Prolonged expansion supports calls for optimism

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This chart shows the growing trend of prolonged expansion. Courtesy JLL

Travis Hodge
Travis Hodge
Vice president, multifamily, capital markets, JLL, Denver

A mathematician, an accountant and an economist apply for the same job. The interviewer asks each of them, “What does one plus one equal?” The mathematician replies, “Two. Exactly two.” The accountant replies, “Two … give or take three percent but, on average, two.” When the economist’s turn comes, he gets up, locks the door, closes the blinds, sits down next to the interviewer and says, “What do you want it to equal?”

Craig Kalman
Craig Kalman
Vice president, multifamily, capital markets, JLL, Denver

Economics is funny. While a snapshot of economic indicators are what they are, there are a number of levers to pull and buttons to push in order to move those indicators in the desired direction. Ideally, making the right moves allows us to reverse a recession or continue economic growth. But, we all know that what goes up must come down. We might disagree as to when the next recession will hit, but we can all agree that it’s coming … sooner or later.

In general, brokers are optimistic. Whether that’s by nature or nurture, we feel it’s our obligation to inform you that good times are still ahead. There’s no doubt many of you are concerned about overbuilding the apartment market. Indeed, there are nearly 30,000 units under construction in metro Denver with another 25,000 in planning. This certainly seems like a lot, especially when considering metro Denver has permitted approximately 4,000 multifamily units per year on average over the last 30 years.

Enter optimism.

Per Apartment Insights, annual absorption was 6,069 in the third quarter, which marked the 14th consecutive quarter of annual absorption above 5,000. Annual in-migration for the Denver metropolitan statistical area has averaged nearly 33,000 people per year since 2010. Metro Denver has experienced annual job growth of 2 percent or above in 67 of the past 69 months. Denver’s economy is more diversified than it’s ever been. As long as our economy keeps churning, strong absorption and in-migration should continue. It may not be enough to immediately fill all of the units under construction and currently in lease-up, but that just means rent growth in some spots will level off for a bit.

The Class A luxury market will see the most moderation, and there might be a few value-add plays that end up extending their hold period, but given current levels of leverage and underwriting standards, the vast majority should have no problem weathering any slight dip in the market. All of that could change if our economy enters into another recession in the next two years, but we don’t think that’s likely to happen.

Instead, we’re busting out the cake and cookies in celebration of the current economic expansion’s birthday! Happy 101st consecutive month! It’s the third-longest economic expansion in U.S. history – dating back to 1854, a time when you could die from a splinter because doctors didn’t understand infection.

Not until July 2019 will it surpass the 120 months during 1991-2001 to become the oldest U.S. economic expansion. If you’re already doubting that possibility, then you’re only looking at the typical length of a cycle and not the whole picture. First of all, you’re pulling from a small sample size of 34 cycles. If you’re going to use past cycles as a barometer, you have to analyze all of their circumstances and indicators. The Bulls only won 30 games in 1985-1986, but that’s not because they assembled a bad team; it’s because Michael Jordan was injured for 64 games.

There’s some truth to Janet Yellen’s argument that cycles don’t die of old age. Like living beings, they die of symptoms. Just as modern medicine has allowed us to overcome splinters and extend life expectancy, modern economics has allowed for extended periods of economic prosperity. The chart shows the growing trend of prolonged expansion.

This chart doesn’t show pre-World War II times, when expansionary periods averaged less than 39 months. PostWWII expansions, including the current one, have averaged almost 62 months. Starting with the creation of the Federal Reserve in 1913, and continuing in 1933 when it went off the gold standard to completely cutting ties to gold in 1971, we’ve been able to hone our economic skills and sharpen our tools, constantly breaking new ground and learning from our mistakes.

Another thing to point out in the chart is the average gross domestic product growth during these periods. Most economists agree that ideal GDP growth rate is between 2 and 3 percent. Have we finally landed in that sweet spot where we can expect continued steady growth? Look carefully at the last four periods of expansion. If we hadn’t acted so foolishly leading up to the financial crisis, could that expansion have lasted longer than the one prior? Who knows, but it sure taught us some valuable lessons, and that’s the point. We’ll continue to improve in managing the booms and busts that have plagued the past.

During this cycle, Japan and the Eurozone have flip-flopped between contraction and expansion. With these two major economies now finally in simultaneous expansion along with the U.S., we’re just beginning to enter a period of synchronized global growth. The economy at home and abroad appear to be in decent shape, suggesting business as usual. Of course, there are always curveballs, but there’s no cure for those. In the movie “Major League”, Pedro Cerrano tried to get Jobu to help him hit curve balls by offering cigars and rum … that just doesn’t make any sense. There’s no reason for us to start doing the same.

Each part of the current cycle has been prolonged, starting with the slow recovery of credit after the crisis. From there, we’ve gradually expanded leverage, and now the Fed is gradually hiking rates. We’ve yet to enter the next phases of rising default rates or an overheated economy; in assessing the current situation and nature of this cycle, there’s reason to believe those next phases will be prolonged as well, allowing everyone to continue sitting on fastballs in the strike zone. What we’re really saying is this cycle still has a lot of room to run.

Featured in the November issue of Multifamily Properties Quarterly.

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