The Trump Effect on Commercial Real Estate

Donald Trump has won the US presidency in a shocking upset. News of his victory coursed through global stock markets, causing them to briefly tumble, though they stabilized quickly thereafter. While Trump came to power by exploiting a surge of populist sentiment, there are many open questions as to what the real estate mogul’s presidency will look like for businesses, and commercial real estate (CRE) in particular.

Major Planks in Trump’s Economic Platform

“Despite all the noise, Trump in my mind won on a promise of growth,” said John Kevill, Avison Young principal and managing director for U.S. Capital Markets. “His proposed infrastructure spending, plans for lower taxes, moving jobs back and a target of 4% growth all speak to that. If it appears that things are starting to happen in that regard, expect CRE investment to follow as yield will look to be relatively attractive.”

Trump has, among many other things, run on a platform of protectionism, wall-building, and economic growth. If he succeeds in bringing manufacturing back to America and follows through on his vow to construct a US-Mexico barrier, it could portend a greater volume of construction, including factories, warehouses, and commercial offices– particularly in the Rust Belt. Yet there are also the negative feedback effects of protectionism to consider. For instance, while manufacturers stand to gain from such policies, developers who source construction materials may face higher prices born of decreased competition.

Trump has also vowed to boost defense spending and invest $1 trillion in infrastructure, which also presages a construction boom. Accordingly, Caterpillar’s stock, following his victory, surged 7.7%. Increased government spending in such sectors will likely lead to an expanding portfolio of properties owned by the government.

“We will more than likely see a significant increase in spending on real estate by the General Services Administration (GSA), government contractors, consultants, and, of course, lobbyists,” said John Kevill, Avison Young principal.

And, with the House and Senate firmly under Republican control, some are predicting reduced political gridlock and dysfunction, paving the way for Trump to follow through on his promises to pare back corporate and individual taxes as well as to roll back Dodd-Frank regulations. This also augurs well for CRE. In particular, Trump has proposed taxing long-term capital gains on real estate ownership and investment at a maximum rate of 20%, judiciously capping business interest expense deductibility, and taxing carried interest as ordinary income.

Luxury Real Estate

Despite the outstanding uncertainty surrounding the nature of, and policies proponed by a Trump presidency, some are confident that, given Trump’s background, he will be a champion for the luxury real estate sector in the US and abroad.

Trump’s win “will bring a property industry leader into the White House for the first time in American history. Without a doubt a Trump presidency will be pro-property and pro-real estate,” said Peter Wetherell, a London-based real estate broker and CEO of Wetherell.


Tempur Sealy Shares Plunge Following Lower 2016 Sales Guidance

Shares of Tempur Sealy International plummeted by 22% to $57.60 following the dismal sales guidance issued by the company, informing investors to expect a 1% to 3% decrease in net sales for 2016 compared to last year. Tempur Sealy also put its revised EBITDA at between $500 million and $525 million, down from the EBITDA guidance of $525 million to $550 million that it issued earlier this year in July.

“While our net sales are below expectations, our operational initiatives are going well and are continuing to drive considerable margin expansion,” Chief Executive Officer Scott Thompson said in a press release. “We currently expect net sales for the full year to be down 1 to 3 percent as compared to 2015.” Thompson, who was brought on board by activist investor H Partners Management LLC, has been aiming to cut costs and boost profit margins at the company in keeping with his mandate.

While Tempur Sealy has not been forthcoming with reasons for the decreased guidance, one likely culprit is the booming online market for mattress sales by e-retailers such as Casper and Tuft & Needle. These companies represent only $300 million, or 2% of the industry, but have captured 13% of non-innerspring mattress sales, and continue to increase market share rapidly.

Another factor put forth by The Wall Street Journal is that the rebranding efforts of Steinhoff International Holdings have had a detrimental effect on mattress sales. Steinhoff recently acquired Houston-based The Mattress Firm, the largest US specialty mattress retailer, and currently accounts for 25% of Tempur Sealy’s sales.

Tempur Sealy will release its third quarter results on October 27. According to USA Today, analysts surveyed by S&P’s Global Capital Intelligence forecast $834.5 million in revenue for the third quarter, down from $880 million in revenue that the company made during the same quarter in 2015. Analysts are also projecting $3.1 billion in revenue for the full year, down from $3.15 billion in revenue for 2015.


CALPERS Votes to Gradually Reduce Discount Rate to 6.5%

The California Public Employees’ Retirement System (CALPERS), the largest public pension fund in the United States, announced in November 2015 its plans to reduce its discount rate from 7.5% to 6.5% incrementally over the next twenty years. This latest reduction in projected investment returns followed a March 2012 discount rate decrease from 7.75% to 7.5%.

“Ensuring the long-term sustainability of the fund is a priority for everyone on this board, and this policy helps do that,” said Rob Feckner, President of the CalPERS Board of Administration. “It makes significant strides in lowering risk and volatility in the System, and helps lessen the impacts of another financial downturn.”

CALPERS currently has $410 billion in unfunded liabilities owed to 1.7 million former and current public employees and $300 billion in assets, 77% of which was funded as of the end of 2015, according to Chief Investment Officer. While CALPERS has averaged 7.8% returns over the past 20 years and 11% over the last five years, investment earnings have not been stable. In 2014-15, it posted a mere 2.4% in returns, and in 2015-2016, an abysmal 0.6%, according to the Sacramento Bee.

Judging that maintaining high expected rates of return is untenable and would only encourage risky investments and generate volatility, CALPERS has opted for reduced expectations. The pension fund voted to reduce its annual forecast of investment profits as part of its risk mitigation strategy, which will likely result in safer investments and lower returns, although the move forces government agencies, their employees, and taxpayers to pick up the slack and increase contributions. Specifically, the strategy lowers discount rates during years of good investment returns, aiming to provide greater predictability, reduce volatility, and help pay down the funds sizeable unfunded liabilities. The policy mandates that CALPERS reduce its discount rate by a minimum of 0.05% and a maximum of 0.25% when investment returns outperform the 7.5% discount rate by at least four percentage points and concomitantly bump up contribution rates.

Credit rating agency Moody’s has argued that the move still leaves CALPERS vulnerable to “sharp asset declines” even before the policy is fully implemented, while pushing up liabilities and costs.


Rental Households Continue to Increase as U.S. Homeownership Plummets

According to recent figures released by the Census Bureau, homeownership in America has dwindled while the incidence of renting is rising steadily. As of June 30, 2016, there were 118.3 million households in the US, 63% (74.4 million) of which were “owners” and 37% (43.9 million) of which were “renters. The number of homeowners has been flat for the past year whereas the number of renters has increased by 1.0 million.

Even as the housing market improves, leading to upticks in housing prices, sales, and investment, it has forced increasing numbers of American households to rent and placed homeownership out of reach. In the decade between 1996 and 2006 the split between owners and renters, respectively, rose from 65/35 to 69/31. The percentage of owners has since sunk below 1996-levels, a trend which shows no sign of stopping.

According to Harvard’s Joint Center for Housing Studies, the number of new rental households has steadily increased by 770,000 per year since 2004. In 2013, the Center found that nearly half of rental households spent more than 30% of their income on housing.

Some households have been pushed to rent due to low credit scores and stringent credit standards instituted following the recession. Millennials, saddled with low-paying jobs and student loans, have also struggled to make the down payment on a home.

Another contributing factor is the dearth of affordable housing, low rate of housing starts, and the overall housing inventory storage in the U.S. Exacerbating this factor is the fact that rental operators continue to acquire 10-15% of new single-family homes built in the U.S.

More and more households are instead pushed to rent, driving rental costs to rise faster than inflation, especially in major metropolitan areas. This vicious cycle, in turn, hits low- and middle-income households in their checkbooks, forcing them to apportion greater shares of their income for housing.

According to the Wall Street Journal, economists expect this trend to continue on in the short term, especially in cities.

“It’s more of a new normal,” said Robert J. Shiller, Yale economist and Nobel Laureate, to the New York Times. “We went through a wrenching experience with the biggest housing bubble and the biggest collapse since 1890. This is an anxious time.”



2016 U.S. Housing Market Faces Inventory Shortage

Barron’s has conducted an interview with Ivy Zelman, in which the famed housing analyst warns of a critical shortage of housing inventory in America. Zelman, who rose to prominence for betting against home builders in 2006, states in the interview that, four years into the post-recession housing recovery, America is still 35% below a normal level of housing starts.

Broadly, she observes that the cycle has been “elongated” and that the recovery slope has not been as steep as analysts previously believed it would be. The sluggish recovery has, in turn, impeded growth in home building and created a shortage of shelter, even as demand for homes has grown and driven prices up.

First-time homebuyers are being crowded out by the lack of affordable housing, whereas would-be sellers are shying away from putting their starter homes on the market due to fears that they cannot afford the next step up. Investors have snapped up low-end properties looking for returns, further exacerbating the shortage. Overall, the number of starter homes on the market has declined 43.6% in the past four years.

The National Association of Realtors found that total housing inventory by the end of 2015 dropped 12.3% to 1.79 million existing homes available for sale. Currently, total housing inventory is 3.8% lower than a year ago. Zelman concurs, noting that the “ U.S. is at a 30-year low of inventory available for sale.” As such, she predicts “double-digit housing-starts growth this year, next year, and in 2018.” Moreover, Zelman notes that there is a shortage of affordable housing concentrated at the low-end of the market, which large builders are only now addressing and making a killing while doing so.

This shortage comes at a time when millennial unemployment rates have dropped from a 14% peak to 7% and nonbanks are experiencing a boom in requests for FHA loans. Millennials, the oldest of whom are turning 34, are approaching an age where they are more likely to live in or seek single-family shelter, especially if they are married. Zelman cites figures showing that 70% of households 40 years of age or older and 80% of married couples live in single-family shelters.

One impediment to housing starts is impact fees, which can reach prohibitively high levels and make it impossible for builders to profit from low-end housing construction. There is a positive correlation between low impact fees and robust housing start growth, Zelman observes.

In addition, the occupancy rate of single-family rentals in the U.S. is a staggering 97%. Sensing demand and an opportunity, single-family rental operators continue to snap up 10% to 15% of new single-family homes. As new houses are acquired by rental operators and people are pushed to rent due to low inventory levels, the market becomes more susceptible to inflationary increases in housing costs.