Richard Chichester, president and CEO of Faris Lee, knows we’re late in the cycle, but he doesn’t see this as a bad thing. Nor does he see this timing as a cause for near-term concern.
“The U.S. is extremely well positioned in 2020,” he explains. “The economy continues to prove itself to be very resilient. We’re in a safe spot right now but in a mature position within the cycle. This is also the longest expansion in history, so we have to understand what the late-cycle implications are and make decisions based on that.”
This, he notes, all boils down to risk mitigation and scenario planning.
“There’s always a risk of economic contraction, yes, but it doesn’t look like it’s going to be in 2020,” he continues. “Right now, it’s not about avoiding risk but understanding and building in the appropriate risks. Alternative investments like real estate need to be underwritten and valued at the individual asset level and then aggregated up into the overall portfolio as investors look to rebalance and align with this sort of risk mitigation approach.”
Chichester notes there are several key drivers that should ease the minds of many Americans who subscribe to the theory of “what goes up must come down.”
Eye on the Prize
These positive economic drivers include sustained low interest rates through 2020, the Fed’s focus on job creation and meeting its inflation target and Trump’s recent trade deals. The president signed the U.S.–Mexico–Canada Agreement (USMCA), replacing the North American Free Trade Agreement (NAFTA), in November 2018. This agreement was followed in January of this year by phase one of the China trade deal. Though phase two isn’t expected to be completed until after the election, Chichester believes these factors will keep business boosted throughout this year.
“Having both of these trade deals signed means that these particular risk factors have diminished, suggesting that you should be able to adjust your business/investment strategy accordingly, certainly for the balance of 2020,” he says.
When facing the threat of tariffs and the related unknowns, Chichester says, businesses must consider the ‘what if’ scenarios. This can lead to businesses limiting hiring, expansion and research and development until the unknowns are resolved. But having the U.S.–Mexico–Canada and China deals behind us reinforces the strength of the 2020 economy.
This sentiment doesn’t just extend to businesses, but to the general consumer as well.
“The average American focused on tariffs and trade wars should feel comfortable with where we are in the economy,” Chichester says. “This stabilizes us in the near term and ensures a high probability that there will not be a recession in 2020. The fear or challenge or risk for the public has been substantially mitigated. Continued economic expansion — and maybe even more robust expansion — is more probable throughout the balance of the year.”
Uncharted Waters
Chichester understands the naysayers who hold onto the theory of gravity perhaps a little too tightly when it comes to new territory, such as the longest expansion period in U.S. history. He understands it, but that doesn’t mean he subscribes to it — or to the theory that past behavior is the best predictor of future behavior.
“For those of us who have tried to apply a historic view on expansion and contraction when it comes to predicting a recession or growth, it’s safe to say our historic views have gotten in the way of really seeing what this new expansion looks like,” he cautions. “We stimulated and supported this expansion in ways that have never been done before — and we’ve done it for far longer than expected,” Chichester indicates.
“We’ve proved that we are dependent on the current low interest rate environment,” he continues. “The Federal Reserve tried in late 2018 and early 2019 to raise rates and it created uncertainty within the markets, and we saw the markets react to the downside with haste. So, we’re in a low-rate environment and most likely will be for the foreseeable future.”
The results of these policies, Chichester believes, may reveal a strategic approach the U.S. could potentially use to calm some of the economy’s most dramatic peaks and valleys.
“As much as we invested via the stimulus and the Fed’s monetary and fiscal policies, the growth was always less than what was modeled and/or was targeted,” he continues. “That slow growth might be one explanations for why this expansion has gone on for so long. Had these policies created hypergrowth, it might have overexpanded the economy, causing the market to need to cool off via contraction. We might be looking at a new pattern in terms of how we can manage expansion and contraction. We may actually be able to manage ourselves into slower, lower expansion cycles and into less severe contraction cycles.”
Of course, Chichester cautions, there are always events outside of our control that threaten to move the markets, whether we’re aware of their presence or not. This includes uncertainty surrounding terrorism, war, issues with Iran and others, oil shocks, the upcoming elections, natural disasters and diseases like the coronavirus.
A Divided Market
As investors look to mitigate risk with any commercial real estate decisions made this late in the cycle, Chichester notes this particular period is one of high division among product types.
“There is a bifurcation or a have and have-not situation happening in the property segments,” he says. “Right now, industrial is the highest demand product type as it is thought to be the safest investment. Then there’s multifamily (which still remains in strong favor with many investors although it is subject to challenges from the threat of rent control in some states) and office (which continues to be a preferred asset class, especially for the institutions). Retail falls to the lower end of that real estate spectrum because the business of retail is challenged at the retailer level, and that is having an impact at the property level.”
This division also extends to asset classes as investors are hungry for what they deem to be “investable” properties. The demand from interested investors far outweighs the supply of attractive offerings, thereby increasing competition and causing some to get a little more brazen when it comes to getting deals done.
“This bifurcation becomes even more significant as the demand for core, stable assets amplifies and capital is prevalent,” Chichester notes. “I would advise investors to show discipline and caution at both ends of this investment spectrum, and most especially on the property segments and markets of higher exposure.”
This supply/demand imbalance can also be seen on the jobs front. The U.S. is at historically low unemployment and it is projecting to add about 75,000 to 125,000 new jobs per month in 2020, but that doesn’t mean the positions are all filled once they become available. In fact, there is a labor shortage in many industries, including construction, manufacturing, education, health services and, yes, even retail.
“Now that the economy is stable and seasoned, the real issue becomes how do we find the untapped labor to fill all these jobs?” Chichester asks. “There are quick-service restaurants [QSRs] in some markets that are closing one or two days a week because unemployment is so low that they can’t find the appropriate labor pool to fill the jobs. Usually, we think of high unemployment as a problem, but in this case, low unemployment rates are creating problems for business owners. We’ve got more demand for workers in some cases than we have supply.”
Regardless of the particular outcomes for any one business, product type, investment or location, the demand for more growth, more opportunities, more deals and more workers speaks to the health of the U.S. economy. Though the threat of a wildcard event will always loom — especially in an election year — Chichester believes our upcycle may have at least another 10 months in it.
“If there are no major changes, I see an opportunity for the economy to stretch out and continue to expand in 2020,” he says.
Only time will tell…