There is a Chinese proverb: “May you live in interesting times”. Whether it is the consistent drip of 140 character tweets from our new President or the ever changing rumors of how the Republican-led Congress will deal with a change in tax code, there is no doubt that we are now living in interesting times. However, as a veteran of over 40 years of investing and operating real estate, there are some things that I look to consistently which help me feel like I have a little more control over our investment decisions. In the spirit of trying to use facts as we know them, rather than conjecture and hyperbole, I outline sources that I look to for information and give you my take in this quarterly Economic Outlook.
On February 14, 2017, Chair Janet L. Yellen testified before the Senate and House of Representatives on February 15, 2017 regarding the Federal Reserve's semiannual Monetary Policy Report. In her remarks she reviewed the considerable progress that has been made in attainment of the two objectives assigned to the Federal Reserve by Congress — (1) maximum sustainable employment consistent with (2) price stability. She noted that the FOMC expects the economy to expand at a moderate pace, with the job market strengthening somewhat further and inflation gradually rising to 2 percent.
She pointed out that 2016 job gains averaged 190,000 per month over the second half of the year, and the number of jobs rose an additional 227,000 in January 2017. This brings the total increase in employment since its trough in early 2010 to nearly 16 million.
As I look at the data available, I am confident that she is also correct in noting that overall economic growth has been driven by consumer spending sustained by substantial gains in household income and wealth. However, it is also important to point out that she stated that business investment was rather soft, but business sentiment has noticeably improved in the last few months.
In my view, the U.S. economy has recovered from the 2008 to 2010 recession. Since 2010, we have seen steady, albeit slow, economic growth. Rising made over 3 million square feet of investment from 2011 to 2016 and we have seen very strong returns from the assets we have sold and feel very good about the assets we currently own and operate. We believe that the U.S. economy is well positioned to move forward with strength.
In my opinion, the California economy remains strong. At Rising, we believe that there is still a strong investment window to buy real estate here. With its diverse economy which includes tech, trade, tourism, business services, healthcare and entertainment, we feel there is a strong roster of potential tenants and residents to fill office and residential buildings.
As I look for “tea leaves” to read, I do my best to read a wide variety of economic publications. The latest forecast by UCLA Anderson School of Management concluded that California will likely grow at a faster clip than the rest of the country, fueled by technological innovation and the critical mass developed with California’s research institutions. The forecast concludes that there will be steady growth through 2018. In the real world, there is nothing that we see at Rising that would cause us to disagree. In fact, we consistently see tech or related creative tenants looking at our projects like The Park DTLA and The CalEdison in Downtown Los Angeles
As I look for factual context for our investment decisions, and as former Chairman of the Federal Reserve Bank of San Francisco, I am always sure to review the The Federal Reserve Beige Book. The January 18th Beige Book indicated that the economy continued to expand at a modest pace across most regions from November to year end. That is clearly supportive of our analysis. Activity in the service sector remained strong, activity in manufacturing was stable, and the housing sector reported strong results. Further, the real estate industry is very dependent on the financial sector and when looking at interest rates, from a historical vantage point, it certainly feels extremely accommodative. As I write this article, the one month Libor is 0.78; the ten-year treasury is 2.44%; the 30-year treasury is 3.05%, the Fed Funds Rate is 0.75; and the 30 fixed rate home mortgage is 3.74%. From someone who has invested through Prime Rate above 20%, it feels to me that the financial sector indicates a strong time to invest in hard assets which produce income.
The elephant in the room for any article entitled “Economic Outlook” is our new President, Donald J. Trump. While President Trump’s name does not appear in Janet Yellen's testimony, we must keep in mind that his three main objectives are:
- Increase infrastructure spending
As we know, President Trump outlined a blueprint while on the campaign trail, explaining that he would offer $137 billion in federal tax credits to private firms that back transportation projects. In turn, this would unlock $1 trillion in investment over a 10-year span. Clearly, our infrastructure needs to be improved but by approaching the issue in this way, I think we must be cautious of an inflationary outcome.
- Reduce regulation
President Trump signed an executive order that would require agencies to revoke two regulations for every new rule they want to issue. The goal in mind here is to make life easier for businesses, small businesses in particular. Earlier this month, President Trump has made moves to reduce regulation, which affects Dodd-Frank. I am always concerned when people are proposing in broad strokes. We must understand that there will always be unintended consequences, so we shouldn't have a rush to judgment.
- Reform tax plan
The White House has made it clear that they intend to lower taxes. Unlike past proposals, the House tax reform blueprint is forcing stakeholders to rethink prior assumptions. If we look back at history and Reagan's Tax Reform Act of 1986, we are painfully reminded of the repercussion of retroactive tax changes.
As I stated previously, we should always be aware and cautious that making changes to programs of this size may have unintended consequences.
- Nelson Rising
Chairman & CEO, Rising Realty Partners
Former Chairman of the Federal Reserve Bank of San Francisco