ARCAN CAPITAL MARKET UPDATE

July was a record-setting month for the U.S. economy, as it officially became the longest expansion in history at 10 years and counting.[i]  While a number of factors point to continued growth, such as strong consumer spending and solid job growth, there are clouds on the horizon.  Worldwide, economies are slowing, particularly in Europe and China.  Additionally, the trade war between the U.S. and China is heating up and this has already had a negative impact on business sentiment and investment around the world.  As we consider the medium-term outlook, we believe that a (hopefully) shallow recession and accompanying decline in asset values is likely.

Europe’s overall economic picture continues to be exceptionally weak, with the eurozone’s second quarter economic growth clocking in at an anemic 0.8% annualized rate.[ii]   The European Central Bank (ECB) data shows that this slowdown is most acute in the manufacturing sector, hitting export and manufacturing-dependent Germany hard.  IHS Markit’s July manufacturing index for the eurozone fell to its lowest level since December 2012.  PMI readings indicate that this trend is likely to continue.[iii]   As the largest eurozone economy, and the 4th largest economy in the world,[iv] Germany has a large impact on the health of both the eurozone and worldwide economies.  As Europe continues its march toward recession, we believe that it is only a matter of time before this begins to affect the U.S. economy.

Another major factor indicating headwinds for the U.S. economy is the burgeoning trade war with China. While trade negotiations between the two countries are making little progress, President Trump has ratcheted up the pressure on China by announcing tariffs on virtually all Chinese exports to the U.S.[v] These tariffs will hit the American consumer directly, as they should raise the cost of everyday products.  In a retaliatory move, China’s central bank announced that it would devalue the Yuan further, undercutting the intended effect of the new U.S. tariffs and possibly setting off a new round of currency devaluations around Asia.[vi]  As this trade war continues, it will likely weaken economies around the world and perhaps even drive the next recession.

On the domestic front, recent U.S. economic data is mixed. Second quarter 2019 GDP rose 1.8% on an annualized basis, which is the slowest pace since 2017.  Strong jobs growth and consumer spending offset what is likely to be the first decline in U.S. business investment since 2016.[vii]  While job growth and spending are up, however, wages remain stagnant and the labor picture remains complicated, with the average workweek shrinking as companies cut overtime.  Moreover, total hours worked by non-managerial employees have not grown since January.[viii]  This, coupled with the meteoric rise in consumer debt, specifically student loans, in the past decade calls into question the consumer’s ability to keep the U.S. economy growing in the medium-term. (For an excellent analysis on consumer debt, read this WSJ article).  One factor pointing to troubles ahead was the Federal Reserve’s decision to cut their target benchmark rate to 2-2.25%.  While this reduction was only 0.25%, it indicates that the Fed is concerned about headwinds affecting the U.S. economy, or, as Fed Chief Jerome Powell described them “downside risks”.  This, coupled with other recession indicators such as the inverted yield curve, are worrisome for continued economic growth.

Overall, we see economic growth slowing and the risk of recession rising.  This could affect multifamily real estate in several ways.  First, slow or negative economic growth will likely put downward pressure on wages and employment.  We think that this will reinforce the recent return to the long-term trend of homeownership rates in the low 60%’s as consumers will be unable to afford to purchase homes.  While this will likely also drive down home prices, we believe that one of the biggest barriers to home purchases today are not nominal prices or mortgage rates, but rather the purchaser’s ability to afford the down payment required.  This will benefit multifamily owners and investors as many people will continue to rent and well-managed, properly underwritten assets will continue to perform well.

We also believe that slower growth and/or a recession should lead to a correction in the multifamily space. We think that this will hit newer Class A and smaller Class C/D properties the hardest.  One of the primary contributors to a market correction will likely be newer market entrants who are overleveraged and have poorly executed management programs at their properties.  This will likely lead to an overall reduction in pricing for multifamily assets, allowing those with readily available cash and financing to find numerous deals at attractive prices.

As we look toward a period of slower and potentially negative economic growth, we think that a shallow recession and correction in the multifamily market would be healthy for the long-term outlook. At Arcan, we are preparing for both and believe that we are well-positioned to take advantage of the coming uncertainty.

[i] Lee, Yun. “This is now the longest expansion in US economic history.” CNBC, July 2, 2019. https://www.cnbc.com/2019/07/02/this-is-now-the-longest-us-economic-expansion-in-history.html

[ii] Hannon, Paul. “Europe’s Stalling Economy Sounds Alarm for Global Growth.” The Wall Street Journal , July 31, 2019. Web. https://www.wsj.com/articles/europes-stalling-economy-sounds-alarm-for-global-growth-11564563688?emailToken=6c23f219932d49ad77ab739ae48e4017l2eyosz5tKdwlgAsrK5jHFCwS01DoS9DPDx1wQvWj51DUsbYyS0RX2U5WOGv3+IK2MtKcBG4HSxsD7ktkUItk2d7IdUzl4X96WQk/sJbM0JGKErgIsuAqtPF9hlttAje&reflink=article_email_share

[iii] Williamson, Chris. “Eurozone manufacturing downturn accompanied by falling payrolls and lower prices.” IHS Markit, July 1, 2019. Web. https://ihsmarkit.com/research-analysis/eurozone-mfg-downturn-accompanied-by-falling-payrolls-and-lower-prices-190701.html

[iv] "GDP (current US$)". World Development Indicators. World Bank. Retrieved 4 May 2019.

[v] Lee, Yun. “Trump says US will impose 10% tariffs on another $300 billion of Chinese goods starting Sept. 1.” CNBC, August 1, 2019. Web. https://www.cnbc.com/2019/08/01/trump-says-us-will-impose-10percent-tariffs-on-300-billion-of-chinese-goods-starting-september-1.html

[vi] Stevenson, Alexandra. Swanson, Ana. Smialek, Jeanna. “China Uses Currency as Weapon in Trade War, Rattling Markets”, New York Times, August 5, 2019. Web. https://www.nytimes.com/2019/08/05/business/economy/us-china-yuan-renminbi-trump.html

[vii] Dimitrieva, Katia. Haar, Ryan. “U.S. Economic Growth Seen Stumbling as Trade Hits Companies”, Bloomberg, July 25, 2019. Web. https://www.bloomberg.com/news/articles/2019-07-25/u-s-economic-growth-seen-stumbling-as-trade-weighs-on-business

[viii] Sparshott, Jeff. Ip, Greg. “Real Time Economics Special Edition: More Jobs But at a Slower Pace”, The Wall Street Journal, August 2, 2019. Web. https://economics.cmail20.com/t/ViewEmail/d/A7CAAEC15336FA382540EF23F30FEDED/F3BC317E6931E19E981D23A7722F2DCD