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Commentary: Looking Forward

_In a commentary shared with DSNews.com, Peter Muoio, chief economist for ""Auction.com Research"":http://www.auction.com/market-research/, revealed the company's predictions for 2014._


*Housing Recovery Gets a Second Wind:* Homeownership stabilizes and household formations pick up with economic growth providing organic demand for housing. Sales and prices will continue to move up in a jagged manner, but the second leg of housing has a smaller investor composition.

*REO to Rental Cools:* Hand in hand with organic housing demand gaining steam and interest rate normalization will be a cooling in the REO to rental trade many private equity firms and banks had been doing. However, we expect the focus of activity to shift to capital markets as many of the already rented properties have their income streams securitized or even spun out as REITs in an IPO in the coming year.

*Apartment Supply and Demand Hit Equilibrium:* While we still expect robust multifamily demand in 2014, we expect this is the year the robust permitting and development activity in the sector comes to fruition. We expect multi-family vacancies to finish the year near where they start, in the low 4 percent range.

*Retail Sector Continues to Struggle:* While we expect accelerated economic activity in 2014 as this year ends on a strong note, we believe the retail property sector remains left out in the cold once again. We expect continued modest gains in retail fundamentals in 2014 as the sector continues to face secular headwinds. E-retail sales continue to grow at a much higher rate than brick-and-mortar sales, and big box chains are still struggling to cope. This will continue to bifurcate the retail market as only premium shopping centers continue to perform.

*Inflation Picks Up:* Inflation has been running below Fed expectations throughout the year and has oft been cited as a reason to keep QE going. We expect inflation in 2014 normalizes to its long-term rate mildly above 2 percent. With the labor market improving, wages should continue to see upward pressure and begin to translate into a normalized inflation environment.

*Investor Rotation into Secondary Markets:* The initial commercial real estate (CRE) recovery saw a flood of activity in gateway large markets. We began to see some rotation this year, but we expect 2014 investor activity will hone in on secondary and tertiary markets.

*Normalization of Cap Rates in Trophy Markets:* A corollary to our prior prediction is as investors hone in on secondary markets and interest rates normalize, cap rates will normalize in the U.S. trophy markets. New York, D.C.,


L.A., and other super large markets will lose some of the safety and liquid premiums priced into their very tight cap rates as investors shift into a growth mode.

*Congress Gets Out of the Way:* This one may be a bit hopeful, as it is always dangerous to bet on Congress to be rational and functional, but we believe 2013 marked the near term nadir for Congressional dysfunction. A two-year budget deal is in the works with a high likelihood of passing and at this point the future of the Affordable Care Act relies more on success or failure of its implementation than on legislative fights over its existence.

Additionally, 2014 marks a mid-year election cycle, giving legislators on both sides of the aisle increased reason to be wary and defensive, and not take huge risks that increase uncertainty and damage the economy or capital markets.

*Europe Resurrects:* Recent years have been a tumultuous mess for Europe, as the bloc has struggled economically, with periphery countries seeing sky-high unemployment, tumbling housing prices and rocketing loan delinquencies; and even stalwarts like the U.K., France and Germany in recession or struggling to grow. We believe this year Europe begins to crawl its way back. Recent economic indicators have shown a pulse and it is hard to imagine there being much froth left in the European banking system.

However, we caution that this is the prediction we believe has the highest likelihood to make us look stupid in a year, as the sovereign debt situation remains and capital markets flare ups are tricky, sudden and hard to predict. Should Europe see another bond market flare-up, things could get ugly and interesting fast.

*QE Taper Takes Longer Than People Think:* After months of premature speculation (we told you so), the Federal Reserve shocked the consensus and begun to taper its quantitative easing (QE) program at Bernanke's final meeting in December, right before the holidays. Now many are expecting a gradual tapering at each successive meeting to wind the program down. We believe the process will take longer than many think.

Janet Yellen has been dovish in her comments on monetary policy and the Fed has long maintained its data dependence more so than the media believes. We believe Yellen will be cautious and respond to economic and capital market developments, while erring on the side of leaving the spigots open.

*Canada's Housing Market Bubble Pops:* This one may take more time than 2014 but the conditions have never been riper for a bubble bursting. Canadian housing prices are sky high relative to incomes, development activity is at all-time peak levels, and the Bank of Canada is concerned about mortgage debt levels and activity.

Recent data has shown modest declines in home sales, and once the liquidity dries up, prices will fall to a level based more on incomes and less on expectations of equity increases. However, we caution this does not mean another global financial collapse, as the Canadian housing market is smaller than the U.S. and its assets are less ingrained into the financial system.

_Peter Muoio, Ph.D., is the chief economist for Auction.com Research and a regular lecturer at the New York University Real Estate Institute._

About Author: Peter Muoio, Ph.D.

Peter Muoio, Ph.D., is chief economist for Auction.com Research. He is a veteran of the real estate industry and founder of the research and consulting firm Maximus Advisors, which Auction.com acquired in December 2012. Prior to forming Maximus Advisors, he was a managing director and global head of Deutsche Bank Real Estate Research with teams in New York, London, Frankfurt, and Sydney. He is also a regular lecturer at the New York University Real Estate Institute.

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