Market Watch

Unintended Consequences

2nd Quarter 2021

Market Watch
by Joe A. Hollingsworth, Jr.

As far as industrial real estate goes, what is the biggest challenge today?

• One challenge is certainly not the economy with the GDP (in spite of COVID) continuing to provide reasonable growth. The economy seems unlikely to fail.

• Another challenge is industrial building codes or related problems such as construction shortages? While construction costs and inspections always seem ridiculously high and we continue to experience a high level of frustration over shortages and delays, it does not seem that construction will be a big impediment. Also, another challenge for development are lenders…But, they are everywhere, so let’s not consider that to be a problem.

• The biggest challenge is an “administration induced labor shortage”. This is consequential because of several factors. The workforce is being coddled to the point where their attitudes about working (as being a requirement for life) is resulting in the workforce being less committed to actually working. It seems like the ones that want to work and fulfill a psychological need by working are very committed. However, the very sizable market of workers on the margins have had their work ethic greatly diluted to the point of the comment, “It just doesn’t make sense.” However, this is not the whole story. The globalist theory that there “are no borders” is being experimented, again, with an onslaught of illegal immigrants. While there is still a way to legally become a citizen, the vast majority are simply skipping that step, because there is no penalty for doing so. This is forcing America to “dumb down” the manufacturing or distribution floor, introducing several new languages, accommodating several new religions (or other forms of worship), and tolerating the additional company burdens of communication and culture.

Included in the recent stimulus bill that was just passed is to extend additional funds for unemployment to September 2021. This is paying those in the workforce to stay at home instead of them even applying for a job. Why would they look for a job when the majority of them are making as much money (and in some cases more money) by staying at home instead of working, putting them totally out of the labor market? Small businesses are experiencing a huge drop in job applicants, and they are having to contend with existing rebellious workers and their demands instead of firing them. This is because employers do not have a labor market to replace those rebellious and insubordinate workers.

The above-mentioned trends are solidly in place. At least through September 2021, this could be the most difficult time for companies wanting to “fulfill their growth patterns”. Good, easy-to-train, and qualified workers are being paid to stay at home and exchanged for a set of challenges to accommodate illegal or unqualified workers. The “I am getting paid to sit at home” mentality is a huge nanny state problem instead of each individual being a contributing member to society and enjoying their individual success.

However, more importantly, it is contributing to a totally “unemployed qualified workforce”. Most industries have to adjust to the new reality and pay the cost associated with it, but some cannot “afford the freight”. I think this will show up in our larger cities and metro areas before it shows up in semi-rural areas. It is clearly a concerning pattern that affects our industrial partners’ abilities to grow the economy for all.

Three Random Thoughts That May Affect Today’s Real Estate Values/Economic Outlook

1st Quarter 2021

Market Watch
by Joe A. Hollingsworth, Jr.

• The hot topic of the moment is vaccines and how they are going to solve our pandemic.  I must say, I am a skeptic on this as more of the honesty and side effects come to be known. Coupled with people who don’t naturally prefer to take vaccines, I think the consensus is wrong; and, vaccines will not be the absolute economic solution.  While much is at risk, a great deal of the economy will not be returning even if vaccines are 100% successful (restaurants, concerts, office buildings, etc.).

I believe over a period of time people will come to adjust to COVID and its perpetual threat just like we have cars.  Obviously, we must find a way to mitigate car crashes, because we like the use of cars.  First, we implemented seat belts, then air bags, then assistance from AI such as back up assistant cameras.  More and more, people will realize that this is a virus (or some variation thereof) we will have to live with.

• After being appointed to her position at NASDAQ, the President and CEO Adena Freidman announced a new social requirement for capitalistic companies to meet NASDAQ requirements and possibly be eliminated from the NASDAQ index.  Diversity, not profit, has become the topic of the day for her.  Instead of making it easier, less costly and with less regulation being the mantra of the day to be on the NASDAQ, Ms. Freidman’s demand that Board Members self-identify by race, gender, and sexual orientation which is not only problematic, but hilarious.  Have we really come to that?  Surely, we realize that these are not socialistic companies with socialistic tendencies, but their job is to return dividends or equity appreciation for their clients.  It sounds like the book “Atlas Shrugged”.

It appears to me that this is best handled by the federal or state legislators; and, if they believe the public favors it over capitalism and at the penalty of lower returns because of less informed and knowledgeable board members, they should pass the legislation.

• Last, but not least, the world economic forum at Davos has become globalized, again. They have an idea to repackage themselves as “the great reset”, and America’s corporations are standing in line to help fund their “eliteness”.  Irresponsible and low yielding corporate actions always create the inability to govern properly.  These large companies use hard earned cash to support causes that shareholders have very little input on.  They seem to be operating by their recently released quote which is “endeavor everyday to create value for all of our stakeholders whose long-term interest are inseparable”.  When they substitute the word stakeholders, they mean customers, employees, suppliers, and communities as well as shareholders.

Our opinion is a little bit agreed goes a long way! Industrial real estate and business in general best benefits its goals when allowed to earn returns largely uninhibited.

Real Estate…Life or Death

4th Quarter 2020

Market Watch
by Joe A. Hollingsworth, Jr.

Generally, I do not care about a party’s platform, because party platforms are thrown away the moment the President gets elected. But, this time, it is unique. This time, Biden is not disclosing what his policies are; because, as a 48-year politician, he has never had stable policy positions. Plus, the Bernie and AOC wing of the party were allowed to help draft the party platform positions. Progressives control the only key Biden has to victory, so he is dependent on them. Even if Biden just passed 2/3 of these (and other) party positions, he would become more progressive than FDR; and, when you couple that with a vow to break the Senate Filibuster rule, a Biden Senate and House would have no checks or balances.

How does this platform affect real estate, construction, manufacturing, distribution, real estate lending institutions, developers, and related and dependent industries? • Like Kind Exchanges, which are the pillar of real estate, will be eliminated; • The capital gains rate would basically be doubled to 39.6%; • Right to work laws would be repealed, and labor law would be rewritten to favor the unions nationally; • The Federal Reserve ends up with a new mandate to address racial injustice; and, • The “Green New Deal” would dramatically increase every industry’s energy and regulatory cost.

Being in real estate for 54 years (yes, I am that old…but I started early, LOL), this would be the most radical change in my lifetime for real estate along with all the above-mentioned related industries. Every existing real estate deal would practically be frozen, and virtually every real estate trade would become far more difficult to justify. The result will be that, if I must pay this much capital gains tax, I will “simply just sit on it”. A great part of America’s “creative destruction” that empowers efficiency and regeneration of ideas and concepts would be greatly diminished. While new startups over the last 20 years are ½ of what they were in the 50s and 60s, per capita, I believe the above rule changes would further devastate startups; because, it raises risk and lowers potential reward. This will produce greater income inequality that they will once again want to tax and redistribute.

Unfortunately, real estate is not the only part of the economy that would be affected by this platform. Virtually every part of the economy is! However, I am trying to point out what is likely to happen to real estate as we know it.

Vote like your economic life depends on it, because it does!

Stark Reality

3rd Quarter 2020

Market Watch
by Joe A. Hollingsworth, Jr.

Wake up!  You are living in a big city in a blue state!  It is time to rethink this situation.  Whether it is Seattle, Los Angeles, San Francisco, New York City, Boston, Chicago, etc., it just doesn’t work anymore.

A few of the things you may have noticed:

  • This pandemic’s danger (as well SARS and similar to ones before and the ones to come after) is greatly heightened by living in high density areas;
  • Protests with no apparent definable reason are now unrestrained and are morphing into thieves doing harm to neighborhoods, not to mention shootings and drugs.
  • The cost of living and quality of life have greatly deteriorated, even the millennials are moving out.  Every big city is shrinking;
  • Non-sense, political progressive leadership is totally incompetent and largely incoherent; and;
  • Federal tax changes on SALT have raised your taxes to better reflect devastating local and blue state spending excesses.

New York Governor Cuomo said when addressing the street protests, “You don’t need to protest.  You won.”   Then, he added, “What reform do you want?  What do you want?”

All the media and the TV talking heads are in big cities, furthering the myopic progressivism that fuels the unrest.  Would their agenda be any different if they were all based in towns like Cookeville, Tennessee?

As you may know, I wrote a book twenty years ago called The Southern Advantage, and it chronicled the South’s rise to economic prominence from abject poverty.  While there is some truth that air-conditioners changed people’s feelings about the South, the migration of “can do” people to the South has made it the largest population region as well as the economic engine of the United States.

How does this affect industrial real estate?  We constantly are talking about reconfiguration of supply chains, or more recently the onshoring of jobs.  Those are powerful trends, specifically helping the South.  However, unfortunately, another trend is overtaking both of those; and, that is the dramatic increase of migration from the blue state big cities by “can do” people with affluence escaping, taxation and lifestyle meltdowns, and bringing their companies with them.  While I don’t support state vs state recruiting battles, that is clearly not what is happening.  It is the realization of over-taxation, over-regulation, bowing to powerful unions and their pensions, and other short-term “politically-correct” decisions that are frightening the people that remain in these areas to the point where they are now having to re-evaluate the lifestyle they want for their families.

In open candor, I have been accused of being the “Mouth for the South”; however, I prefer to say that I am delivering a reality message that says the South is still blessed with common sense, workable policies, reasonable taxation, and empowering individual success.  Come on down!  The weather is wonderful!

Comments:  jah@hollingsworthcos.com

Current Perspectives

2nd Quarter 2020

Market Watch
by Joe A. Hollingsworth, Jr.

Our articles are written to better guide industrial real estate developers, investors, and professionals; but, there is never a point when investing decisions are not affected by outside events. Those events range from regulations, taxation, right to work laws, GDP growth, etc.; and, occasionally, there is a “tsunami”.

A few thoughts on our virus/tsunamis: • The virus has proven the fallacy of globalism and elitism, and believing that all countries have mankind’s best interest at heart. “Blind Globalism” has forever been blown apart with some countries openly lying to great harm and hoarding supplies of “single source material”. • Companies in America must reassess their “global supply chains”, because the complications of different governmental interactions halting a crucial part is immense, especially if it is sole source. • American companies’ products that are produced overseas for marginal savings have begun the evaluation of coming home to produce, thus accelerating of America’s manufacturing resurgence. • America’s realization that being without rare-earth metals (which are totally controlled by China) will bring Silicon Valley and the building of computers and electronics to a halt, which must immediately change. • Oil is no longer the ultimate economic weapon; it is food. America is blessed with agricultural capacity. • This “tsunami” is accelerating the demise of the $40K annual tuition to universities. Why not just study from home and not mortgage the house or have student loan debt? • The realization that not grouping college students on campus together will allow them to think more freely and have less liberal “group think”. By staying at home, they interact with their local community population instead of liberal university professors and radical “on campus groups”. • This problem forces us to recognize, as a community, how our economy is dependent on all our interactions with good consistent policies and regulations that apply wisdom with the small price you must pay for preparing for devastating events, thus promoting nationalism. • How important it is for the “hysteria-driven” media to use just facts to help educate the population? • The words “fake news” have become more real as inaccuracies in news, by intention or lack of research, constantly are proven wrong. • Downtown office towers are at risk, because people have learned to work at home. • Recognition by 2/3 of Americans that some of the big city/urban problems are unsolvable.

The above list goes on and on. The seismic effects will be felt for years. It will be uncomfortable and a little frightening. As to industrial real estate, while some developers are putting new projects on hold, we believe that by the time a facility is finished there will be a scarcity – build baby build!

Comments:  jah@hollingsworthcos.com

The Soft Spot Is Behind Us

1st Quarter 2020

Market Watch
by Joe A. Hollingsworth, Jr.

2019 rolled along superb in every way with CEOs making the determination to take down new space for distribution and manufacturing at a fast pace. However, we hit a wall October 1st. It’s like the spigot turned off. Everyone wondered why their phones were not ringing. Hot deals went cold. While there were few exceptions to this, most deals just simply went on pause. By Thanksgiving, things picked up. Then, by mid-December, things were hot gain; and, deals were getting committed. Going forward, we see extremely strong demand and little supply. But, what caused the soft patch?

“Impeach 45” was promoted for 3 years to much laughter! On September 20, 2019, The Washington Post released the news concerning Trump’s talk with the President of Ukraine, which indicated that there were possible impeachable implications. As of today, the House impeached with no Republican votes, and Speaker Pelosi is holding it to hopefully get a better trial with more evidence being presented in the Senate. By December 1st, the American public (and CEOs) knew it was a political ploy, which is one of many that have been tried to oust the President.

While I think the latest hoax is behind us, we also saw 269,000 jobs created in November, which was an unexpected uptick with consumer sentiment becoming more positive and total retail sales looking stronger. So, the realization of the “business of America is business” is coming into full media play. When good business practices and policies are put into place on a relentless basis by a very proactive and disruptive President (whether you like his Tweets or not), the outcome becomes in jeopardy if that leader is guilty of an impeachable offense. One thing that came out of this is the stark realization of how DEPENDENT America’s economy is on good practical leadership that has a vision. When that vision is jeopardized by a series of competing parties’ “free for everyone” policies, then the stark reality sets in. If you didn’t appreciate where we’ve been for the last 3 years (and I’m not saying it’s been smooth, pretty or politically correct), the thought of losing it only to be replaced by unworkable promises is a paradigm reality check.

Let’s keep building industrial properties…the next five years will be the best of our economic lives!

Cap Rate Validation

4th Quarter 2019

Market Watch
by Joe A. Hollingsworth, Jr.

As industrial developers, we live and die by interest rates.   While supply and demand affect the market tremendously, the interest rate on medium to long-term borrowings dramatically affect the outcome in rents.  Many of us have stood on the sideline and watched cap rates drop from 10% and 11% down to 5.5% to 6.5%.  Although we have been shocked (and in some cases utterly astounded) on how far they have dropped, the market has clearly been giving us signals that we all will sooner or later adopt.

The global financial challenge is evident where $13 trillion out of $33 trillion worth of bonds have negative yields which forces you to pay a fee to allow financial institutions or sovereign bonds to hold your money; it’s a paradigm quake.    I don’t think the market could send us a louder signal.  For the first time in hundreds of years, half of the world may soon be in negative yields.  Hypothetically, if there is a negative 1.5% financial yield, and you have a 5% cap rate on a real estate investment, the spread is still 6.5%.  Many of us are willing to invest in that long-term scenario.  The trick will always be matching your long-term rental structure with long-term maturities.

The naysayers of the world are always worrying about “the sky is failing” and will say negative interest rates in America would devastate the financial system, even though this has proven to be false elsewhere in the world.  Japan has experienced a deflationary period for the last two decades. Admittedly, it is unusual; and, it requires a paradigm shift in investment strategy.  However, it is workable.  I think the United States Federal Reserve is faced with the stark reality that if they don’t lower interest rates that America (with the world’s largest economy) won’t be able to continue to pull the world’s GDP along with it.  Clearly, China is a “debt bubble” waiting to pop, which we consider the greatest threat; and, behind that, the next largest threat to the world is the United States Federal Reserve not realizing they need to adjust rates rapidly.  A 0.5% adjustment in the interest rate could grow our exports by 4.5% (due to a lower exchange rate on the US dollar) making a huge difference in the manufacturing sector and our economy.  With manufacturing currently onshoring to America at a rapid rate, I would predict that with the interest rate move that manufacturing could be growing at double the rate that it has over the last couple of years.  Together, this will keep us from following into Japan’s deflationary cycle.

All that being said, maybe the 5.5% to 6.5% cap rates are defining our future for us; and, those that are locking in returns at that level could have captured “the goose that lays the golden eggs”.

Continued Excess Demand

3rd Quarter 2019

Market Watch
by Joe A. Hollingsworth, Jr.

Those of us that have been in the industrial development business for several decades have really never seen a time when excess demand is repeatedly outstripping supply. The below chart highlights how radical this is. Our opinion is that the industrial sector of the economy is progressing very well. There are repeated naysayers, such as the nightly news highlighting everything that could possibly go wrong. However, the solid proof is still an expanding GDP that leads us to more aggressive positions when speculating on industrial real estate. Even with the surge of speculative activity and more than doubling of the build-to-suits, the vacancy rate is at an all-time low. However, this chart also begs for bifurcation of the market. New Jersey, Dallas, California, and Central Pennsylvania were some of the top industrial markets last year, accounting for over 34% of the total US absorption. While these areas will continue to grow, we think they will grow at a much more moderate rate; because, even higher paying companies cannot fill the minimal job needs for distribution in these locations. It is our opinion that a great deal of that demand for space has already begun to shift to tertiary cities that are interstate-connected where they can expect cheaper land, less taxes, less regulation, a chance at a TIF, and can find employees. Also, while you may have differences in logistical costs from the big distribution hubs, being able to operate at all without labor is impractical. In fact, we are seeing more projects use existing available labor pools as the driving reason, even over geography, for their next plant location.

Source: CBRE Econometric Advisors, Q1 2019.

Also, the chart highlights and brings forth the question of how much speculative is enough in these high-velocity logistical areas. We believe these tertiary markets have already begun to see the onshoring of all the early movers with tariff exposure. Available buildings outside of those areas mentoioned above are seeing a much higher proportion of manufacturing and value-added company visits versus logistics. The industrial developers that are working either on build-to- suits or existing space in these tertiary markets are getting cap rates that make all the REITs jealous.

High-Tax State “Screaming”

2nd Quarter 2019

Market Watch
by Joe A. Hollingsworth, Jr.

What a nice time to be an industrial property developer, owner, or investor in the Midwest or the South! It almost feels like a warm, spring day when the sun pops out, and everything is beginning to bloom. Finally, all the low-tax state citizens that have been subsidizing the high-tax state citizens of the Northeast and California have gotten their “reprieve”. We are going to be hearing the constant whining from the Illinois, New Jersey, Connecticut, etc. states about how their citizens are being “stolen” by the low-tax states. However, in all reality, “the worm has turned”. For the first time in literally decades, SALT (state and local taxes) are not slanted toward subsidizing the citizens of the high-tax states through their federal income tax deductions. They are actually having to pay their fair share. Therefore, the statement that the citizens that have been “stolen” that Governor Cuomo constantly talks about is not accurate. In fact, Governor Cuomo’s citizens have been “stealing” from the citizens of low-tax states for decades through the subsidizing of taxes with us paying higher federal taxes to accommodate them paying lower federal taxes.

When higher income individuals move (generally influenced by their age), they are not bringing children for the local government to have to school. However, they do bring a sense of knowledge, work experience, consulting ability; and, probably most importantly, they bring capital and the willingness to invest it. In some cases, they become “angel investors”. Now, it is true that the people in the Midwest and the South have to educate them to not convert our areas to high-tax states. However, if we can get them over that hurdle, a lot of good things happen with our Northeast transplants. Where there is population, commerce follows. Therefore, industrial and distribution projects bloom!

Industrial real estate in most cases follows population migrations. From the invention of air conditioning in the South, the great migration of population began, now culminating in the South having such a vibrant and dynamic economy. Out of each recession, the South has gotten proportionately stronger compared to the other regions of the country. Therefore, this bodes well for real estate investment, both short-term and long-term in the Midwest (except Illinois) and the South. Cities like Nashville are becoming the new Philadelphia. In fact, one percent of the world’s cranes are currently in Nashville. Tertiary cities near the interstates in the South and Midwest are becoming hot growth areas; because, they still have labor, and they are attracting business to utilize that labor.

We are just now hitting the sweet spot. As I mentioned before, industrial cycles (compared to residential and commercial cycles) are much longer in length and much more stable. Population migration, lower regulation, and less taxation is a winning combination.

Enjoy the sunlight of the a spring day!

No, it wasn’t the “new normal.”

1st Quarter 2019

Market Watch
by Joe A. Hollingsworth, Jr.

In the Obama years, how many times did we all hear the words “get used to the new normal” – whether they were talking about Baby Boomers retiring, persistently high unemployment (if you included all the unemployment variations), lack of productivity increases, or the words “manufacturing jobs will never come back”?  Well, as it worked out, they had almost half of the country believing it by the end of 8 years. However, in the case of manufacturing jobs during the Obama years, overall employment grew faster than employment in the manufacturing sector; thus, causing the New York Times columnist and economist Paul Krugman on November 25, 2016 to say, “nothing policy can do will bring back those lost jobs. The service sector is the future of work, but nobody wants to hear it”.  We were destined to be a country of lower paying restaurant and retail outlet jobs which was the grand vision by the Obama administration. However, slightly more than the other half of the country decided they would take a gamble on Trump; and, with Trump’s policies (and expectation of those policies), things changed on manufacturing.

In the 22 months of Trump’s presidency, manufacturing employment grew by 3.1%, and non-farm employment grew by 2.6% which was just the inverse under Obama.  In fact, in the last 22 months of Obama compared with the first 22 months of Trump, more than 9 times the number of manufacturing jobs were being created under Trump – so much for Obama’s “new normal”.

Never have regulations been lifted, modified, or revised at such a rapid rate.  In fact, some estimates say as much as 3 times the rate of the Reagan years. However, that’s not the best of it.  We have finally got a tax code that makes sense for business, and thus industrial real estate. Whether it’s totally expensing off new building upfits or purchasing higher productivity equipment, this manufacturing resurgence is likely to continue at an extremely fast clip. Sure, we have a Federal Reserve that just went crazy with QT (quantitative tightening) and raising interest rates at the same time (December’s terrible decision) as well as the ever-evolving threat of higher tariffs. However, such variables are always present in a Democracy!

As Phil Graham constantly says, “Government can’t rescue the poor”. But, I believe higher paying manufacturing jobs stand a good chance.  After 50 years of the war on poverty, roughly 13% of Americans lived in poverty both at the start and the end of the 50 years. There is not enough federal money to make everyone rich; only individual initiative can accomplish this.

Less regulation and more individual initiative with less government dependency are greatly expanding the opportunities for an individual’s economic destiny, and it’s playing out in front of our eyes! Higher income jobs are being created; lower income jobs are being eliminated; and, in some cases, jobs are being replaced by robots or software.  Let the good times roll!

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