Business is booming in America. The economy is on a record tear, corporate profits are soaring and unemployment is at historic lows — there are more jobs than people to fill them. Occupancy rates are high, cap rates are low and inflation has, allegedly, been modest.
Kenneth Rosen, head of real estate and urban economics at Berkley’s Haas School of Business, wants the real estate industry to enjoy the good times while they last — because they won’t for much longer.
During an event hosted by the Urban Land Institute’s New York chapter last week, Rosen warned of a likely slowdown in 2019 before an inevitable recession in 2020 or, at the latest, 2021.
He pointed to the ballooning national debt, rampant over-valuations in the tech sector, stock market trepidation over the U.S. trade war with China and a convergence of short- and long-term bond yields as warning signs.
“The spread between the long bond and the two-year is nearly inverted, which is to say the 10-year almost below the two-year,” he said. “Every single time, 100 percent of the time, when that inverts, within a year we get a recession. It never fails.”
A rash of financial and environmental deregulation has opened the flood gates for business expansion and, though Rosen worries about the long-term impact of weaker pollution laws, “business feels very positive about that,” he said.
Also, the Republican-driven tax cuts that went into effect earlier this year helped extend the decade-long growth cycle and boost consumer confidence, Rosen said. But that doesn’t make it sound policy.
“We added a trillion dollars a year to the deficit,” he said. “This is pouring gasoline on a red-hot fire and it’s actually the wrong policy at this time, but we’re taking advantage of it. It’s a sugar high, so enjoy it, because when it wears off in the next couple of years, we’re going to see a retrenchment.”
A strong job market — national unemployment is below four percent — has benefited both the multifamily and office rental markets, Rosen said, and kept vacancy rates low in most major metros. Low interest rates and moderate wage growth, however, have kept rent rates fairly steady.
For-sale housing markets have stagnated, however, and not just in cities with high barriers to entry, such as New York and San Francisco, which briefly benefited from foreign buyers investing in luxury condos but have since over-built.
Sales figures have been weak nationwide, Rosen said, with similar trends taking shape in other developed countries such as Canada, Australia and the United Kingdom.
Home sales have stagnated, in part because of rising construction costs, Rosen said, adding that builders and developers have seen inflation levels around three percent, contradicting the Federal Reserve’s approximation, which pins inflation in the low two percent-range.
Rosen believes a 3.5 percent rise will soon be felt more broadly, thanks, in no small part, to a barrage of tariffs deployed by the White House.
There are potential off-sets, Rosen noted, such as the low-cost oil, which he attributes to “the beheading effect” — a reference to Saudi Arabia increasing the global oil supply in return for continued U.S. support in the wake of the state-sanctioned killing of a journalist in October.
“Saudi Arabia is, all of a sudden pumping a huge amount more oil to get prices down at the request of our president and he in turn is supporting their regime,” he said. “But all commodity prices have fallen down so the question is, is it demand side or supply side? I think it’s supply but we’ll have to wait and see.”
Rosen believes the valuation of many tech companies is “crazed” and venture capital activity is beginning to resemble the late 90s, during the tail end of the dot com bubble.
Looking at New York alone, where technology growth has outpaced stalwart industries, such as law and financial services, during this recovery, Rosen sees strong evidence that the next downturn will be sparked by a tech correction.
“We think the valuation adjustment alone means roughly 85 percent of startups will not make it and there will be billions of dollars of losses, but most importantly, they’ll cut back jobs like they did two decades ago at the end of the last boom,” he said. “There’s real value, though, in companies like Google and Apple and other people. They have a lot of cash and cash flow, so it won’t be as bad as all that, but there’s really a strong case to think the technology sector, which has led us up will lead us for a correction.”
In addition to its tax cuts and tariffs, Rosen also has concerns about the Trump Administration’s policy on legal immigration, which he said accounts for roughly 45 percent of population growth and is a key distinguishing factor between the U.S. and other mature economies, such as the U.K. and Japan.
An aging population brings increased health care and pension costs. Without a replacement workforce to cover those costs, Rosen said the country risks further exacerbating its growing deficit.
“I’m worried we’re going to hit a debt crisis, not just here, but worldwide,” he said.
For real estate, that demographic shift creates new development opportunities in the health care and senior living sectors.
Rosen also believes industrial assets will continue to return strong profits to service a growing demand for e-commerce distribution.
Over all, Rosen estimates that the next recession is about 18 months away, though he doesn’t see it being nearly as detrimental as the last downturn in 2008.
Moving into 2019, he expects there to be renewed political gridlock in Washington now that Democrats control the House of Representatives, though he’s hopeful that the split government can cobble together an infrastructure bill. He’s also watching China, not only in how it responds to the U.S. roughneck negotiating tactics, but also how it deals with its own debts.
Other potential trouble spots on the horizon include Brexit, which is set to take place next year, and the ongoing war in Yemen, which could have untold ripple effects.
At home, however, the biggest question is about how the country will respond once the adrenaline shot of big corporate tax breaks wears off, Rosen said.
“We have labor shortages, so we never should have put a big stimulus plan in place,” he said. “We didn’t need it. We needed that in 2009, we don’t need it now, but the president doesn’t have any economic advisors, he has Larry Kudlow, he’s not an economist he’s a talking head and he’s a very smart guy, but this is very bad.”
