The State of the Market:
Where have we been, where are we now, and where are we going?
I have received a number of questions recently as it relates to the market. I’m a big history guy, and a huge fan of Sir Winston Churchill. I revisit past events that I experienced firsthand to better understand how I can plan for the future. In a speech to the House of Commons in 1948, Churchill famously tweaked a quote by George Santayana saying, “Those who fail to learn from history are condemned to repeat it.”
I do remember the last recession and I the awkward sales meetings we had as everything seemed to crash. I remember people talking about things they did in 2001 and how they were implementing similar strategies. In the last recession everyone seemed to analyze 2001 because that is what they knew. I didn’t have that luxury then, but I do now, and I find it interesting to compare the last recession with the current recession we find ourselves in now.
The best analogy I have heard for the 2008 Recession is “a car crash in slow motion.” There were several factors that lead to this crisis. In my opinion, IT IS ALL ABOUT THE BANKS. When the banks fail, the market crashes. Think Savings & Loans and MBS/CMBS debt. To way oversimplify it, the banks found ways to afford credit to buyers that had no business buying homes by pooling the loans and selling them off. When the housing bubble burst in 2005 and 2006 and people defaulted on their loans, the market began to unwind (once again – way over simplified).
Though it is a thing in and of itself, people always point to the stock market as a barometer of the overall economy (I’m not saying I agree with it, but it is what it is). If you look at the chart below (yes, I hand drew on it), you will see that the peak of the S&P 500 was on October 8, 2007. Over the next +/-18 months, the stock market would bottom out on March 2, 2009, and it would take four years to fully recover.
So if 18 months in the 2000s was a slow motion car crash, 2020 was like we were driving along at 120 mph and never saw the invisible wall in front of us (the wall being the two black swans: Oil market collapse and COVID-19). History will tell, but assuming that we are on the path to recovery, the S&P 500 peaked on February 10, 2020, and it bottomed roughly a month later on March 16, 2020. In the past 2.5 months we are well on our way to a full recovery. THE SPEED OF THIS CRASH IS LIKE NOTHING WE HAVE EVER SEEN. See the chart below.
The biggest question I am getting is how this impacts the real estate markets, and my initial impression is that it doesn’t impact them as much as you might think (depending on the market). In Dallas-Forth Worth, we are already seeing an increase of companies from California, New York, and Chicago coming to the area. This has been a general trend over the last 10 years, but as a firm, specially over the last 30 days, we have been engaged to help companies from California to move to DFW. We expect this trend to continue to increase.
Historically for office product, the peak in office rents was 9 months after the stock market peak. The bottom was nine quarters later. On the most expensive office complex in the market, the decline was 16.0% and averaged at 10.8% overall. To put this in perspective, the stock market decline was 57.7%. The most recent decline in the S&P 500 was 32.6%. BUT YOU MOST REMEMBER THE BANKS – I’ll discuss them in just a minute.
I always tell my clients to take a long-term view and not make long-term decisions based on short-term data. If you try to time the bottom, you will miss. If you signed a 3, 5, or 7-year lease between 2008 and 2014 you either had an opportunity the first or the second time to take advantage of a market correction. If you signed a 10 year lease at the peak, taking the most expensive building in the market for example, ten years later you would be well below the market (DFW is a growing market and will continue to be).
So, what about industrial? The trends were very similar to office as it relates the peak in rents being nine months after the stock market peak. The bottom was nine quarters later. However, industrial recovered faster than the S&P 500 by two quarters. Furthermore, the decline in rate was only 3.2%, compared to the stock market decline of 57.7%.
Remember when I said it was all about the banks? Here’s why. Most of the commercial real estate in DFW has some form of debt on it. After all, leverage will help increase the potential returns. Banks are in the business of lending money, not owning real estate. Lenders’ and Landlords’ interests are aligned in that they want tenants to pay the rent and for the mortgages to get paid.
When tenants don’t pay rent or can’t pay rent, the Landlord has no choice but to proceed with default proceedings. Landlords don’t want to go through this because often times there is really nothing to go after or sue for and they are left holding to the bag. To simplify the concept, if this happens with enough tenants, the Landlord may default on the loan and the lender could call the loan and take the building back. Since banks are not in the business of owning buildings, this can result in a fire sale and a deep discount. When someone in a submarket buys a competitive building at a lower basis, they can afford to reduce the rent and neighboring landlords are faced with a decision to either reduce rent (their loan covenants may prohibit this), or to default themselves and let the lender foreclose and take the building back. The thing is, the tenant defaults, the bank foreclosure, and the fire sale take TIME. 18-24 months.
It is the 18-24-month lag that made the 2008 recession so powerful from a commercial real estate standpoint. It was an 18-month slow decline that allowed for a full realization in the commercial real estate market. And, even still, in DFW the decline was not very great.
So what does this mean for today? (By the way, it is worth noting that Oil & Gas accounts for less than 4% of the DFW Gross Domestic Product (GDP), so markets with a large concentration may see much larger declines than forecasted for DFW.)
For office, we are already seeing a softening of the market with the deals we are working. In my opinion, if you are lucky, you will see a 3% decline in rate. But you are in that window as we speak, point being, I cannot tell the future, but in my best guess, this is a window to garner more concessions as we are evaluating how to go back to work and what the new workplace looks like. I do not see a decline in industrial, in fact we are seeing increased demand. Most of the headlines people read are based on retail (which is to be expected), but I have yet to see bad news in office or industrial.
CNBC had a great article recently as it pertains to tracking the public Real Estate Investment Trusts (REITs). Industrial REIT rent collection was 96% of normal. The article goes on to note that the REITs have also seen “demand increase due to the pandemic.” From our own client base, most of the industrial users that are struggling are industries directly impacted by the pandemic (i.e. we have one client in the event planning / tradeshow business). Once again, given where we live, the amount of pressure on the market and increased demand, we expect the industrial market should, at worst, stay stagnate or continue to increase. Office rent collection was 92% of normal. However, the headline that media has focused on is, “Shopping center REITs saw a slight improvement over April but still reported just 48% of typical rents collected in May.” Most of the doom and gloom headlines capture the retail aspect but are not telling the whole story.
Furthermore, the Dallas Business Journal recently published an article with Hunt Southwest that talks about industrial being “among the top performing asset classes during shelter-in-place.” It also talks about the reduced peaks and valleys in the industrial market. At Whitebox, we happen to agree with this sentiment, as historically the fluctuations have been de minimis over time for the greater DFW Industrial market.
Lastly, if you are looking to buy, be a long-term player, it is much like the stock market in that respect. In a growing market like DFW it doesn’t really matter where you get in if your goal is to make money long term. The slide below is a great example.
So what does it all mean? Play the long game. Make good long-term decisions and hire Whitebox to help you navigate these challenging times. Whether you need more space, less space, or just have questions, we can help.
You can reach Grant at firstname.lastname@example.org or 214-380-4575.