Economic Outlook

MCC Construction Zone

Economic Outlook

David Gibbs, CPA, CCIFP, CRE, MBA

The media issues new information on the state of the U.S. and global economies daily. Depending on the source, we are either heading towards a recession or not. My intention with this article is to present information from various sources about the state of the economy since it is a fluid situation that can change quickly.

Moving into a Bear Market Stocks tumbled lower on June 13 to open the week. The S&P 500 and NASDAQ Composite finished down last week for the ninth week in the previous ten. Notably, after hitting an intraday "bear" market decline (as measured by a 20% or more drop from a recent high) on May 20, the S&P 500 finally succumbed to weeks of selling pressure, closing below the bear market threshold for the first time since the depths of the pandemic. The Index currently sits at its lowest level since February 2021 and is down 22% from its recordJanuary high. By the market close, the NASDAQ and Russell 2000 Index were off 30% or more from their highs, and the 10-year U.S. Treasury yield finished at 3.39%, its highest level since 2011. (Ameriprise Global Asset Allocation Committee. After the Close. Anthony M. Saglimbene. June 13, 2022)

Interest Rates The Federal Reserve raised interest rates by three-quarters of a percentage point on June 15, its biggest move since 1994, as the central bank ramps up its efforts to tackle the fastest inflation infour decades.

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The big rate increase, which markets had expected, has underlined that Fed officials are serious about crushing price increases even if it comes at a cost to the economy.(New York Times. The Federal Reserve raises interest rates by 0.75 percentage points.Jeanna Smialek. June 15, 2022)

The 10-year Treasury forecast varies widely depending on the source. Interest rates are generally expected to rise at a moderate rate over the next 10 years. Moody’s anticipates that interest rates will rise 4% by 2026. Oxford Economics, on the other hand, expects a dip down to 2.8% by then. (Construction Dive. Real Estate pros ask: Are we headed into a recession? Mary Salmonsen. June 9, 2022)

Cap Rates “While there is some upward pressure on cap rates from higher interest rates and borrowing costs, cap rates are ‘very sticky’ and do not experience much movement when markets are strong,” says Bill Maher, director of strategy and research at RCLCO. “Cap rates move in the opposite direction of asset values, so prices are moderating.”

Still, in the current high borrowing rate environment, investors can overcome cap rate difficulties by taking on shorter term debt or negative leverage.

“Real estate markets are very healthy right now,” Maher said. “So, I don’t think it will have much impact until there’s an economic event, we’re really in a recession and rents and occupancy start heading down for properties. That would be the real trigger.” (Construction Dive. Real Estate pros ask: Are we headed into a recession? Mary Salmonsen. June 9, 2022)

Inflation Some economists and administration officials had hoped for signs that inflation was cooling. Instead, data from the Consumer Price Index (CPI) showed prices climbed 8.6% from a year ago, keeping inflation on track for the most rapid increase in 40 years. That figure, however, included the. more volatile food and energycomponents, which are stripped out when measuring “core” CPI, which rose 0.6% from the prior month.“Energy prices increased 3.9% from a month ago, bringing the annual gain to 34.6%. Within the category, fuel oil posted a 16.9% monthly gain, pushing the 12-month surge to 106.7%. Shelter costs, which represents about a one-third weighting on the CPI, rose 0.6% for the month, the fastest one-month gain since March 2004. The 5.5% 12-month gain is the most since February 1991. Food costs also increased another 1.2% in May, bringing the yearover-year gain to 10.1%. (New Jersey Business. June 10, 2022)

Home Prices Rising rates and buyer urgency kept home price gains above 20% in April. Many home buyers are hurrying to lock in purchases before rates climb even higher. (Forbes. Brenda Richardson. June 7, 2022)

A new report by real estate data analytics provider CoreLogic shows that home prices posted another record-high year-over-year increase in April, marking the 123rd straight month of gains. About 70% of U.S. homes are selling for more than asking price this spring. Higher mortgage rates are expected to putthe brakes on buyer demand in the coming months, causing annual home price appreciation to cool to 5.6% by April 2023.

Lumber Prices Lumberprices fellas low as $780 per thousand board feet in May and are tradingbelow $600per thousand board feet, according toChicago Mercantile Exchange. That'sthe lowest point for lumber this year –but still higher than the 2020 high of $400 per thousandboard feet.

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Three months ago, lumber traded for as much as $1,357 per thousandboard feet,not far from its peak price of $1,733 about this time a year ago.(USA Today. Lumber prices are falling. Could prices in the housing market follow? Terri Collins. June 6, 2022)

Fuel Prices Oil and refined fuel prices have risen to their highest levels in 14 years, due largely to the Russian invasion of Ukraine and resulting sanctions, and a rebound in energy use as the economy recovers from the coronavirus pandemic. The national average price of gasoline on June 11, 2022, was $5.00 per gallon, up 60 cents from a month ago. A year ago, gas sold for $3.08, according to the AAA motor club.

Supply Chain Disruptions Supply chain disruptions continue to be an issue across all industries. The price of construction materials jumped nearly 20% overall in 2021.

Construction Starts U.S. construction starts should continue to grow for the rest of the year, despite economic and geopolitical headwinds, according to a Dodge Data & Analytics report. Most of that positivity stems from the number of projects sitting in backlog, or projects that are planned but not yet begun, said Dodge Chief Economist Richard Branch.

“Over the past year, we’ve seen volatility but an upward rising trend here in the Dodge Momentum Index,” which tracks the dollar value of construction projects when they enter the earliest stages of planning according to Branch. His forecast includes three major assumptions: • Each subsequent wave of the COVID-19 pandemic impacts the economy less. • The war stays within Ukraine’s borders and significantly abates by next year. • TheFederal Reserve can raise interest rates to combat inflation without pushing the U.S. economy into recession.

Possibility of a Recession Bloomberg Economics says there is a 72% chance of recession before the first quarter of 2024. But on the upside, "thebroader picture for the global economy in 2022 is a slowdown, not sudden stop," according to Chief Economist Tom Orlik. He and his colleagues see global growth of 3% in 2022.

Bank of America economists are among those still seeing reasons a recession canbe avoided. Among them: • Inflation may have peaked, with prices in many countries starting to rise by less. • Demand has ample support, with households enjoying high savings and companies having built up cash balances. • If it turns out that tight monetary policy threatens a recession, that still leaves central banks capable of shifting tack, limiting the damage.

"We wouldn't completely rule out a major recession," says Ethan Harris, Bank of America's chief global economist. "The commodity shock or COVID could come back with a vengeance just as monetary tightening is starting to really hurt. However, our base case remains an extended period of weak growth and we think any recession is likely to be mild." (Bloomberg. New Economy. June 10, 2022)

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“Recession is not inevitable today, nor is it the most likely path for the economy,” said Moody’s Analytics Chief Economist Mark Zandi. He noted that there are several bright spots including high corporate profits, strong bank balance sheets, and abundant consumer savings. “Ignoring the calls is not advisable, but given the economy’s strong fundamentals, buying into these calls is not recommend either.” (Construction Dive. Recession in ‘not inevitable’ Moody’s says. Jim Tyson. June 6, 2022)

“When inflation has been above 4% and unemployment has been below 4%, we’ve always had a recession within the next two years,” Treasury Secretary Lawrence Summers said. “The likelihood is that we’re not going to get through this with a soft landing.”

The Fed’s aggressive tightening has worked, bringing down inflation expectations in recent weeks, Zandi said. “With inflation expectations contained, inflation will recede,” he predicted, adding that the pandemic will continue to fade “and the worst of the economic fallout from the Russian aggression is behind us.”

Pent-up demand for vehicles and housing will probably buoy economic growth, and “businesses are also in great financial shape –they have never been so profitable,” Zandi added. “Corporate debt burdens are also as light as they’ve been in a half century.”

“Perhaps most encouraging, the nation’s financial system has arguably never been stronger,” Zandi said, noting that “banks are highly profitable and awash in capital.”

“It is difficult to conjure up scenarios in which financial institutions would suffer to the point that they curtail providing credit, and as long as credit continues to flow, recession is less likely,” Zandi concluded.

A majority of financial sources —including Morgan Stanley, S&P Global and The Wall Street Journal —place the probability of a recession within the next 12 to 24 months at 50% or less.” (Construction Dive. Real Estate pros ask: Are we headed into a recession? Mary Salmonsen. June 9, 2022)Time will tell. My thoughts, prepare for the worst and pray for the best.

About the Author David E. Gibbs, CPA, CCIFP, CRE, MBA, is the partner-in-charge of the firm’s Real Estate Services Group. He works with real estate professionals in a wide range ofsectors including commercial, industrial, and residential. Clients benefit from David’s profound knowledge of the unique tax elections for real estate professionals. David holds the well-respected Certified Construction Industry Financial Professional (CCIFP) designation from the Institute of Certified Construction Industry Financial Professionals (ICCIFP), as well as the elite Counselors of Real Estate (CRE) designation. He can be contacted at 610.828.1900 or David.Gibbs@McCarthy.CPA.

Disclaimer: This article is for informational purposes only and should not be relied upon for tax or accounting advice. We strongly advise you to seek professional assistance concerning your specific issue(s).