US NEWS: Symptoms of uncertainty

With global property transactions rising 34 percent this year through the end of the third quarter, it’s easy to argue that the prospects of commercial real estate are improving. Rental incomes are rising in almost all property types, and cap rates are steadily falling across the board. As deal flow returns to the market, there is a real sense of optimism about the asset class.

It’s somewhat paradoxical, therefore, that massive uncertainty still reigns in the US and global commercial real estate industry. However, that’s precisely the situation facing institutional investors and investment managers as they eye the private real estate markets today. That is because real estate never operates in a vacuum, obvious as that is to state. And as the world’s financial markets are engulfed in a political maelstrom, so too does commercial real estate feel the symptoms of uncertainty.

“It’s critical that people know the path we are on,” said Diane Swonk, chief economist and senior managing director of Mesirow Financial, speaking at the PERE Forum in New York last month. “We will deal with the potholes in the road if we know where we’re going, but it’s not something we are acknowledging in government right now.”

Indeed, it is that “impotence of Washington DC,” as Swonk called it, that is hamstringing consumers and companies from reinvesting the liquidity currently sitting on their balance sheets after years of deleveraging. Today, the US is faced with consumers reluctant to buy new goods and companies extremely hesitant to make new loans, acquire new inventory and hire new staff. To put it another way, both groups are hesitant to invest in the drivers of real estate demand.

Take for instance, the debt ceiling debate that consumed the US Congress in August and the subsequent downgrading of the US’ debt rating. “That had an impact,” Swonk explained. “Business and consumer confidence collapsed.” For companies, it left many chief executives “afraid of hiring,” Swonk told more than 250 delegates at the PERE Forum. “CEOs don’t like to hire and then fire. They hate it more than anything else as they feel responsible for those people, and it [affects] morale across the board.”

Yet, without any clear message from government – or sense of political direction – consumers and companies will continue to hoard their liquidity, presenting what Swonk deems a “liquidity trap.” Citing Samuel Taylor Coleridge’s The Rime of the Ancient Mariner, she said the US was facing a similar situation as the mariner: “Water, water everywhere, nor any drop to drink.”

“Liquidity is the oil of the market machine,” Swonk said, and the Federal Reserve is doing everything in its power to make holding risk-free debt so repulsive that investors instead bet on riskier and more productive investments. “Without that, we cannot get out of this vicious cycle.” Furthermore, without some basic political consensus on the road the US must take to help grow its way out of the Great Recession, Swonk fears consumers and companies will continue to sit on the sidelines with their capital waiting for clearer – and calmer – waters ahead.

“The reality is we are moving into a period where we have a lot of icebergs ahead, but we’ve still got the opportunity to avoid them,” Swonk added. “The problems today are not insurmountable … why not take that opportunity and seize that opportunity?”

For commercial real estate, those opportunities could be great. “Private investment in commercial real estate is starting to pick up,” Swonk noted. “The sector was the very first to be hit by the financial crisis, but it didn’t overbuild like it usually does and because of that there is fundamental demand.”

However, just like every other asset class, real estate investors and investment managers need greater macroeconomic certainty. “People want to know where are going, so they can plan and strategize,” Swonk said.