4th Quarter 2018 Hotline
by Joe A. Hollingsworth, Jr.
As readers of the Market Watch articles know since September 2016, I have been a persistent optimist about what should happen to the manufacturing and distribution industrial space sector. I have covered: 1) the accelerating GDP; 2) the ever-increasing on-shoring of jobs; 3) the improving protective tariffs and equalizing trade; 4) relentless regulation relief; 5) low inflation and inflation not driving interest rates; 6) more jobs available and more people working than ever in America’s history; 7) reasonable energy costs; 8) more consistent business friendly courts, etc., etc.
With the knowledge that the longest expansion in America’s history would take us to September 2019, I am constantly asked what carries this expansion beyond that. While there are numerous answers and possibilities (some political and some not), I think it comes down to two broad points.
With a stroke of a pen and at the appropriate time when the economy needs a boost, President Trump can simply inflationadjust the capital gains tax rate. The courts have approved that the government can change regulations to reflect the inflation indexing of capital gains. However, the President has the power to do such on his own by executive order to demand treasury issue a “definitional order”. This could be a powerful motivator that can be well-timed and used as a tool to continue to prime the economy. This should be a significant decrease in the capital gains tax, thus prompting more velocity of real estate turns and more key investing which would literally free up billions of dollars for further investment. We have no crystal ball but, I think the 2nd quarter of 2020 would be a politically-potent and economically-viable time to unleash this mighty tiger, if not sooner.
In my opinion, it is not enough to just have 4% growth in the GDP; but, it also has to be coupled with productivity gains. There are so many new workers coming into the workforce that there is a time lag in the learning curve necessary for them to operate in an efficient manner. Within the next 6 months, we will start seeing productivity gains from all the newer employees becoming “seasoned”. Seasoned employees will be using new and more efficient equipment bought under the new tax reform act (allowing 100% write off) producing a productivity miracle. While major expenditures are taking place for capital investment, these will all be productivity based and designed to be operated by less employees; thus, stretching our existing employee base further. This combination of 4% GDP growth and tax inspired capital expenditures will finally restore our natural historic productivity back to the American worker and our economy. This by itself can extend the expansion an additional 3 to 4 years.
Barring any catastrophic political or global economic issues, we continue to stand by last quarter’s comments, “Build Baby Build”! These economic times will be part of the history we will be so proud of in a few years that is leading to the restoration of the American Dream and the fact that our kids will be better off than us. We are not only in for the longest economic expansion in American history but, we project it will go on several years longer than economist project. Now is not the time to dream small dreams!
3rd Quarter 2018 Hotline
Well, officially, we are in the second longest economic expansion ever! And, as I said before, there is an awful lot of naysayers, and they cannot help but talk about it constantly. However, they are wrong!
The tax cut that Congress passed has motivated businesses of all sizes to reassess the opportunity of using the tax savings for capital expenditures that will dramatically increase productivity. This is happening from sandwich shops to major defense firms. CFOs are actively using the tax savings to dramatically increase productivity and profits. This is playing out in company valuations, share prices, capital expenditures, etc., thus benefitting everyone all the way down to the factory floor. Daily, we talk to management of any of the 124 companies that we lease to, and it seems like that is their opening line. They are excited about what they can achieve.
Onto the statistics…Last month, the Bureau of Economic Analysis revised its assessment for the 1st Quarter of 2018; the BEA now says that the GDP grew 2% annualized, down from the previous figure of 2.2%. A more accurate measure averages factors in statistics on incomes which shows growth at 2.80%. The difference between this is the BEA does a separate analysis by adding up all the different sources of wages, profits, and various forms of income. BEA calls this Gross Domestic Income. Using those numbers, it is closer to 3.7% annualized. Generally, forward-thinking economists average these two together, thus the 2.80%. This shows the GDP is accelerating for 1st quarter, and 2nd quarter 2018 should be north of 4.5% using the same average.
Okay, maybe you are still a naysayer……A few things that could happen on the upside such as the NATO Alliance fully funding their part of the military, North Korea continuing to calm down, and the WTO making China play by the rules – all of which will indirectly affect the stability of the global economy, that will result in better support for the US growth. But, here are a couple of big surprises that we predict are coming October of this year. These will totally turn the midterms toward conservatives and also assure the re-election of conservatives for the presidential cycle: 1) The NAFTA surprise! – a greatly improved NAFTA agreement that gives blue collar and union voters a direct impact and reason to support conservatives; and, 2) President Trump through an Executive Order will invoke a 2002 Supreme Court ruling that sets the stage for indexing capital gains for inflation like most IRS rates are. This in effect would lower taxation on capital gains which always provides significant economic growth.
Based on all the above, this will be by far the longest expansion in American history. Internally, our company is preparing for the ride! Therefore, industrial builders, build baby build!
2nd Quarter 2018 Hotline
As it pertains to construction as an industry, for thousands of years, we have basically performed construction with materials that are largely from the earth such as clay, wood, iron ore, limestone, crude oil based materials, etc. Now, things are on the cusp of changing and changing very rapidly, and these will substantially affect industrial real estate. Composite materials are now becoming very common such as carbon fiber, plastics, and lab-produced finishes. Federal and state regulations have become so onerous and costly in the removal and processing of earth materials that it has forced many manufacturers to go to a more predictable and less costly methods to control outcomes by minimizing the use of earth materials. An elementary example is that we are now beginning to use concrete spoils or old concrete previously removed to crush it in lieu of gravel (that is often monopoly pricecontrolled), thus cutting the cost by half. However, a new concrete is now being developed with a bacteria in it that can last 200 years, and that bacteria can actually heal itself in case of a structural crack. Does it sound far-fetched? It’s already been proven and being tested! Additionally, concrete as it is presently formulated is estimated to produce 4% of all greenhouse gases (GHG omissions), but this new bacteria concrete actually becomes a consumer of said gases.
Another dramatic advance in construction would be utilizing the advances in carbon nanotubes that directly affect the strength to weight ratio of structural materials, thus allowing for tremendous increases in flexibility and strength per pound. This would dramatically decrease the cost of construction once these materials are commercially produced (Image bar joists at roughly half the size).
Artificial intelligence and robot builders are already being coupled together in laboratory test and trials – much as robotic surgery has been used in hospitals. Imagine the advances in precision and predictable outcomes with up to three times the production per man hour and how that will affect construction timelines and better use the existing labor pool!
As it applies to real estate developers and builders, we have been virtually stagnant in construction processes for years. These radical changes are about to disrupt everything we have known in construction practices, similar to how the smartphones with all their applications did to replace the old flip phones.
1st Quarter 2018 Hotline
For the last decade, landlords have had those calls that will absolutely ruin a landlord’s day from tenants saying that they need a “downward rent adjustment” or “shortened term or to shrink their space”. We have become so accustomed to hearing those requests that we, as an industry, have gotten into a very defensive mindset. Day after day for over a decade, we have been scared to raise per square foot sales price or rent price thus leading to lengthened debt amortization schedules and constant pressure on costs to construct. As developers and landlords, we have re-looked at our cost structures so much in the last 10 years that we have rung every possible penny out of them; and, most of us have had to become very efficient in what we do, or we could not survive.
Finally, the game changed over a year ago, and some in the industry still have a fear of asking for rent increases. We now have tremendous pricing power, both in sales and leasing. In my estimation, it is likely to be this way for the next decade. However, the biggest hurdle might still be ourselves. The mindset of what “we think” companies may be able to pay based on what they have said for the last decade is definitely a challenge for us to overcome. Finally after years of mediocre returns, it is time to be bold, assertive, and farsighted. Scarcity should be driving landlords’ demands for: 1) longer term leases; 2) stronger protective covenants; 3) parent company guarantees; and, 4) “take it or leave it” on “as is” space – all contributing to a much better outcome on build-to-suits, renewals, or new leases.
One thing that developers can be sure of is that costs are going to continue to go up with: 1) the international building codes forced on the states by the “DC” crowd; 2) the ridiculous EPA energy code that has been adopted in most states; 3) the prolonged drought of new industrial construction limiting capacity with so many suppliers; 4) the developing shortage of skilled labor to build facilities; and, 6) last but certainly not least, rising interest rates. All of these are contributing simultaneously to sizable cost increases to any type of industrial construction. There is simply nowhere to go with these cost increases, except pass them on. Therefore, let’s make “golden hay” while scarcity exists and demand is high.
4th Quarter 2017 Hotline
By now, you have read it over 50 times. You have heard it on TV over 30 times. Sometimes it just seems to be relentless…that the media has to drive home the point that we are in an economic cycle that should have already matured or is approaching the downturn. Economists, who try to do forecasting based on the past (which is like driving a car looking in the rear view mirror), cannot get it right. When they say they estimate something, it is more of a guesstimate. In fact, my weatherman does a much better job of being accurate. It’s obvious that the stock market doesn’t agree with the economists.
I, for one, am strongly convinced that at no point in time (that I can recall) in America’s economic history that: 1) The onshoring of jobs/business has become so massive; 2) The discussion of protective tariffs are realigning America’s national corporations to relook at investing in the United States instead of overseas; 3) Regulation after regulation in literally every department of the federal government is being lifted or revised. In fact, a recent statistic quoted in the Wall Street Journal said over 610 regulations have been substantially altered as of June 30th year-to-date; 4) Capital is fleeing from the potential controls of China; 5) Low inflation is justifying (to some extent) lower than normal interest rates; 6) Over 40 million people are receiving federal assistance in which a portion of those could be active participants in the workforce if the entitlements were lowered or drug tests were implemented; 7) The controls of federal government are more in conservative hands (not saying that they are good at it yet); and, 8) There is pent up demand that has built up over the previous 8 years. In fact, the list goes on and on.
I maintain that the next 12 years (whether Trump is re-elected or not) will be the “best 12 years of our economic lives”. Small business ownership and individual initiative can lift this country again easily, unleashing the ingenuity behind individuals and their thirst for personal success. Although, this is not limitless; it can certainly carry us for a decade.
As it pertains to industrial real estate, I believe that there is no better time to build; because, scarcity has taken hold of the market, driving rental prices up. Older space has taken a “grand ride”, also. Many might say, “Why not just buy existing space?” However, as we have experienced in the market, existing net leased properties are greatly overpriced. And, while I certainly don’t want to throw rocks at that business model, to have new highly-flexible space with life spans of 40 to 45 years is now beginning to command premiums. The real question is whether developers can force the market to longer term leases with firm escalators to justify new builds; we say yes!
As far as our company’s direction, we are buckled up, strapped in, and ready to experience what will be “the greatest ride of our economic lives”.
3rd Quarter 2017 Hotline
At the end of the first quarter in 2017, the US industrial market has really never been stronger. Specifically, only 5.4% of the nation’s industrial space was vacant; and, it turns out that this percentage is the lowest rate on record. Even though new construction slowed down at the end of 2016, there was almost 60 million square feet of new supply that was completed and absorbed in Q1 2017. This is a tremendous record.
Market rents for higher quality space are averaging above $6.00 PSF; and, as we have written before with the ridiculous new EPA enforced energy codes and drainage codes adopted by several states, they are affecting new construction prices dramatically. We predict that rents will average $6.40 PSF nationally by the end of the Q1 2018.
So, where is all the space demand coming from?: 1) The onshoring of companies is accelerating because of the current administration’s jawboning and trade policies; 2) the House of Representative’s proposed Border Adjustment Tax; 3) Monies needing to flee the “China bubble”; 4) the incremental increase of demand for products that are currently made in the US; and, 5) a burst of innovation in retailing and logistics.
A case in point on the President’s trade policy working is that out of 30 years of showing industrial property up to December 1st, 2016, we had only seen one Chinese company express any interest in the Southeast. However, since January 1st, we have had four specific serious Chinese interactions. These range from 90,000 SF up to 300,000 SF. Two of the Chines companies openly said that the reason they are moving is that they have been making the same product in China for over twenty years, and they read the “handwriting on the wall” and are now going to have their first American footprint. Some on the “left” would say this is coincidence. However, instead, this is real hard, tangible evidence that a seismic shift is occurring and increasing the pace of onshoring which is bringing high-paying manufacturing jobs back to America.
Another observation relating to the above list of reasons that space is being “taken down” at such a rapid rate is the supercharged innovation cycle that always follows an economic crash, slow recovery, or a period of overregulation (which in this case we have all three). The supercharged innovation that we are seeing is technology combined with a slight shortage of labor. Ingenuity is creating this cycle of supercharged innovation causing “reconfiguring” in ways we currently make products using new composite materials creating new products and the need for space.
I think the next twelve years are likely to be the best sustained period in our economic lives. Speed bumps will occur; however, this will be like the Reagan/Clinton years, only on steroids.
2nd Quarter 2017 Hotline
Instead of direct comments on industrial real estate, I wanted to share some thoughts on democracy and capitalism. My belief is that democracy and capitalism literally go hand in hand. People generally cannot believe in democracy if it doesn’t bring happiness through improving economic environments. They are not interested in the right to vote every few years in order to just experience voting but instead do so for the hope of improving their and their family’s lives.
The true test of a democracy is to provide the framework so that progress is recognized on an incremental basis, thus providing the hope for each succeeding generation to improve their livelihoods. However, democracy by itself cannot succeed to the levels that the populous would expect just on their votes. It is best coupled with capitalism. Capitalism offers the hope of harnessing individual greed (and greed is not a bad word as long as it is managed) to produce the solid experience of earning new goods, services, or tangible experiences that justify the hope that democracy holds out. Coupled together, there has never been a more reliable form of government (even if it is not perfect). However, a quick glance at the alternatives may be enlightening: Many poets have romanticized about forms for governments. Priests have gotten involved to push the equalization in personal incomes in government. The youth envision utopia. Glorification of autocrats or outright dictators that appear to temporarily succeed all fade when compared to democracy and capitalism.
We can romanticize about what is perfect, but where is the constant migration of the poor that envision their own individual success? Throughout history, they have migrated to the successful structured democractic and capitalistic nations. Does anyone really believe that any substantial number of people have ever migrated from capitalistic nations to poor unstructured countries? Populations don’t aspire to be poor, and they very seldom aspire to be mediocre, thus industrious people are constantly looking for ways to risk their lives to flee socialism and Third World countries to experience the individual freedom to produce!
The societies that have experienced the most success throughout history have always been those that have been based on business (through a small amount of individual greed), never on military or aristocracy domination. People in those societies tend to exhibit very little jealousy toward the success of others if they are allowed to enjoy their own success. Yet, as we have seen, constant talk of inequality in income is divisive. Instead, the vision has to be to pull everyone up the economic ladder by allowing them to enjoy their own individual efforts.
Maybe the above thoughts don’t seem to be in sync with the industrial market, but it clearly has been demonstrated that our country is at a turning point where “animal spirits” are finally beginning to be stirred. Risk is not as much of a four letter word; the vision of success is no longer a kaleidoscope of random diversity; and, people can envision their family’s individual successes. I recently traveled for several weeks in Southeast Asia. To my surprise, my conversations that I had were with industrious individuals living under communist rule about the fact that America once again needs to lead the world back to hopeful societies.
1st Quarter 2017 Hotline
The so-called “Trump Revolution” that has one-half of America seemingly in despair and the other half in euphoria, from our industrial perspective, is a good thing. The full control by the Republicans of the White House, Senate, and House of Representatives means there will be accountability. For the half of America in despair, this total realignment of responsibility means Republicans have to prove their despair is totally baseless. For the half that are euphoric, Republicans will be required to produce substantial results. Additionally, as many of you know and many have been nice enough to help, my son (Trey) has joined the 115th Congress from the 9th Congressional District of Indiana (so it could be that I am a little biased).
In addition to the responsibility that comes with newly elected authority, a relatively small shift in increasing industrial needs will have a profound impact on existing space and resulting rents. It has been roughly estimated that the on-shoring of jobs from foreign countries back to America (but especially the south) could accelerate as much as 30%.
The roll back of the immense EPA overreach during the last 12 years that has given us costly energy code and drainage regulations will roll back the scheduled construction cost increases (that we have been anticipating) and could save as much as 14% of new construction cost on industrial facilities. This would go a long way to close the gap between existing rent rates and new construction rent rates. It will also increase speculative building by aggressive developers.
Corporate tax changes will have profound effects going forward. The punitive taxes that corporations have had to pay on worldwide income have been causing inversion; and, when adjusted, it will immediately
keep business at home. Taxes could also be bifurcated in so much as foreign income earned by US corporations could be taxed at higher rates
than domestic earned income thus shifting more business to America. Lower domestic taxation would present more opportunity for on-shoring,
but also enabling smaller companies to grow at faster rates allowing them to keep their money rather than having it taxed away.
The repatriation of up to 3 trillion dollars of US Corporate money positioned overseas to avoid US taxation will totally change the dynamics in America. This is the fuel America needs to accelerate the growth of operating businesses domestically. While there should be several things attached to the money coming home (in order to get the lower taxation) and if the strings are properly structured, it will be forced to be used domestically and will breed capital stacks and formation for years to come.
Whether its regulation, on-shoring, tax changes, or repatriation, these changes coupled together can produce a domestic GDP that is almost hard to fathom in this eight year old “restricted economy”. Our belief is that it could be at least 5 consecutive years of 4.5% GDP growth annually. These massive structural reforms will have long lasting effects with an economic run record that could be in excess of 12 years. Euphoria?…maybe, but I don’t think so…let’s enjoy the risk and the ride!
4th Quarter 2016 Hotline
After making the recent decision to keep interest rates down, Chairwoman Yellen cited an improving labor market specifically noting that labor force participation was improving off multi-decade lows. Her interpretation is that improving wages are drawing more Americans into searching for (and hopefully securing!) work.
Talking with many distributors and manufacturers across the southeast, this interpretation does not jive with the anecdotal evidence we hear. For many managers and owners, securing productive labor is their number one issue constraining them from taking advantage of market opportunities, but higher wages aren’t drawing in new workers off the sidelines.
The slight bounce of workforce participation rates off lows set in the 1970s is likely more a reflection of a higher proportion of graduating kids obtaining work. For illustration, if overall workforce participation is at 62% but each year, for the last few years, 85% of graduating students are getting into the workforce, then the workforce participation rate will creep up even without a single discouraged worker getting back into the labor force.
From what I hear from employers, this explanation is more likely for a few reasons. First, with today’s pace of rapid change, skills are decaying quickly while a worker is unemployed; employers might elect to hire a newly-minted graduate at an entry-level position over trying to retrain a worker into a mid-level position that might have antiquated skills. Second, to generate the need for mid-level managers and skilled employees, more dynamic economic growth is needed; you don’t need a supervisor until after you’ve hired several or many entry-level employees. There hasn’t been the growth necessary to reach the capacity constraint requiring new mid-level employees.
The concern for America – and many employers – is that this will result in longer bouts of unemployment for discouraged workers leading to further skills erosion, such that it’s not a question of wages that could draw them into the market but rather an unsolvable skills gap. Yellen’s optimistic view for workforce participation doesn’t reflect the significant challenge employers face today in attracting long-absent discouraged workers, something a skills gap might prevent at any wage price.
This extended so-called “recovery” has created many legacy problems that call out for a huge directional change in our country, not more of the same. Quite possibly, the government coddling and the P.C. Revolution might be exchanged for individual effort and initiative – the American way!
3rd Quarter 2016 Hotline
When one focuses all their time on developing products and delivering them to customers, it can be tempting to take government policy as an unchangeable impediment or enhancement to business. But, governments are competing for talent, investments and risk initiatives in a new global environment.
Stark reminders of this fact are events like Brexit, where thousands of corporate plans were scuttled immediately by a change in policy. For companies that located facilities in Britain to serve both the U.K. and European populations, that assumption of free flow of goods may no longer be valid. Similarly, the passing of ACA in the United States created sudden and continuing uncertainty that has curtailed hiring and investment by businesses facing a new, burdensome and ever-changing regulation.
More immediately relevant for the manufacturing and industrial businesses we serve is how government policies shape location decisions. Businesses are growingly attuned to the long-term affects of government policies have on their taxation, regulatory enforcement, and future workforces. This information is all available instantly on Google so these decisions are never in a vacuum.
Whether it be poor fiscal positions that might lead to massive tax increases in the future (e.g., Chicago) or underinvestment in education that could impair the ability to retain and attract top talent (e.g. Detroit), understanding the policy context is an important heuristic in any location decision. More and more, even a past history of erratic policy decisions at the state or local level can remove a particular location from consideration; with the size of investment in a particular location, businesses understand how costly a mistake can be. With all the economic uncertainty, decision-makers don’t want to layer on political uncertainty because in the end businesses hate variables.
Municipalities, states, and even countries need to understand they are competing for investments and talent and should understand the signals they are transmitting to business decision-makers. From success stories like Ireland and Singapore to horror stories like Russia or Brazil, the resulting differences in economic growth can be enormous, both in current years but also in decades to come as companies hesitate to make big investments in unstable regulatory or political environments.
Watershed moments like Brexit put the effect of policies on business decisions in the headlines, but more and more government living in their own protected bubble with an endless stream of highbrow overblown do-good causes affect the decisions of new risk and investments. The results of these decisions “play out” in our news every day, often locking entire populations into almost hopeless financial challenges largely beyond their control.
Often, the power of our vote is the only restraining tool available to allow hope, risk and individual success to thrive.
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