It’s been more than seven years since the global financial crisis and the economy has continued to grow, albeit without the same vigor as previous recovery cycles. As we reflect on 2016, it may go down as a year when nationalism reared its head again as evidenced by the United Kingdom’s Brexit referendum and the recent victory of Donald J. Trump as the 45th president of the United States. Only time will tell whether this burst of nationalism is a blip in the march of globalization; one of the big questions is whether President-elect Trump will stay true to his campaign rhetoric, which focuses on economic protectionism or will he take to a more moderate stance on global trade and international relations. Already, President-elect Trump’s campaign promise to cut corporate taxes and create jobs to spark economic growth has driven the U.S. stock market to historic highs as well as caused long duration Treasury bonds to sell off. As expected, the Federal Reserve (Fed) increased its benchmark short-term interest rate in December and signaled that more rate hikes will be on the horizon in 2017. With many uncertainties on the table, it’s a good time for commercial real estate investors to take stock of what a Trump Presidency could mean for the U.S. economy and growth in 2017. Our recently released report, Inside Real Estate Annual Strategy Outlook for 2017, provides insight on this question and more.
Key themes include:
- Economic expansion seven years on – In the short-term, the economic expansion should remain on track given the healthy state of payrolls and consumer spending. Following one of the worst financial crises in modern history, the United States recovery has accomplished much. Consumer balance sheets have healed, the labor market is robust, real wages are rising and corporate profits are strong. Yet, the velocity of growth continues to disappoint with the economy failing to replicate the successes of its previous recovery cycles. Our base case remains that the current recovery and expansion will continue over the forecast period, but the outlook for growth will likely be shaped by policy over the coming months.
- Path of monetary policy unclear – With an interest rate hike behind, further tightening will depend on financial conditions and the fiscal stance of the incoming administration. If current verbiage is any indication, the Fed is prepared to let the economy run “hot,” and thus continue to take a more measured approach to monetary tightening. However, if inflationary expectations take hold strongly on the back of a large stimulus package, expectations of rate tightening may also move higher accordingly.
- Choosing the right strategies – While cautiously optimistic on the economy, analogous to equity markets, we believe that investors need to increasingly focus on picking the right “stocks” or in the case of commercial real estate, property types, quadrants, leverage posture and strategies. Investing in “beta” opportunities in commercial real estate will be less rewarding than more targeted and focused investment strategies.
- United States still a global favorite – Notwithstanding the modest growth outlook at present, the U.S. commercial real estate market still remains a favored destination for global capital, barring a sharp uptick in protectionist rhetoric and action. Transaction data suggests that the United States continues to attract significant global capital due to its relative stability, highly active debt markets and its favorable rent growth outlook.
- Maintain tilt to debt and pursue select equity opportunities – A reversion to the mean for core real estate performance that is unfolding has validated the caution suggested in our 2016 annual report. Given the softening in rent growth and a slowing pace of appreciation, our broad tilt remains to debt over equity.
In other words, the glass half-full view seems to be prevailing for now. Initial investor reaction seems to suggest that increased economic activity in turn could add some tailwinds to rent growth, even if the cost of capital does rise. However, much about the new policy framework still remains unclear, which ensures that we retain our generally cautious view, wherein a tilt towards debt over equity appears appropriate.
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