Economic Forecast, Part 2

Last week I attended a small private presentation hosted by my good friend Tom Wilson at the BACOMM monthly meeting held in Silicon Valley. The guest speaker was Dr. Doug Duncan, Chief Economist for Fannie Mae. Doug has been a guest on the show before. Doug leads a large team of nearly 200 economic analysts and have consistently won awards for having the most accurate economic predictions anywhere in the US.

We covered part 1 of Doug’s predictions on Friday’s show.

On today’s show I’m going to share a few more highlights from Dr. Duncan’s presentation that I believe are relevant for all real estate investors.

This year the Federal Reserve changed their stance on inflation. The Fed doesn’t see moving the overnight funds rate above 0.25% until the end of 2022. This is the part that is significant. They have also changed their stance on inflation. Rather than setting a 2% ceiling on the rate of inflation, the Fed is now saying that they’re going to be fine with an average 2% for inflation. That’s a dramatically different stance. That means that the Fed might not raise interest rates when core CPI creeps up above 2%. They will wait until the average is above 2%. For 2020, they’re estimating inflation below 1.8%. This means that inflation would need to exceed 2.2% next year before they take action to cool inflationary pressures.

So as real estate investors we can count on low interest rate policy for some time to come.

Dr. Duncan shared data on the office market for a number of cities across the US. He noted that many office markets can expect it to take more than 6 years for local office vacancies to return to pre-Covid levels.

Part of the reason has to do with the amount of new office construction in the pipeline. Most cities are experiencing growth in supply that is far in excess of demand over the next three years. That new supply was already committed prior to the pandemic.

San Francisco is expecting a 7% growth in office supply over the next 3 years, with a 0% increase in demand. Many of the major markets are experiencing flat demand over the next several years and increasing supply. Doug believes that many businesses will want to return to the higher productivity environment of an office. Nevertheless, office space is one of those areas that is under extreme pressure over the next 5-7 years.

The only city that is expected to show a fast rebound in office is Washington DC. That’s largely driven by government.

Cap rates in multifamily don’t appear to have changed at all during 2020.

Fannie Mae is looking hard at migration. They’re looking at where applications for new loans are being from, and the location of the loans for the subject properties. From this data, they can clearly see that migration is underway from more dense zip codes to less dense zip codes. They have the actual data from real transactions. This isn’t a survey or a statistical poll. It’s based on boots on the ground activity. Whether that is sustainable remains to be seen.

Job prospects for millennials over the past 5 years have been in the urban core. Not surprisingly, they have moved close to their jobs. Do they want single family homes? Yes, but those don’t exist in the downtown core. Now that they aren’t tied to being in the core, millennial are migrating to the suburbs.

When it comes to rental properties, Fannie Mae is seeing much more tenant rotation in the A class properties than in the B and C properties. Those who are upwardly mobile and can afford a house are buying a house and moving out of a high density property to low density.