05-05-2008 @ 4:15 am

Market Commentary from our May eNews


The Economy and the Financial Markets:
A Look at the “C” Word and the “R” Word

In Webster‘s dictionary, the word “capitulation” has several different, but related meanings. When used in relation to financial markets, it means “to surrender, to give in.” Although seemingly contradictory, in times such as this, astute followers of the financial markets welcome the arrival of this phenomenon – an overall sentiment that the market is terrible, there are no signs of hope, and it will never get better. Only when this sentiment arrives, can there be a true market recovery.

The question is, are we there yet? And, given the amount of investable money “on the sidelines” as well as any significant market downturn being viewed as a buying opportunity, regardless of any changes in baseline fundamentals, can this happen in a timely manner? Or are we faced with a series of “dead cat bounces” masking the inevitable march to the bottom?*

Of course, most of this turns on the “R” word – recession, that is, not recovery. You may recall that as recently as a few months ago, some very well known and respected economists, including Dr. Albert Niemi, featured in our February newsletter, had thought that chances for a full blown recession were less than 50%. Many of these more optimistic predictions had focused on continuing economic strength, and a slowing but not negative economic growth rate. As to their predictive abilities, there is a popular saying that economists as a group have forecast 16 of the last eight recessions.

The most recent numbers, however, tell a different story. Seventy percent of economists are now beating the recession drum; 80% of CEOs think we will be in a recession by year-end, if we’re not on the leading edge already. Paradoxically, many professional money managers only see a 34% chance of a recession. Recent questions at a major money manager meeting ranged from, “Where is the bottom?” to “What will make you turn bullish?”  In the capitulation stage, one would like to hear questions more along the lines of, “Should I be 100% in cash?”

If you are interested in more tangible recession related facts and figures, especially from a historical perspective, consider the following:

  • Bear equity markets (which by any measure we are certainly in) typically end four months before a recession ends.
  • The average recession lasts 10 months. The technical definition of a recession is at least six consecutive months of negative economic growth.
  • Since the War of Northern Aggression (which some of you may know as the Civil War), there have been 32 expansions and 32 recessions.
  • In each of the last two asset deflation cycles – the real estate recession of the early 1990s and the tech wreck of the early 2000s – it took three years of aggressive action by the Federal Reserve to push the economy back to the point where demand at least equaled supply, thus capping unemployment and propping up  capacity utilization rates.
  • During the Great Depression, despite all the hype of the 1929 crash, 1937 was the worst year for bank failures (a record that held all the way until 1985).

Other Indicators

From a technical analysis perspective, one highly regarded recession predictor, the KRWI (constructed by Paul Kasriel, Director of Economic Research at Northern Trust) is expected to soon signal a recession if the current trend lines continue.** It has not been wrong in 45 years.

On the anecdotal side, a recent survey of the membership of the National Association of Homebuilders sees a full recovery in 2010. The definition of full recovery has been appropriately adjusted by this normally optimistic group to mean sustainable, long-term stability, not explosive growth.

So, what indicators should we look for to determine if we are at an economic bottom, and poised for a recovery?

Consumer confidence – Since this is more of a consumer driven recession, an uptick in consumer confidence would be welcome. In most recessions, consumer confidence surveys usually hit a trough of about 65%; the latest survey showed measurements around 75%.

Jobless rates – History indicates that recessions typically end once unemployment rates rise one and one-half percentage points above their low point during the expansion. We are nowhere near that, and in fact the most recent data showed a minor dip in jobless claims.

New home construction – New home starts need to reduce to about 500,000 units per year, from about 700,000 now.

Junk bond yield spreads – A reduction to the low 600 bps from today’s 800+.

Will these signal the recession’s end? Only time will tell. Perhaps we should insert the phrase, “Past results are not indicative of future performance.”

* The phrase is derived from the saying that even a dead cat, when dropped from high enough, will bounce. Used to describe a short-lived, deceiving uptick in a financial market that masks briefly the downward trend of that market, often luring in unsuspecting investors.

** The KRWI predictor is essentially a negative spread between the yield on the 10 year Treasury and the Fed Funds rate, on a four quarter moving average basis, and a year over year contraction in the quarterly average of the CPI adjusted monetary base (sum of bank reserves and coin/currency).

Sources: “Merrill Lynch Economic Report”, “Northern Trust Economic Survey”, “NAHB Newsletter”, “Whiskey and Gunpowder” 


SDG Focuses On The Fundamentals of Success

So what does all this economic news mean to commercial real estate?

1) Less trading of assets - The combination of higher equity requirements and the uncertainty of both the capital markets and the overall economy will reduce the pool of buyers for most classes of properties. Some classes will be hit harder than others.

2) Smaller properties feel the pinch - such as those typically bought by private investors are most likely to see a dramatic dip in transactions as these purchases are more discretionary than larger institutional purchases. These buyers are more likely to do nothing as a result of market uncertainty and are affected more by tighter lending conditions. Additionally, a large number of these transactions were fueled by 1031 exchanges. The 1031 pipeline has slowed in part by the end of the residential land boom.

3) Values plummet - The natural result of fewer buyers is the retreat of values, which have climbed steadily for most of the decade. Here again, the impact will vary depending on many factors, including size, quality (of the asset and the income stream), product type, and location.

4) Quality is king - High quality, institutional, “trophy” properties will be impacted the least and, in fact, demand for this product in some markets, such as Washington, DC and Manhattan still outpaces supply. As in any down market, there is a flight to quality.

And what does all this mean for SDG?

SDG has entered this tumultuous time with our eyes wide open. Stan and I have both lived through several downturns in our career and seen them from different vantage points. And the secret to our strategy is one that we’ve learned from the sports world: stick to the fundamentals.

Michael Jordan, Tiger Woods, Peyton Manning, or Greg Maddux did not become legends by doing the spectacular. They each carved their name in history by being better than just about anybody at what the athletic world calls the “fundamentals.” Whether its Greg Maddux’ ability to lay down a bunt in a tight game, Michael Jordan’s consistent defensive play, Tiger’s putting, or Peyton’s ability to check-off receivers, they got a chance to do the spectacular by excelling at the mundane.

In our business, the basic fundamental is underwriting. Analyzing a property is not about running numbers as much as it is about understanding where the numbers came from and how reliable they are. Underwriting begins by establishing assumptions. Our experience over the last 25 years helps us to ask the right questions to understand where an assumption came from in the first place. The old computer analogy, ”garbage in, garbage out” is very true. When times are good, the market gets sloppy and abandons solid fundamentals. Some common underwriting lapses are pricing an asset based on proforma instead of operating history (what it might do vs. what it has done) or assuming above average rate growth (we’re better than the competition). This type of incremental fudging can easily bury a project when any type of snag happens.

The joy of a success is rarely as long lasting as the sting of a failure. The voice of experience has taught us that some of our most profitable deals are the ones we didn’t do. I can proudly say that we have passed on a number of deals in the last year that we tried hard to make, however at the end of the day, we had to respect the fundamentals.


The recent violent outbreaks in our schools and universities serve as a potent reminder of the deep unrest that permeates our country right now. As investors in the infrastructure of our communities, we also feel a responsibility to invest in the social fabric of our society. And one of the best ways we have found to do just that is through Marketplace Chaplains, an employee care program that we’ve adopted at SDG.

And to help other business and community leaders understand how Marketplace Chaplains has made an impact at SDG and hundreds of other companies, SDG co-hosted a luncheon along with American Lube Fast, at Maggiano’s in Buckhead this past January. There were 26 executives in attendance from a variety of Atlanta-based businesses and organizations.

The keynote speaker was John Coors, former Vice President of Global Brewing Operations at the Coors Brewing Company and current president of CoorsTek, a leading manufacturer of technical ceramics. With over 2,700 workers at four different plants, John has seen the Marketplace Chaplains program make a big difference in the satisfaction of his employees, “So many of our employees have no network of support, and often, no one to talk to, or turn to in a time of crisis.”

Typically, chaplains visit the workplace once or twice a week and are generally on call 24-7 for emergencies. They also make hospital visits, offer premarital counseling, and officiate at weddings and funerals. While it may seem strange to some to see a clergyman at work, the increased emphasis on spirituality in the workplace since 9/11 has led to a boom in growth for Marketplace Chaplains. They now serve employees at 254 companies in 38 states.  “We are there as caregivers, not as a representative of any denomination,” says Gil Stricklin, the former Army chaplain who founded Marketplace Chaplains in 1984.

As a result of our luncheon, two companies have contracted with Marketplace Chaplains. One of them is Prime Insurance Group Insurance, owned by Rob Young who explains why he chose to get involved, “I am very fortunate to have a good relationship with my small staff.  Still, I am their ‘boss’ and there are limits as to what I can do and what they feel comfortable sharing with me.  Marketplace Chaplains offers me a way to show I care by offering my employees a safe and confidential place to turn when dealing with the issues of life that we all face.”

To find out more about Marketplace Chaplains, visit marketplacechaplainsusa.com, or call Mark Parker at 404.229.5413 for more information on upcoming events.

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