The declines pose a conundrum: If California is continuing to enjoy good job growth, low unemployment, and low interest rates, why are home sales and prices dropping? BUYER CONFIDENCE. The talk of a recession is in the air, buyers are forming their own opinions of the market. In addition, political chatter, including Governor Newson’s continual warning that we are heading toward a recession, coupled with news outlet coverage of the statements, is getting people talking.
Iconic Investments has been consulting their clients about recent shifts in the apartment market. Even with low interest rates, strong rental demand, and rising rents – cornerstones of a strong market – buyer sentiment has shifted to the negative. Since 2014, investors were satisfied with sub-4% Cap Rates in exchange for anticipated price appreciation. Today, the sentiment of most buyers is that prices will likely be lower in the next 6 to 12 months. Buyers are reverting back to traditional real estate fundamentals that seek yield and cash flow today, and put future price appreciation on the back burner.
Ed Leamer – Recession?
How far into the future can economic forecasters actually see? Looking backwards actual tells a more compelling story than looking forward. Economist rely on history to determine the future. Three alarms that are usually telltale signs of a recession are: 1) Decline in building starts (permits); 2) an inverted yield curve, and; 3) Length of expansion time.
Why is an inverted yield curve a precursor to recessions?
Predictive Story: No one would buy a 10-year T-Bond with a lower yield than a three-month T-Bill unless short-term rates are expected to decline. Confidence that the Fed is soon going to reverse its mistaken policy of rate increases has created an inverted yield curve. Casual Story: An inverted yield curve causes elevated lending standards because it takes intermediation profits away from banking sector.
Length of Expansion: Between 1945 to 2009 the average economic expansion was 56 months. The longer the expansion the greater chance a recession is in the foreseeable future. The current expansion has been going for over 116 months as of February 2019.
Despite all the talk of recession, Leamer predicts that there is a 17% chance of a recession in 2019 and a 28% in 2020.
Although this most recent UCLA forecast didn’t directly link the topic of the Business of Entertainment to the real estate industry, there are significant correlations investors and real estate professionals can look to to get a better sense of the future. While the entertainment industry as a whole continues to exert influence in the local economy, the streaming media sector is increasingly playing a more major role. Conference panelist Harry Sloan of Silver Media Acquisitions Corp discussed Netflix’s plans to spend $15 billion in 2019 towards the creation of new content. This amount is greater than the combined budgets of the four major U.S. television networks. Additionally, the Westside Pavilion mall is being converted to 584,000 square feet of office space dedicated to Google and YouTube production space. All of this new media and production will directly benefit landlords and developers through the creation of thousands of new high-paying jobs that will be filled by highly educated people - all who need someplace to live.
