I can’t believe it’s been a month since I posted—I’ve been traveling almost constantly the past few weeks, and between that and the elections, my dance card has been fairly full.
The trigger for today’s post was a recent article in The Wall Street Journal, “Investment Falls off a Cliff,” with obvious homage to the impending fiscal cliff (“FC”). I don’t want to minimize the danger of the FC, and in fact all bets are really off if the worst case scenarios come to pass. Here at Greenfield, we don’t really believe Congress and the White House will both fail to blink. Nonetheless, “keeping your powder dry” is always good advice in perilous times.
I’d like to comment on two things, though. First, while the direction of corporate investment isn’t good, it’s not quite “double dipping” just yet. Indeed, one might argue that the current downswing in investment is nothing more than seasonal backing-and-filling.
Note that after coming out of the recession, overall investment spending took a brief respite in early 2011, as well. Of course, equipment and software appear to continue healthy, but structures are dragging the overall index down. Part of this can be explained by the relaxation of the apartment construction surge that we saw over the past several quarters. Many analysts now believe that the demand-overhand in apartments is close to saturation (or at least satisfaction) and this sort of slow-down is neither unusual nor unhealthy. Note that the National Federation of Independent Business (NFIB) optimism survey is still trending upward, although the Business Roundtable CEO survey (which surveys heads of larger firms than the NFIB does) had turned downward. I suspect that’s a rebound effect—small businesses are still clawing their way out of the recession and are less affected by what may happen if the FC becomes reality. The larger firms were the first to enjoy the fruits of the recovery and would be the worst hurt by tax increases and the FC cutbacks (particularly in defense). Nonetheless, both of these sentiment measures are well off their 2009 bottoms. Consumer sentiment, which ultimately drives much of this, is as good as it’s been since before the recession.
Second, I’m concerned about the negativity spreading to real estate. Note that real estate investment comes in three flavors—development, capital gains, and income. The downturn in investment has SOMEWHAT negative implications for the first. Real estate developers will have to be more careful in a slow-down environment, but that’s been true throughout this recovery. Financing is difficult, even in the “hot” apartment market, and so admittedly, the commercial real estate developers may be in for a tough run. (Residential development, on the other hand, is rebounding nicely.) Capital gains is a “long game” anyway. Certainly the tax changes that seem inevitable in 2013 and beyond have negative implications for the buy-and-sell crowd, but the returns to those who can hold through cyclical downturns have always been healthy even after tax considerations.
Real estate income (primarily REITs) may actually be benefitted by a slight retrenchment in development. If and as the economy continues to rebound, offices, warehouses, and shopping malls continue to fill up. Lack of new supply (from a cyclical downturn in development) benefits the sort of existing structures that are typically part of a REIT portfolio. As always, investors will benefit from looking at good managers with top-drawer properties and a history of increasing funds from operations (FFO).
– John Kilpatrick