One by one, the pieces of the puzzle are falling into place. A picture is now emerging of a real estate industry substantially improved in terms of both supply/demand economics and investment performance potential. The keynote of the 1994 Landauer Real Estate Market Forecast identified the fundamental theme - the U.S. economy is now the ally of the real estate industry, not its enemy.
The broadening base of the economic expansion could, in fact, serve to lull the impatient into overconfidence. Government tallies of non-agricultural employment were showing a year-to-year gain of three million jobs by mid-1994. The unemployment rate dropped below 6%. We are bound to hear some claim that "a rising tide lifts all boats." This cliche, always a sign of sloppy thinking, is especially dangerous now, when the rate of change differs so much among economic sectors and across regions of the country.
Real wages have risen for the first time since 1986, and the Federal Reserve has taken that as a signal of potential future inflation. The Fed sees other warning signs as well: high capacity utilization rates of 84%, delays in shipments and rising sensitive materials prices. So even with the CPI well behaved and wholesale prices quiescent, the cycle of rising interest rates appears to extend into 1995.
Last year's Forecast warned of the potential for a brief 6% - 8% spike in inflation sometime during the 1994 - 1998 period. Now the Fed and the debt markets seem to be acting upon a similar belief. The "inflation premium" represented in the spread between the current CPI and the yield on the 10-year treasury bond has risen to 4.4%, and there is a possibility it could grow above 5%, as it did the last time real wages expanded. This would raise the risk of the kind of severe slowdown the economy experienced in 1986, the so-called "growth recession," which was the precursor of the 1987 market turmoil.
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Landauer does not believe such severe retrenchment is likely. Instead, we think economic growth will moderate to just under 3%. Sectoral advantage will shift. Non-durable goods production and retailing should accelerate while interest rate-sensitive sectors like durables manufacturing and new home construction will experience less vigorous activity.
Real corporate profits have risen to the highest levels in 15 years. Annualized net corporate cash flow rose 10.8% by mid-1994, and the after-tax profits of domestic industries were $485.7 billion. Consistent with almost all economic indicators, durables manufacturing had the most striking advances, showing a doubling of profits between 1992 and mid-1994.
Earnings at non-durable goods producers are up 9.7% from a year ago and 24.8% from the 1992 level. At $73.5 billion, profits are a fraction of the hard goods industries, but the recent pace of improvement points to expansion potential.
Landauer thinks that this may well be in the cards. Not only should the rise in interest rates dull sales of big ticket items, but much of the recent growth was due to pent-up demand. During a recession, businesses and households alike need to replace applicances, machinery, equipment and cars, but lack the necessary resources. Typically, in the first years of a recovery, they satisfy those needs, providing a major boost to GDP. This recovery thus far has run true to form.
A shift in spending patterns from big-ticket items to soft goods and services should come next. An easing of the growth curve is likely, as finance payments on capital goods purchases take an increasing share of disposable income. The reduction in major individual outlays, though, allows for a greater volume of pay-as-you-go purchases. Retail prospects should therefore imporve in 1995.
Employment patterns provide a ready measure of the recent economic shifts and their implications. Job gains have spread to the point where 48 of the 50 states are adding jobs. Only California and Hawaii were still in decline as of mid-1994, and the large California economy should turn modestly positive in the coming year. The Intermountain states are the biggest gainers, led by Nevada (6% growth), Utah (5.9%), Idaho (5.7%) and Arizona (4.0%) in the West, joined by Georgia (4.8%) and Florida (3.3%) in the Southeast.
The Northeast states are all in the positive column, with even Connecticut experiencing a .2% employment increase. Maryland (.6%), New York (1%), Pennsylvania (1.5%) and New Jersey (1.8%) have also turned the corner. This growth is a welcome indication that a platform for expansion is now firmly in place for this key region. At the metropolitan area level, signs of pervasive recovery are confirmed. Of the 52 MSAs with employment bases in excess of 500,000, 44 are posting employment advances. Overall, 85% of the nation's largest MSAs are gaining jobs. The biggest cities are doing especially well. Nine of the ten largest MSAs are gaining, with Atlanta (5.5%), Dallas (4.6%) and Boston (3.1%) surging at rates well above the national average.
Six of the eight still declining MSAs are in California, both in Southern California (Los Angeles, San Diego and Orange Couty) and in the Bay Area (San Francisco, Oakland and San Jose). On the East Coast, Baltimore and Long Island showed modest losses in their job bases at mid-year.
Despite the statistically encouraging trends, wariness by commentators and investors alike surfaces in concerns about the quality of the new jobs being created. But a detailed look at recent job change patterns does a great deal to allay those fears.
It is true that ten production workers are being hired for every new supervisory job, lower than the prevailing 18.3% proportion of managers to total workers. Still, more than 250,000 well-paying supervisory jobs were created in the year ending June 1994, a respectable gain for this category.
The disproportionate addition of production workers does not, in itself, mean that the jobs are in poor-paying categories. Landauer's systematic analysis of 21 industries, which together accounted for three-quarters of all the production jobs generated in the past year, shows that advances have been distributed broadly across the wage spectrum.
As the above table shows, 321,900 production jobs were added at the meager annual earnings level of $15,000 or below. The majority of these were in eating and drinking establishments where wages are supplemented by tip income and where cash earnings are systematically under-reported. Social services, including residential care and day care, also fall into this group.
JOB CREATION BY INDUSTRY
Range of Annual Average Earnings
Number of Industries
Less than $15,000
4
$15,000-$20,000
1
$20,000-$25,000
6
$25,000-$30,000
7
Greater Than $30,000
3
Range of Annual Average Earnings
Production Jobs Added
Less than $15,000
321,900
$15,000-$20,000
587,600
$20,000-$25,000
436,500
$25,000-$30,000
241,600
Greater Than $30,000
288,400
Range of Annual Average Earnings
Total New Annual Wages
Less than $15,000
$3.19 Billion
$15,000-$20,000
$10.53 Billion
$20,000-$25,000
$9.56 Billion
$25,000-$30,000
$6.6 Billion
Greater Than $30,000
$8.86 Billion
Range of Annual Average Earnings
Major Industry Types
Less than $15,000
Retail & Restaurants, Social Services
$15,000-$20,000
Business Services
$20,000-$25,000
Non-durable manufacturing Wholesale, Trade, FIRE, Healthcare
$25,000-$30,000
Durable manufacturing, Trucking, Legal Services, Engineering, Management Consulting
Greater Than $30,000
Automobiles, Chemicals, Construction
Business services earnings, for non-supervisory workers, average about $18,000 per year. But this category also includes higher-income advertising and computer services jobs, which accounted for 70,000 of the 587,600 production jobs gained last year. Furthermore, business services firms generated 91,100 management positions, one for every 6.5 production jobs.
Landauer found that nearly a quarter of the new jobs in the 21-industry study were in the $20,000 - $25,000 earnings range. This wage level characterizes both the comparatively slow-growing non-durable manufacturing sector, and the more robustly advancing wholesale trade (101,000 new jobs), FIRE (97,000), and health services (216,400) employment sectors. While management cuts continue to thin the ranks in FIRE and trade, health care firms added one supervisor for every 4.5 line workers in the year ending June 1994.
Jobs in the $25,000 - $30,000 wage class (25% to 50% above the U.S. mean) accounted for approximately 13% of all new production workers. Higher skilled workers in durable goods industries benefitted from the sustained expansion in consumer and business expenditures for appliances and equipment.
The highest wage levels, over $30,000 annually, captured a 15% share of the growth in production jobs, thanks to vigorous performance by the automobile industry and new residential construction. These high wage, blue collar jobs were precisely those which were supposed to be disappearing, according to a conventional misperception. In a climate of reasonable interest rates, reinvestment in the country's manufacturing base, and consequent productivity gains, the economy has demonstrated its ability to expand materially the number of good quality jobs, to a degree that has taken nearly everyone by surprise.
Over the medium term (three to five years) and longer we see a number of variables to monitor. Military spending continues to plunge. The consolidation of the defense industry is still not complete, but the most draconian adjustments have been made.
The twin deficits in trade and the Federal budget remain serious factors, retarding the economy's growth potential. Our international trade imbalance should, over the course of the coming decade, show a decisive correction. The NAFTA and GATT accords create further room to expand international trade flows. More importantly, our most significant bilateral deficit, with Japan, will be inexorably reduced as the Japanese savings rate plummets under the influence of its aging demographics and the heightened consumption patterns of the younger generation. Changes in trade patterns have the potential to add a full percentage point to real GDP in the later years of this decade.
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Unfortunately, the interest costs of the government will not yield so readily. The huge debt racked up during the '80s is embedded in the nation's books, costing $190 billion annually in net interest payments. No wonder the Fed finds itself in the custody of treasury bond investors, dancing to the tune of the slightest fears of inflation.
With the economy thus on short rations at its punch bowl, the theory of "economic subsidence" which has governed Landauer's annual Forecasts since the mid-'80s deserves restatement. The passing of the era of inflation-driven boom and bust (roughly 1967 to 1983) means that economic cycles are likely to be longer but less dramatic. The real estate bubble of the '80s developed in willful blindness to this economic reality, and our industry paid the price. Now, the real estate cycle and the economic cycle are reinforcing one another. With any decent business discipline, this should mean at least seven good years ahead for the property sectors.