2019: Forecasting Business Getting More Difficult Every Day

2019: Forecasting Business Getting More Difficult Every Day

By Alan Nevin published on Xpera Group newsletter dated 01-07-2019

On the surface, everything is still looking good, but I’m beginning to worry, particularly about the real estate market.

Let’s look at the basics:

Population: Despite efforts to limit immigration, the U.S. continues to add 2.3 million to the population annually. This year, our population will top 328 million, with 42% of the increase occurring in the “big three” states – California, Texas and Florida. That’s a lot of consumers.

Employment: We are still on track to add 200,000 jobs a month nationwide. The big three states continue to account for almost half of all new jobs. The other growing states listed my book, The Great Divide, take up nearly another third. The problem is the other 35 states, including the “Trump” states, have not been able to produce jobs in a meaningful way, as shown in the pie chart, causing outmigration in those states. Goodbye Ford, GM and Harley Davidson.

Unemployment: According to the U.S. Bureau of Labor Statistics, there are more than 7.0 million unfilled jobs. That has led to the lowest unemployment rates in decades. We should note, however, that the labor participation rate is not rising, thereby creating an anomaly. There appears to be a disconnect between the types of jobs that are available and the people available to fill them.

Inflation: I won’t dig too deeply into how the inflation rate is calculated, but there are several ways to do this.  The basic inflation rate reported every month consists of a “basket” of typical everyday purchases. However, that rate excludes food and energy. Needless to say, that exclusion drives down the inflation rate. When food and energy are included, the rate moves sharply north, well past the 3.0% level.

Interest rates: The Federal funds rate is the basic tool the Federal Reserve uses to manipulate the money market. It propels the prime rate, the T-bill rate and, ultimately, construction loan and mortgage rates. It can also cause recessions to begin when pushed too high.

Net Foreign Investment: Net foreign investment (NFI) has been a substantial factor in California’s growth, but it has been slowing down for the past few years. In 2015, NFI in California was $121 billion.  It declined to $42 billion in 2017. With that said, California still represents 21% of the total NFI in the U.S.

What’s Next?

With these factors as background, let’s turn to real estate and construction.  Rising interest rates are already causing a slowdown of existing home sales, even in very healthy economies like California. In 2019, there is a reasonable chance that existing home sales will decline 10-20%.

This means that home prices will not remain on their upward trajectory of the past few years. History tells us that a 6.0% interest rate is the tipping point. We’re not quite there yet and lenders are doing their best to keep interest rates down on mortgages. (They have to keep their point-making machines going.) However, the rising rates make it more and more difficult to qualify for loans.

In the new home market, we already see slowdowns in traffic and sales, particularly at the upper end of the market. It’s tough to trade up to a new house if your mortgage interest rate is going to balloon and your property taxes accelerate. It would be better to stay put until things cool down. Not a good thing for homebuilders, but great news for remodelers.

The price of construction continues to rise as a result of several factors:

  • Skilled Labor shortages (that inevitably cause wages to rise)
  • Tariffs on steel, aluminum and other imports
  • Overall inflation
  • The cost of borrowing
  • The cost of holding land longer than anticipated
  • Accelerating costs of moving goods

This last factor is rarely discussed, but we are experiencing a massive nationwide shortage of long-haul/construction vehicle drivers. Over 90% of all the materials in construction arrive by truck.

I am not implying a collapse of the housing market, but definitely a softening, especially in high-priced markets.

In the world of apartments, construction will continue unabated, except for a few markets that are overbuilt with high-end apartments, such as San Diego and Orange County. In those markets, I anticipate high-end projects that were scheduled to move forward in 2019 will take a breather until the developers can be convinced that newly completed units are being rented, and without serious concessions and at rental rates that match their pro formas. Apartment lenders are tightening their requirements and requiring more equity and more assurance of demand.

Existing apartments will continue to do quite well in terms of occupancy (95%+), but it will not be possible to push up rents as vigorously as in years past. I project that existing apartment rental rates
in Southern California will move up at a paltry 3-4% annually in 2019, if that.

On the non-residential side of the ledger, business should continue to be vibrant with construction of hotels and industrial space reaching new highs throughout the West Coast. Modest construction can
be anticipated in office and retail space, although substantial funds will be expended on renovating and adding product to regional centers.

San Diego should be particularly blessed with federal government expenditures relating to the military and technology. In addition, there will be substantial funds expended throughout California on its aging infrastructure.

Overall, 2019 will be a perfectly decent economic year, but without the raw enthusiasm of the past decade. It will be interesting to see how the White House handles a slowing economy.

Lastly, 2019 should be a field day for economists and a time for reflection at the Federal Reserve Bank.

Alan Nevin is the Director of Economic and Market Research at Xpera Group. He serves the real estate and legal industries with residential and commercial real estate valuations, real estate development market studies and litigation support. He can be reached at (858) 436-7770 or [email protected]

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