Swirling Economic Winds
With negative economic news seeming to dominate the business headlines and with the Fed poised to raise interest rates once again in November, where we are heading is a frequent discussion topic. Last month, noted economist Dr. Anirban Basu conveyed his perspective to Kenwood’s investment community at our exclusive event. This month’s featured article will reiterate some of Dr. Basu’s insights, along with the Fed’s perspective on Asset Valuations and our thoughts on the future of remote workforce and the real economic impact of Hurricane Ian.
Recap of Kenwood’s Investor Event
In early September, Kenwood held an event for our investor community featuring Dr. Basu. He has twice been recognized as one of Maryland’s 50 most influential people. Dr. Basu has also been named one of the Baltimore region’s 20 most powerful business leaders. He teaches global strategy at Johns Hopkins University and from 2014 to 2021 served under Governor Larry Hogan as the Chairman of the Maryland Economic Development Commission.
Dr. Basu discussed several interesting topics, including his belief that some of our current inflationary issues resulted from excessive federal government economic stimuli initiated by both the Trump and Biden administrations and that once inflation has taken hold in an economy, it is very difficult to eradicate. He added that the Fed is being very transparent about its intentions to fight off inflation via its primary weapon—increasing the federal funds rate.
He also believes that the current interest rate inversion that exists between the two-year and 10-year treasury bills is in fact a true indication of a coming recession; however, Dr. Basu believes that the recession will be moderate and last most of 2023. Dr. Basu also said he believes that the bond market is a much better indication of our economic future than are the equity markets.
Dr. Basu also discussed the current labor markets, the very low unemployment rate, and the way that employers have had to adjust to employees having the dominant position in the marketplace. He was concerned at the phenomena exhibited by some employees, referred to as “quiet quitting.” This occurs when employees are doing only the minimum level of work needed to remain employed.
Asset Valuations: The Fed’s Perspective on Real Estate
In the Fed’s May 2022 Financial Stability Report, the number one topic was asset valuations. They noted, “House prices continued to rise at a rapid pace that further outstripped rent growth. With valuations at high levels, house prices could be particularly sensitive to shocks. Nonetheless, little evidence to date exists of an erosion in mortgage underwriting standards or a surge in speculative practices, suggesting that while a negative shock to house prices may hurt homeowners, such a shock is unlikely to be amplified by the financial system.”
Commercial real estate was also noted: “Driven by the multifamily and industrial sectors, overall commercial real estate (CRE) prices continued to increase since the November report, with some price indexes surpassing their 2006 peaks. With capitalization rates at low levels and capitalization spreads at moderate levels, CRE valuation pressures remained somewhat on the high side.”
Non-traditional Asset Valuations: Art and Baseball Card Index
When values for traditional assets are at peak levels (or past peak for equities), it’s always interesting to look at non-traditional assets. Below are two perspectives on the fine art and baseball card markets, both of which also reflect high prices.
“At a time of geopolitical uncertainty, soaring inflation and falling stock prices, the art market is beyond booming. The explosion is fueled by a combination of an unusual number of highly desirable works becoming available, and an increase in those who can afford to buy them.”
“Auction houses and appraisers say they are seeing surging demand and higher prices in the sports memorabilia market, particularly for baseball cards and other sports trading cards. A 1952 mint condition Mickey Mantle baseball card sold for $12.6 million on Sunday [August 28, 2022], a record price for a piece of sports memorabilia.”
The COVID-19 years produced a new term in the workforce: “The Great Resignation.” Employees left the workforce for personal reasons, moved to remote areas that provided a better lifestyle, or they wanted to work fewer hours to have a better work/life balance. This left many employers fighting and bidding for fewer workers which produced increased labor costs. As employees demand remote work or fewer hours, employers respond willingly due to lack of options.
However, over time, employers will recognize that if remote workers can accomplish certain tasks, why pay the higher prices demanded by US remote workers, when overseas remote workers can accomplish similar tasks for a fraction of the cost. Proximity, which was the advantage US workers had compared to their overseas counterparts, is being devalued, but will become more pronounced as employers become tired of unsustainable wage growth and realize substantial cost savings from overseas workers. The labor markets will then adjust once again, but not entirely back to pre-pandemic conditions. A mostly remote workforce is not a sustainable model. It will have to change. It is likely that a 4-day in-office work week with one day work from home will become the norm. Employers will likely also remain more flexible for employees with young children than they were pre-pandemic.
Impact of Hurricane Ian
Since Hurricane Ian hit Florida and the southeast states, the primary focus has been on search and rescue and restoration of utilities and water supplies. However, in the coming weeks and months, the focus will shift to rebuilding. The impact of this will be significant, affecting the global markets, and it will be long-lasting. As a result, supply chain pressures, which have impacted everyone since March 2020, will continue and become more exacerbated. The need for limited available materials and supplies will increase prices further. Once the war ends in Ukraine, the rebuilding efforts there will further add to the material and supply chain pressures. These issues will continue for years to come. They will also add to inflationary pressures as insurance companies, contractors, state governments and homeowners look to complete projects and restore normalcy to their lives. The rebuilding efforts from Ian will likely become one of the largest areawide construction projects ever experienced in this country.
Where We’ve Been: The Silver Linings
It is very easy to focus on current economic conditions and think they will continue indefinitely. However, history reminds us otherwise. Commercial real estate led to the recession of 1990–1991. However, if you purchased commercial properties from the RTC or during the following years, generally your returns were exceptional. Commercial properties purchased after the dot-com bubble in 2000–2002 also performed exceptionally well. And we experienced similar growth after the Great Financial Crisis in 2008–2009. It remains our opinion and belief that highly functional commercial properties in good locations, purchased at appropriate prices, and managed efficiently, will continue to perform very well. Current economic conditions will change, and uncertainty will be present, but therein lies the opportunity.
Kenwood Management is always looking for new investors to join the Kenwood Community. Learn more about our investment services and how you can generate steady and secure commercial real estate gains with our team of experts.