There’s a psychological malady that affects professional athletes in a number of sports: the yips, usually impacting veteran players with years of experience in high-pressure situations. CRE professionals can get the yips too, abandoning what they know in the late stages of a cycle.
But according to James Shilling, PhD, the George L. Ruff Endowed Chair of the Department of Real Estate at DePaul University, now is not the time for industry pros to forget what they know. Even as the current cycle reaches a record duration, commercial real estate markets can and should stave off near-term bearish sentiments.
“Real estate fundamentals are solid for most property types, but potential appreciation is limited and is unlikely to pick up as the real estate cycle matures and as bull investors become bears,” Shilling said.
Shilling was speaking as the keynote speaker at the 15th Annual REIA/DePaul Fall Summit. In his assessment of the market, Shilling highlighted several points that, in his mind, suggest that it’s probably too early to become defensive about the current state of the CRE markets, in Chicago or nationally.
How anxious should we be about this economy?
According to Shilling, the probability of a decline in real GDP during the next quarter is only around 15 percent. However, by 2021 that probability increases to nearly 75 percent. Shilling also noted that this cycle—as beneficial as it has been to many–doesn’t have to end just because we are reaching a record number of years of economic growth. He cited the Australian economy which has been in growth mode for three times as long as in the U.S.
How well is this economy performing?
A number of statistics and benchmarks point to a positive economic performance. Shilling noted that, while the current expansion has set a record for duration, the average growth has been slower than in previous expansions. The economy appears to be moderating toward a long-term trend of roughly 2 to 2.5 percent real GDP growth, Shilling said, with real GDP growth of 2.7 percent expected for 2019 and a forecast of between 1.5 and 3 percent for 2020.
What are the real bright spots in this economy?
There are bright spots in the economy, according to Shilling. Consumer sentiment is high, unemployment remains low and supporting income growth is strong—including that for low-wage industries. Further, Shilling noted that lower mortgage rates have kicked off a wave of mortgage refinancing.
How are we to interpret what the Fed is doing?
In years past, the Treasury has been somewhat inscrutable. Currently, however, they are fairly transparent about interest rate movements. One troubling development of late, however, is the return of the inverted yield curve. That in and of itself may not be a harbinger of a looming downturn, Shilling said, citing a number of factors that are putting downward pressure on long-term yields, including secular stagnation, declining interest rates and a lack of investment opportunities.
How do we read the real estate market?
Along with many local real estate experts, Shilling contributed his expertise on the market to the 2019 Mid-Year Perspective on Chicago Real Estate Markets, released earlier this year. Comparing the 2019 and 2018 results from the report, Shilling said investors in Chicago are becoming more bearish. “The bears now outweigh the bulls—one-third to two-thirds, down from 50-50 a year ago,” he said.
How concerned should we be over a slowdown in corporate revenues and profits?
A slowdown in corporate revenues and profits, Shilling noted, could lead to reduction in private, fixed, non-residential investment. Yet at the same time, he said a slowdown in corporate revenues and profits may also have a positive effect on real estate.
What are the implications?
Shilling outlined the numerous potential implications of a bear versus bull market. Trading volume will naturally slow, for example. Also, anticipated returns—which have averaged about 7 percent—will be slightly below that for 2020. Appreciation levels have averaged 2.3 percent annually but these, too, may be lower.
Shilling also commented on what the current environment in commercial real estate likely means for REITS. “Changing sentiment in the broader market should positively affect the relative attractiveness of REITs,” Shilling said. “Currently most REITs are trading at a significant discount to NAV. Together with lower interest rates, look for REIT prices to increase.”