Instead of thinking of years in terms of animals, which according to the Chinese Zodiac this is the year of the rabbit, I tend to think about the underlying theme for the economy in the coming year. Looking backwards, 2008 was a year of uncertainty, which bled into 2009 – reality checks and corrections. We’ve been waiting for things to return to “normal,” but what we’ve discovered is there is now a new normal. It’s been dragging on for some time, and 2010 was finally a year of stabilization.
So what is the theme for 2011? Recovering economic poise. This is not going to be a robust economic recovery. All we can do is capitalize on the strengths of 2010 and remain positive that the economy will be improving. Because it will, albeit not as fast as everyone would like. By year-end 2011 we should be more confident in the U.S. economy and beginning to see more prominent signs of recovery.
There are already signs of a renewed confidence in the economy. Consumer confidence has more than doubled since the bottom in 2009, which is evidenced by increased consumer spending. Locally in San Diego County, taxable sales are estimated to be $414 million for 2010 – up from $396 million in 2009. The reason? Households felt more job stability in 2010, which led to a comfort level of higher spending. Economists expect this trend to continue and for retail sales to improve accordingly.
A more obvious indication is the recovery of stocks. The Dow Jones Industrial Average recovered 19% in 2009 after the financial calamity in 2008. The rebound continued in 2010 with the market recovering another 11% of value.
Foreclosures have also decreased in 2010. Local foreclosures in San Diego County have decreased nearly 30% from the peak of 19,575 trustee deeds in 2009. More importantly, the notices of default for homeowners are also down 33% from 2009.
Another positive note is that job losses have stemmed. However, this is welcomed as a mixed-bag because the unemployment rate has been above 9% for 20 months now. And it is likely to stay in this range. Most economists expect GDP growth in 2011 to barely absorb the increases in the labor force, which fails to bring the unemployment rate down significantly.
These factors should bode well for 2011, with more to come as other segments of the economy improve. Yet there is still work to do.
More Work To Do
The main driver behind the recovery is jobs. To put the colossal task of job creation into perspective, we only lost 1.6 million jobs during the early 90s recession. After the dot.com bust in the early 2000s, there was a retraction of 2.7 million jobs. However, a whopping 8.4 million jobs were shed in this last cycle. This magnitude cannot be reversed in a short period of time. It will take years for new industries to emerge, and for existing ones to recover.
This directly impacts the commercial markets, particularly for office. Morgan Stanley estimates that approximately 1.6 million jobs lost since 2007 were occupants of office space. The nation’s vacancy rate now sits at 17.4% – the highest since 1993. This is a great deal of space that needs to be absorbed before any significant growth can occur. As a result, effective rents for commercial buildings are being compressed further in response to vacancy. And experts agree that the fundamentals of commercial markets (e.g. absorption, rents, vacancy) are probably 12 to 18 months out from stabilization.
No More Pretending, Please
But the commercial stress doesn’t stop there. Property values have fallen 30% to 60% across US markets and there is still a significant amount of deleveraging that needs to occur. Landlords are faced with maturing loans – which is an interesting way of putting it because really it’s the banks that have this exposure on their balance sheets.
Approximately 43% of commercial loan balances that came due in 2010 are still yet to be refinanced. Herein lies the problem – these properties do not qualify because they do not generate enough income to cover the new debt payments or because values have dropped where the property is underwater. In the past, banks have been “extending” these loans and “pretending” that values will recover. The most popular type of modification to these commercial loans has been simply extending the loan period (70% of all modifications) or increasing the interest-only period (almost 30% of all modifications). These actions don’t help. It only denies the reality and prolongs the inevitable.
It’s been a tough reality for banks to understand that values will not likely recover in a reasonable time frame. However, there are some signs that banks are increasing their liquidations. According to Morgan Stanley, an average of 70 loans per month was liquidated in the first half of 2010. This number surged to an average of 319 loans per month for the latter half of 2010.
Another positive for the financial sector is the return of Commercial Mortgage Backed Securities (CMBS) lending activity. This industry has virtually shut down for the past two years. However, experts forecast that this industry is now recovering. Approximately $40 billion of new CMBS loans is forecasted to be generated in 2011. This money will ultimately refinance properties that qualify as well as financing the acquisition of liquidated loans from other banks. This is an important source for the financial industry because it is another segment that “gets the money movin’.”
All of this is positive news. I’m not bullish on the financial industry, and there is still a long ways to go, which bogs the recovery. But like it or not, the financial industry is the backbone of the American economy. It finances real estate transactions, but more importantly it lends money to businesses to make capital improvements and hire employees. It is no coincidence that President Obama has met with the heads of banks to try and get them to lend money – it is a main ingredient to the economy!
So why does all this national “big picture” data matter to San Diego? Because this downturn was far reaching – it was global and systemic, while affecting the fundamentals and creating a new economic reality. Recalling the early 2000s, San Diego appeared to have an economic Great Wall of China surrounding our region. We were not heavily dependent on the high-tech industry. We had (and still have) a very diverse base of employment sectors. For this reason, the market fundamentals didn’t change that much with the dot.com bust and ensuing recession. But our diversity couldn’t shield us from this recession, nor can it rescue us overnight.
This economic pullback affected every household, including residents of San Diego. Since 2007 households have deleveraged by approximately 14% nationwide, compared to only 10% after the early 90s recession. The good news, however, is that consumers are feeling that their debt is at a more comfortable level again and feel better about spending.
Overall, this year should definitely be better than a rabbit – which suggests being timid and cautious. We can be more confident that we can recover some of that economic poise and confidence and that we have seen the bottom, turned the corner, and are setting the stage for recovery.
