October Issue: Economist’s View—Lessons from Black Swans

By George Ratiu, Contributing Columnist

George Ratiu, NAR

For the past few years, the main event on Europe’s economic stage has been a real Greek drama. Greece’s debt crisis has been the continent’s main economic concern, keeping financial markets on edge and focused on mitigating risks. That was until this summer, at least, as Europe now finds itself grappling with what author and analyst Nassim Taleb famously terms a “black swan”—an event capable of dwarfing the long-running Greek saga and casting a shadow across the continent for years to come.

I’m referring, of course, to the arrival of hundreds of thousands of men, women and children, many of them fleeing conflicts in the Middle East and Africa. The Economist reported in August that some 270,000 undocumented migrants reached Europe in the first seven months of the year. These people have endured horrendous conditions, and the flow of refugees shows no signs of abating. With the exception of Germany’s Chancellor Angela Merkel, the leaders of the most powerful EU economies have failed to act decisively. Instead, they have pushed much of the responsibility to Europe’s peripheral countries—Greece, Italy and Spain in the South, and Hungary, Romania, Bulgaria and Croatia in the East. This has created mounting tension between desperate refugees and EU citizens, many of whom feel besieged. Violent protests have erupted in several countries, and by mid-September, governments were taking drastic steps, closing borders that had turned into flashpoints.

Economic issues, too, loom large in this crisis. The challenge of absorbing hundreds of thousands of refugees adds unpredictability to the EU’s already uneven economic prospects. At midyear, the EU’s economic growth rate stood at 1.2 percent and the unemployment rate clocked in at 11.1 percent—a combination that adds up to a rather cloudy outlook. Unemployment rates are particularly dire in the countries that are bearing the brunt of the crisis: 25 percent in Greece, 22.5 percent in Spain and 12.7 percent in Italy, as of the second quarter. Great Britain and Germany are in much better shape, but France’s second-quarter unemployment rate stood at 10.2 percent.

Mixed Signals at Home
Closer to home, the U.S. economy has its own chorus of risk callers pointing to a raft of worries: sluggish growth in China, the devaluation of the yuan and resulting volatility in U.S. financial markets. And the Federal Reserve is widely expected to hike the funds rate, despite the Federal Open Markets Committee’s Sept. 16 decision to hold off on an increase. For commercial real estate markets, rising property prices are raising concerns of another potential bubble. It is true that most price indices have finally surpassed their pre-recession peaks. Meanwhile, abundant capital and a dearth of product are accelerating price growth, particularly for apartments and central business district office assets.

However, the recovery in most markets is just hitting its stride. While gateway cities—New York, San Francisco, Boston, Washington, D.C., Chicago and Los Angeles—started to find their footing in 2010, most secondary and tertiary markets did not begin their climb from the slump until 2013. Vacancy is declining steadily but continues to average around 15 percent for office properties. With the notable exception of apartments, cash flows have been rising only 2 to 3 percent annually for most of the past few years.

Debt comprised the lion’s share of real estate capital before the recession, but the picture is more balanced today, as a broad spectrum of debt and equity sources actively pursue deals. The spread between cap rates and 10-year Treasuries still exceeds 400 basis points, indicating that investors in commercial assets will remain well-positioned over the next two years.

Concerns clearly remain for the U.S. economy and for its commercial real estate sector in particular. An early lesson of Europe’s refugee crisis may be that any major risks that are in store for us are still lurking out of sight.

George Ratiu is director of quantitative and commercial research for the National Association of Realtors.