Here is something to consider as we move into the Trump Era after eight years under President Obama: More often than not, a recession occurs within a year to 18 months after a new president is elected.
It’s not that new presidents actually cause a recession, but as REIS Inc. notes in its “Election Impact” report, it’s that a new administration tries to implement structural changes via blunt instruments, such as fiscal policy, which then upset fragile economic balances.
REIS cautions, with the economic environment as fragile as it is today, “It might not take much to push our 1.8 percent growth rate economy into a downturn.”
Another way to look at these economic downturns is that they are cyclical, or as Aaron Swerdlin, an executive managing director with Newmark Grubb Knight Frank in Houston, observes, “The recession cycle is predictable, usually just beyond seven years. So, from a historical perspective, there is a 75 percent chance of thunderstorms during the Trump presidency.”
President Obama took office as the country pitched into a severe economic downturn, but over the last seven years the country has experienced moderate expansion, which has supported job growth, wage growth, and consumption. According to a report by Marcus & Millichap, “Barring a significant unanticipated event, these positive drivers will be sustained into the coming year, supporting commercial real estate demand, tight vacancies, and sturdy rent growth.”
The self-storage industry tracks closer to the residential housing market, which has been fairly steady these past few years as well. In another report, this one by realtor.com, expectations are for few surprises in 2017. In its forecast, realtor.com predicts the housing market will experience a “year of slowing, yet moderate growth.”
Rising Interest Rates The big worry for the folks at realtor.com is not a recession but an expected rise in interest rates over the next few years.
“We don’t expect the outcome of the election to have a direct impact on the health of the housing market or economy as we close out 2016. However, the 40 bps (basis points) increase in rates in the days following the election has caused us to increase our interest rate prediction for next year,” writes Jonathan Smoke, chief economist for realtor.com. “With more than 95 percent of first-time home buyers dependent on financing their home purchase, and a majority of first-time buyers reporting one or more financial challenges, the uptick we’ve already seen may price some first-timers out of the market.”
Even without considering anything the Trump administration might do–increase infrastructure investment, reduce taxes, induce repatriation of overseas capital–the two concerns going into the next four years are the possibility of a recession and an expected rise in interest rates.
In regard to recession, that’s not an over-riding consternation for the self-storage industry as the sector performed better than all other real estate categories in the tough downturn of the mid-2000s. “In a normal recession, we will see storage performance go relatively flat, while other product types go negative,” says Swerdlin.
Marcus & Millichap doesn’t project a recession in the next 12 to 18 months, but it does expect “headwinds,” says Richard Bird, national director of the Self Storage Group at Marcus & Millichap, based in Denver. “Because of that we are seeing some opportunistic investors put money aside to be ready in the event there is some distress in the marketplace in the future.”
Obviously, a recession would be challenging for newly developed properties, Bird adds, and there will be some markets that will struggle.
Once we got through the last recession, these were extraordinary years for the self storage industry, suggests Kenneth Nitzberg, chairman and CEO of Devon Self Storage Holdings LLC in Emeryville, Calif. “And the big driver was simply interest rates. It made borrowing easier and it gave the public additional dollars to spend because they had lower car and house payments. Between 2012 and 2016, low interest rates caused the storage industry to go ballistic, as measured by the performance of the real estate investment trusts.”
A lot of the success that the self-storage industry experienced during the last several years has been related to a low interest rate environment over a sustained period of time, adds Shawn Hill, principal with The BSC Group LLC, in Chicago. “It meant very low cap rates and it meant very good cost of borrowing, and it propped up a lot of things with real estate being one of them.”
Despite everything that Donald Trump has said he will do once he takes office, most owners, operators, and transactional people in the self-storage industry expect the big issue in the next few years to be interest rates, in particular whether the expected upward movement will be enough to make a difference.
If one looks at net valuation in terms of the publically-traded companies, that had to do with stagnant interest rates and the low cost to finance development and acquisitions. The upside of the real estate business has been very strong with the Fed keeping those interest rates at bay, which should change.
“The interest rate rise is a big unknown,” says Swerdlin.
Scott Zucker, an attorney at Weissman Zucker Euster Morochnik PC in Atlanta, adds, “Interest rates climbing will be a wake-up call for what people have considered free money for development. A change in interest rates from zero to one percent or higher is still historically low. It may slow things up a bit, but in reality, it is going to take a long time to get back to the interest rates where we had inflation that hampered economic growth.”
So, the big question is: How much will interest rates rise?
“Looking at the appointments Trump made to date, including putting a Goldman Sachs guy in at Treasury and Trump being a real estate guy, I would assume–maybe dangerously–that we are not going to see interest rates rise too dramatically,” says Nitzberg.
Indeed, even before the Trump inauguration, the market began factoring in a rise in interest rates. Realtor.com predicted in November, due to mortgage rate increases over the last few weeks, that first-time buyers will face new hurdles.
Interest rates are expected to reach 4.5 percent due to higher expectations for inflationary pressure in the year ahead, suggests realtor.com
Changes will happen and already have happened, observed Todd Amsdell, CEO and president of Cleveland-based Amsdell Companies. “The market, expecting interest rates to rise, has pounded the REIT valuations as it tries to get in front of potential changes in interest rates. The market realizes a small 100 bps rise in interest rates can dramatically change the value of a self-storage center. Operations won’t be able to keep up with the change and properties will become less valuable–just like the REITs have become less valuable to investors, so stock prices declined.”
Near the end of 2016, Bird commented, “We have already seen an interest rate rise of 50 bps and on the larger deals that has a big effect on total returns an investor makes on a purchase.”
In order for investors to get the same return they were getting just 12 months earlier, they would need to pay less.
“We began to see that effect on many of our transactions toward the end of 2016,” Bird says. “The Trump administration is putting in some pro-growth policies right now that should help the economy grow; some of those policies should create jobs with an investment in infrastructure that should spur an increase in consumption. When people buy more things, they have more things to store and their need for self-storage increases. As consumption and inflation rises, we should see rent increases that will hopefully offset some of the cap rates increases that we will be seeing.”
The more cautious view is this one, “In the current environment we may have overdevelopment and increased costs of construction [because of increased interest rates]. This may cause current owners to be concerned with occupancies and rates that will support the increased cost of ownership.”
If rates go up 100 bps, they would still be within the historical lows of the last 25 years. So, even if rates inch up from the three-percent level to the five-percent level, that might slow down a couple of projects, but it won’t kill general growth. Where the effect will be is on rate sensitive transactions, i.e., if you are borrowing $10 million and the rate changes from 3.5 percent to four percent, that’s 50 bps on $10 million or an extra $50,000 in interest costs, which can make a difference.
There is, of course, one positive to rising interest rates: the inflation factor.
“When you start talking about a rising interest rate environment with real estate, it affects things both ways,” says Hill. “Inflation, if that’s where we go, means higher rental rates. Generally, inflationary times mean an opportunity to push rent. To the extent that you can control expense growth–and there will be some expense growth associated with inflation–could mean higher net operating income.”
Regulatory Changes Now let’s turn to the places where the Trump administration can make a difference and intends to make that difference. The first is regulation, including the repeal or modification of the Dodd-Frank Wall Street Reform and Consumer Protection Act and less regulation on the oil and gas industries. There is some hope for less regulation on environmental issues as well.
“The thing that has happened under the Obama administration is that it has become more difficult for the self-storage industry due to the amount of regulation that has come down,” says Ann Parham, president and CEO of Joshua Management in San Antonio. “One of the things Trump says is he is going to do is get rid of some of those regulations. We’ll see. Regulations have to be backed off; they have to be more practical. The worst thing the Trump administration can do is to continue to regulate everything, micro-manage, and not let businesses do what businesses do best.”
A lot of environmental and zoning regulations are more local issues than national, but some rollback of environmental restrictions could happen under the Trump administration. The bigger regulatory questions involve the lenders, which have been severely constrained since the Great Recession of the mid-2000s.
REIS legitimately asks the question: “What will replace Dodd-Frank should it be truly dismantled, and will the proper incentive structure be enforced to both promote growth as well as protect against risks like relaxed lending standards–risks that helped bring down the economy in 2008?”
Many regulations that were put in place coming out of the recession were just being implemented at the end of 2016, meaning a lot of the meat and potatoes of the Dodd-Frank bill are still very fresh. Nevertheless, the expectation is the new administration may peel some of this back.
“I don’t think that will happen immediately, but I think that the new administration may feel like some of the policy and regulatory rules that were put in place were over-reaching and are going to be punitive to real estate borrowers,” says Hill. “A push-back would be a positive, because some of the regulatory stuff will have a big impact. We saw CMBS volume come down in 2016 as CMBS lenders struggled to figure out how to work with the new regulations coming into the fold. This caused disruption. Any time you can get rid of some of that regulation, the banks would appreciate that.”
Regional banks certainly would like to be lenders of construction money, but current regulations restrict them from doing so. That’s not such a bad thing, says Swerdlin. “I’m in the camp that if you liked 2008 when there was a lack of regulation and the fox was guarding the hen house, then an economic catastrophe is what happens. New development has been in check over the past four years. Some of that is due to the difficulty in getting construction loans; only the people that have real capital can develop. If it becomes a lot easier to borrow and build, that could easily become a negative.”
Taxes And Infrastructure The Trump administration is also expected to address tax issues, which some members of the self-storage community find an attractive proposition.
“When we are over-taxed, that money goes to government and not back into our businesses,” says Parham. “Cutting the tax on companies would be extremely helpful as would streamlining the tax code.”
The Trump administration and Republican majorities in the House and Senate will likely push to change the corporate tax structure and the current regulatory regime, REIS reports. Policies are outlined in broad terms, but changes are aimed to promote pro-growth tax structures with initial figures suggesting large cuts in both personal and corporate income taxes.
“As a buyer of self-storage, it would certainly be nice if the Trump administration could bring down taxes,” says Amsdell. “It wouldn’t be such a hit to current owners and operators to sell their properties. Lower taxes might be an incentive to potential sellers to move from where they are now to get more interested in selling. That would help those in the industry who are consolidators, and it would help those in the industry who want to be sellers.”
Finally, there has been a lot of discussion about increased infrastructure investment, which should spur economic growth. Nothing involving infrastructure is set in stone, and implementation will once again be the deciding factor as to whether this will be a net benefit for U.S. commercial real estate, notes REIS.
Trump talks about infrastructure, creating jobs, and promises to give the economy a boost, says Zucker. All that would be a good thing for self-storage, because if the economy is doing well and people are moving for jobs or moving from apartments to houses, any of that transition helps self-storage.
“It is interesting to have a Republican president with a Republican House and Senate,” Zucker adds. “It is a unique situation. I would think the number one thing on their plate would be economic growth and development. Any beneficial change to the economy has a trickle-down impact on all businesses, including self-storage.”
While there has long been a consensus that additional infrastructure investment would be beneficial, the significant costs surrounding such an undertaking have stalled action thus far,” states a Marcus & Millichap report, which added, “Should meaningful additional infrastructure development be undertaken, it could yield substantive returns, including the creation of jobs and increased efficiency.”
In the end, it’s all about being optimistic or pessimistic, whether the self-storage mavens were more Democratic than Republican doesn’t make a difference at this point. Everyone hopes the new administration gets things right.
“The country never has had a pure businessman in office,” Parham considers. “I am hopeful he will bring more of a business approach instead of how a politician looks at how the country needs to be run. Right now, everyone is thinking that capitalism is back in style because we have a capitalist going in the White House. We kind of moved from a socialist agenda, so we will see how this works.”
And this from Hill, who says, “I’m expecting positive things from the new administration. Political affiliations aside, I find it hard to believe that a guy who has built his entire fortune on borrowing money from banks and building real estate is going to be an advocate for policies that will hurt the real estate industry.”
Steve Bergsman is an author, journalist, and columnist. His stories have appeared in over 100 newspapers, magazines, newsletters, and wire services around the globe; his most recent book is “The Death of Johnny Ace.”