This entry updates the July 14, 2011 post and discusses implications for economic recovery, real estate market development, and local government performance in 2012.
A number of recent positive indicators suggest that the United States is likely to continue its tepid economic recovery in 2012 despite uncertainty caused by the European debt crisis, economic slowdown in emerging Asian markets, and property value declines in China. While this news is causing volatility in the global markets, these factors are not likely to push the U.S. economy, which began recovering from the Great Recession in 2009, back into a recession.
The U.S. economy experienced a strong finish in 2011 with rising payrolls, increasing consumer confidence, and improved manufacturing (Bloomberg News). While the GDP has bounced back after Q2 2009, growth in employment has been modest, reflecting a substantial increase in output per worker over the last two years (NPR News and Bureau of Labor Statistics). Though unemployment remains high, the rate has gradually declined since its peak in early 2009. By the end of 2011, the seasonally adjusted unemployment rate in the U.S. declined to a 2.5-year low of 8.5 percent, a decrease of 90 basis points or approximately 118,000 jobs from a year ago (Bureau of Labor Statistics). However, some of the improvement reflects shrinkage of the labor force, as many job seekers left the labor market unable to find work or choose early retirement (e.g. baby boomers). EPS expects future employment growth to remain slow through 2012.
2012 Outlook by Industry
Although there is no consensus on the specific U.S. industry sectors leading the economic recovery, the majority of new employment occurred in the healthcare and manufacturing sectors, while many other private sector industries remain relatively stagnant (Grubb & Ellis). Meanwhile, the public sector has been shedding jobs since 2009 on a national, state, and local level, driven by decreased revenues and contracting governmental budgets. EPS expects the public sector to remain weak in 2012 as unemployment remains high and property values and wages are slow to recover.
2012 Outlook for Real Estate
Despite low interest rates and the availability of low-cost mortgages, U.S. housing market demand remained weak throughout 2011. Many homeowners were unable to refinance given the decrease in home values below existing levels of debt while banks still carry substantial foreclosed inventory that continues to weaken the housing market by adding to existing supply. Qualification for new debt has also become increasingly difficult given the new set of regulations and stringent mortgage lending standards facing home buyers. As a result, new construction was weak in 2011 as market prices have generally not justified new residential or commercial development. In an effort to stimulate the economy, the Federal Reserve has lowered short-term interest rates to nearly zero and has indicated that the rates are likely to be kept at these low levels through 2012 and beyond (Wall Street Journal).
Apartments were the only sector to experience substantial recovery in 2011. While rent growth in most markets has been modest, vacancies fell to the lowest level since 2001. According to Reuters, vacancies fell to 5.2 percent in the fourth quarter of 2011 relative to 8 percent in 2009. Apartment performance in the San Francisco Bay Area was particularly strong with 5.1 percent rent growth in San Francisco and 5.0 percent in San Jose. For comparison, single-family home prices in San Francisco increased by 3 percent, while prices in San Jose remained stagnant during the same time period (Rand California/Housing Prices and Transaction Statistics). While recovery in different markets will vary, EPS expects strong performance in the Bay Area apartment market to continue in 2012 and beyond, particularly in locations experiencing job growth, though potential recovery and new construction in single-family homes could dampen the rental market performance mid to long-term.
Office and R&D space vacancy rates in key markets also decreased in 2011, partly due to low construction activity. In certain inner Bay Area markets like San Francisco and the Silicon Valley, lower vacancy rates are reflective of growth in technology sector, driven by increased venture capital investment and the culture of innovation. Venture capital investment in the Silicon Valley and the Bay Area as a whole has been increasing with 2011 as the best investment year since 2008 based on the first three quarters (PricewaterhouseCoopers/MoneyTree Report). Space characteristics in these inner Bay Area markets are becoming more interchangeable with collaboration-conducive floor plans, open seating, and high ceiling features. EPS expects continued recovery in the Bay Area office and R&D market, particularly in well-established workspace locations.
On a national level, improvement in all major real estate sectors is likely in 2012 as the United States economy continues to recover from the Great Recession. EPS anticipates the real estate recovery to be more pronounced in established urban markets within proximity to existing infrastructure and urban amenities.
2012 Outlook for Local Government
Declining property tax and other public revenues will continue to hit local government budgets and spending. Reduced Federal and State revenue ultimately increase burden on local government as grant and subventions revenue decline. However, in many cases, costs continue to escalate, creating a structural imbalance and fiscal deficits across local governments that trigger reorganizations and other cost cutting measures.
The California Supreme Court’s December 30th ruling to eliminate redevelopment agencies could have significant implications. Over short-term, local government will be affected by formation and costs of the successor agencies and disposition of agencies’ assets. Over long-term, redevelopment elimination creates a challenge for financing new development in urban infill areas. This will likely have particularly severe consequences for production of affordable housing going forward.
Supreme Court ruling against redevelopment will hit some cities hard, especially those that relied on redevelopment to help fund related overhead and staff activities. Look for local government to explore alternatives to fund redevelopment activities, for example, through the use of tax increment from non-property tax sources. Other funding sources may include special assessment districts, impact fees, and tax credits. In addition, the use of Infrastructure Financing Districts (IFDs) is garnering attention in California as a redevelopment alternative to generate economic activity and improve fiscal prospects.