post-attack economy: An outlook across America, The

Real Estate Issues, Fall 2001 by Kelly, Hugh F

INSIDER'S PERSPECTIVE

THE POST-ATTACK ECONOMY: AN OUTLOOK ACROSS AMERICA

Literally, before the dust settled following the collapse of the World Trade Center from the terrorist attack of September 11, 2001, and throughout the month thereafter as the fires still burned at Ground Zero, economists have been attempting to analyze the immediate effects of the catastrophe and to estimate its implications for the future. By September 14, Bank of America's Chief Economist Mickey Levy had completed an economic brief, preparing clients for a mild recession with unemployment peaking at 5.5 percent near the end of this year. Economy.com prepared a preliminary analysis by September 17, and its CEO, Mark Zandi, offered some refinements at a Property and Portfolio Research client conference in Boston on September 20-21. Updates to the forecast were issued, for a while almost on a daily basis. On September 21, Bank One issued its economic interpretation, as did Morgan Stanley three days later. Their senior economists, Diane Swonk and Richard Berner, helped lead a September 28 conference call for members of the National Association of Business Economists. The initial consensus seems to center on a recessionary episode lasting perhaps into the spring of 2002, with Federal fiscal and monetary stimulus jump-starting a recovery that could see real GDP growth in the 3.5 percent to 5.5 percent range by the final quarter of 2002.

Macroeconomic trends such as the national growth rate, the movement of interest rates, patterns of job change measured by employment and unemployment, income, and consumer spending, all are important factors considered by real estate professionals. But since real estate quintessentially remains a local commodity, it is the array of economic impacts across the geographic reach of the U.S. that most significantly affects choices and decision-making in our industry. Over the years, analytical tools to assess such impacts have been developing and may help us to unpack the likely exposure of metropolitan areas to shifts on the demand side of the real estate equation.

More than a decade ago, researchers at Prudential Real Estate Investors, led by Charles Wurtzebach, proposed what they termed "the portfolio construction process." Their work offered a model they called "the Economic Location Matrix," which arrayed cities by two characteristics: the structure of the local economy, and its long-term growth trend. Over the past 10 or 12 years, I have extended and modified that research for institutional equity and debt investors, and for developer clients. This extended work has taken the initial concept and analyzed the local economic structure in finer levels of detail, and has shifted the focus from long-term trend lines toward the exposure of the MSAs to economic cycles. This is especially pertinent now, as the economy suddenly downshifts into a post-9/11/01 recession.

Exhibit 1 shows where 58 of the country's more than 300 MSAs are situated in these basic economic terms. The 58 selected urban areas include all 40 of the nation's largest MSAs, plus several (such as Las Vegas, New Orleans, Jacksonville, and Orlando) with claims on real estate industry attention beyond their relative city sizes. Finally, a number of smaller areas (e.g., Bakersfield, Killeen, Tacoma, and Reno) are displayed to illustrate cells in the matrix not populated by the larger metro areas. Where cells (the boxes in the. Exhibit) are empty, that means that none of the MSAs in the country fall into the statistical groupings defining the matrix. This illustrates some important relationships. For instance, there are no diversified or military/defense-based economies in the boom/ bust category. Neither are there any stable economies with a high-technology or energy-based economic structure.

Understanding the structure of the local economic base and the historical propensity to swing to a greater or lesser degree in response to macroeconomic cycles is an important aid in assessing demand risk in the present circumstances. Still, every recession has its own fingerprints, and therefore, the Economic Location Matrix is not a mechanical tool to be blindly applied. Thus, in looking at the outlook for the 2002 - 2004 period, I have overlaid factors of particular immediate concern in evaluating the forecasts. Such factors include the relative exposure of each MSA to the global economic slowdown that began in 1998; the already existing trends in place as a result of the bursting of the NASDAQ bubble; and truly local effects, such as the dispersal of downtown Manhattan tenants into neighboring markets such as Long Island, New Jersey, and Connecticut.

It appears to me that the "shape" of the local outlooks can be described as following one of five basic patterns. Those scenarios are termed "Recessionary Profiles," and are coded by letter: S for a standard MSA that is expected to mirror national trends; M for an MSA that is expected to have a "minimal" response to the recession, outperforming the U.S. trends; V for a local economy expected to have an immediate and steep contraction into 2002, with a sharp rebound in 2003 and good growth prospects in 2004 (a so-called "V-shaped recession"); U indicating a more lasting contraction, where the local economy does not recover to its 2001 level of employment until 2004 (which the economists are terming a "U-shaped cyclical contraction"); and L representing a sharp dip in employment in 2002, and a failure to return to 2001 employment levels in the three-year forecast horizon. Salt Lake City is the only exception to these scenarios, as the 2002 Olympic Games introduce unique local influences into this MSA's forecast. Exhibit 2 lists some representative cities for each outlook.