HFF Research Update for June 3, 2016: Evaporation

Friday, June 3, 2016

Weekly insights on current research in the commercial real estate industry from HFF Managing Director of Research Jimmy Hinton. View Daily Rates on the HFF website.

As the temperature of a liquid increases, so too does its propensity to evaporate into gas. The nation's job market has been running hot for a long time. “Peak employment” is at the doorstep, demonstrated by the unemployment rate now measuring 4.7 percent – the lowest level since August 2007. Yet suddenly the Bureau of Labor Statistics has reported two consecutive lackluster BLS Employment Situation reports. Is the job market so tight that the decline in additions is natural, like net absorption declining as a market approaches full occupancy? Or is corporate America manifesting a lack of demand for additional employees?

Is corporate demand to occupy real estate going to evaporate? Is it time to adjust our posture? Ask three pundits what to make of the reports and you will get four different answers. Before we dive into the report, make no mistake, it's not favorable and the impact to CRE could soon be highly scrutinized underwriting standards.

To read HFF's monthly update on the BLS’ Employment Situation, click here. In that report we see the slowing of monthly payroll additions.

The average monthly payroll creation since October 2010 is 199,000 jobs, the highest level of growth since the 1990s when the real estate industry’s NOI expansionary cycle lasted approximately eight years. In fact, this pace of growth even exceeds the average monthly payroll creation reported in the era that lead up to the Great Financial Crisis, where the NOI expansionary cycle lasted four years.

But as the below graph demonstrates, the tepid growth since February has driven trailing 12-month payroll expansion to their lowest levels since 2013.

Stable expansion in payrolls is a primary tenet of the confidence many investors have held in the economy’s trajectory in spite of periods of volatility in the summer of 2015 and again in the first two months of 2016. Three consecutive months of sub-average job growth are upsetting that confidence.

Another reason this may have happened relates to the impact the underwhelming jobs data will have on the FOMC’s willingness to hike its Target Fed Funds Rate when they meet on June 4th and 15th. Their decision will be announced at 2:00 p.m. EST on June 15. In the meantime, it would appear investors anticipate hesitance to increase that rate.

If there is any good news in the employment report, it is coming in the form of wage growth. When discussing wage growth it is important to invoke the Goldilocks doctrine, wherein we want wages to grow not too fast or too slow but just right. While this sounds like an asinine stance, it is very much proven. A period of wage growth above four percent can represent a labor market that holds too much sway over employers. With limited options to hire new employees, corporations must significantly raise wages. While this helps the consumer and thus the largest portion of the country’s economy, it hurts corporate profitability – a leading indicator of economic health. How bad is four percent wage growth? Well, it has preceded some nasty recessions, as demonstrated below.

Wage growth near 2.5 percent feels very appropriate. Wages are growing but not so fast they significantly undermine corporate profitability. The unemployment rate is signaling a tight labor market, but a labor participation rate being near the lowest levels since World War II signifies capacity. Low interest yields will prove attractive to anyone with financing needs within the next few years.

Watch the 10-year UST for sentiment and watch future job growth announcements as they bode part of our industry’s future.

Sources: Bloomberg, Bureau of Labor Statistics, HFF Research

About Jimmy Hinton

Mr. Hinton serves as managing director of HFF, responsible for the firm’s national research efforts. Mr. Hinton works with the executive management team to assist in investor relations and to inform both HFF staff and firm clients with in-depth analysis of economic, property and capital market trends. He is also responsible for providing extensive market reports, client presentations and deal-specific analysis for debt placement and investment sales assignments. Mr. Hinton’s responsibilities include substantial interaction with pension funds, life insurance companies, regional and CMBS lenders, REITs, foreign investors and private equity funds.

During his tenure at HFF, Mr. Hinton has supported the execution of more than 150 commercial real estate transactions totaling more than $4.5 billion in 20 states. Mr. Hinton has experience in fixed- and adjustable-rate debt, mezzanine debt, construction loans and joint venture executions on behalf of clients engaged in the acquisition, development and recapitalization of property types including multi-housing, industrial, office, retail, medical office and storage properties.

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