DESPITE THE MARKET TURBULENCE, THERE WILL BE NO DOUBLE-DIP RECESSION

By Victor Calanog, NREI Contributing Columnist

The tumultuous events of the last four weeks have prompted downward revisions to economic forecasts, and for good reason. On July 29, U.S. GDP growth figures for the second quarter came in at an anemic 1.3%, with first-quarter figures revised down to 0.4%.

Then came the debacle over the debt ceiling debate, and the S&P downgrade. The probability of a double-dip recession has now risen to between 30% and 50% based on consensus estimates, up from a relatively low 15% earlier in the year.

And yet there is good reason to believe that the economic recovery will continue to putter at an uninspiring pace, but progress nonetheless. Monthly job growth has been positive for 10 straight months since October 2010. Some 930,000 jobs have been created in the first seven months of 2011, about as much as the 940,000 jobs that were created in all of 2010.

Yes, it is disappointing that projections made early this year calling for 3.5% to 4% annualized GDP growth never materialized, but this is hardly like late 2008. Back then, major institutions were failing and had to be bailed out, and the economy shed hundreds of thousands of jobs beginning in January 2008.

Sentiment is a powerful force
The main problem is not an economy on the ropes, but a weak recovery plagued by institutional gridlock, and changing expectations of whether U.S. policymakers can encourage job creation while managing debt and deficit levels. We are at a critical juncture given the decidedly mixed nature of economic and financial data.

If we lose confidence as individuals and curtail spending quickly, and if businesses lower expectations and pull back on hiring, then we just earned ourselves the kind of low growth and high inflation environment that characterizes periods of stagflation.

Already we’ve observed a 0.2% drop in consumer spending in June. Preliminary August numbers from the University of Michigan’s consumer sentiment survey indicate a sharp drop to 54.9, its lowest level in 30 years.

A second recession is certainly not outside the realm of possibility, particularly if consumer and business spending pulls back. If this happens, however, then this would be a recession largely of our own doing, and we will really only have our fears, proclivities and frustratingly gridlocked systems to blame.

Commercial real estate effects
Obviously, a double-dip recession would suspend any hopes of a quick and robust recovery in fundamentals. But today’s uncertainty actually raises questions about how investment sales will fare. The sharp drop in equity markets may actually prompt greater demand for assets considered “safe havens,” generating a positive halo effect for Class-A properties in gateway cities and nudging cap rates downward.

For now, reports from brokers indicate that few buyers are pulling back or lowering pending bids on attractive properties because of the events of the last few weeks.

As new information arrives over the next two months, we will find out whether the optimists are prevailing or if the pessimists will win the day. Consensus estimates now place 2011 U.S. GDP growth at 1.6% to 1.8%, but that still implies that second-half GDP growth will accelerate to around 2.5%. For now, a double-dip recession is unlikely to happen, but sentiment is a fickle thing.

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FLOOD OF DISTRESS RETAIL NOT FORTHCOMING, RCA FIGURES SHOW

By Elaine Misonzhnik, Retail Traffic Associate Editor

The retail sector may be moving to the next stage in the cycle of distress resolution. In the second quarter of the year, the volume of new retail centers entering distress fell to $1.6 billion, the lowest figure since the third quarter of 2008, according to Real Capital Analytics (RCA), a New York City-based research firm.

At the end of June, the level of outstanding distress for U.S. retail properties was $26.7 billion, only 3% higher than a year earlier.

RCA’s definition of distress includes properties that have been delinquent on their mortgage payments, defaulted on their loans, have been foreclosed on, experienced an owner bankruptcy or are in lender REO.

At the same time that the number of new retail properties entering distress has begun to taper off, resolutions have been on the rise. In some cases, lenders’ improved financial state has allowed them to realize the losses from bad real estate bets.

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S&P U.S. DEBT DOWNGRADE: IMPLICATIONS FOR COMMERCIAL REAL ESTATE

Chris Macke, Contributor, Forbes

To understand the implications of Standard & Poor’s lowering the credit rating of U.S. government debt by one notch to AA+, we first have to understand why U.S. debt was downgraded, and maybe more importantly what was not part of the reason for the downgrade. Let’s start with the latter.

The title of the statement on the downgrade is very revealing, especially the word order, “United States of America Long-Term Rating Lowered To ‘AA+’ On Political Risks And Rising Debt Burden.” In reading the S&P statement on the downgrade, the U.S. debt wasn’t downgraded because it didn’t have the ability to pay its debt obligations today; the U.S. does.

U.S. debt was downgraded because it nearly didn’t have the go-ahead from U.S. leaders to agree to pay the debt obligations today. That is why S&P’s primary focus was on the process used to increase the debt ceiling. There is the ability to pay one’s debt, and then there is the choice to pay one’s debt.

While I am not addressing whether the downgrade was warranted, I will say that S&P got it right when it focused on the political process. Think of the Republicans and Democrats as two partners in a real estate partnership or two members in an L.L.C. They had the means to borrow the money necessary to continue operations including servicing their debt; however, they very nearly weren’t able to agree to do what was necessary to pay the debt, i.e. raise the debt ceiling – that was the reason for the downgrade.

A borrower’s ability to service its debt and their ability to agree to service their debt are two different things. In the five C’s of lending this falls under the “C” that stands for character – will you do whatever it takes to meet your financial obligations. The U.S. character has been impaired. As a result, continued rhetoric and indications that either party might be willing to default on its debt will have the same effects as a real estate partnership that does the same: They will pay a higher interest rate and at some point if it continues long enough will have increasing difficulty borrowing money.

The difficulty that Democrats and Republican had in agreeing to do what was necessary to service their debt obligations was painfully obvious. This is what led to the downgrade, not whether the U.S. had the ability to service its debt today. Is there a possibility that at some point, again like in a real estate partnership, the U.S. debt will rise to such a level that you start having to pay a higher rate of interest? Yes. Given what was going on in the European Union and the rate on 10- year Treasury notes, it doesn’t seem we were there, yet.

With this heightened concern, why haven’t rates on U.S. Treasuries skyrocketed? While there are a number of reasons, including favorable expectations regarding inflation, in the near term the U.S. can thank the EU to a large degree. The rate on U.S. Treasuries is a function, among other things, of inflation, creditworthiness of the U.S. and alternative sovereign debt investment opportunities.

The recurring fears of sovereign debt default by various EU member countries is making the U.S., even with all its political dysfunctionality, look better than it otherwise would. We may have difficulties in taking the steps to agree to pay our debt, but we have the capacity to pay our debt. Conversely, there are very real concerns regarding the ability of various EU member countries’ ability to pay their debt.

The larger impact for commercial real estate could be on the demand side, at least in the near term. Companies and consumers are already hesitant to spend. Downgraded U.S. debt will likely only increase that hesitancy given the increased uncertainty it creates. There could be a negative impact on consumer and business confidence and thus spending, which could translate into reduced economic activity and as a result reduced commercial real estate demand, at least in the interim.

At this point there seems to be minimal negative impact on the cost of capital for the U.S., which is the starting point from which the real estate industry’s cost of capital is figured. This could change in the future. Whether it does depends on many factors, including, as S&P correctly pointed out, the functionality of the partnership between Republicans and Democrats. That is why they call it the study of politcal economy.

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OFFICE LEASING STRONG IN SPITE OF ANEMIC JOB NUMBERS

Randyl Drummer, CoStar Group

Lease Deals Inked As Office Tenants Take Advantage of Lower Rents in Prime Buildings; 'Phantom Space' and Weak Job Growth Keep Lid On Net Absorption

Despite slower-than-expected job growth and the uncertain impact of the debt-ceiling issue and overseas economies, office leasing remained very strong in the second quarter of 2011 as office-occupying businesses continued to gradually add workers and absorb space.

Preliminary second-quarter CoStar data shows that bargain-hunting tenants are trading up to larger and better buildings, taking advantage of concessions and asking rents that average 10% lower than their 2008 peaks.

Driving that demand is the expectation that, should more robust job growth resume as expected, office rents could be poised to increase ahead of demand growth as the shutdown in new development has curtailed any meaningful new supply.

Brisk gross leasing activity continued in the second quarter at an expected 120 million square feet -- well above the average of 90 million square feet over the last few years and up a robust 60% from the market bottom in 2009, according to data presented at CoStar Group’s Mid-Year 2011 Office Review & Outlook.

The national office vacancy rate edged down slightly to 13.3% at mid-year from last year's cyclical peak of 13.6%. The percentage of CoStar submarkets with declining vacancy rates, an important leading indicator of office market health that dropped several percentage points in the first quarter, began trending back up in the second quarter.

Class A asking rents across the U.S. stood at an average $27.50 per square foot at the end of the second quarter, down from $30.50 per square foot in mid-2008, with concessions knocking off an additional 10%-20% from the cost of occupancy. As rents decrease and terms become more flexible, tenants are increasing or upgrading their space, said Andrew Florance, CoStar founder and CEO, who led the presentation of the latest quarterly data.

The second quarter saw the fifth consecutive increase in net absorption of office space. However, the gain was very modest due to faltering growth in jobs over the last two months exacerbated by an abundance of 'phantom' space from prior layoffs.

In the previous recovery cycle in commercial real estate from 2003 until the downturn in 2008, each new job added to the office-occupying workforce created an extra 233 square feet of demand for office space. The current recovery has brought demand for just 88 square feet of added space per new employee, Florance said.

"We’re sort of in the doldrums right now. The only thing driving net absorption is bargain hunting," Florance said. "It will be pretty difficult to find super strong absorption numbers the next quarter or two."

The U.S. economy hit a soft patch last quarter, with the debt ceiling debate and other fiscal issues undermining business confidence and most indicators continuing to disappoint analysts over the last eight weeks.

However, business investment in IT and technology are creating strong real estate demand among tech companies, and the office-dwelling professional and business services segment is seeing the strongest employment growth, generating one-third of all new hires. Other sectors showing gains are education, health services, trade and manufacturing, and leisure and hospitality.

Losses in public sector jobs have partially offset those gains, with the private sector adding 2 million jobs over the past year while total job growth is closer to 1 million due to reductions in government payrolls, mostly at the state and local level, with some at the federal level as well.

Lower Rents Spur Leasing, Absorption
Houston logged the strongest year over year net absorption at 2.5 million square feet, although landlords lowered average rents in that market by 2.4%. Landlords in the technology-centered San Francisco Bay area raised rents by nearly 4% but still achieved an increase of 2 million square feet in absorption.

Other top markets that dropped rents and saw absorption increase include Seattle/Puget Sound, Philadelphia, Boston, South Florida, Orange County, CA, and Dallas -- all of which had modest absorption gains of around 1 million square feet.

Absorption was down about 1 million square feet in New York City, where owners have aggressively raised rents 7.3% year over year and cut discounts.

Class A buildings enjoyed the strongest net absorption, with many Class B and C tenants trading up for better quarters.

If robust job growth projections by Moody's Economy.com come to pass and the nation avoids a fiscal crisis due to government default, the national vacancy rate could fall to a phenomenal 8.5% by 2015 amid diminishing supply, according to CoStar forecasts. Those same factors could push rents up by more than 12% annually within four years.

"Markets continue to regain their footing as a result of the combination of tenants looking to capitalize on favorable lease rates and construction that is at 40 year lows," adds Chris Macke, senior real estate strategist for CoStar. "The rate of recovery going forward in the office sector will depend on how aggressive corporations are in their hiring activities."

In investment sales, the second quarter saw a big uptick in sales volume, roughly back to 2006 levels. While core investment-grade properties are seeing some price appreciation, prices remain soft in general-grade commercial property. However, this year could be the tipping point on overall pricing. Prices per square foot in several large metros in 2011 are exceeding their historical averages in such markets as Washington, D.C., San Francisco, Seattle, Boston, Denver and Orange County, CA.

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JONES REAL ESTATE WELCOMES 3 NEW TEAM MEMBERS!

JonesRE has brought in three new agents to better serve our clients. We would like to announce our new team members, Michael Moniak, Manuel E. Hernandez Hernandez and Jana Farman.

Michael Moniak
Michael Moniak began his career with Greg Jones in 2003. Michael has an extensive background in commercial real estate and working with Fortune 100 companies. His experience in marketing, property management, and computer technologies enables him to work effectively with both property owners and tenants to obtain profitable results.

Michael's commercial real estate career began in 1984 with C.J. Segerstrom & Sons where he established their first PC's and evaluated profits for all properties, including The South Coast Plaza. His marketing expertise includes working on national brands, such as: Kraft-Budget Gourmet, StarKist Tuna, and Schick Razors. Technology achievements include working in New Zealand for Unisys to sell a multimillion dollar data warehouse system to the largest retailer in the South Pacific, The Warehouse.

Blending solid educational training along with proven professional expertise, Michael earned an MBA from Pepperdine University and BA in Finance from California State University, Fullerton. He has taught business classes at San Bernardino Valley College and served on the board of directors for the American Red Cross-Rio Hondo Chapter, The Gary Center, and the Whittier Uptown Association. His hobbies include long board surfing and teaching paraplegics to ski at the U.S. Adaptive Recreation Center (USARC) in Big Bear.

Manuel E. Hernandez
Most people refer to him as “Manny”, he is a native Angelino and a veteran of the United States Army. He studied Economics at the California State University Los Angeles. After he obtained his education, Manny went on to be a top performing sales representative at Rich Steel of Los Angeles for 20 years. In 1984, Manny found his calling for Commercial Real Estate specializing in the sale of commercial, land, investment and new tract homes. Manny is a licensed real estate broker in the states of California and Washington. He began working with Jones Real Estate in 2011. Manny is currently a member of the RIAOC Board of Directors and is Chairman of the Education Committee. Manny’s enjoys studying world history and spending time with his grandsons at the ball park.

Jana Farman
A North Orange County native, Jana is a Commercial Real Estate advisor with extensive knowledge in site selection, negotiations and marketing of retail, office and industrial properties. She places a high value on customer service and in maximizing the client experience while maintaining transaction satisfaction and profitability for both sides. She gets those tough deals done!

In 2011, Jana was actively pursued by a number of brokerages due to her success and strong work ethic selecting Jones Real Estate as her brokerage of choice being attracted to a successful, well established brokerage with a team atmosphere focused on customer service.

Jana is a member of the Greater Southern California chapter of CCIM, RIAOC, and a Board of Director for the North Orange County YWCA. She has a BS Degree in Business and an MS Degree in Organizational Leadership with 20 years experience working in the corporate sector which gives her richer business acumen as she understands the inner workings of a corporation.

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JONES REAL ESTATE RECEIVES 15 OFFERS IN 3 WEEKS!!

JonesRE just went under contract in the sale of a 60,000 square foot multi-tenant retail shopping center anchored by Ralph’s Super Market, known as the Pacific Place Shopping Center. Located in Los Angeles County, in the city of North Whittier, this property is a great investment opportunity. Within 3 weeks of being on the market, JonesRE received 15 offers! Four Buyers were all cash at full price! This is due to our extensive marketing and strategic approach in locating qualified Buyers.

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CALIFORNIA BUDGET WARS: LEGISLATURE APPROVES ELIMINATION OF REDEVELOPMENT AGENCIES

On Wednesday, June 15, the California Senate and Assembly passed ABX1 26 and ABX1 27 as part of a larger package of budget bills intended to close California’s approximately $9.6 billion budget deficit. ABX1 26 and ABX1 27 are so-called “trailer bills” which go along with, and help implement, the state budget bill. ABX1 26 eliminates all California redevelopment agencies (“RDAs”) effective October 1, 2011. However, ABX1 27 provides that a California RDA can continue to operate and function after the October 1, 2011 elimination date if certain steps are taken by the applicable local jurisdiction, including passage of a local ordinance requiring the local jurisdiction to remit certain revenues to school entities and special districts. Taken together, the two bills effectively eliminate RDAs unless these agencies “voluntarily” turn over certain tax increment revenues for local government uses.

Yesterday, Governor Brown vetoed the state budget bill (AB 98 and SB 69). As of this writing, ABX1 26 and ABX1 27 have not yet been sent to Governor Brown for signature. Budget talks are still ongoing, so it is impossible to predict with certainty what will happen. Nevertheless, many believe that Governor Brown will sign ABX1 26 and ABX1 27 as soon as the Legislature sends him an acceptable, revised budget bill. If signed, ABX1 26 and ABX1 27 would take effect immediately.

Most of the provisions of ABX1 26 are taken from Governor Brown’s initial proposal to eliminate RDAs, and therefore will be familiar to those who have received Cox Castle & Nicholson’s client alerts and e-mails over the past few months. ABX1 26 eliminates RDAs effective October 1, 2011, and protects only those “enforceable obligations” existing as of the date of the Governor’s signature. It also prohibits RDAs from taking actions or spending money between the effective date of the legislation and the October 1 RDA elimination date, except for actions or payments made to honor existing obligations. ABX1 26 also empowers the state controller to “claw back” certain assets transferred by an RDA to the relevant local jurisdiction or housing authority after January 1, 2011—a direct response to the efforts of certain RDAs earlier this year to avoid prospectively the reach of Governor Brown’s proposed RDA elimination by moving RDA assets over to the city, county or local housing authority, as applicable. Accordingly, any financing involving the direct or indirect use of RDA funds that was committed after January 1, 2011, needs to be reevaluated immediately to consider the application of these two bills.

The enforceable obligation requirement is intended to protect existing contracts with RDAs. Under ABX1 26, however, an RDA must submit a list of its existing obligations within 60 days of the effective date. Thus, a party to an existing contract should work closely with the applicable RDA to verify that the RDA includes the contract on its list of existing obligations, and timely submits the list.

There are some notable differences between the final, approved version of ABX1 26 and the prior drafts of that bill that circulated in Sacramento over the last few months. For example, prior versions of ABX1 26 provided that the local jurisdiction that authorized the creation of an expiring RDA could elect to retain the housing assets and functions previously performed by that RDA, in which case all amounts on deposit in the RDA’s Low and Moderate Income Housing Fund would be transferred to that local jurisdiction. The final version of ABX1 26, by contrast, treats the RDA’s Low and Moderate Income Housing Fund like all other RDA unencumbered assets, requiring that all of those assets be distributed to local taxing authorities pursuant to a statutory method of apportionment.

Turning to ABX1 27, this bill reiterates that the motivating public policy behind the elimination of RDAs is primarily budgetary. If the local jurisdiction voluntarily commits to make annual Department of Finance–calculated deposits into an Educational Revenue Augmentation Fund (ERAF) benefitting local schools and into a Special District Allocation Fund (SDAF) benefitting local special districts (i.e., units of local government that provide some service not provided by the county or city), then the local RDA may continue to operate and function without regard to the October 1, 2011 elimination date. Essentially, these ERAF and SDAF funding obligations would serve to plug the local jurisdiction’s share of the approximately $5 billion in property tax revenues the Legislature believes are being diverted each year to RDAs.

Assuming that the Governor signs both ABX1 26 and ABX1 27, RDAs would have no power to approve new projects effective immediately. Local jurisdictions would be able to restore such power by enacting an ordinance pursuant to ABX1 27, but due to timing issues under the bill it is unclear if local jurisdictions will be able to do so for several months. In the interim, though, RDA doors would appear to be closed for new business.

These bills are lengthy and complicated, and contain many revisions negotiated at the eleventh hour. Therefore, we are continuing to study the final, approved versions of ABX1 26 and ABX1 27.

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