Wednesday, April 22, 2015

Commercial real estate booms

Updating my comments from January: U.S. housing starts have almost doubled in the past 5 years, and, according to Case-Shiller, housing prices have recovered 56% of their recession-era losses. But the recovery of the residential real estate market pales in comparison to the boom in commercial real estate, where prices have recovered substantially all of their recession-era losses, thanks to double-digit annual gains for the past 4-5 years.


Repeating the comments from this month's Co-Star report on commercial real estate:

COMMERCIAL REAL ESTATE PRICES CONTINUED TO CLIMB IN FEBRUARY. The two broadest measures of aggregate pricing for commercial properties within the CCRSI—the value-weighted U.S. Composite Index and the equal-weighted U.S. Composite Index— gained 1.5% and 1.4%, respectively, for the month of February 2015. Both indices have increased by more than 13% over the 12 months ending February 2015 as the pricing recovery for commercial property expanded into smaller markets and secondary property types.

HIGH LEVEL OF INVESTMENT ACTIVITY SUGGESTS COMMERCIAL REAL ESTATE WILL CONTINUE TO BE A SOUGHT-AFTER ASSET CLASS IN 2015. ... transaction activity through February 2015 suggests this will be another active year for commercial real estate acquisitions. The U.S. composite sales pair count of 2,357 and sales volume of $18.9 billion in the first two months of 2015 exceeded totals from the same period in 2014. Meanwhile, the share of commercial property selling at distressed prices fell from 32% in 2011 to less than 10% for the 12 months ended February 2015. 

The strength of commercial real estate belies the fact that this continues to be the weakest economic recovery on record. That's a conundrum which in turn suggests that 1) the economic fundamentals are arguably stronger than most people realize, 2) very low borrowing costs (i.e., easy money) are artificially boosting property values, and/or 3) commercial real estate never experienced a bubble of the magnitude that residential real estate did. I think government meddling in the mortgage market was a significant factor contributing to the overbuilding, overpricing, and eventual crash (think Fannie Mae, Freddie Mac, no-down payment loans, stated income qualifications, government guarantees, and interest-only loans). Things never got so carried away in the commercial real estate sector, where market forces were still operating to keep things more or less rational. 

In any event, a vibrant commercial real estate market is at the very least a source of comfort for us bulls. Things can't be that bad if commercial real estate values are increasing more than 10% per year.


Monday, April 20, 2015

Recommended reading

I can highly recommend John Tamny's new book, Popular Economics: What the Rolling Stones, Downton Abbey, and LeBron James Can Teach You about Economics. John is a long-time supply-side friend and a solid thinker who knows how to make complex issues simple to understand.

George Will praised Tamny's book in a recent column, calling him "a one-man antidote to economic obfuscation and mystification." George Leef also praised the book, and proffers a good distillation of its contents.

This book should be required reading for high school, college, and graduate school econ classes. Instead of signing pledges, politicians should simply declare they have read the book and can't find anything wrong with it. It's especially timely, since many of the issues discussed in the book are at the heart of important national debates (e.g., wealth inequality, the estate tax, government regulation, progressive taxation).

To compile this sampling of the many economic truths he lays out and explains in simple terms with examples that come straight from daily life, I've simply drawn from the titles of the books' chapters:
Taxes are nothing more than a price placed on work 
When we tax corporations, we rob them of their future
Government spending has never created a job 
Budget deficits don't really matter—government spending does
Capital gains are what really drive innovation 
The best way to "spread the wealth" is to abolish the estate tax 
Weath inequality is beautiful 
Government regulation almost never works 
Anti-trust laws are counter-productive 
Outsourcing is great for workers 
Falling prices for computers are not deflationary
Energy independence would be economically crippling 

If some of these strike you as very wrong (and I'm sure many will), I urge you to read the book. There's a good chance you will discover you haven't thought about these issues in the right way.

Thanks, John, for this much-needed contribution to economic wisdom.

Friday, April 17, 2015

2% inflation is alive and well

The prevailing inflation meme is that it is dangerously low, and for years central banks have been trying very hard—without much success—to get it to rise. The reality—at least in the U.S.—is that the underlying "core" rate of consumer inflation has been running at close to 2% for over a decade. Energy prices have been the principal cause of variations from this trend. 


The chart above shows the 6-mo. annualized rate of inflation according to the CPI and the Core CPI (ex-food and energy). The experience of the past decade is a great example of why it pays to ignore big swings in food and energy prices. The core rate of inflation has been much more stable, and inflation according to these two indices has been exactly the same since 1986 (2.7% annualized per year). The core CPI is up 1.75% in the past year, and in the past six months it has risen at an annualized rate of 1.77%. It's very likely that the overall CPI will soon be averaging about the same rate.



If we look at the ex-energy rate of consumer price inflation (see charts above), it has averaged very close to 2% per year since 2003. The 10-yr annualized rate of ex-energy inflation currently registers 1.99%, and the year over year rate of ex-energy inflation is 1.84%.


Unsurprisingly, the bond market is very much aware of these underlying trends. As the chart above shows, the expected rate of CPI inflation over the next 5 years (as embedded in 5-yr TIPS and Treasury prices) is currently 1.89%.


The chart above shows the bond market's expected rate of CPI inflation over the next 10 years, which is currently 1.92%.

Inflation is not dangerously low. It is running just below 2%, and that's where it's been for many years and where the bond market expects it to be for at least the next decade. There is no reason for the Fed to be trying to boost inflation.