Real Estate Forum - November/December 2009

Economic Outlook
By Rocky Tarantello
How Do We Truly Measure
An Economic Recovery?

SO MUCH IS TAKEN FOR GRANTED IN OUR understanding of common terminology. This is especially true in attempting to define economic conditions or real estate market activity. What exactly constitutes a recovery in the real estate market? We are all aware that current market conditions are depressed, but even this simple comment implies that we know the indicators, levels and consequences of what that means. We’re all awaiting the inevitable recovery. But what combination of rents, values, vacancy absorption and capital investment represents the recovery we seek? How will we know when we get there?

The stock market is up nearly 50% since March. To the extent the stock market anticipates future economic growth and corporate profits, this is a very positive sign of investor sentiment. In like fashion, third quarter GDP grew at an annualized rate of 3.5% following declines of - 6.4% and -0.7% in the first and second quarters, respectively.

Despite healthy increases in stock prices and productivity, the economy has lost roughly seven million jobs since late 2007. The October unemployment rate reached 10.2% and many leading economists and forecasts are predicting a rate between 10.5% and 10.75% by the middle of 2010.

It is conceivable that some combination of events could blunt the impact of the highest unemployment rate in a generation. There are three things that continue to show up on my radar screen: the federal stimulus program, potential growth in US exports and increased US business investment.

Regardless of whether one supports massive deficit spending, the fact remains that federal spending will help to contain job losses. The extent to which it actually creates jobs is being debated between the administration and its detractors. But federal spending definitely helps state and local governments retain public-sector jobs. Creating private-sector jobs is entirely another matter.

It is possible that many of the job losses in the manufacturing and financial services sectors may be lost forever. The restructuring of these sectors eliminates some positions as obsolete, and redirects others to lower-cost global labor markets. But there are other forces at work. European and Pacific Rim countries have not all suffered the same degree of economic decline nor are they likely to follow the same path to recovery. Many countries, especially China, are already showing growth ahead of that in the US.

In conjunction with a decline in the value of the US

dollar, this positions American businesses very favorably. We are already witnessing a significant reduction in trade imbalances and increased US exports. With lower labor costs, an export currency valuation advantage and the restoration of inventories depleted by months of reduced output and corporate cost cutting, US businesses are poised to increase their spending, adding fuel to the recovery.

But the biggest piece of the US economic pie is the consumer. Roughly 70% of total output is related to consumer spending. Until it shows tangible signs of recovery and growth, the US economy will continue to struggle. Current estimates for GDP growth in 2010 are consistently below 3%, with some estimates below 2.5%. Though exports and business investment will improve, employment growth will lag for most of next year.

So how do we measure the recovery of the real estate market? I suspect that will happen when absorption rates increase, causing rents, cash flows and values to follow suit. Absorption rates will grow as a result of increased demand for space caused by increased demand for goods and services, both globally and domestically.

Rocky Tarantello is president of Tarantello & Associates, which is based in Canandaigua, NY. He may be contacted at rtarantello@tarantello.com

We will know the recovery is real when the old
jobs return, the new jobs are defined and the
growth in US employment is once again on track.

But the linchpin is jobs. Without job growth, a real estate recovery is problematic at best. It is possible that real estate capital flows and investment will increase as risk takers anticipate the recovery, but genuine lasting recovery cannot and will not be present until those seven million jobs are replaced, and then some. Many of those jobs may be lost forever, but replacements may be in industries and job descriptions yet to be determined as technology, communication and research evolve. We will know the recovery is real when the old jobs return, the new jobs are defined and the growth in US employment is once again on track. ◆