July 24, 2018
Half-Time Report: Test Your Knowledge 
Test Your Knowledge at Midpoint for 2018: The first-half of 2018 is behind us and it is the second-half of the year in which performance matters the most – just ask Coach Saban. It has been anything but a “Lazy Dog-Days of Summer” economy thus far in June and July. Tariffs and a trade war are now a reality. President Trump has met with all world leaders of consequence from China, North Korea, and Russia to G-8 and NATO allies – and all are wrestling with whether the Trump message is negotiation or more of a move back to isolationism and protectionism . There should be little doubt, though, that a new U.S. Sheriff is in charge of the “Wild, Wild Trade with the West” show. Global supply-chains are about to be turned upside down impacting every aspect of our economy and commercial real estate from agriculture and automobile manufacturing to retail sales and warehouse demand. It is time to wrap up vacations, get kids back to school, and develop tariff mitigation plans. 

The Fed has delivered on two of its 2018 rate hikes - and Fed Chair Powell was clear last week in his mid-year testimony to Congress that “continued gradual rate increases” are on tap. Expect another rate hike in September.

Bank and corporate earnings were as good as they get in Q1, and thus far released for Q2 - especially in banking. That was 1H 2018. 2H 2018 earnings will be much more difficult in a tariff environment.  

The critical Q2 GDP numbers come at the end of this week on Friday July 27 thQ2 GDP should exceed 3.0 percent and may surprise at or near 4.0 percent.  As in the case of corporate earnings, that is history. Q2 GDP occurred in a non-tariff environment.  Decelerating exports will detract from Q3 and Q4 GDP; as will higher prices imports for commodities like aluminum and steel and everything cheap that stocks a Wal-Mart store. Ask yourself if you could find 5 items in a WalMart store not made in Asia. We need the paper products, toys, and cheap plastic goods as we don’t manufacture them in the U.S. any more.  We are about to learn a lesson in global supply-chain

Housing remains in focus with a dearth of inventory holding back sales and buoying home price appreciation north of 6.0 percent again in 2018, and +7.0 percent for Alabama. Builders are not adding inventory (latest data last week showed a 12 percent decline in Starts back to 1.1 million units range) despite healthy demand and rising home prices . Why? The demand is deepest at the under $300,000 price points, but margins are terrible in single-digit range for <$300,000 new homes. Compounding matters, banks are still under pressure by regulators not to make land and site development loans known as A&D loans. As a result, builders are only adding inventory at a price point that is safe and yields double-digit margins.  Welcome to housing affordability crisis – the sequel.

The real question at hand is what impact will these tariffs and a trade war have on the U.S. and global economies. Tariffs and a trade war are the “Black Swan” event that many if not all media economists - but not yours truly - had been forecasting would never occur. The tariffs are more a political issue that won’t ripen as an economic issue until after the November mid-term elections. I fear too much economic damage will be done by then. My forward view is that the U.S. has at least a 50 percent chance of recession in 2019 and 2H 2018 GDP contracts back into 2.0 percent range before turning negative again in Q1 2019.
 
History could be repeating itself. One reason I am introducing a “Test Your Knowledge” component in this column is to stimulate some historical retrospect to the last truly punitive and prolonged period of global tariffs that commenced June 16, 1930. We need to be connecting the dots to what is unfolding with the Trump tariffs and realize the potential economic, political, and real estate consequences.  Eighty-eight years ago this Summer, President Hoover signed the infamous Smoot-Hawley tariff bill on June 16, 1930. It raised U.S. tariffs on some 890 products. Other countries retaliated and world trade shrank such that by the end of 1934 world trade had plummeted some 66 percent from its 1929 level. Two years later unemployment had reached almost 24 percent in the U.S., more than 5,000 banks failed, and hundreds of thousands were homeless and living in shanty towns called “Hoovervilles”. Our economic woes spread around the world. If we thought the Great Recession was bad 2008-2010, a repeat of a 1930-1934 type trade war could bring about worse economic damage and what followed – another World War.  These global trade disputes and crises start out small in nature and escalate quickly. The Tariff Act of 1930 (aka the Smoot-Hawley Tariff Act), started out as a bill that would only raise tariffs on some agricultural products, but a host of other special interests piled on. Before the legislation finally reached President Hoover’s desk, it represented one of the largest tariff increases in U.S. history.  Does that sound familiar as these tariffs have mushroomed against China, NATO allies, and our neighbors to the north and south?  Didn’t this all start with an attempt to renegotiate NAFTA and build a wall? In 1929-1930, Smoot-Hawley was about protecting our agriculture industry as the world had become so efficient at agricultural production post WWI that prices were destabilized.  Could today’s efficiency in manufacturing with robotics and e-Commerce be the modern-day equivalent to agricultural overproduction of the late 1920s? And is our reaction with tariffs akin to Smoot-Hawley and the pile-on that occurred? It is something to be reflecting upon as we embark on a trade war that the U.S. has not really been through in four generations. 

Test Your Knowledge Quiz:
Enough of Smoot-Hawley, let’s see how well you have been paying attention to the economy in 1H 2018 and your ability to answer the following 10 Test Your Knowledge questions. The answers are at bottom of the quiz.
The Bulls & Bears Scoreboard:

Post the July 4 th holiday, the economic and corporate earnings news has been lively. Let’s run through the metrics.

Retail Sales (Monday July 16 th ): Let’s start with the good news with retail. A week ago the big news in the June retail sales report was the surprising upward revisions to May’s data. It overshadowed the actual June sales data meeting consensus forecasts of +0.5 percent.   Autos sales were also strong in both June and May, up 0.9 and 0.8 percent respectively, suggesting maybe consumers were buying popular import brands like Toyota, Honda and Mercedes before the onset of 25 percent tariffs. Combining strong auto sales with stellar restaurant sales - up 1.5 and 2.6 percent in the months of May and June - suggests confidence among consumers and are consistent with the strength in the labor market. And consistent with the record-setting activity in Amazon’s Prime Day last week, non-store retailers/e-commerce, rose 1.3 percent in June and continue to make ground on traditional retail store sales. All in all, retail sales are like the summer weather – hot!

Employment: And like retail, the labor data is hot as well.  The Jobless Claims reported last Thursday for the week of July 7 th were just 207,000 – or the lowest weekly rate since December 1969. A note of caution, though, the week of July 7 th included the 4 th of July holiday which occurred mid-week and spanned a time period here in July when auto manufacturers typically shutdown for retooling. This data may rise back near the 4-week moving average of 220,500 for the remaining weeks of July.

Small Business Optimism:  Unlike the home builders, small businesses remain optimistic about the economy and prospects for expansion.  The June reading of 107.2 slipped from 107.8 in May, but was still the 6 th highest reading in the 45-year history of this survey. The big concern, though, remains both the lack of skilled labor and the rising wages for it. There seems to be a disconnect between the Fed and Small Business over wage inflation. My take is that the Fed is behind the curve on wage inflation – and inflation overall.  Inflation is well above 2 -3 percent range for housing, energy, and skilled labor. And after the tariffs kick in, I think we add food to the mix. Tariffs are inflationary and input costs will rise in 2H 2018. 

CPI: Speaking of inflation, the government’s reading on inflation at the consumer level for June was just +0.1 percent MoM - and +2.9 percent YoY. The June data was below consensus forecast for +0.2 percent.  The spin was “subdued but still inching higher.” I am not buying into these low inflation figures and see inflation running higher than 2.5 percent range on many levels – housing (home prices at or above 6 percent again in 2018; rents above 2 percent at luxury level but >5 percent for Class B MF), energy (gasoline prices up $0.65 per gallon or >25 percent YoY), construction (materials up high single-digits pre tariffs on lumber and steel), and skilled labor (NFIB and home builders are telling us in surveys it is their #1 or #2 issue with wage rates increasing >5 percent for skilled labor). Add in the tariffs component in 2H 2018 and the Fed will be seeing >3.0 percent infaltion. Will Fed Chair Powell call that “temporarily distorted” and not contrary to its “symetrical view,” or will the voting FOMC members throw the inflation flag? The Fed is historically late to raise and cut rates. I am in the camp that believes the Fed is behind on rate increases. Factor in the falling Bid-to-Cover ratio on 10-Year Treasury bond auctions, and Treasury is going to be telling the Fed higher yields are needed to fund our growing debt and Fed’s balance sheet sell down. 

Housing: It continues to be the area of the economy that we only appreciate for its rising prices. However, housing continues to disappoint in builder optimism, new inventory (both Starts and Permits), and sales. Last week’s refreshed NAHB Housing Market Index (HMI) held steady at 68, but is down from the higher readings of 70 earlier in the year.  The big concern by builders is inflation from higher labor, materials and lending costs as interest rates rise. And this concern spilled over to a 12 percent decline in Housing Starts for June to 1.1 million range at what should be a peak activity month in the home building season. “Bob the Builder” is not building.

Treasury Auction:  The bellwether 10-Year Treasury auction last week put back on the radar a weak Bid-to-Cover ratio below 2.5:1. Although the yield was below 3.0 percent at 2.84 percent, the Bid-to-Cover ratio was an anemic 2.02:1.  Perhaps the Trump tour to NATO and doubling down on Chinese tariffs are suppressing foreign demand for our debt – another unintended consequence of a trade war for a high debt economy like the US with a Debt-to-GDP ratio that exceeds 100 percent. This debt-to-cover ratio and its correlation to the permanent CRE debt market is the metric I am watching.  With such a low ratio, the 10-Year Treasury Note will be under pressure to attract more interest at auctions and yield will likely rise above 3.0 percent in 2H 2018 given both the volume of new debt the U.S. is occurring from the tax cuts and the sell down of bonds by the Federal Reserve from its balance sheet.  It’s not nice to fool Mother Nature or impose tariffs on those that fund your debt.

Commercial Real Estate Performance: Green Street produces a monthly property price index (CPPI). It has a stellar historic track record that I have followed for years and recommend over the Moody’s CPPI.  Its July 2018 index continues to tell us two things that we have known for quite awhile – Industrial real estate is outperforming all property types in both price appreciation and rent growth; and that retail is losing ground on both value and rentsHowever, the number two perfoming property type might surprise you. It is a tie at +10 percent between manufactured housing and student housing.  If one understands the challenges finding affordable housing in most growing MSAs in the South and Midwest, along with college towns in the South and Midwest producing STEM workforce (Atlanta, Austin, Auburn, Birmingham, Charlottesville VA, Columbus OH, Gainesville FL, Nashville, Orlando, Miami, Raleigh NC, Tuscaloosa, and Washington DC to name a few), the +10 percent value appreciation for these two housing types shouldn’t be a surpriseAdd to that dynamic the constraints on new supply by local governments and universities, and you have a recipe for stellar rent growth and value appreciation due to new supply barriers. The three largest manufatured housing REITS that comprise more than $15 billion market value to monitor are: Equity Lifestyle Properties (ELS), Sun Communities (SUI), and UMH Properties (UMH). I follow UMH. They have a model and track record that is unmatched and is delivering results year-in and year-out. The latest July Green Street CPPI for the respective property types is as follows:
The Bulls & Bears Score Board 2H 2018 Outlook:

My outlook has not changed since the 4 th of July: The bulls were clearly in command in 1H 2018,  but the Bears have come out of hibernation awakened by both Fed rate hikes and the implementation of tariffsEconomic momentum is being lost and is coming through in key metrics from Home Builder Confidence to a declining Bid-to-Cover ratio for new 10-Year Treasury Note auctions. January, March and May were likely the strongest Bull months in 2018. Headwinds will slow the economy from its 3 percent level back to 2 percent level with this tit-for-tat trade war. This next week we get more housing data for Existing and New Home Sales that will likely disappoint due to a dearth of inventory. The bigger news will be the “Advanced Estimate on Q2 GDP (the first-guess at it). It should be strong in the mid to high 3 percent range and might even surprise to the high at 4.0 percent. Don’t fall victim to the media economists spin as Q2 was pre-tariffs and is behind us. What lies ahead is a post-tariffs and early trade war economy. We won’t understand the impact until October 2018 to January 2019 when we get the first readings on Q3 and Q4 GDP, respectively.  Get ready, 2H 2018 is shaping up to be turbulent.

Conclusion:

There are two key items to close on. They relate to: i) Key Dates to note regarding ACRE events and my travels; and ii) invitation for interest in financially sponsoring this bi-weekly column.

ACRE Events and KC’s Travel:
There are a number of ACRE events ahead that I want to make sure are communicated and some are exciting firsts for ACRE. These include:

Tuesday July 31, 2018: ACRE and CCIM publish our ground-breaking paper on Adaptive Reuse. This paper establishes some firsts for the Adaptive Reuse property type including: i) a uniform industry-wide definition so projects can be properly identified and captured for future market analysis; ii) the first quantification of adaptive reuse activity with a forecast for its growth potential to aid in underwriting and attracting more capital to adaptive reuse projects; and iii) a comprehensive analysis of the driving forces behind increased adaptive reuse activity. 

  • Thursday August 9, 2018: KC will be in the Quad Cities, Iowa with CCIM President David Wilson.
  • Wednesday August 22, 2018:  My #2 daughter Grace commences her college career at University of Alabama in Tuscaloosa. We have been brushing up on “Roll Tide” trivia. So proud of Grace and to be an Alabama Dad!
  • Thursday August 23, 2018: KC speaking at IREM Alabama chapter 3rd annual real estate management summit powered by ACRE in Birmingham, AL.
  • Tuesday September 11, 2018: KC in Washington DC for final 2018 briefing to bank regulators at FDIC.
  • Thursday September 13-14, 2018: KC in NY for CRE industry meetings.
  • Tuesday September 18, 2018: KC presenting to REGA in Atlanta at invitation of Michael Bull (host of America’s Commercial Real Estate Radio Show).
  • Friday September 21, 2018: KC speaking to Colorado CCIM chapter
  • Thursday October 4, 2018: ACRE and ICSC hosting a joint program on Adaptive Reuse with Jim Jacoby (developer of infamous Atlantic Station redeveloment in Midtown Atlanta) as lunchtime keynote speaker.
  • Sunday October 7-October 9, 2018: CCIM National Conference in Chicago
  • Sunday October 21 to 23, 2018: KC attending Counselors of Real Estate annual meetings in Charleston, SC and moderating ports panel with the president and chief executive officer for SCSPA.
  • Wednesday October 24 to 26, 2018: KC attending and speaking at annual Am. Property Tax Council meetings in Scottsdale, AZ.
  • Tuesday October 30-31: KC presenting at Kentucky CCIM chapter in Louisville, KY.
  • Thursday November 1, 2018: KC presenting to San Antonio CCIM chapter.
  • Friday November 2 to 4: KC at NAR meetings in Boston.
  • Thursday November 15, 2018: KC presenting at Georgia CCIM chapter.
  • Friday November 16, 2018: KC presenting at NAI Miami meeting.
  • Thursday February 7 and Friday February 8, 2019: ACRE’s annual ACREres and ACREcom annual conferences.

Invitation to Sponsor/Support this ACRE bi-weekly column:
The time has come to test the value of this bi-weekly economic and real estate column produced by ACRE. For the past 6 months I have shared this column without any subscription requirement. As all successful universities and real estate centers do, ACRE has to monetize its activities and research. ACRE does not desire to pursue a subscription model to this column; rather, we would like to first invite those within in our circle of engagement to support this content. This column has a circulation in excess of 20,000 that has nationwide reach to Wall Street, community and government leaders in southeastern states, corporate executives at leading real estate brokerage and REIT organizations, and the leadership for many of the recognized commercial real estate organizations such as CCIM, Counselors of Real Estate, NAIOP, ICSC, IREM, CREFC, as well as state and national levels for the Realtors. 
The Center is open to full or partial sponsorship of this column in which it could be named for a sponsor, or any individual component – such as the Bulls & Bears Scoreboard. Sponsorship at certain levels would also include access to me for an internal or external client events.  If you have interest in sponsoring this column in part or whole for FY 2019 (October 1, 2018 through September 2019), please reach out to either me at the email below – or the Center’s Executive Director Grayson Glaze at gglaze@culverhouse.ua.edu
Send any feedback on this week’s Column to KCConway@Culverhouse.ua,edu  
Disclaimer: This report reflects the analysis and opinions of the author(s), but not necessarily those of the faculty and staff of the Culverhouse College of Business or the administrative officials of The University of Alabama.
Advancing Relationships
Sincerely,
KC Conway
ACRE Director of Research & Corporate Engagement
CCIM Chief Economist
kcconway@culverhouse.ua.edu / 678.458.3477