The Recession’s End and Commercial Real Estate
Tom Acitelli Oct. 22, 2009, 2:02 p.m.
The Board of Governors of the Federal Reserve released the minutes of the September meeting of the Federal Open Market Committee (FOMC) last Wednesday afternoon. The final authority on domestic monetary policy is arguably the most reserved of any institution in its choice of words. And with good reason: Fortunes can be made and lost in the markets’ interpretations of the subtext of an FOMC statement. Given its well-deserved reputation for cautious semantics, the FOMC’s improving characterization of economic and financial market conditions implies that real improvements are at hand.
Consistent with leading indicators from earlier this year, evidence of a thaw in business activity and investment flows is apparent across a breadth of coincident economic measures. The Federal Reserve staff’s review of economic conditions cited several positive trends, including rising factory output in July and August and a modest increase in household spending independent of the temporary rise in automobile purchases. House prices and sales volumes have risen from their lows, and job losses have moderated substantially from late 2008 and early 2009. At least for the time being, consumer price inflation remains within a manageable range.
While some drags on the economy remain entrenched, the prevailing view among the Fed’s economists is that the preponderance of the data weighs in favor of a resumption in growth. As a result, the Fed has revised its outlook for late 2009 and 2010, citing new data that “indicate a more noticeable upturn than anticipated at the time of the August meeting.”
The new projections show real GDP growth for the second half of 2009 and a slow acceleration of output growth in 2010 and 2011. The Fed now anticipates that the national unemployment rate will fall to 9.25 percent at year-end 2010 and to approximately 8 percent at year-end 2011. In spite of a rise in capacity utilization, core inflation is projected to slow.
EVEN APART FROM ITS benign outlook for inflation, the Fed’s assessment of prospective economic conditions affords ample opportunity for disagreement. Fueling the occasion for debate, differing interpretations of the evidence are matched with different definitions for the recession. Contrary to popular notions, the National Bureau of Economic Research—the Cambridge, Mass.–based body tasked with dating economic cycles—does not define a recession as two consecutive quarters of falling real GDP. The NBER’s formula is more ambiguous, defining a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
Based on some of the criteria outlined by the NBER, such as production, the recession ended in June. If greater weight is assigned to outcomes in the labor market, the recession may not end until later in 2010. Ultimately, the decision resides with a small group of individuals who make up the NBER’s Business Cycle Dating Committee.
The determination that the recession began in January 2008 was made by seven people, each held in the highest esteem within the economics profession, but each relatively unknown to the world of commercial real estate. Absent a clear set of metrics, the question of the recession’s end can be contested.
Fed Chairman Bernanke threw his own hat into the game more than a month ago, telling an audience at the Brookings Institution on Sept. 15 that “from a technical perspective, the recession is very likely over at this point.” Speaking to the point, one astute commentator noted that “if Bernanke had delivered that speech in the parking lot at Wal-Mart instead of at the Brookings Institution, the tomatoes would have been flying.”
The art and science of calling the recession’s end, if properly stage-crafted, can help to fulfill itself. In the best case, a credible statement about improving conditions will buoy consumer sentiment and consumers’ contributions to economic activity. Inasmuch as the statement actually coincides with an uptick in key growth measures, it also presages a slow but inexorable return to stability in the labor market.
AN EASING OF THE financial and credit markets’ negative spillovers into the real economy is welcome news for commercial real estate. Downward pressures on property fundamentals will abate as real economic activity normalizes. Perhaps as important, policy attention, spread thin by the myriad challenges of the last year, can focus on our sector’s unique issues and the consideration of appropriate responses.
Evidence of commercial real estate as a cynosure of policy attention is increasingly visible. In the FOMC minutes, for example, it is singled out for its lagging behind the broader economic trends: “[I]n contrast to developments in the residential sector, commercial real estate activity continued to fall markedly in most districts, reflecting deteriorating fundamentals, including declining occupancy and rental rates, and very tight credit conditions.”
Just week weeks ago, I had the opportunity to attend gatherings of the Regional Federal Reserve Banks and of the Federal Financial Institutions Examination Council, where commercial real estate market conditions and challenges were a focal point for discussion. Moving from recognition of the issue to solutions, interagency guidance on commercial mortgage resolution is expected presently. The guidance is expected to reflect F.D.I.C. Chairwoman Sheila Bair’s comments last week that “prudent loan workouts are often in the best interest of financial institutions and borrowers, particularly during difficult economic circumstances and constrained credit availability.”
Sam Chandan, Ph.D., is president and chief economist of Real Estate Econometrics and an adjunct professor of real estate at Wharton.