Grubb & Ellis Montana Commercial, LLC

Inflation 
     CPI-U, % Change Year/Year

September 28, 2009

An outbreak of inflation is unlikely over the next 12 to 18 months because the economy is burdened by excess capacity in the labor market, factories, houses and commercial real estate. In fact, disinflation (slower price gains) and outright deflation (falling prices) are more likely in the near term, particularly for commercial real estate. The average effective rents for office and industrial space, which include concessions such as periods of free rent and above-standard tenant improvement allowances, have declined by 36 and 35 percent, respectively, from their recent peaks. The Moody’s/REAL Commercial Property Price Index, which measures prices based on repeat sales, has slipped 39 percent from its peak in October 2007. Non-residential construction costs have declined by 7.6 percent over the past 12 months according to the Bureau of Labor Statistics while the average price of a development site has plunged by nearly 60 percent since December 2007 as reported by Real Capital Analytics. Though a near-term bout of inflation is unlikely, inflation could crop up as the recovery gains momentum. Under such a scenario, credit demand in the private sector could begin to compete with borrowing by the Treasury Department, which needs to finance a national debt that is expected to more than double over the next 10 years to $17.5 trillion according to the Office of Management and Budget. Federal Reserve Governor Kevin Warsh, in a speech last Friday, recognized this threat and suggested that the Fed will need to aggressively raise interest rates at some point down the road to head off inflation. If the Fed were to adopt such a policy, it would translate into a weaker recovery in return for lower inflation over the next few years.

Robert Bach, Senior Vice President, Chief Economist, has 30 years of professional experience in real estate market research, consulting and city planning. His commentary on the real estate markets is provided here on a weekly basis.

What about Real Estate?

September 25, 2009

 The economic news has been mostly encouraging lately. Even the labor market, a lagging indicator, is showing tentative signs of a rebound as initial claims for unemployment benefits fell for a third consecutive week. A number of analysts contend that the recession has ended, although we won’t know for sure until the National Bureau of Economic Research, a nonprofit organization charged with assigning dates to business cycles, makes the call sometime next year. If you think back to the financial chaos of last September and the mixture of fear and gloom that settled over global markets for the next six months, it certainly didn’t seem like the recession would end this soon.

 For commercial real estate, perhaps the last industry to join the recovery, recent news hasn’t been so good. Both the investment and leasing markets appear to be stuck in molasses. For a more optimistic outlook, it helps to take a long-term view backward and forward.

• In the early 1990s, there was a feeling that commercial real estate was a permanently damaged asset class with market fundamentals unlikely to recover for a very long time. The market had been badly overbuilt, and respected analysts said that it would not need another square foot of space until after the millennium. There was a further sense at the time that computer and networking technology would suppress the need for, and value of, office, retail and even industrial space. That view proved to be far too pessimistic as most markets were on the road to recovery by the mid-1990s. Today there appears to be more confidence that the asset class will embark on a recovery within a year and feel noticeably stronger in the 2011-2012 time frame. For evidence of this relative optimism, look no further than the growing reservoir of capital being raised to target distressed assets. There has even been talk of too much capital, which could serve to put a floor under prices.
• Looking ahead, commercial real estate could be positioned to reprise its role as an inflation hedge, a role it last performed in the early 1980s – see chart on right. Inflation is unlikely to be a problem for the next couple of years, but the growing deficit, weak dollar and a potential reduction in the willingness of investors to buy U.S. government debt could spur a bout of inflation later on as the recovering economy sops up excess capacity in the labor market, factories, housing and commercial properties. This could coincide with a recovery of commercial real estate leasing markets – falling vacancy rates and rising rental rates – which would make the asset class look very attractive to investors. Analysts are divided over the potential for inflation down the road, but the timing of an outbreak, if one occurs, could favor commercial real estate.

Robert Bach

SVP, Chief Economist

Grubb & Ellis

Bob Bach is our Senior Vice President, Chief Economist