Speaker 1:
This is the Real Pulse, a podcast series where RBC Capital Market's experts share their insights on the latest trends and opportunities in commercial real estate.
Nurit Altman:
Welcome to the Real Pulse. I'm your host, Nurit Altman It is often said that when the US sneezes, Canada catches a cold. And it's true that the trends we see emerging in the US are often a precursor to what we will experience here in Canada. So understanding the impacts of rising interest rates, growing inflation and the geopolitical climate on US real estate markets may provide some important insights into what trends we will see playing out in Canada for the balance of the year. Today, I am joined by Tom Porcelli, chief US economist, RBC Capital Markets who will share a US view as to how today's rapidly changing dynamics will play out in real estate markets. Tom, thank you for joining us.
Tom Porcelli:
Thanks for having me. Good to be with you.
Nurit Altman:
Tom, the US consumer was feeling pretty good coming out of the pandemic with increased savings, strong demand for labor and a booming economic backdrop. Fast forward to the spring of 2022, and things aren't feeling quite as rosy. What is the state of the US consumer today?
Tom Porcelli:
Yeah, they're in a tricky spot. We've been highlighting this for quite some time. And so it bears repeating. When you think about the plight of the bottom half of the income spectrum, the reality there is, they've used up all of that excess saving that they were given. And that's been true now for the last couple of quarters. In fact, we've had some earnings reports just over the course of the last week that have really sort of driven this home. These reports have highlighted those sort of the lower end income consumer is starting to really back away.
Tom Porcelli:
And so that is an unfortunate reality for where we are with the lower income consumer. But I don't think the challenges are limited to the bottom half of the income spectrum. I think you have to consider the upper income are now dealing with a negative wealth effect associated with the fact that the equity market is down, what, as of this reporting, 17 or 18% from the highs? And so there are challenges, there are different challenges, but challenges up and down the income spectrum.
Tom Porcelli:
And the other thing I think is really worth highlighting is this idea that people keep on saying, "Hey, the consumer is in pretty decent shape, their balance sheets are in good shape. They're sitting on a lot of cash." That does a massive disservice to this entire conversation because people are looking at that in the aggregate. And you can guess where most of that excess cash, what remains, you can guess who's holding it. It's mostly sort of the up the upper income. And again, we've written about this many times. And so I think just have to be mindful.
Tom Porcelli:
The upper income doesn't need excess saving to go out and spend. In fact, most of that excess saving would probably not be used for spending. It would probably be used for investment. So I think that there are a lot of these challenges right now. Just a couple of other things to layer on top of that. I think you have to keep in mind that the... Think about what's happening to the price of basics, right? Food, rent, gasoline, they have been relentlessly high, and we expect that they will remain high. And so this is eating into a disproportionate share relative to what it always eats into, of disposable income.
Tom Porcelli:
And so that is yet one of these other challenges. If there's anything that you could sort of take away as a maybe it doesn't have to be so bad from the consumer side of the equation is, they are now dipping into credit. They're now using credit more. We've seen a real sort of surge in credit over a recent weeks. And so that could sort of keep things buoyant here for a bit of time, but no one should think otherwise. There are a number of challenges on the consumer front.
Nurit Altman:
Hopefully one thing that may combat some of those challenges is wage growth, but you're right to point out, we're also seeing rapid inflation. So how do you see the dual effect of wage growth and inflation impact consumers demand for goods? And I guess as a follow on for our sector, demand for retail real estate and fulfillment space?
Tom Porcelli:
Yeah. I think that the problem is... And you're right, wages are, are performing well in nominal terms, but you have to adjust that for inflation. So in real terms, real wages are actually in negative territory. And so it's not a buffer. In fact, it's quite the opposite. It actually becomes more of a... Presents even more of a challenge in that context that the wages aren't keeping up with inflation.
Tom Porcelli:
We don't think that dynamic will continue for years to come. In fact, I think that's probably a challenge limited to this year. I think next year, inflationary pressures will have slowed. And so you can get into a better spot from a wage dynamic perspective, but for the more immediate term, those challenges are going to be very present and likely not fade.
Nurit Altman:
So maybe some softness this year for our space, but hopefully, looking forward, a brighter future. I wanted to continue on the theme of... I asked about fulfillment space and continuing on the theme of industrial. With recent challenges to our supply chain caused by the pandemic, weather events and geopolitical instability, do you see more us companies bringing manufacturing back on us, soil creating even more demand for industrial real estate?
Tom Porcelli:
I do. I think for your sector, I think to me that is going to be one of these sort of fantastic structural dynamics that play out over time. I think that's the important idea to keep in mind. This will play out over time, but I think that this, this is one of the great stories that exists out there because it has so many corollaries. So let's just talk about that a little bit. So for starters, yes, I do think that the onshoring/nearshoring is very real. I would submit to that it's already underway. Companies are already planning exactly what they want to do in that regard.
Tom Porcelli:
I think the supply chain is about to shift. In fact, I would, again, submit to you that I think it is already started shifting, and there are going to be certain sectors that I think are really primed to be on or nearshore. And I think tech and pharmaceuticals, they come immediately to mind. I don't think it's limited to that, but those are, I think, obvious ones. When I think about this idea, I think a lot of different things come into play with regard to that. Now, one of the key sort of themes that we've been trying to push is this idea that even if you do get this on or nearshoring, I think most people believe that this will lend itself to even additional inflationary pressure.
Tom Porcelli:
I would take the other side of that. I actually think that companies right now, cognizant of bringing some of the supply chain back on shore, I think they're acutely aware of the inflation implications of that, and I think they're trying to figure out ways to mitigate that. And the classic mitigant in that regard is productivity. And I think, what you're going to see, I would submit is over the coming years, you could see a potential sort of mini productivity boom take place. And I think a lot of things have really sort of put in motion this idea.
Tom Porcelli:
I think you can go as far back as the trade war. I think the trade war really started this conversation of sort of on/nearshoring. I think fast forward to the pandemic. I think that just added even more emphasis to this idea. I think you can, as a result, in part, as a result of that, I think you have to remember that companies, they were desperately trying to get workers were having a really hard time doing it. And when they did, they had a basically bid up wages in a very significant way. I think companies want to try to mitigate that and the great way of doing that is productivity.
Tom Porcelli:
And I think you'll see productivity, permeate sectors that probably people aren't even imagining right now. Most of the times people think of productivity and they think of like an assembly line, right. They think of like Forward or GM or et cetera. But I think productivity is going to show up in places that'll surprise people. I think productivity will show up in collecting trash. They're trying to put robotic arms on these and they're doing it now, put robotic arms on these trucks so that you could basically...
Tom Porcelli:
You don't have to have as many people working on the trucks as you did in the past. Butchering, right? Who would've thought butchering, right? Literally butchering meat. That's a highly skilled job, but there's technology out there now where you can actually use a robotic arm to basically help butchers. So my point in saying this is, I think it's going to be up and down sort of the various sectors where you'll see a lot of productivity gains. I think it's one of the most important stories that's not being talked about.
Nurit Altman:
Well, I'm not sure how I feel about the robotic butcher, but I'll look forward to seeing that in my grocery store. So I can't let you go without asking you about your views on the housing market. What do you see as the impact of rising interest rates on demand for, and pricing of homes in the US? And do you think it will increase the demand for rental as mortgages become less affordable?
Tom Porcelli:
Yeah. So housing here in the US, we're speaking during a week where we receive more housing data. Housing is having a hard time right now. That's the polite way of saying it. And I think it's going to continue to have a hard time. The rise in mortgage rates has been meaningful. And as I think people appreciate, housing is almost always about the average buyer, and right now, the average buyer is basically being priced out, thanks to the rise in rates, the rise in home prices. And so home sales are really starting to slow here. And I would even add slow fairly quickly. I think what's going to follow is home prices.
Tom Porcelli:
It'll follow with a bit of a lag because I do think you'll have some of these fence sitters that are just out there waiting for some home to just pop up on the market. They've been desperately trying to find a house. And so I think once a house that suits their needs pops in, they'll leap at it. But that's sort of the marginal buyer at this point. Sort of the average buyer is now I think dealing with all of these challenges that I mentioned a moment ago. So I think it's very easy to make the case that you could see housing slow and slow pretty dramatically this year. Again, if there's any silver lining, I think one of the things that needs to be remembered is yes, the Fed is engaged in a hiking cycle right now.
Tom Porcelli:
But I think an open question is, not sure how long that cycle's going to be able to go on for. And once the hiking part of it ends, that means the easing cycle is probably not far behind. And I think that's one of the things that the market's going to have to start to sort of come to grips with. Because all I keep on hearing from people is still the notion that, "Hey, the Fed is going to keep on hiking and there's more 50 basis point rate hikes in front of us." I'm not hearing the conversation about rate cuts, and I think that's going to surprise people at how fast that actually arrives.
Nurit Altman:
Well, there's certainly no shortage of interesting data to watch. Tom, thank you for sharing your insights with us today.
Tom Porcelli:
Thanks so much. Great to be with you.
Nurit Altman:
I'm Nurit Altman, and this is the Real Pulse.
Speaker 1:
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