“There is no wealth but life.” ~ Ruskin
I assume most of you watched and enjoyed the Super Bowl a couple of weeks ago. It was interesting because most of these season finales turn out to be sort of ho-hum. This year was a nail biter to the end. On the other hand, I usually look to the commercials to see an expression of great creativity and humor. This year’s ads were frankly awful! I’m afraid that what we saw on the field was the result of incredibly hard work and flawless execution. What we saw between snaps was the kind of creativity you get when you phone it in while working remotely and collaborating by Zoom.
I think something has been going on in our society for some time and it has been exacerbated by the media, social media and COVID, etc. It is called Effort Shock. You can imagine millions of working types saying, “All right, I have NO free time. I work every day, all day. I come home and take care of the kids. We live in a tiny house, with two shitty cars. And we are still deeper in debt every single month.” So they borrow and buy on credit because they have this unspoken assumption that, dammit, the universe will surely right itself at some point and the amount of money we should have been making all along (according to our level of perceived effort) will come raining down.
Meanwhile, the rich get richer. The top 0.1% own close to 20% of all household wealth. The top 10% control about 77% of national wealth. The bottom 25% of households have a negative net worth. Income inequality may be a factor in the stagnation process given that a few wealthy people cannot drive an economy by themselves. In other words, the richest 1% might buy a lot of shoes, but cannot buy enough to keep all of the shoemakers employed. You need workers with enough money to buy shoes too. Karl Marx wrote that workers need to be paid in relation to the value they create. Speaking of value, do you ever question how Tesla can be worth 20 times more than Toyota? In 2018, there was a Canadian marijuana company that was worth more than American Airlines (to be fair, I was worth more than General Motors in 2007 when the government bailed them out!). Another area where we appear to have also suspended our disbelief is California tax revenue. Last month, Governor Newsom announced a $22.5 billion budget deficit, and it now appears he underestimated that by $7 billion. That’s despite California having the highest top income tax rate of any state. Indeed 0.5% of taxpayers pay about 40% of California’s state income tax. Another eye-popping statistic: just nine companies headquartered in the Golden State went public in the first three quarters of 2022, compared to 81 for the same period in 2021 according to Bloomberg News. These IPOs raised just $177 million compared to an average of $16 billion during the same period over the past five years.
Same goes for Venture Capital funding in San Diego, which fell by 50% in 2022. This has led to a 39% drop in leasing activity in the fourth quarter of 2022. On an annualized basis, there was 10% less office space leased in 2022 compared to 2021. The office market has been struggling to find its footing since the pandemic. This has translated to less leasing activity and smaller requirements (and shorter terms, all of which leads to less money for landlords and brokers).
A slowdown in office leasing has a lot of impacts above and beyond its impact on office building valuations. One of those is a booming market for used office furniture. Powered by Craigslist and Facebook Marketplace, traders are profiting from the amount of occupiers looking to get rid of their office furniture right now. The environmental effect of so-called “f-waste” is often overlooked, but the numbers are truly staggering. More than 12,000,000 tons of furniture are dumped annually, and less than half a percent of it is recycled or reused. That’s a catastrophe that has only been exacerbated as the pandemic has accelerated.
Speaking of less leasing and sale activity, Marcus & Millichap reported a 48% decline in commission revenue during the fourth quarter of 2022. Newmark reported a 62% decrease in property sales and Colliers reported a 9% decrease in commission revenue for the fourth quarter 2022. CDC Commercial meantime had a great 2022 and is off to a record start for 2023 (pizza and beer for all!). That’s my idea of income inequality!
Back to income inequality for a minute. It is well-known (or believed) that inequality in the Scandinavian countries is much less than in the U.S. The reason, we assume, is that government redistributes wealth in those countries from rich to poor to a much greater extent than the U.S. does. However, the U.S. does nearly as much redistribution. It’s how we record it (or don’t) that makes us look Scrooge-like.
In 2017, the average household with earned income in the bottom 20 percent of all households received more than $45,000 in government transfer payment; yet, remarkably, Census failed to count nearly $32,000 of those transfers as income to the recipients. This substantial omission has caused the Census calculations of income inequality and the poverty rate to be seriously overstated. In addition, the expanding number and size of these transfer payments has caused the overstatement of inequality and poverty to grow over time.
Because in 1947, over 90 percent of all employment compensation and government assistance was received in cash payments and it was difficult to measure the value of non-cash payments, the decision was made to define income simply as the total of all cash payments received. At the time, cash payments received were reasonable approximations of total income.
Those non-cash payments include food stamps, Medicare, Medicaid, housing subsidies, and numerous other government benefits to the poorer sector of the population that have not been classified as cash payments. They are not the same as cash payments, of course; food stamps cannot be used to buy whatever the recipient wants to buy, and the same is true for Medicare and Medicaid and other benefits. Nevertheless, they substitute for what otherwise would be a need to spend out of other income, for food, for medical care, for housing, and therefore are as good as cash payments for cash-strapped recipients.
Meanwhile, households in the top fifth of the income scale lose 35.2 percent of their pretax income to taxes, including federal, state, local and sales tax. But this income is reported by the Census before taxes.
In short, there is a massive transfer from the incomes of the higher earners to the incomes of the lower earners, but most of those transfers are not reported in income figures by the U.S. Census.
Well, if 2023/2024 turn out to be anything like 2007/2008, dentists will be in the money. Months after the Lehman collapse in 2007, the Chicago Dental Society reported that 2/3 of its members had seen a rise of teeth and jaw clenching amongst patients (Bruxism) causing broken fillings, worn down teeth and jaw pain. All caused by high levels of stress caused by hard times.
Nick’s Numbers
The ISM Manufacturing Index has an excellent track record of signaling recessions. Furthermore, as shown below, it led unemployment by about nine months.
The graph above shows that every time ISM has fallen below 45, employment has declined on a quarterly basis. The following chart shows that nine of the last 10 recessions were accompanied by ISM below 45. The only time such did not occur was in 2020.
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).
A lot could change with the economy’s outlook over the next few months as the impact from the Fed’s aggressive rate hikes over the past year builds and more readings on inflation and recession come in.
We can’t predict what will happen, but these developments have little bearing on how we invest for the long run.
“…an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace.” ~ Warren Buffett
I hope you enjoy the story…
The Pizza Story
Suppose that every day, ten men go out for pizza and the bill for all ten comes to $100.
If they paid their bill the way we pay our taxes, it would go something like this:
The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that’s what they decided to do. The ten men ate at the pizza parlor every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve.
‘Since you are all such good customers,’ he said, ‘I’m going to reduce the cost of your daily pizza by $20.’ Eats for the ten now cost just $80.
The group still wanted to pay their bill the way we pay our taxes, so the first four men were unaffected. They would still eat for free. But what about the other six men – the paying customers? How could they divide the $20 windfall so that everyone would get his ‘fair share’?
They realized that $20 divided by six is $3.33. But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being paid to eat his pizza. So, the bar owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
And so the fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).
Each of the six was better off than before. And the first four continued to eat for free. But once outside the restaurant, the men began to compare their savings.
“I only got a dollar out of the $20,” declared the sixth man. He pointed to the tenth man, “but he got $10!”
Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too … It’s unfair that he got ten times more than I did!”
“That’s true!!” shouted the seventh man. “Why should he get $10 back when I got only two? The wealthy get all the breaks!”
“Wait a minute,” yelled the first four men in unison. “We didn’t get anything at all. The system exploits the poor!”
The nine men surrounded the tenth and beat him up. The next night, the tenth man didn’t show up for eats, so the nine sat down and had pizzas without him. But when it came time to pay the bill, they discovered something important. They didn’t have enough money between all of them for even half of the bill!
And that, boys and girls, journalists, and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start eating overseas where the atmosphere is somewhat friendlier.
-David R. Kamerschen, Ph.D., Professor of Economics, University of Georgia
