Zoltan Szelyes

Structural shifts in the global economy and CRE strategy

Last week’s special report in The Economist described how the structure of the US economy has started to shift away from consumption and debt towards manufacturing and exports. That excellent report laid out the current structural shifts in the US economy, like the implications from the reversal of the regulators attitudes towards credit card debt, regions that might benefit from new technologies (like Pennsylvania from shale gas) or the necessity for American manufacturers to look abroad for opportunities. Such changes are also taking place in the European economies. Countries in Latin Europe (mainly Spain, Portugal and Italy) that built their economic model around an extraordinary large housing and consumption sector are realizing that they need to tackle issues of fiscal austerity, productivity and to foster innovation. At the other end a competitive, strong export oriented German manufacturing sector is also hit by the weakness of those consumer economies and needs to find new markets or create a higher domestic demand. At the same time emerging markets are becoming more and more dominant in the global economy and are grabbing for a higher share of world trade. It’s important to recognize that the latter is not a zero sum game, as the global economic pie is getting larger. The rising incomes in emerging countries are also creating a higher demand for goods and services produced in the developed world. Such a structural change in the global economy is nothing new, as we have been living in a dynamic world for quite a while and the structure of the economies is constantly changing. But the financial crisis seemed to have corrected some trends that were unsustainable like the ponzi game of leverage in many countries.

However why should real estate investors care about these high level macroeconomic issues? Traditionally many real estate investors only apply an opportunistic logic behind investments and hit bids that seem reasonable according to their experience. That can make sense if you consider your properties as single investments and if you think you have an edge in your local markets. But at the same time the macro perspectives for that region need to be ok as well. You can buy good objects which you think are cheap in your region and still lose your whole stake if industries in that region are suffering and need less space. So from a portfolio view you would want a diversified portfolio in order to reduce idiosyncratic risks but at the same time overweight regions and sectors that you think will outperform. And this outperformance and underperformance is heavily driven by macro factors and structural shifts in the economy.

That’s why you need a disciplined investment approach. For every market you invest you need to model demand and supply dynamics (qualitatively or quantitatively). The highlighted structural shifts can go into your demand forecast: There you can account for issues like whether retail spending will decline or the regional banks balance sheet are shrinking or small businesses that specialize on export will thrive. Your macro CRE models then translate these economic trends into forecast of market rents and prices.

Consider for example two regions: Region A is characterized by an oversupply of shopping malls and is home to overleveraged mid income households. Region B comprises of a dynamic cluster of SMEs that are focusing on exports. If you think that exports are going to boom and retail spending is going to decline you rather buy land for industrial development in region B than a shopping mall in region A. While the shopping mall in region A will face higher vacancies and declining rents, the land for industrial development will strongly appreciate due to its option like nature as the export oriented SMEs are able to increase their incomes and need more space for their production. Unfortunately the situation is not so crystal-clear in reality like in this idealized exampled. But our complex background of such investments even strengthens the case for a disciplined investment approach that relies on a strong macro based real estate research.