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Big and Bold Black Friday

Strong start to holiday shopping season

U.S. consumers felt festive heading into the holiday shopping season. Although consumer sentiment fell from October's post-recession high, it remained elevated in November. A tight labor market and the prospect of income tax cuts propelled not only good feelings, but actions. Retail sales activity on Black Friday and Cyber Monday exceed expectations. In an ongoing change, much of the activity occurred online. Roughly $5 billion was spent online by U.S. consumers between Thanksgiving and Black Friday, a one-day record. But that record lasted only a few days because consumers then spent roughly $6.6 billion on Cyber Monday. 

Physical bricks-and-mortar stores also fared well because many consumers – roughly 65 million – chose to shop both online and in a store. Foot traffic declined only slightly versus last year. And millennials, who are becoming a larger part of the consumer base, prefer to shop in stores (somewhat counterintuitively) according or recent survey data. 

Many stores exhausted or were running incredibly low on inventory of hot sellers, a sign that some retailers were caught flat footed by the strong retail sales activity. We still believe that holiday retail sales should see growth over last year's number.

Finally, some good news for retail real estate?

Clearly, this is good news for physical retail real estate. While not every retailer or retail center reaped the benefits of this consumer bonanza, many did. 

This reaffirms our belief that the "retail apocalypse" is more hype than reality. The centers that struggle dominate news headlines. But many centers, particularly those located in markets along the coasts which boast strong trade areas full of affluent consumers, performed well. 

The majority of the markets with the lowest vacancy rates and highest rents in the U.S. are concentrated in places like Northern California, Southern California, and the New York metro area due to the underlying strength of those metro economies. Yet even within those metro economies, variation exists because retail real estate's fortunes are determined at a very micro level – trade areas are often just a handful of miles and most malls typically don't draw consumers from large distances. Even very affluent economies such as those mentioned above don't have uniform distributions of wealth and income at the county and city level which greatly impacts the performance of individual centers. Investors and tenants should continue to focus on individual retail centers, not headlines.

Existing home sales continue to rise

Existing home sales grew at an annualized rate of roughly 2 percent in October. Although the hurricanes in August and September produced some lingering impact on sales in Texas and Florida, that was not significant enough to nullify gains in other parts of the country. Inventory for sale remains the largest constraint to greater sales activity. The supply of homes for sale declined on an annual basis for the 29th consecutive month while demand remains strong. Excess demand pushes prices upward, particularly for smaller, entry-level homes, which are increasingly difficult to find at prices that are affordable to many entry-level buyers. Slowly, construction activity in housing is increasing, but quickly enough to keep up with demand. The tax reform bill could spur sales activity in 2018, but we will need to see the specifics of the finalized bill before we have clarity on housing sales volume. 

As we've mentioned before regarding the apartment sector, rising residential home sales don't necessarily correlate to a lack of demand for multifamily product and, in fact, is more of a complement than a substitute. 

Durable goods orders somewhat disappointing

Durable goods (good that are not used for immediate consumption, but held for a relatively long time) declined in October. But this followed two months of strong increases so we are not overly alarmed by this. Additionally, core goods orders (which exclude somewhat volatile components such as defense spending and aircraft) increased. We believe capital expenditures by businesses have not slowed and expect to see a rebound in headline durable goods orders in the fourth quarter.

Fed minutes signal rate hike next month

The Fed released the minutes of their November meeting last week and barring some significant idiosyncratic shock, we expect the Fed to raise interest rates by 25 basis points next month. According to the statement, Fed officials believe that the economy remains firm and the labor market will continue to tighten. The Fed believes that inflation, which was weak throughout most of 2017, will rebound in 2018. We generally agree with this assessment. But the Fed has been a bit unclear about how it uses its dual mandate (price stability and full employment) to make decisions. When inflation was falling, market participants did not generally expect the Fed to raise rates once more this year. Now that the Fed has communicated it will raise in anticipation of future inflation, forecasters need to closely watch inflation forecasts. And the tax reform proposal takes on outsized importance. At this relatively late stage of an economic expansion, with the economy operating near capacity and near full employment, throwing fuel on the fire risks overheating the economy and stoking inflation. The would likely cause rates to rise faster and even potentially bring about rate increases greater than 25 basis points.

For commercial real estate, because growth in the economy continued during the last two years, the individual rate increases not have not had much if any impact. Lofty pricing largely drove buyers and sellers apart in 2017, not higher rates. But if economic growth fails to keep up with cumulative rate increases over time, growth in real estate fundamentals (and consequently net operating income) will slow. That will dampen investor spirits and put upward pressure on cap rates.  Investors will need to closely pay attention to trends in inflation because they will determine the future trajectory of interest rate increases.

What we are watching this week

New home sales should continue to increase in October after a small gain in September. Although lack of construction restrains the market, underlying trends in starts and permits (spurred on by high prices) should continue to boost sales volumes. Consumer confidence should remain elevated in November. Ongoing labor market strength and tax cut optimism should continue to push confidence toward levels unseen since the dot-com boom years. GDP growth for the third quarter should be revised up slightly due to greater inventories and solid retail sales.

Thought of the week

In order to better compete, an increasing number of retailers ship online orders from individual stores and not warehouse/distribution centers. This can significantly shorten delivery times.

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