Beep Beep…5 Signs of an Impending Recession

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In the 1500’s, houses had thatched roofs – thick straw, with no wood underneath. It was the only place for animals to get warm, so all the cats and dogs lived in the roof. When it rained, it became slippery and sometimes the animals would slip off the roof, resulting in the idiom, “It’s raining cats and dogs.”

While on the subject of animals, we wish you a Happy Thanksgiving. Just remember if you burn the turkey this year, just tell everyone you were experimenting with a Cajun blackened recipe!

Since today is October 31st, besides being Halloween (plenty of scary news to follow), it is 10-31 which is a section in the Internal Revenue Code (IRC-1031) that allows you to buy and sell income property on a tax deferred basis. We do 1031 exchanges regularly and they are a great way to build wealth. However, you should engage us early to avoid many of the mistakes that could disqualify the deal. Here’s just a few nightmares.

  1. Miss the 45-day Identification period – once you close on the relinquished property, you have 45 days to identify in writing what you intend to acquire in exchange.
  2. Fail to clearly identify what you are going to buy – you must identify unambiguously (i.e., street address, APN, legal description).
  3. Miss the 180-day deadline – you must close on replacement property(ies) within 180 days of closing on the relinquished property.
  4. Close before you sign exchange documents – you must sign exchange documents before you close on the relinquished property.
  5. Take possession of your exchange funds – you cannot have possession or control of the proceeds from the sale of the relinquished property.

Now for a little treat, San Diego’s unemployment rate dropped to 3.1% in September from 3.4% the previous month. So, despite all the doom and gloom, unemployment dropped a little bit. I tell people to focus on jobs because that has the single biggest impact on commercial real estate (more people moving in than out / supply and demand / higher sales-higher rent).

An additional treat is that GDP growth returned in the third quarter with a 2.6% annualized rate. This rise was driven predominantly by increased exports.

Now for the scary, Halloween prognostication. Here are the top five signs we are either in or heading into a recession.

  1. Declining monetary base – Fed creates money out of thin air creating lower interest rates leading to economic booms. Eventually, money supply slows, interest rates rise. That leads to an economic bust. The money supply has slowed from 40% last year to 4.9% this year.
  2. Inverted yield curve – two-year treasuries are yielding more than ten-year treasuries. This has preceded every recession in recent decades.
  3. Tightening bank standards – banks are tightening their standards (not just raising their rates). The number of banks tightening their standards has risen to levels seen in prior recessions.
  4. Housing market – mortgage rates have more than doubled over the past year. The housing supply is now 11 months. Every time the housing supply has risen above ten months, there has been a recession – 100% of the time.
  5. Declining real manufacturing and trade sales – real manufacturing and trade sales only decline in a recession. They are already down 1.5% year over year.

So, what are we seeing in the field? Maybe surprisingly, we are staying really busy. So, either we’re helping the last people out of the burning theater or we’re doing what we have always done – give good advice and help people navigate change.

We were speaking with one of our contractors this month and they had some interesting insights.

Are prices on materials coming down at all? The short answer: Not yet. The reason for this is fewer raw materials; fewer production sites and logistical challenges keep prices on the rise.

How have lead times changed on items and services? With the shortage of many materials, lead times have increased considerably. We are experiencing a shortage of lumber, cement, steel, drywall, electrical products, and HVAC units (to name a few).

How is the current permit process and timing Different cities give different estimates for permit timing. The City of San Diego clearly states six months and up to one year! Of course, many of us are experiencing even longer permit processing times. And as you know, time kills all deals!

Despite being busy, we are hearing from other brokers that their deal activity is slowing. Sales volume for all property types in the U.S. has declined over the past 12 months ending September 30, both in terms of volume and number of deals. At the moment, investors seem to have plenty of capital to deploy but are waiting to see how things settle out with inflation and recession. The amount of available capital is reportedly 20% higher than in 2019.

Nick’s Numbers

Here’s a chart that shows the dramatic drop in deal volume going on.

US Deal Volume Slumps

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regard to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

Again, Happy Halloween! Happy Thanksgiving! Just remember anybody can face a crisis. It is the idiots that wear you out! Hope you enjoy the story…road runner was as close as I could come to a turkey story this month!


Dear Landlord: I cannot be held responsible for the Coyote-shaped hole in the wall. And look out for the sticks of dynamite in the supply room. by Ross Murray

Dear Landlord,

I am responding to the notice you slipped under the door of my office yesterday morning detailing amounts owed for damages and repairs, this following your unannounced visit to my premises the previous afternoon.

As I explained then, the coyote-shaped hole in the wall is not my fault. It was caused by an erratic and impulsive predator (carnivorius iwodimemium) that has been persistently entering my office thanks to lax building security as well as a seeming ability to punch in alarm codes and turn doorknobs.

In this instance, the coyote was blasted through said wall following a violent explosion of his own devising, a subject I will return to presently. Note that, though it is of significant size and indeed coyote-shaped, it is a clean hole with no otherwise structural damage and should not be difficult to repair, though again I must insist I am not responsible.

Yes, I own a roadrunner (aparlmentpelicus imbecilicius), but when I signed the lease, I specifically asked you if I could keep a bird, and you assured me that this would be acceptable as long as it was clean and quiet. Except for the occasional, care-free “beep-beep” and a whooshing sound as it races fleet-footed from room to room, I believe my roadrunner has been an ideal pet.

Perhaps I should be seeking reparations from you, for at no time prior to signing the lease did you lead me to understand that I would be beset by an overly tenacious coyote with an insatiable lust for bird flesh and surprisingly refined engineering skills. Which leads me to your second item: I have not, as you claim, extended the balcony and transformed it into an entirely new room. Despite the fact that you were somehow able to walk into this “room” during your surprise inspection, I assure you it was merely a drawing of a room

placed at the edge of the balcony by the devious coyote, a fact I discovered following your departure when I too attempted to enter the space, only to burst through the canvas. There was a second when I was suspended midair that I must say was thrilling, though the feeling was fleeting as I plummeted three floors to the parking lot below, terrifying Mrs. Bembaum and her Bichon Frise. Luckily, I was not seriously harmed by the fall nor by the impact of the subsequent anvil, the provenance of which remains a mystery.

Returning to the subject of explosions, you, unfortunately, did not escape unscathed from the apartment after you casually approached my upright piano and began picking out the tune of “Believe Me If All Those Endearing Young Charms,” only, upon striking treble C, to be blown to what must be described as “smithereenies.” I assure you I had no idea the piano was loaded. I have been playing that song regularly without mishap. Or perhaps I was playing it wrong.

Again, I am sure it is that cunning coyote who is to blame for this destruction of property and injury to your person. But, as you are undoubtedly now aware, the damage is temporary, and your scorched face has returned to its usual shade of puce and piano keys no longer dangle melodiously from your mouth.

I am sorry you stepped in the quick-drying cement by the front door on your way to the hospital.

I had no idea it was there. Again: coyote. I was able to recover your shoes and will return them to you at your convenience.

Also: the giant slingshot at the entrance to the bedroom is not mine.

Brokers Giving DirectionsHow commercial real estate brokers give directions…

TURN LEFT AT THE STARBUCKS. GO STRAIGHT TIL YOU SEE THE NEW TACO BELL AND TURN RIGHT. THEN IT’S RIGHT THERE NEXT TO THAT PLACE WITH THE REALLY GOOD PULLED PORK…IF YOU SEE DUNKIN’ DONUTS, YOU HAVE GONE TOO FAR.

Well three 75 basis point hikes by the Fed would seem to be sending the message that fighting inflation is job number one. They are going to whack markets down until everyone believes the narrative. Unfortunately, inflation is not just a number nor is it just the cost of gas or dollars per hour wage. It’s an attitude. I remember the late 1970s and early ‘80s, when Paul Volcker struggled to tame inflation. Despite double digit interest rates, it wasn’t until he realized he had to change how people and companies thought until he had success. Right now, people think they have to pay more or charge more or make more.

People say things are different this time. Investors are betting that we live in a digital world and a simple flick of the interest rate switch will quickly revert things back to normal. Well, I’ll tell you that I do think things are different this time. In the ‘70s and ‘80s, debt levels were lower and asset valuations were cheap. Today, our economy relies heavily on debt for consumption and to rollover maturing debt to avoid bankruptcy. High interest rates will be exponentially more damaging now than they were 40 years ago.

In a recent American Express survey, 75% of small businesses surveyed reported being impacted by inflation. Interestingly, those surveyed reported nearly double their last year’s revenues while profits were down slightly (-4%). Small business leaders reported that 37% planned to raise prices, 22% were going to negotiate better deals with supplies and 22% were going to cut lower margin products and services. Thirty-three percent planned to strengthen customer relations to increase revenues. Lastly, 47% said inflation is impacting their labor market due to higher healthcare, employee benefits or increased raises.

Americans with Disabilities Act (ADA) litigation continues to rise. Many owners and tenants wonder, “Will I be next?” Lack of knowledge is not a valid defense with respect to access compliance. ADA lawsuits are costly and time consuming experiences. A common misconception is that accessibility modifications are necessary only when the property is upgraded. However, the ADA requires “readily achievable” barrier removal regardless of whether or not alterations to the property are made. Because there is no enforcement agency for ADA, individual lawsuits are now the most common way to become aware of violations at a property.

The first step is to have an inspection and report by a Certified Access Specialist (CASp). They can determine violations, what is readily achievable, create a priority schedule and assist you in getting the work performed. Once armed with a CASp report and plan, you have your first line of defense formed.

In 2016, Assembly Bill 2093 went into effect requiring landlords to provide prospective tenants with any report and/or disability access inspection certificate issued by a CASp for the premises being leased. In addition, landlords are required to insert in their leases the following:

1.      A disclosure stating whether or not the subject premises have undergone inspection by a CASp; and

2.      A statutory CASp inspection disclosure when an access inspection certificate has not been issued for the subject premises.

If the subject premises have undergone inspection by a CASp, and there have been no modifications which have impacted accessibility since that inspection, then the landlord is required to provide the prospective tenant with a copy of any report prepared by the CASp in connection with that inspection. The tenant must keep such reports confidential, except as necessary for the tenant to make repairs.

In addition, the prospective tenant has the right to review any CASp report at least 48 hours prior to execution of the lease. If the report is not provided to the tenant, the tenant has a right to rescind the lease based upon information contained in the report for 72 hours after execution of the lease. If the CASp report indicates that the subject premises meet applicable standards, the landlord must provide a copy of the current disability access inspection certificate and any inspection report to the tenant within seven days of the date of execution of the lease.

If a subject premises has not been issued a disability access inspection certificate, the landlord must include the following specific language in the lease:

“A Certified Access Specialist (CASp) can inspect the subject premises and determine whether the subject premises comply with all of the applicable construction-related accessibility standards under state law. Although state law does not require a CASp inspection of the subject premises, the commercial property owner or lessor may not prohibit the lessee or tenant from obtaining a CASp inspection of the subject premises for the occupancy or potential occupancy of the lessee or tenant, if requested by the lessee or tenant. The parties shall mutually agree on the arrangements for the time and manner of the CASp inspection, the payment of the fee for the CASp inspection, and the cost of making any repairs necessary to correct violations of construction-related accessibility standards within the premises.”

Below are several CASp inspectors if you are interested to pursue further for your business or property. Please let us know if you get a report so we can act accordingly with regards to disclosures and leases for your property.

Greg Izor – greg@izoraccess.com

Jason James – jason@buildingprinciples.com

Craig Lobnow – ProCASp.com

Nick’s Numbers

This month, I am sharing a chart that shows CPI / Inflation over the last 8 decades and how hard it was for Fed Chair Volcker to get it back under control.

CPI over time

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

In our overinflated world of social media, the team here at CDC Commercial is trying to win the hearts of our actual clients, not “likes” on social media. In the meantime, government continues to use its bureaucracy to make “things” less readily available and more expensive. Ultimately, personal choices will determine whether or not behavior around “things” and their cost will shift in the long term. Personal choice is always the key to everything…hope you enjoy the story…


The Taxi Driver

“I was waiting in line for a ride at the airport. When a cab pulled up, the first thing I noticed was the taxi was polished to a bright shine. Smartly dressed in a white shirt, black tie, and freshly pressed black slacks, the cab driver jumped out and rounded the car to open the back passenger door for me.

He handed me a laminated card and said, ‘I’m Wasu, your driver. While I’m loading your bags in the trunk, I’d like you to read my mission statement.’

Taken aback, I read the card. It said, ‘Wasu’s Mission Statement: To get my customers to their destination in the quickest, safest, and cheapest way possible in a friendly environment.’

This blew me away. Especially when I noticed the inside of the cab matched the outside. Spotlessly clean!

As he slid behind the wheel, Wasu said, ‘Would you like a cup of coffee? I have a thermos of regular and one of decaf.’

I said jokingly, ‘No, I’d prefer a soft drink.’

Wasu smiled and said, ‘No problem. I have a cooler up front with regular and Diet Coke, lassi, water, and orange juice.’

Almost stuttering, I said, ‘I’ll take a lassi since I’ve never had one before.’

Handing me my drink, Wasu said, ‘If you’d like something to read, I have Good Housekeeping magazine, Reader’s Digest, The Bible, and a Travel + Leisure magazine.’

As we were pulling away, Wasu handed me another laminated card, ‘These are the stations I get and the music they play, if you’d like to listen to the radio.’

And as if that weren’t enough, Wasu told me he had the heater on and asked if the temperature was comfortable for me.

Then he advised me of the best route to my destination for that time of day. He also let me know he’d be happy to chat and tell me about some of the sights or, if I preferred, to leave me with my own thoughts.

‘Tell me, Wasu,’ I was amazed and asked him, ‘Have you always served customers like this?’

Wasu smiled into the rear-view mirror. ‘No, not always. In fact, it’s only been in the last two years. My first five years driving, I spent most of my time complaining like all the rest of the cabbies do. Then I heard about power of choice one day.’

‘Power of choice is that you can be a duck or an eagle. If you get up in the morning expecting to have a bad day, you’ll rarely disappoint yourself. Stop complaining! Don’t be a duck. Be an eagle. Ducks quack and complain. Eagles soar above the crowd.’

‘That hit me right,’ said Wasu. He continued and said, ‘It is about me. I was always quacking and complaining, so I decided to change my attitude and become an eagle. I looked around at the other cabs and their drivers. The cabs were dirty, the drivers were unfriendly, and the customers were unhappy. So, I decided to make some changes. I put in a few at a time. When my customers responded well, I did more.’

‘I take it that has paid off for you,’ I said.

‘It sure has,’ Wasu replied. ‘My first year as an eagle, I doubled my income from the previous year. This year, I’ll probably quadruple it. My customers call me for appointments on my cell phone or leave a message on it.’

Wasu made a different choice. He decided to stop quacking like ducks and start soaring like eagles. I hope we all decide to soar like an eagle and not quack like a duck.”

“It was a bright cold day in April, and the clocks were striking thirteen.” ~ opening line of George Orwell’s book 1984

1984 George OrwellThis line seems innocuous enough, but you immediately know something is wrong with the world. As a writer, I recognize this is done to drive the reader to find out what. As a citizen, when I see a $750 billion spending bill get approved that is called an inflation-fighting bill, I am thinking it is 13 o’clock!

Gun control has increased gun ownership, the Mira Lago search has raised more funds for Trump, Whole Foods CEO warns about socialism, Chase CEO Jamie Dimon says the economy is “strong” and consumers’ balance sheets are in “good shape,” however warns that “something worse” than a hard recession looms.

The fact that the Fed was surprised by the persistence of inflation (after saying it was transitory) is like yelling “fire” in a theater and being surprised by the stampede because you had fire extinguishers and sprinklers throughout the building.

My new way to process truth in news and politics is as follows; listen to both sides and believe the exact opposite! My dad used to say, “when you watch a magician, watch his other hand.” During these crazy times I work hard to follow my ANTS philosophy (Avoid Negative ThoughtS). Former General and Secretary of State Colin Powell had 13 rules of life and rule #13 was – “perpetual optimism is a force multiplier.” At CDC Commercial, we abide by that rule!

I am optimistic to see schools back open and students returning without masks.

I know I said be optimistic, but a couple of negatives first. The 2-year and 10-year Treasury rules have been inverted for about a month. This is a sign that the bond market expects a recession in the next six months. The second negative is negative leverage has come back to commercial real estate (borrowing rates higher than cap rates). Interest rates have risen but cap rates haven’t. A key axiom in developing and investing in commercial real estate is buying real estate where the cap rate is higher than the cost of debit. This means the return on your equity (cash on cash) will be greater than the cap rate. If you don’t have a 20-year horizon, then its necessary to look to properties where you can increase cash flow dramatically in order to outpace inflation.

Something that is happening more is, “retrading.” This is where a buyer gets under contract and prior to closing looks for a significant price adjustment tied to an increase in interest rates or deal risk. More investors will be demanding higher cap rates soon which will put downward pressure on prices. I think we are entering a “hold” phase with prices leveling or decreasing for 12-24 months.

How do we beat inflation? I know in business and government it involves slashing spending and budgets. However, in your life here are a few ideas.

  • Review and get rid of paid subscriptions – newsletters, gym memberships, subscription home delivery services, music services, etc.
  • Buy recycled or refurbished products
  • Buy direct – see if you can buy from producer or wholesaler
  • Use technology – price compare – price match. Technology like Gas Buddy or the AAA app to find the cheapest gas near you at the moment.
  • Can you offshore anything? India, Philippines, even Australia offer lots of services that even an average person can use. I know a 14-year-old that uses a Philippines tech firm to mine crypto for him.
  • Better use of tools you have – have you looked at your Microsoft Office subscription and looked at what all it can do or how to better use Word, Excel or Outlook? Have you learned to use Lens on your phone to take a picture and turn it into a PDF?
  • Save on travel costs by becoming an expert of Zoom or Teams. Can you turn your camera on and off quickly, mute your mic, share your screen with others, create work rooms to send others to on large group calls?

I have said for a long time that the health of the commercial real estate market revolves around the labor market, namely jobs and unemployment. Here again I am bewildered as to the truth. After loosing 22 million jobs in two months in 2020, the Bureau of Labor Statistics is finally reporting that we have recovered to pre-pandemic levels. However, if we had continued the trajectory, we were on from 2017-2019, we would have had an additional 5.5 million jobs by this time.

San Diego’s labor force is still in recovery. San Diego lost about 6,700 jobs in July (CA Employment Development Department) yet unemployment went down to 3.1% (Don’t ask me). Although, we added more than 11,000 jobs in the office sector in the last 12 months, the financial services sector lost 600 jobs in July. I think this is the sector to watch as residential real estate finance and refinance-related fields (mortgage companies, escrow companies, real estate offices) shrink. Additionally, as more and more companies move to remote or hybrid, we are seeing a rocky office market. Hiring figures may no longer represent a definitive indicator of the office sector’s stability.

A case in point would be Geico Insurance opting to leave all of its brick-and-mortar space in California including its 267,000-square-foot facility in Poway. In January, Farmers Insurance did the same shift to remote and vacated 500,000 SF in Woodland Hills. However, no layoffs were announced – everyone is working from their couch with a green gecko on their shoulder.

Another rule of thumb I always use is that you want to buy real estate where more people are moving in than moving out. San Diego’s population fell in 2021 according to U.S. Census data. Yet apartment vacancy rates are at 2.6% and rents are up 20%! Is it 13 o’clock yet?

Nick’s Numbers

This month I am sharing a chart that illustrates Don’s point of San Diego’s continued employment recovery.

SD Civilian Employment

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

With the clock striking 13 and the kids going back to school, I hope you enjoy the story…


The Animal School

Once upon a time, the animals decided they must do something heroic to meet the problems of the “new world” so they organized a school. They adopted an activity curriculum of running, climbing, swimming, and flying. To make it easier to administer the curriculum, all the animals took all the subjects.

The duck was excellent in swimming, in fact better than his instructor, but he only made passing grades in flying and was very poor in running. Since he was slow in running, he had to stay after school and also drop swimming in order to practice running. This was kept up until his web feet were badly worn and he was only average in swimming. But average was acceptable in school, so nobody worried about that except the duck.

The rabbit started at the top of the class in running but had a nervous breakdown because of so much make up in swimming. The squirrel was excellent in climbing, but he developed frustration in the flying class where the teacher made him start from the ground up instead of from the treetop down. He also developed charley horses from overexertion and then got C in climbing and D in running. The eagle was a problem child and was disciplined severely. In the climbing class he beat all the others to the top of the tree, but insisted on using his own way to get there.

At the end of the year, an abnormal eel that could swim exceedingly well, and also run, climb and fly a little had the highest average and was valedictorian.

The prairie dogs stayed out of school and fought the tax levy because the administration would not add digging and burrowing to the curriculum. They apprenticed their child to a badger and later joined the groundhogs and gophers to start a successful private school.

George H. Reavis

 

 

In the opening scene of Shakespeare’s Macbeth, the witches gather around a cauldron making a potion and chanting, “Double, double toil and trouble; fire burn and cauldron bubble.” Well, let me tell you that a bubble’s famous last words are always, “I’ll be back!” The Fed is in an unenviable position of controlling rampant inflation and not creating too much unemployment. Obviously, we are at the end of ZIRP (Zero Interest Rate Policy) because ZIRP requires printing money and that causes inflation. As stated, the Fed is trapped, and it must choose to fight inflation or refuel the stock market bubble (so ZIP for ZIRP!).

With interest rates rising, we are seeing pressure on cap rates. Thus far, we are seeing some slow down in deal volume. Buyers struggle with interest rates and inflation and sellers are slow to accept price reductions.

Speaking of sellers being slow to accept price changes, I thought it might be worth sharing my phases of a seller going through an economic cycle.

Market is strong – “Not interested in selling, it’s still going up.”
Market is turning – “Ok, I will sell but I want higher than what you are telling me.”
Market starts down – “I’m not accepting that, I had higher offers last year.”
Market keeps going down – “I had higher offers two years ago. I’ll wait until it comes back.”
Market really goes down – “I can’t believe I could have gotten so much 2 ½ years ago. I can’t afford to sell now because all I will be able to do is pay off the loan and commission.”
Market in free fall – “It’s never coming back. Commercial real estate sucks! The world has changed forever. Why should I keep paying the bank when it’s worth less than the loan? Can you sell it for more than the loan or work out a short sale for me?”

Back to inflation, I would like to point out that rent and real estate prices are not directly indexed to inflation. Inflation looks like a straight line, but rent and price increases tend to come in bumps and bursts. There are many times where rents go up by CPI and end up much higher than what the market goes up. Rents need to stay between 7% and 15% of gross sales. So, in an inflationary time as long as the tenant has pricing power to raise prices, then they can stomach increased rent. But, if they are not able to increase prices and their expenses (including rent) go up, then they will quickly go out of business.

In the end, however, real estate is one of the best hedges of inflation. That is because as it costs more to build (materials and labor increase), they have to ask more for rent, so existing buildings have margin to raise rents but stay below the new building rents. Eventually tenants all pass it on in their prices. Higher rents equal higher prices and the world keeps moving!

Besides interest rates, inflation, and supply chain issues, you have probably noticed all of the businesses with staffing shortages. The courts and Sheriff’s Departments are facing critical staff shortages and experiencing significant backlogs due to the increased number of eviction filings. It is anticipated that due to the current influx of cases being filed, it will further set back the courts and Sheriffs Departments and will delay their ability to process the volume of cases in a manner most landlords are accustomed to and unfortunately, these are not minor delays. In many jurisdictions, it is taking closer to two months to schedule a lockout as opposed to the two to three weeks it used to take before the COVID-19 pandemic.

I was recently on a flight from LA to Monterey (yes to play a once in a lifetime round of golf) and noticed the plane was filled with bankruptcy attorneys and judges. Turns out, they were heading to a bankruptcy convention (didn’t know there were such things). The buzz was loud, and the energy was palpable. They left some of their materials on the seat and I read the following – which explains the lawyers’ excitement.

“Bankruptcies declined abnormally during the 2020-2021 pandemic period. Without fuel from stimulus and inflation, bankruptcies would have risen significantly in 2020-2021. Just 6,100 business bankruptcies were filed in California during 2021, a fraction of the 63,200 California filings during the 2011 peak year following the 2008 recession.

But today, the economy has started to contract as it ushers in the second act of the 2020 recession. Expect a cyclically disproportionate rise in bankruptcy filings in the next three years, likely exceeding the aftermath of the 2008 recession. For the housing market, leveraged owners who see the equity in their property disappear often file bankruptcy petitions when job loss occurs. Watch for more personal and business bankruptcies, beginning to rise in 2023 and peak in 2026.”

According to Richard Duncan of Duncan Economics, between 2009 and the end of 2021, household sector wealth soared by 150%, increasing from $60 trillion to $150 trillion. To track the household sector wealth, the Fed publishes an index called Household Net Worth as a Percentage of Disposable Personal Income. The index, which is commonly referred to as the Wealth-to-income Ratio, has a 68-year average of 550%. It’s interesting to observe how the index behaved in the face of past examples of record-high stock prices. For example, in March 2000, the index reached a then, all-time high of 615%. Notable for sky-high valuations of soon-to-be failed companies such as WorldCom, Global Crossing, NorthPoint Communications, Alta Vista, InfoSpace, Pets.com, Ask Jeeves, and Excite, this was the apogee of the “dot-com bubble” that burst shortly thereafter. By October of 2002, the NASDAQ 100 had fallen by 78%.

How did the wealth-to-income ratio react? The index reverted to its long-term average of 550%.

In October 2007, the wealth-to-income ratio reached another all-time high of 670%. Over the next 18 months, the Dow fell by more than 50%. The index? It again fell right back to its long-term average of 550%.

As of June 30, 2022, the wealth-to-income ratio stood at a never-before-seen level of 818%. Due of the sell-off in stocks, $16 trillion of wealth has already been destroyed this year, dropping total household wealth to $134 trillion. If over the next several months, the index once again falls back to its long-term average, we can expect an additional $34 trillion in wealth destruction, taking total household sector wealth from $150 trillion down to $100 trillion.

Nick’s Numbers

wealth to income ratio

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

On a positive note, San Diego has finally surpassed its pre-pandemic employment level. Unemployment was 3.2% in San Diego in June. That bodes well for real estate values in the meantime since employment and real estate value are the most directly correlated. Despite these great employment numbers, Lending Club reports that people have horrendous financial literacy with over 36% of Americans making over $250,000 a year reportedly are living paycheck to paycheck.

With another birthday coming this month, I am fastening my seat belt for another trip around the sun. Enough doom scrolling for now. The sun will still come up tomorrow. Just remember what it takes to be rich…hope you enjoy the story.


What makes a person rich?

One day a father of a very wealthy family took his son on a trip to the country with the firm purpose of showing his son how poor people live. They spent a couple of days and nights on the farm of what would be considered a very poor
family.

On their return from their trip, the father asked his son, “How was the trip?”
“It was great. Dad.”

“Did you see how poor people live?” the father asked.

“Oh yeah,” said the son.

“So, tell me, what did you learn from the trip?” asked the father.

The son answered: “I saw that we have one dog and they had four. We have a pool that reaches to the middle of our garden, and they have a creek that has no end. We have imported lanterns in our garden, and they have the stars at night. Our patio reaches to the front yard, and they have the whole horizon. We have a small piece of land to live on and they have fields that go beyond our sight. We have servants who serve us, but they serve others. We buy our food, but they grow theirs. We have walls around our property to protect us, they have friends to protect them.”

The boy’s father was speechless.

Then his son added, “Thanks, Dad, for showing me how poor we are.”

Every 4th of July, the Liberty Bell in Philadelphia is tapped (not actually rung) 13 times in honor of the original 13 colonies.

Cheers to you and Happy Independence Day – may your day be filled with beer, hot dogs, family, and friends.

Two years ago in the early months of COVID (April 2020), I wrote about the impending pandemic and a history of my 35 years in the business. I also implored everyone to keep moving forward (running in my case) and remember that luck is when preparation meets opportunity. Now, two years later, I want to report back.

Two months after I wrote the above letter, I traveled to Arizona for the 4th of July (yep that alone is pretty contrarian!) and purchased a part of a shopping center named, of all things, Corona Plaza with a sports bar as a tenant! The proprietor is a fishing and hunting woman-owned sports bar and let me tell you, I have never met a more resilient tenant (who serves the best chicken wings anywhere). She never closed the doors and never missed a rent payment!

Oddly enough 2019 (pre-COVID) was our worst year and 2020 and 2021 were solid good income years. COVID was just another problem for us to solve in closing a real estate transaction. During the last year, we have done transactions with interesting users that aren’t always in most brokers’ wheelhouse – churches, motels, non-profits, and schools (besides our normal retail, office and industrial users).

We saw spaces and buildings go empty and re-filled them. We also saw spaces that never went empty and others that have never re-filled.

In the last two years, I became a grandfather for the 3rd time, and despite published accounts that “no one was getting married”, we were happy to witness two of our children’s marriages (yes – 4 for 4 are married!). Unfortunately, we lost both of my in-laws who died “with COVID” but not “of COVID.”

On the running front, I have had to adapt. I haven’t been able to run internationally for two years (kind of tough when you are trying to run a marathon on all seven continents!). As racing and travel have come back in the states, I am attempting to run half marathons in all 50 states. At a few per year, I might be done in my 70’s!

So, what is the point of the chatty letter this month? Well, I think that today’s rising interest rates, dropping stock market and rising inflation are heralding an economic downturn which will be the second act of the 2020 recession we just came out of. I want to remind you once again to keep moving forward and look for opportunities to be lucky.

Elon Musk has been vocal that a recession is inevitable and near. During COVID we tried the PPP strategy (paycheck protection program) which cost us $6 trillion, however, Musk gives us a different PPP to deal with the coming recession.

  1. Predict – always stay multiple moves ahead. Live as if it’s here long before it arrives. Know that most successful start-ups started during downturns (Google, Uber, Netflix).
  2. Prepare – get ready for what’s ahead. Put the big risk on pause, cut back on excess spending, reduce overhead, avoid high-interest debt and variable debt.
  3. Persevere – get ahead and stay there. Good reactions, good planning, and good execution. Weather the storm and stay ahead.

Speaking of $6 trillion of COVID PPP, a trillion is a lot of money! (We also just spent $5 trillion on Ukraine and Biden infrastructure and $5 trillion more on quantitative easing). Did you know that if you paid out $1 per second, to settle a $1 mil dollar debt it would take less than 12 days. To pay off $1 billion it would take 32 years. Paying off $1 trillion at a dollar per second? 32,000 years. Wow! I need a beer.

And speaking of beer, beer consumption spans almost the entire world but in San Diego, it adds $300 million to the local economy. Recent news of Stone Brewing being bought by Sapporo and Ballast Point and Modern Times also being sold leaves San Diego with plenty of breweries but no longer with a locally based top 50 brewer. Sapporo plans to brew its beers here which should nearly double the local brewery’s current capacity. Good news for Californians who consume about 25 gallons of beer per capita. We also have the most breweries at 1466 – double any other state.

Nick’s Numbers

This month I thought I would ride on the beer theme with my numbers. It’s also a great consistent tradable commodity to track inflation.

If you’d like to catch a beer and discuss leasing or sales, I welcome the opportunity to share with you some of San Diego’s finest craft breweries.

the price of beer around the world

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

Beer wasn’t the only thing in the local real estate news. Apple recently signed two new office leases in Rancho Bernardo totaling 150,000 sf. That brings their total in RB to nearly 600,000 sf. This rivals the nearly 750,000 sf Apple has leased in UTC. All told Apple is one of San Diego’s biggest tech footprints with a local headcount of about 5000.

I try not to repeat stories. However last month we did back-to-back stories by accident (good news, I still have a story for another month) but this month I am intentionally going to repeat a story that I used in October of 2007 and again in October 2019 (looking back at those dates I appeared to be prescient. I hope you enjoy the story…again…


The Hot Dog Story

Once there was a man who had a stand on one of the busy streets downtown and he sold hot dogs. He sold good hot dogs and folks bought from him on a consistent basis. He put signs up advertising his hot dogs, he placed ads in the newspaper, and he told everyone in his community how good his hot dogs were. And he sold a lot of hot dogs!

So, he increased his inventory. He bought more buns, more hot dogs, more wrappers, and more condiments. He built a new stand and made it larger, added signs advertising his good hot dogs, and kept his sales area neat and clean. He made sure his hot dogs were always hot and that his customers always walked away with a smile. And his sales continued to increase!

He was so successful that he was able to send his son to Harvard University. After graduating with a master’s degree in business, the son returned home to join his father in business. At the end of his first day on the job, the son said: “Dad, I know you’re not educated in Economics, and you have not had the opportunity to read and study the latest journals on business and economic forecasts. But the overall economy is in terrible shape. The huge federal deficit, the trade deficit, oil prices, and the unemployment rates are undoubtedly going to plunge this nation into a horrible recession. I think you should consider these things for future planning.”

The man scratched his head and thought: “Well, my son has the finest university education from the most acclaimed business college in the country. He must know what he is talking about.”

So, the man reduced his inventory by half. He stopped advertising in the newspapers and took down his signs to save money. He quit telling everyone in his community about how good his hot dogs were, and he even went back to using the old cart from years ago. And his hot dog sales went down the tubes almost overnight!

“Son”, the man said to his Harvard-educated offspring, “You sure were right. Damnedest recession I’ve ever seen.”

So, what’s the moral of this story?

A recession mentality starts in one’s head. If you believe that a recession is coming and that times will soon be tough, then they will be for you. Like the old man in the story, you’ll start to change your successful behavior patterns and replace them with less resourceful habits. You’ll sleep in later. You’ll take longer lunch breaks, make fewer phone calls, generate less e-mail, and go home earlier. Keep on selling your products, your services, and yourself. No one can stop you from succeeding but yourself!!

They used to use urine to tan animal skins, so families used to all pee in a pot, and then once a day it was taken and sold to the tannery. If you had to do this to survive you were “piss poor.”

But worse than that were the really poor folk who couldn’t even afford to buy a pot. They “didn’t have a pot to pee in” and were the lowest of the low.

Historically, when the Fed begins to consistently increase its benchmark interest rate, a recession follows 18-36 months behind.

Thus, even as the job losses of 2020 have yet to be fully recovered, the economy is heading for a second recession.

The average interest rate has increased such that the amount of mortgage money available to a typical investor has fallen nearly 25% from December 2020. Absent other changes in circumstance – say, income increases or sudden cash windfalls – investors today are at a major disadvantage compared to just a year ago. Rate increases will lead to reduced demand for properties – and while the drag on prices is not yet perceptible in mid-2022, the decline is imminent.

The irony is that the Fed has been charged to fight the very problem it has helped to create. But, you have to thank them for the best recovery that $6 trillion could buy! Now, the Fed must prove it can control inflation at any and all costs. Maybe it is the old guy in me, but I am a bit worried about the “born in a bull market” generation who have not ever seen a real recession in their adult working life. I am afraid they are confusing brains with a bull market when it comes to their future expectations.

Ultimately, it comes down to knowing the difference between trading, speculating and investing. If you are trading, you value the property, the cost of adding value (construction, re-tenanting, raising rent, etc.) and what you can resell for (you know your profit going in). If you are speculating (buying and assuming it will go up) – stop or get out now. If you are investing, know what your free cash flow is – that’s after inflated expenses and higher debt service. What is your cash return on your cash investment?

On the good news front, unemployment nationally is at 3.5% and in San Diego at an all-time low of 3%. This bodes well for occupancy and rents, but it also emboldens the Fed to keep pumping up rates until unemployment rises.

Inflation is the #1 concern amongst small business owners There is a lot of controversy around the government’s inflation index. The Fed has an incentive to report low numbers. However, it is a bit like the fox guarding the chickens because they are also in charge of what items are in the basket of goods and what they report. If we were to calculate using methods used in the ‘80s and ‘90s, the official inflation rate would be 14% and 10%, respectively. To extrapolate this further, the natural borrowing rate for a loan should be about 3% over the inflation rate. That puts us at projected double-digit borrowing rates! Let me just tell you that if this chicken got out of the hen house and interest rates and cap rates rose to double digits, we’ll all be looking for a pot to pee in!

As we continue to hear about inflation shooting to the moon or outer space, I reflected on the current billionaire-fueled race to space. It is interesting to see that it is now extending to space lodging and orbiting business parks. Fontana-based Orbital Assembly Corp is touting plans for “the first commercially viable, space-based business park with gravity.” Let it be known, that I have volunteered to be the first on-site leasing agent!

Nick’s Numbers

While the Truflation index is based on the same calculation model as the widely used CPI, it is different because it uses real-market price data like Zillow, Penn State, and Nielsen. So where does that leave us with the “real” inflation rate?

Truflation

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

Always keeping my eyes open for new economic indexes, I recently found an interesting one. It’s called the “Men’s Underwear Index.” Since men’s underpants are one of the last pieces of clothing that men look to buy, it’s a good indicator of when times are hard. Apparently, sales of men’s underwear are quite consistent, but dips in sales indicate that men’s finances are so stretched that they decide to hold off on buying replacements (Gives new meaning to the phrase, “Hang onto your shorts!”)

Like many things, inflation, recessions, and good times are all part of our perceived reality…I hope you enjoy the story…


Pennies from Heaven by Julie Bain

My dad loved pennies, especially those with the elegant stalk of wheat curving around each side of the ONE CENT on the back. Those were the pennies he grew up within Iowa during the Depression, and Lord knows he didn’t have many.

When I was a kid, Dad and I would go for long walks together. He was an athletic six-foot-four, and I had to trot to keep up with him. Sometimes we’d spy coins along the way – a penny here, a dime there. Whenever I picked up a penny, he’d ask, “Is it a wheat?” It always thrilled him when we found one of those special coins produced between 1909 and 1958, the year of my birth. On one of these walks, he told me he often dreamed of finding coins. I was amazed. “I always have that dream, too!” I told him. It was our secret connection.

Dad died in 2002. By then, I was living in New York City which can be exciting, or cold and heartless. One gray winter day, not long after his death, I was walking down Fifth Avenue, feeling bereft, and I glanced up and found myself in front of the First Presbyterian Church, one of the oldest churches in Manhattan. When I was a child, Dad had been a Presbyterian deacon, but I hadn’t attended in a long time. I decided to go.

Sunday morning, I was greeted warmly and ushered to a seat in the soaring old sanctuary. I opened the program and saw that the first hymn was “A Mighty Fortress Is Our God,” Dad’s favorite, one we’d sung at his funeral. When the organ and choir began, I burst into tears.

After the service, I walked out the front doors, shook the pastor’s hand, stepped onto the sidewalk—and there was a penny. I stopped to pick it up, turned it over, and sure enough, it was a wheat 1944, a year my father was serving on a ship in the South Pacific.

That started it. Suddenly wheat pennies began turning up on the sidewalks of New York everywhere. I got most of the important years: his birth year, my mom’s birth year, the year his mother died, the year he graduated from college, the war years, the year he met my mom, the year they got married, the year my sister was born. But alas, no 1958 wheat penny—my year, the last year they were made.

Meanwhile, I attended church pretty regularly, and along toward Christmas a year later, I decided I ought to join. The next Sunday, after the service. I was walking up Fifth Avenue and spotted a penny in the middle of an intersection. Oh, no way. I thought. It was a busy street; cabs were speeding by–should I risk it? I just had to get it.

A wheat! But the penny was worn, and I couldn’t read the date. When I got home, I took out my magnifying glass and tilted the copper surface to the light. There was my birth year.

As a journalist, I’m in a profession where skepticism is a necessary and honest virtue. But I found 21 wheat pennies on the streets of Manhattan in the year after my father died, and I don’t think that’s a coincidence.

Even giving my two cents worth each month is shrinking! Mike Tyson is famous for once saying, “Everyone has a plan until they get punched in the face.” I wonder what his seatmate’s plan was when he repeatedly insulted the former world boxing champion on a recent flight? My parents taught me that “sticks and stones may break my bones, but words can never hurt me.” In today’s rude and “cancel culture” it might be time to rethink that colloquialism!

Speaking of a punch in the face, we seem to be climbing a wall of worry. The S&P 500 is down more than 10% from its peak in January. Inflation is at a 40+ year high and ongoing supply chain issues are being extenuated by China’s COVID lockdown and the Russia/Ukraine war. Add rising interest rates and the U.S. political mess and you have to wonder how big a wall we can climb?

In general, inflation is kind to real estate. It can boost cash flow (raise rents) which leads to higher valuations. But that’s with 2% to 3% inflation. With 5% to 10% inflation, it starts eating into consumer spending forcing the Fed to pump the brakes. Consumers are already tapping the brakes themselves. Gas prices were up more than 18% in March, yet sales at gas stations grew by only 9%– telling me people are just not driving as much. In a recent survey, 53% of those surveyed said they had cut back on driving in the last six months. When tenants can’t pay higher rents and cap rates rise because of higher borrowing costs, it can be unkind to commercial real estate or an “RYFO” moment – (Rip Your Face Off)!

I was recently asked if a recession is a certainty, will it affect the booming housing market? My answer, “Yes, it is the only way people will know we are having a recession.”

The second question I am regularly asked is, “What about all of the office vacancy?” My answer remains the same, “It will fill back up.” Sam Zell recently said, “There is no substitute for motivation.” He also said, “I don’t know how you motivate by modem.” I can’t agree more, business leaders I speak with are concerned their culture is deteriorating. People need to be there to hear what they are saying about you. They need to be there to get the plum assignments.

Despite the rise of the metaverse and online working platforms, the vital role of the physical office as a place for collaboration and collective creativity will continue. But what will offices of the future look like? Many experts believe they will become social hubs, suggesting we could see the integration of bars, wellness spaces, expansive communal tables and residential-style lounges. Spaces will be adapted to enhance creativity, relationship building and face-to-face communication between professionals, while the hybrid working model will allow workers to use these new facilities in ways that best fit their own lifestyles and working needs. Cubicle farms are out. In 2022 and beyond, workspace providers will be delivering seamless video-conferencing suites to convivial social spaces, recording studios, hot desks that can be booked by app and al fresco forums for team gatherings.

For many companies, cutting-edge design will be used to boost motivation, creativity and a sense of ‘culture’. Even fun will have an important part to play – just think of tech giants such as Google, which, even pre-pandemic, had Lego zones, slides and bowling alleys built in. Access to green space will also become a major boon, suggesting that major companies could invest in surrounding parks and gardens for employees. Within the building, touchless technology powered by facial recognition, for example, could ease virus concerns. Workplace experience is clearly connected to other areas of focus, such as mental health and well-being, as well as employee retention and productivity. Companies such as Netflix and Jaguar Land Rover are powering the shift, leading the way by employing workplace experience managers to make their offices places where staff are happy to spend their days, and build a positive culture that manifests brand values. Although hybrid workers will only be going into an office or coworking space part-time, when they do, they will have a highly motivating experience. Workplace experience managers can also assist with events and extracurricular activities for teambuilding, which is essential to ensuring a sense of togetherness and inclusion.

Speaking of togetherness and inclusion, as we return to the office and work in these edgy belligerent times, how do we get along, so we don’t get punched in the nose? After all, we are supposed to be working together, not against each other. As we like to say here at CDC Commercial, “We’re here to do deals!”

We live in a world right now of noise and pressure and people feeling polarization everywhere they go. It would be nice for the world to stand still so everyone can catch their breath, but that’s not realistic. So instead, we need tools to work with one another harmoniously. Here are some that we use every day while “doing deals”.

  • Start with empathy – find something to talk about that’s not the subject of your difficulty.
  • Let them empty their cup first – when there is conflict, let the other person speak first. Find out why they believe so strongly in the other direction.
  • Be curious – lead with a question (my favorites always start with “why”. Remember everyone is comfortable in their own realty.
  • You may be closer than you think – find points of agreement.
  • Choose acceptance – acceptance is understanding the situation for what it is, even if you don’t agree.
  • Show respect – agree to disagree.

As much as I love our new digital world of Venmo, DocuSign and wiring funds, fraud is on a huge increase. Please be careful with your wire transactions:

  • Call, don’t email (get numbers from original documents or business cards)
  • Be suspicious – there shouldn’t be changes
  • Confirm all #’s
  • Verify when sent and/or received

Last year, Prop 19 went into effect. The impact of Prop 19 is just starting to be felt – another RYFO moment for many families. As most of you know, Prop 13 caps property taxes at 1% of the assessed value. So, property taxes typically didn’t increase much until a sale of the property. Prior to Prop 19, parents could transfer/bequeath property to their children, and the transferred property would retain its property tax basis despite the change of ownership. Now, either your heirs (under a gross lease) or tenants (under triple net leases) could see a big property tax increase. Time will tell, but the impact could make it difficult for heirs to retain property (there are some exclusions, but it affects residential property as well). For generations now, many homes were passed from homeowners to their children, providing them with homes in areas that would otherwise be impossible for them to move into, such as San Francisco or the beach communities of Southern California. You should definitely speak to your tax advisors, but there may be some workarounds available. A long-time friend, partner and attorney, Larry Murnane, provides this one as an example.

Nick’s Numbers

To illustrate Don’s point about inflation and the accompanying loss of confidence by consumers and small business owners, I have enclosed a couple of very illustrative charts. If you would like an evaluation of your property value, let me know.

consumer price index for urban consumers

conference board consumer confidence index

Please give me a call or email me if you would like an analysis of your properties’ value or discuss what you should be doing with regards to interest rates or inflation and their impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommerical.com).

Since I got into the business, I have heard about 18-hour and 24-hour cities (think London, NYC, and San Francisco). Envious cities have tried to grow to this status. Frankly, it’s never been that attractive to me. However, my head was recently turned by an idea pioneered by French academic Carlos Moreno. It’s called the 15-minute city. The idea is for your work, live and play to all be within a 15-minute walk or easy bike ride. This could be one of the most dramatic and long-lasting legacies of the pandemic. I hope you enjoyed my two cents worth this month and the story…


Pennies from Heaven by Julie Bain

My dad loved pennies, especially those with the elegant stalk of wheat curving around each side of the ONE CENT on the back. Those were the pennies he grew up with in Iowa during the Depression, and Lord knows he didn’t have many.

When I was a kid, Dad and I would go for long walks together. He was an athletic six-foot-four, and I had to trot to keep up with him. Sometimes we’d spy coins along the way – a penny here, a dime there. Whenever I picked up a penny, he’d ask, “Is it a wheat?” It always thrilled him when we found one of those special coins produced between 1909 and 1958, the year of my birth. On one of these walks, he told me he often dreamed of finding coins. I was amazed. “I always have that dream, too!” I told him. It was our secret connection.

Dad died in 2002. By then, I was living in New York City which can be exciting, or cold and heartless. One gray winter day, not long after his death, I was walking down Fifth Avenue, feeling bereft, and I glanced up and found myself in front of the First Presbyterian Church, one of the oldest churches in Manhattan. When I was a child, Dad had been a Presbyterian deacon, but I hadn’t attended in a long time. I decided to go.

Sunday morning, I was greeted warmly and ushered to a seat in the soaring old sanctuary. I opened the program and saw that the first hymn was “A Mighty Fortress Is Our God,” Dad’s favorite, one we’d sung at his funeral. When the organ and choir began, I burst into tears.

After the service, I walked out the front doors, shook the pastor’s hand, stepped onto the sidewalk—and there was a penny. I stopped to pick it up, turned it over, and sure enough, it was a wheat 1944, a year my father was serving on a ship in the South Pacific.

That started it. Suddenly wheat pennies began turning up on the sidewalks of New York everywhere. I got most of the important years: his birth year, my mom’s birth year, the year his mother died, the year he graduated from college, the war years, the year he met my mom, the year they got married, the year my sister was born. But alas, no 1958 wheat penny—my year, the last year they were made.

Meanwhile I attended church pretty regularly, and along toward Christmas a year later, I decided I ought to join. The next Sunday, after the service. I was walking up Fifth Avenue and spotted a penny in the middle of an intersection. Oh, no way. I thought. It was a busy street; cabs were speeding by–should I risk it? I just had to get it.

A wheat! But the penny was worn, and I couldn’t read the date. When I got home, I took out my magnifying glass and tilted the copper surface to the light. There was my birth year.

As a journalist, I’m in a profession where skepticism is a necessary and honest virtue. But I found 21 wheat pennies on the streets of Manhattan in the year after my father died, and I don’t think that’s a coincidence.

“The point to remember is that what the government gives, it must first take away.”

~ John S. Coleman

Although the quote above is both funny and true, it is not entirely accurate. If taxing was the only way our government paid for things, our taxes would be much higher. Instead, our government prints more money by borrowing it with no intent to pay it back. This simply devalues our currency, effectively taxing you out of your money. In a simple example, that $3 gas or $3 hamburger you used to enjoy is now $6 – you just experienced a 100% tax!

The two-edged sword is that the Federal Reserve is tasked with fighting inflation. They started doing so at their March meeting by raising interest rates a quarter percent. Unfortunately, this increases borrowing costs which leads to greater costs of goods and services until…it puts a damper on economic activity.

Shorter term rates (overnight lending all the way to two-year Treasuries) are affected by the Federal Reserve rate increases. Long-term rates 10–30-year Treasuries (and yes, home and commercial loans) are determined by market supply and demand. However, there is a warp in the universe when those short-term rates are higher than the long-term rates. This makes no sense. Why get a better return on a short-term loan than a long-term one where there is far more risk? Going back to the 1950s, every time the two-year treasury yield has exceeded the yield on the 10-year Treasury, a recession wasn’t far behind. The last time such an inversion occurred, briefly, was in August 2019, and we all know what happened the following year. Although there is no way the pandemic could have been predicted, an economic pullback was highly probable. This phenomenon is called the yield curve inversion.

This month Bank of America sounded the alarm, telling clients it expects an inversion to occur sometime this year as the Fed is forced to raise rates to slow inflation and slow the U.S. economy. With inflation running at a scorching 7.5% over last year, the Fed may be compelled to hike rates more aggressively than initially planned, which could shock economic growth.

BREAKING NEWS: Yesterday March 31st the 10/2 Yield Curve became inverted – Beware!

As of the first of the year, California is 1.2 million jobs above last year, but we are still 690,000 below the pre-recession December 2019 peak. The 2020 recession was officially the shortest on record, but the hangover continues today. Government stimulus (see printing money above) is catching up with us in the form of inflation (“pay me now or pay me later”).

While lost income from high unemployment normally results in reduced sales volume and prices in real estate, the opposite occurred in 2020-2021. Recessionary conditions never took hold in the housing market due to the combination of historically low inventory for sale, unparalleled loan rate reductions, massive cash disbursements to consumers and foreclosure and eviction moratoriums. As these events reverse course in 2022 hang on to your hat and look for opportunity.

If you are like most of us, looking for your next mini-series to watch, you might check out “WeCrashed.” It is the story of WeWork, the co-working office space company, and it is on Apple+ (you can subscribe free for a week). Being in real estate makes it fun to watch how landlords, tenants and brokers are portrayed. It’s the repeating real estate story we see daily as leasing brokers. The guy with a dream–faking it until you are making it. In Adam Neumann’s case, a zero to $47 billion valuation. If you want to see the antithesis of how “fake it until you make it” doesn’t work out, you may want to watch “Inventing Anna” on Netflix.

As March madness comes to an end, I reflected on how people pick their brackets. Some people pick their favorite team to win and then work backwards. They fill in their pool based on a fixed notion for which team is best. They disregard the path no matter how hard it might be for their team to become champion. This reminds me of how some people buy real estate. “It doesn’t matter what the price or value is, I want it.” Others pick their bracket based on potential match up, analyze records, schedule strength, skills, weaknesses and even how the team travels. This also reminds me how people should buy real estate. They pick based upon a path to becoming a champion.

So, why do many investors use a less rigorous process in investing than they do in filling out their NCAA tournament brackets? Over the long run, those who follow a well-thought-out, time-tested, process-oriented approach will raise the odds of success in compounding wealth by limiting damaging losses during significant market setbacks and being afforded generational opportunities when others are fearfully selling.

Real estate investing deserves considerably more thoughtfulness than filling out a bracket.

Nick’s Numbers

Here is a chart that illustrates Don’s point about the yield curve and recessions.

2s10s yield curve

Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommercial.com).

Like most of you, I have been shocked and appalled by Russia’s invasion of Ukraine. Corporate America has responded by pulling brands out of Russia, but in a weird turn of events, closed McDonald’s locations have been taken over, renamed Uncle Vanya and had the famous “golden arches” turned on their side while maintaining the same color scheme (I wonder if Uncle Vanya is dressed as a red headed clown?).

As you prepare to give the government a share of last year’s income, I hope you enjoy this month’s story…


The IRS decides to audit Grandpa and summons him to the IRS office. The auditor was not surprised when Grandpa showed up with his attorney.

The auditor said, “Well, sir, you have an extravagant lifestyle and no full-time employment, which you explain by saying that you win money gambling. I’m not sure the IRS finds that believable.”

“I’m a great gambler, and I can prove it,” says Grandpa. “How about a demonstration?”

The auditor thinks for a moment and says, “Okay. Go ahead.”

Grandpa says, “I’ll bet you a thousand dollars that I can bite my own eye.”

The auditor thinks a moment and says, “It’s a bet.”

Grandpa removes his glass eye and bites it. The auditor’s jaw drops.

Grandpa says, “Now, I’ll bet you two thousand dollars that I can bite my other eye.”

Now the auditor can tell Grandpa isn’t blind, so he takes the bet. Grandpa removes his dentures and bites his good eye.

The stunned auditor now realizes he has wagered and lost three grand, with Grandpa’s attorney as a witness. He starts to get nervous.

“Want to go double or nothing?” Grandpa asks. “I’ll bet you six thousand dollars that I can stand on one side of your desk, and pee into that wastebasket on the other side, and never get a drop anywhere in between.”

The auditor, twice burned, is cautious now, but he looks carefully and decides there’s no way this old guy could possibly manage that stunt, so he agrees again.

Grandpa stands beside the desk and unzips his pants, but although he strains mightily, he can’t make the stream reach the wastebasket on the other side, so he ends up urinating all over the auditor’s desk.

The auditor leaps with joy, realizing that he has just turned a major loss into a huge win. But Grandpa’s attorney moans and puts his head in his hands.

“Are you okay?” the auditor asks.

“Not really,” says the attorney. “This morning, when Grandpa told me he’d been summoned for an audit, he bet me twenty-five thousand dollars that he could come in here and pee all over your desk and that you’d be happy about it.”

In June of 1812, Napoleon with all of his generals plotting to invade Russia was strategy. Getting half a million soldiers to march into Russia was culture!

In a recent interview, a glass half full of water was placed in front of me. I was asked if I was a pessimist or an optimist. I proceeded to knock back the glass of water and responded, “I’m a problem solver.” These days it is easy to get bogged down in fear. However, it is important to notice something needs to be done and get it done. So many today might entertain a thought and consider it worthy of action but leave it for later (or never). It is easy to get bogged down in fear. At CDC Commercial we are working daily to cut through the “stuff” and get the job done!

We experienced Another Upbeat Year according to local economist Alan Nevin. His great report is linked below. Note, however, he does start out with the 12 plagues that we have experienced.

Vertex 2022 U.S. & California Economic Forecast

COVID-19’s second anniversary is upon us, now what? We have lost over 900,000 Americans and over 4,800 San Diegans who have died with COVID. We are experiencing challenges with child development as kids lag from two years of modified school and the lack of social contact. Behavioral health issues have increased dramatically while drug overdoses have spiked. The precautions we exercised due to COVID separated us. Social media exacerbated everything. If you spend five minutes on social media, you’ll see a chasm of divisiveness. Debates spin out of control creating another kind of separation. We live in a society of people who want the front of the bus, the back of the church and the center of attention.

On a regular basis, I am asked, “What’s going to happen when the Fed raises rates?” What I know is when the Fed starts to slow or drain its monetary liquidity, the clock starts ticking to the next corrective cycle.

History shows us what will happen. Once the Fed begins to hike interest rates, corrections in markets occur quickly– generally within 2-4 quarters. However, recessions and bear markets generally take a while longer and have sometimes been extended due to ongoing interventions. The current median time frame between the first-rate hike and the onset of a recession is 11 quarters.

Note: there are ZERO times in history where the Fed hikes rates that did not end negatively.

In the meantime, in the field or battlefield as it often seems, we are seeing lots of different activity. Commercial space is starting to get upcycled. We are seeing office space be converted to residential, shopping centers and office buildings being converted to biotech and lab space. All kinds of property being torn down for multifamily construction. In retail, we are seeing a resurgence of store inside of a store. Toys ‘R’ Us is back but within Macy’s. Sephora is expanding within Kohl’s and Bed Bath & Beyond is opening within Krogers.

Meantime, millennials are finally heading to the suburbs. Whether it is COVID that has flushed them out of urban markets or their biological clocks going off, millennials are going to urbanize suburbia! Look for more Amazon delivery and Uber Eats in the neighborhood and small pop-up shops in old downtowns and shopping centers. Look for more multigenerational housing (millennials using parents’ money to buy in return for living in the ADU (additional dwelling unit) or “Granny Flat.” Time for the gray wave to start moving into the millennial’s basement! (Payback is a bitch!).

NICK’S NUMBERS

Biotech is booming which is what is forcing the upcycling of properties to create more space.

Biotech investment in San Diego reaches record high

I threw in an extra chart illustrating Don’s point about rate hikes and recessions.

Fed & 10-year interest rates vs real economic growth

Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommercial.com).

Former Federal Reserve Chief Ben Bernanke used to say the Federal Reserve was a hall of mirrors. He said this because the Fed listens to the market and the market listens to the Fed. It would seem we need some leadership…or maybe some culture instead of strategy. In the meantime, last month I questioned where all of the workers were. I am glad to report our research has found the answer to that AND why you and I are sooo tired. I hope you enjoy the story…


Are you tired?

I have run across some irrefutable statistics that show exactly why you are tired. And it’s no wonder. There aren’t as many people actually working as you may have thought, at least according to recent surveys.

The population of this Country is about 300 million. 85 million are over 60 years of age, which leaves 215 million to do the work. People under 20 years of age also total about 85 million which leaves 130 million to do the work.

There are about 30 million employed by the government, which leaves 100 million to do the work. There are about 5 million in the Armed Forces and about 23 million unemployed (as of April 2020) which leaves 72 million to do the work. 55 million have mental health issues and 15 million work in city and state offices leaving us with 2 million to get the work done.

Now it may interest you to know that there are 1,999,998 people in jail, so that just leaves two people to carry the load. That’s you and me and I don’t know about you, but I am sure getting tired!

He was a lowly intern in Philadelphia picking up dry cleaning or fast food for coaches… He was promoted to a coach’s assistant for a few years and then a scout for a few more. A decade later in Kansas City, he was mesmerized by a player on video no one else saw. “What’re you watching? Kansas City Chiefs Coach Andy Reid asked Brett Veach. “The next quarterback of the chiefs,” replied Veach. He wasn’t just enamored by Mahomes, he was borderline obsessed. He contacted Mahomes’ agent for 94 straight days heading into the draft. Yet no one saw it. When Mahomes was drafted he was graded as a C+ pick at best. Yet with that one value-based decision, one man is the face of the NFL (maybe not as much after Sunday’s loss to the Bengals!), and one lowly intern is the general manager of the Kansas City Chiefs!

I keep reading the economists prognosticating that 2022 will be a strong growth year, and no stop to rising markets (real estate, stocks, etc.). However, I am reminded of the quote, “Economists know the price of everything but the value of nothing.” Just remember that market conditions can and do change. Football analysts, economists, and investors like to believe things will continue to be the same in the future as they are now. This is called, “normalcy bias.” We’re still in that fear of missing out (FOMO) stage. Rates are rising and buyers of property (residential and commercial) are trying to jump in before they go up further. Eventually, the pendulum swings to FOBO – fear of better opportunities. This phenomenon occurs when buyers hold back because they are afraid prices will go down further. It is also referred to as, “Don’t try to catch a falling knife.”

To be clear, I am not saying we are in a bust, but trees don’t grow into the clouds. At the same time, commercial property investors have been getting it wrong for two years waiting for distressed sales which haven’t materialized. The apartment industry thought it would face an eviction crisis, instead, rent grew 11% and owners hung on and many sold for record prices. The pandemic killed almost all retail but in 2021 there were more store openings than closings. Unemployment levels skyrocketed during the pandemic, yet unemployment rates are now near pre-pandemic levels. Another one we got wrong is inflation. Fed Chair Jerome Powel said inflation is “transitory” but it doesn’t appear to be coming down anytime soon.

President Calvin Coolidge once said that inflation is repudiation. Webster defines repudiation as, “an act or declaration before performance is due under a contract that indicates that the party will not perform his or her obligations.” Thought-provoking!

During recessions, central banks typically respond by cutting interest rates, which stimulates the economy by encouraging more borrowing and reducing the relative debt cost. This process of debt accumulation and lowering interest rates repeats itself for decades. When interest rates hit the floor at 0% it marks the beginning of the end of the long-term debt cycle and the start of a deleveraging period where central bankers begin to devalue their currencies. Interest rates can no longer be lowered because they are at zero. Therefore, policymakers only have two remaining options: quantitative easing (i.e., printing money and buying financial assets) or printing money and putting it directly into the hands of people in the form of stimulus payments. In the words of Ray Dalio: “When the risk-free interest rate that they control hits 0% in a big debt crisis, central banks lowering interest rates doesn’t work. That drives them to print money and buy financial assets. That happened in 1929-33 and 2008-09. We call the power of central banks to stimulate money and credit growth in these ways “the amount of fuel in the tank.” Right now, the world’s major central banks have the least fuel in their tanks since the late 1930s so are now in the later stages of the long-term debt cycle.”

The late economist and stock picker Richard Russell used to say, “inflate or die.” He meant that the Fed was committed to fighting deflation and when faced with debt, they would crank up the printing presses.

What stops inflation? People’s belief and acceptance that it is contained. How does that happen? Interest rates go up and everything else goes down (yes, that includes real estate). Then the Fed steps in – see paragraph above. Goldman Sachs recently predicted that the Federal Reserve will be raising rates four times in 2022 (up from earlier predictions of three times).

Goldman Sachs also reports that 98% of small business owners in CA report that labor shortage is affecting their bottom line. Eighty-one percent report inflation, 77% site supply chain, and 70% say COVID-19 is dragging on their bottom line. The mystery to me, however, is the disappearing workforce. Although the San Diego unemployment rate has dropped to 4.2% in December (5% for CA and 3.7% for the U.S.), we still have almost a million fewer workers employed in California than in January 2020 before the pandemic.

One thing you can expect to go up is property insurance. The supply chain and inflation are making repairs to commercial properties more expensive with higher costs for labor, lumber, and steel.

NICK’S NUMBERS

Please give me a call or email me if you would like an analysis of your properties’ value or to discuss what you should be doing with regards to the Coronavirus pandemic and its impacts on your business, tenants, or property (Nick Zech, 858-232-2100, nzech@cdccommercial.com).

Another thing that boomed in the pandemic despite predictions was the industrial market! Biotech accounted for 15% of the new office and industrial leasing in San Diego in 2021. Amazon signed 4 leases in the County for almost 2 million square feet accounting for 13% of completed leases in 2021.

industrial leasing boom

 

A little early but Happy Valentines Day to you. Did you know that chocolate manufacturers currently use 70% of the world’s almonds and 20% of the world’s peanuts? And now for the interactive part of this letter. Email me and let me know if 2021 were a candy, what would it be? And if 2022 were a candy, what would it be?

This month’s story is a video production that I thought you would like. It is a bachelor-like episode poking fun at what it is like as a tenant being courted by a property owner (get it – won’t you be my Valentine humor!). Hope you enjoy it…


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