*Post includes paid articles necessary to convey accurate and pertinent information from reputable sources
Here at Axia Partners, we pride ourselves on keeping a finger on the pulse of the latest developments in the worlds of commercial real estate, finance, and economics in order to make informed decisions and stay ahead of emerging trends. In our ongoing quest to bring transparency and value to our investors, I would like to share some of the topics and stories shaping the commercial real estate investing landscape and to provide commentary on how I interpret this information.
In the latest iteration of CoStar Group’s repeat-sales indices report, reflecting data as of April 2023, several dynamics which I had anecdotally suspected in commercial real estate transaction activity were confirmed. The headline takeaway from the April report was that CoStar’s value-weighted U.S. Composite Index, tracking repeat-sales across all major property types, was down 7.6% year over year while their equal-weighted index, which better reflects lower-priced property sales and sales in smaller markets, was up 2.8%. This divergence would imply significantly more favorable performance among the subset of smaller deals, typically occurring in non-core markets. As cited in CoStar’s analysis of the report, “institutional investors have pulled back and are exercising caution because of the uncertainty ahead, while private investors are more active and pricing through it as they see real estate as a good inflation hedge”. Intuitively this checks out as larger institutional investors with huge amounts of dry powder to deploy and lower return targets have and continue to pour money into loftily valued properties in overheated markets. The pendulum was bound to swing the other way and we are now seeing value degradation as some of these larger trade-outs occur, presumably underwritten with much less rosy assumptions. Applying some second-order thinking to these numbers in the context of Axia Partners’ investing strategy, it appears there is still enough life left in capital markets to support transaction activity among non-institutional market participants without requiring widespread discounting. From both a buy and sell-side perspective, the sooner the softening witnessed at the institutional end of the market can make its way down-market the better.
High-level Summary: deals priced below the threshold for institutional investors, likely in smaller markets, have traded significantly better than larger deals as of late. The multiple factors driving this performance discrepancy could be the subject of a research white paper all on their own, but the takeaway here is that our approach of focusing on the space between “mom n’ pop” owner operators and larger institutional groups continues to be supported by the data as an effective value capture strategy.
Perhaps the biggest data related development of the past week has been the release of the latest payroll report, which continued the trend of far surpassing survey expectations to the upside. Economists surveyed were eyeing May payrolls to come in at 195k, but lo and behold we were sent into the weekend with a print of 339k jobs added for the month. On the surface a beat of this magnitude should have roiled markets as one could easily interpret the numbers to mean the Fed still has rate-raising work to do to tighten labor markets and rein in inflation. However, a deeper dive into the payrolls numbers exposes a countervailing dynamic in which wage growth edged lower and unemployment rose to 3.7%. Furthermore, the household survey report for May, which includes the self-employed segment the establishment payroll report excludes, actually revealed a steep DROP in employment. Interestingly, this gap between the household and establishment reports has existed and steadily grown since roughly mid-2022. There’s a lot that can be unpacked here, however, the takeaway seems to be the Fed has in fact elicited the tightening effect on the labor market it has sought and therefore should be able to justify a pause in rate hikes, at least for their next June meeting.
High-level Summary: Looks can be deceiving when it comes to economic data and news headlines, especially during transitional points in market and debt cycles. The U.S. labor market remains resilient in the face of stymied growth and tight credit, however, it is not as strong as the headline numbers would have it appear. This gives hope that there is still potential for a “Goldilocks” outcome in which economic weakness is contained to specific sectors overdue for correction without the wheels completely coming off the wagon with the Fed overshooting more than they already may have.
The gap between the household and establishment payrolls reports isn’t the only gap worth reflecting on as of late. As reported on in the Wall Street Journal, the economic picture in the U.S. looks markedly different depending on whether gross domestic income or gross domestic product, both measures of economic output, are examined. While GDP has grown at an annualized rate of roughly 1.0% over the first two quarters of 2023, GDI (gross domestic income) has contracted -1.4% over the same period, which would indicate a technical recession. At a high level, the divergence is driven by declining productivity, with employment growing faster than output. While it is not uncommon for the U.S. to experience periods in which economic output outpaces employment, five consecutive quarters of negative productivity growth has landed us in the inverse of this scenario. Correlation should never be confused for causation, but previous instances in which GDI significantly undershot GDP occurred during both the Global Financial Crisis of 2008 and the recession experienced throughout the early 1990’s. The most popular culprit to explain this phenomenon currently is the purported labor hording many companies are accused of perpetuating as they hold onto workers for fear of having to re-hire at pricier levels of compensation. Maybe the hype around AI and its ability to augment productivity can come to fruition and serve as this economy’s white knight, but more likely the Fed needs to readjust the measures it fixates on when making policy decisions.
High-level summary: Sometimes it pays to have a “glass half full” outlook, but at times of economic cycle transition those that can spot the risks and warning signs early have a much better shot at navigating, capitalizing on, and surviving the unfolding market situation that remain Pollyannaish. History suggests the current dynamic between GDP and GDI would indicate we are already in or are entering a recessionary period. As always, at times of stress and transition there can be found some of the best opportunities, but only if one is able to realistically assess the environment.
To wrap up this iteration of Axia’s “In the News” newsletter, I’d like to share the concept of narrative fallacy, as one of my favorite authors and thinkers, Nassim Nicholas Taleb, popularized in his 2005 book “The Black Swan: The Impact of the Highly Improbable”. Narrative fallacy occurs when objective information is subjectively interpreted in order to fit a predetermined story. We humans have survived and thrived on our ability to recognize patterns and as such are continuously weaving narratives to help make sense of the chaotic world around us without getting bogged down and overloaded with information. In recognizing and responding to patterns we must be careful not to let the tail wag the dog, however, as narrative fallacy opens the door to blind spots and the missing of crucial signposts in markets, economies, politics, and our own daily lives. As the excellent Bloomberg Opinion columnist John Authers points out, amidst data and reports that appear contradictory and confusing we have already rotated through a plethora of narratives this year in an effort to simplify and make sense of things. As each of the topics in this newsletter hopefully make clear, it is critical to apply second-order thinking and to approach information in an unbiased and unemotional way to properly read the tea leaves and make informed decisions.
High-level Summary: Beware of how the narratives you cling to influence your interpretation of data. Much of the economic and market data at present can be interpreted in ways supporting any variety of bull or bear cases. While nobody has a crystal ball that works 100% of the time, investors should consider how a desire for their beliefs to be “right” could create blind spots and missed opportunities to spot shifts in the market.
Portfolio Manager - Director of Investment
Before joining Axia, David developed real estate experience at Everbank/ TIAA CREF in the distressed MBS trading unit and on one of Colliers market-leading investment brokerage teams. David brings a decade of financial services experience, working at Credit Suisse and Goldman Sachs within their Wealth Management and Hedge Fund Strategies groups, and an MBA from Vanderbilt.