ct national forecast june 2010[1]

8/9/2019 CT National Forecast June 2010[1]

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cassidyturley.com | 1

U.S. Forecast ReportOffice & Industrial June 2010

It is said that there are two types of

economists: those who knowthey cant

forecast, and those who dontknow

that they cant forecast. Leaving aside

the exactitude of that saying, what we

economists doknow is that historically,

the U.S. economy and property markets

follow certain patterns called business

cycles. According to the National Bureau

of Economic Research, the average length

of a U.S. recessionary cycle dating back

to 1854 is 2 years and 5 months. These

recessionary periods are typically followed

by a period of economic expansion which

lasts an average of 3 years and 2 months.

That pattern changed after World War II.

Since 1945, recessionary periods in the

U.S. have been shorter (lasting only 10

months) and the expansionary periods

longer (averaging 4 years and 9 months).

Although we are still experiencingchallenging times in the U.S. economy,

there is some comfort to be found in

studying the historical patterns. They

consistently show that through 32 business

cycles spanning over 156 years, that what

goes up, must come down, and vice versa.

Cassidy Turley uses econometric modeling

to help us predict market direction, and

our regression analysis is based on the

notion that patterns from the past can be

used to help predict future values. Thus, if

todays U.S. economy does in fact conformto business cycle patterns from the past,

then our analysis should be reasonably

accurate in forecasting economic and

property market trends.

The Economy

Despite the mounting fiscal challenges

facing Europe and the decidedly downside

risk that it creates in our forecast, there

are strong indications that the U.S.

economy has entered into the next cycle of

expansion. In April of 2010, the national

economy created 290,000 new jobs a

monthly gain that rivals some of the

strongest employment growth during the

technology boom of the late 1990s and the

real estate boom of 2003 to 2007. While

its true that temporary hiring for the 2010

Census accounted for 66,000 of those

new jobs, the majority represent real, full-

time, private sector job gains. Moreover,

February and March payrolls were revised

significantly upwards, giving further

credence to the notion that the recovery is

evolving into a self-sustaining expansion.

More importantly, corporate profits have

been surging, up 9.2% in the fourth

quarter of 2009 compared to the previous

quarter, with a bigger gain expected when

the numbers roll in for the first quarter of

2010. Historically, corporate profits leadjob growth by 6 to 9 months. With real

personal consumption expenditures (i.e.,

consumer spending) growing at a healthy

clip of 3.6% in the first quarter of 2010,

businesses are likely to continue adding

to payrolls to keep pace with growing

demand.

There is one indicator preventing us

from calling this a full fledged recovery:

persistently low consumer confidence. The

Conference Boards Consumer Confidence

index registered 63.3 in May. Althoughthis is a marked improvement from the

reading of 25.3 in February of 2009, the

index is still well below its historical average

of 96. Until this index achieves a level

greater than 80, we cannot rule out the

small possibility of a double-dip scenario.

The European financial crisis and its

potential to spread to the U.S. will continue

to weigh on the minds of investors. In

addition, the fiscal tightening in Europe

that is certain to follow will suppress short-

term economic growth in Europe and thus

constrain growth in U.S. exports overseas.

That, in combination with a stubbornly

high unemployment rate, leads us to

believe that the Federal Reserve will not

raise interest rates prior to 2011. Europe

is not alone in its growing concerns over

rising national debt. The U.S. debt-to-GDP

ratio will near 65% by the end of 2010.

Although this is not the tipping point

levels witnessed in Greece (105%), rising

debt levels do have U.S. policy makers

looking for ways to tighten our own belts.

Interestingly, despite the rising U.S. debt

levels, global investors continue to gobble

up treasuries. As recently as May 5, 2010

investors purchased $17 billion of 30-year

government bonds at an average interest

rate of 4.5%. If global investors are thebarometer for the U.S. economy, then this

suggests the vast majority remain confident

that the U.S. is not heading down the same

path as Greece.

Office Sector

The latest data suggest that the U.S. office

sector has started on the road to recovery.

The first step towards improved NOI

levels is the return of absorption, which

starts with job growth. The U.S. economy

The Recovery is Gaining GroundDownside risks remain

Kevin Thorpe, Chief Economist

-6%

-4%

-2%

0%

2%

4%

6%

1 98 0 1 98 3 1 98 6 1 98 9 1 99 2 1 99 5 1 99 8 2 00 1 2 00 4 2 00 7 2 01 0

JobGrowth(Y/Y%)

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

C o r p o r a t e P r o f i t s ( Y / Y % )

Job Growth Corporate Profits

Profits Point to Job Growth

Source: BLS, Dismal


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began producing office-using jobs again

in the fourth quarter of 2009. Since

October of 2009, 311,000 Professional &

Business Service jobs have been created.

Historically, the trend in office-using jobs

has led the trend in net absorption by

an average of 2-3 quarters. This puts

the national office market on track to

begin absorbing space again by the third

quarter of 2010. However, the level of

shadow space (the space that companies

are leasing but not using) is difficult to

measure, and that could throw off the

timing of the forecast. Nevertheless, the

trend in demand for office space is headed

in a positive direction, as evidenced by the

fact that declines have decelerated rapidly

for four straight quarters. Regardless of

quarterly nuances, 2010 is tracking to be a

year of positive absorption for the national

office market. With more new supply(much of which is empty) still delivering

to the market, vacancy will not trend

downwards until 2011. Consequently,

even under a bullish scenario, the national

office market will remain oversupplied,

which suggests that sustainable rent

growth will not occur until the second half

of 2011, at the earliest.

Industrial Sector

In terms of improving demand, the national

industrial sector is trailing the office market

by 1-2 quarters. Whereas the U.S. waschurning out office-using jobs in the fourth

quarter of 2009, industrial employment,

which includes manufacturing, wholesale,

and transportation/warehousing, was

still contracting. However, 2010 has

been a rebound year, primarily for the

manufacturing sector. In fact, 44,000 new

manufacturing jobs were created in April of

2010. This, in combination with the ISM

index registering a reading of over 50 for 8

straight months (an index greater than 50

is consistent with expansion) suggests the

industrial employment base will continue

to grow in the coming months. Given

that absorption lags, we are projecting the

industrial market will not begin to absorb

space consistently until the first quarter

of 2011. With over 40 million square feet

of new supply in the pipeline according

to REIS, Inc., we do not expect vacancy

to tick down until 2011, with rent growth

following in 2012.

Investment Sales

The combination of still-tight lending

conditions and weakened property

fundamentals resulting from the recession

will continue to constrain sales activity

in 2010, although the overall volume will

be slightly higher than in 2009. Through

April 2010, national office sales volume

has totaled just $5.1 billion and industrial

volume $2.9 billion, compared to $55.4

billion and $15.5 billion, respectively,

during the peak year of 2007. Looking

one layer deeper, investment sales remain

a tale of two markets: core vs. value-

add. Investors are seemingly coming

out of the woodwork for core product,

particularly in top tier markets such as

Washington DC and Manhattan, which

is bidding values up. The value-add

product remains plagued by a clear lackof incentive to sell in a down market. As

the economy continues to shift from

recovery to expansion, that will help

properties lease up. We will then see

the gap close between buyer and seller,

and more value-add properties will trade

hands. However, a sustainable period of

job creation is required before occupancy

levels make value-add attractive again.

That is not likely to happen until 2011.

Cap rates will continue to tighten for

core markets, but with a greater share

of value-add transactions in the mix, we

expect the overall cap rate for both office

and industrial properties to rise in 2011.

Quality real estate in top tier markets are

leading, and will continue to lead, the

recovery in commercial real estate, with

secondary markets following suit in 2011

and more so in 2012.

*Value-add: Property with lease-up greater than 10%;

in-place tenants are below market by at least 10%;

property can be physically improved resulting in

higher rents; yields 12-15%.

*Core: Long-term credit leases prime locations, or if

secondary, lease term and credit overshadow location

yields 8-12%.

The Recovery is Gaining GroundDownside risks remain (continued)


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Office Sector Industrial Sector

$0

$5

$10

$15

$20

$25

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0%

5%

10%

15%

20%

25%

Asking Rent Vacancy Rate

Vacancy vs. Asking Rents

AskingRents

Vacancy

Source: Cassidy Turley Research

$0

$50

$100

$150

$200

$250

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0%

2%

4%

6%

8%

10%

12%

$ Volume Avg Cap Rate

Source: Real Capital Analytics; Cassidy Turley Research

Billions

$ Volume vs. Average Cap Rate

CapRate

-30

-20

-10

0

10

20

30

Q1

05

Q2

05

Q3

02

Q4

05

Q1

06

Q2

06

Q3

06

Q4

06

Q1

07

Q2

07

Q3

07

Q4

07

Q1

08

Q2

08

Q3

08

Q4

08

Q1

09

Q2

09

Q3

09

Q4

09

Q1

10

Q2

10

Q3

10

Q4

10

Q1

11

-600

-500

-400

-300

-200

-100

0

100

200

300

400

Net Absorption Office-using Employment

Net Absorption vs. Office-using Employment

Millions

Thousands

Source: BLS; Cassidy Turley Research

$0

$1

$2

$3

$4

$5

$6

$7

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0%

5%

10%

15%

20%

25%

Asking Rent Vacancy Rate

Vacancy vs. Asking Rents

Vacancy

AskingRents

Source: Cassidy Turley Research

$0

$10

$20

$30

$40

$50

$60

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0%

2%

4%

6%

8%

10%

12%

$ Volume Avg Cap Rate

Source: Real Capital Analytics; Cassidy Turley Research

Billions

$ Volume vs. Average Cap Rate

CapRate

-50

-40

-30

-20

-10

0

10

20

30

40

Q1

05

Q2

05

Q3

02

Q4

05

Q1

06

Q2

06

Q3

06

Q4

06

Q1

07

Q2

07

Q3

07

Q4

07

Q1

08

Q2

08

Q3

08

Q4

08

Q1

09

Q2

09

Q3

09

Q4

09

Q1

10

Q2

10

Q3

10

Q4

10

Q1

11

-1000

-800

-600

-400

-200

0

200

Net Absorption Industrial-using Employment

Net Absorption vs. Industrial-using Employment

Millions

Thousands

Source: BLS; Cassidy Turley Research


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2009 2010 2011Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2009 2010 2011

U.S. Economy

Real GDP (%) -6.4 -0.7 2.2 5.6 3.0 3.1 2.5 2.6 2.9 -2.4 3.1 3.1

Non-Farm Employment (q) -2,205 -1,702 -1,035 -438 283 540 155 240 340 -5,870 -663 1,900

Office-using Employment (q) -550 -442 -377 23 74 189 54 84 119 -2,055 -232 665

Industrial Employment (q) -826 -638 -320 -170 32 103 29 46 65 -1,115 -126 361

Retail Employment (q) -252 -147 -103 -99 71 62 18 27 39 -669 -76 217

CCI 29.9 48.3 51.8 51.0 52.0 60.0 59.0 62.0 70.0 45.0 58.0 80.0

CPI Inflation (Yr/Yr Chg) -2.2 1.9 3.7 2.6 1.8 2.1 0.9 1.2 2.0 -0.3 1.9 2.5

Real Disposable Income (q%) -0.3 1.9 -0.3 0.9 1.0 0.8 2.0 2.5 3.1 1.1 1.6 2.8

Unemployment 8.2% 9.3% 9.6% 10.0% 9.7% 9.8% 9.9% 9.9% 9.9% 9.3% 9.8% 9.5%

ISM Manufacturing Index 35.9 43.0 51.4 54.6 58.2 58.4 58.4 57.9 57.9 46.2 58.2 58.5

Retail Sales (q%) -1.6 -0.1 1.8 1.8 1.0 1.5 0.9 1.2 3.0 -6.8 4.6 6.2

Existing Home Sales (b) 4,610 4,780 5,280 5,970 5,137 5,400 5,100 5,300 5,500 5,156 5,234 5,600

Exist ing Home Prices (b) 167.6 174.4 178.1 170.8 166.7 173 184 175 173 172.5 174.7 185

Housing Starts (b) 528 540 587 559 617 643 683 720 800 553 666 920

Fed Funds Rate 0.2 0.2 0.2 0.1 0.1 0.2 0.2 0.2 0.7 0.2 0.2 1.6

3 Month T-Bill 0.2 0.2 0.2 0.1 0.1 0.2 0.2 0.2 0.6 0.2 0.2 1.4

Corporate AAA Bond Yield 5.3 5.5 5.3 5.2 5.3 5.3 5.5 5.6 5.7 5.3 5.4 5.8

10-year Gov't Bond 2.7 3.3 3.5 3.5 3.8 3.8 3.9 4.1 4.2 3.5 3.9 4.6

30 year Gov't Bond 3.5 4.2 4.3 4.3 4.7 4.5 4.6 4.7 4.8 4.0 4.6 4.8

30-year Mortgage Rates 5.1 5.0 5.2 4.9 5.0 5.6 5.6 5.7 5.8 5.0 5.5 6.1

Office Sector

Net Absorption (m) -22.0 -18.6 -13.5 -7.8 -3.7 -3.26 7.12 3.35 5.96 -61.8 3.5 39.9

Vacancy 15.2% 15.7% 16.2% 16.5% 16.8% 17.0% 16.9% 17.0% 16.9% 15.9% 16.9% 16.7%

New Deliveries (m) (r) 12.5 17.1 8.5 7.2 6.1 45.3 24.7 17.9

Asking Rents $22.17 $21.95 $21.73 $21.51 $21.62 $21.43 $21.39 $22.49 $22.54 $21.84 $21.73 $22.76

Effective Rents $18.63 $18.24 $17.88 $17.62 $17.64 $17.43 $17.34 $18.39 $18.39 $18.09 $17.70 $18.26

Investment Sales ($vol, bil) $3.7 $2.8 $4.8 $4.6 $4.3 $4.8 $6.0 $6.2 $13.0 $15.9 $21.3 $52.0

Cap Rates 7.8% 7.8% 8.3% 8.8% 8.6% 8.2% 8.3% 8.4% 8.6% 8.2% 8.4% 8.6%

Industrial Sector

Net Absorption (m) -38.2 -36.5 -43.4 -23.2 -28.7 -19.2 -14.2 1.8 -7.3 -141.3 -60.3 77.4

Vacancy 8.7% 9.3% 9.7% 9.8% 9.8% 10.0% 10.2% 10.2% 10.3% 9.4% 10.1% 10.0%

New Supply (Deliveries) 32.4 15.3 28.9

Asking Rents $5.50 $5.40 $5.31 $5.21 $5.12 $5.14 $5.18 $5.15 $5.06 $5.35 $5.15 $4.99

Investment Sales ($vol) $1.5 $2.4 $1.8 $2.6 $1.8 $3.1 $2.4 $2.6 $3.3 $8.3 $9.9 $12.0

Cap Rates 8.5% 8.3% 8.4% 9.0% 8.6% 8.5% 8.5% 8.6% 8.7% 8.6% 8.6% 8.8%

q = qtr/qtr chg, 000s q% = qtr/qtr % chg b = measured in 000s m = millions, sq. ft. r = Reis, Inc LLC

Key

Annual

*Sources for economic indicators include: US Census Bureau, BLS, BEA, Dismal, The Conference Board, NAR, Department of the Treasury and the Federal Reserve; all

forecasts generated by Cassidy Turley Research.

ct national forecast june 2010[1]

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