The investment sales market’s recovery after The Great Recession began in 2010 and now has five years under its belt. As history has shown us, our market, like all markets, is cyclical, so the question is not if the market will turn, but when. Trying to figure out if, and when, the market is turning is one of the most difficult things to determine. We rely on many factors to try to pick up the scent. We look at current momentum, activity on current transactions, investor sentiment and also try to apply historical reference from past market turns.
As a student at the Wharton School in the early 1980s, I was always fascinated by the various illustrations economists used to show the impact of decision-making dynamics and how market forces work. For instance, in the “Guns vs. Butter” model, a simple production possibility frontier demonstrates the relationship between a country’s investment in defense and civilian goods. This model provides an analogy for choices within more complex economies.
Another favorite of mine is the “Diamonds vs. Water Paradox,” which illustrates the apparent contradiction that, although water is essential for life, diamonds command a higher value in the marketplace. Here, “value is use” and “value in exchange” determine what Adam Smith called the relative, or exchangeable, value of goods. Counterintuitively, things with the greatest value in use frequently have little or no value in exchange. And the opposite holds as well.
The constant battle between greed and fear often determines market participant behavior. They represent two of the three main emotional motivators that impact the ebb and flow of business behavior and market cycles (herd instinct is the third). This dynamic is typically used in relation to equity markets but its application to commercial real estate markets is clear.
So in today’s investment sales market, what are fear and greed looking like?
Those who are fearful about the market point to an apparent softening in the land market for sites in secondary and tertiary locations; the challenges facing the hotel market today (hotels have the most dexterity with regard to market changes, as “lease terms” are just one day); the sluggishness within the end user condo market; value metrics that have demonstrated signs that their trajectory is changing; and tales of woe from active sales brokers fighting to achieve offers at sellers’ expectations.
On a more macro basis, gross domestic product growth is sluggish at best, averaging only 2.2 percent over the past year, which unfavorably compares to a 3.8 percent average in past recoveries. Corporate earnings, with the exception of a few very large tech firms, have been mostly disappointing. Add to that the fact that our national debt is larger than it has ever been at a staggering $18.6 trillion and GDP is just $18.1 trillion, resulting in a debt-to-GDP ratio of over 100 percent for the first time. Our unfunded liabilities have eclipsed $100 trillion and the total of our nation’s assets is just $118 trillion. Nothing coming out of Washington D.C. indicates a reasonable chance of tangibly addressing this.
For these reasons, and several others, the percentage of those who are fearful is growing.
Those who are greedy—or more appropriately, optimistic—point to the massive amount of capital that has targeted commercial real estate investments; plentiful financing options; extraordinarily low interest rates; a supply/demand imbalance that heavily favors demand; and low gas and oil prices that leave consumers with more disposable income to spend, which will serve to stimulate the economy. They also point to an environment with virtually no inflation, a housing market that has grown by 6 percent in real terms nationally (the growth rate in the bubble inflating years of 1998-2005 was 6.8 percent in real terms, adjusting for inflation), and they also view the current growth rate of GDP positively.
Optimists also point to the cyclically low current unemployment rate of 5 percent and the 13.5 million jobs created since the recovery began. We lost 8.4 million jobs during the recession, so we are over 5 million jobs ahead of where we were in the last cycle. This, they say, is very positive for the underlying fundamentals of the commercial real estate market.
So who is winning in this battle between fear and greed? Greed has had the upper hand for a while but fear seems to be gaining momentum. In trying to determine if we are about to have a market correction, two things are almost always true. The first is that we rarely see it coming and the second is that the tipping point is rarely the same. Only time will tell…