Economic and market trends in second half of 2007 and early 2008: an assessment and outlook.

Panelists:

RAYMOND G. TORTO Ph.D., CRE

Principal and Chief Strategist

CB Richard Ellis--Torto Wheaton Research

Boston, Mass.

KENNETH P. RIGGS, JR., CRE

President and CEO

Real Estate Research Corp.

Chicago, Ill.

ALAN C. BILLINGSLEY, CRE

Head of Research, North America RREEF

San Francisco, Calif.

Moderator:

PETER C. BURLEY, CRE

Associate Editor/REI

Vice President, Research

Simpson Housing LLLP

Denver, Colo.

Peter Burley Sets the Scene

ON ANY GIVEN DAY, one can usually find me in my office "studying." My job requires it. As the chief--and only--research executive in the building, I am the guy who monitors, analyzes, interprets and synthesizes incoming reports and data that reflect developments in U.S. economy and property markets. I write what I have learned for the various clients I serve within the company (read: the Boss, the Boss's Boss and our investors).

A big part of my daily routine is playing host to a parade of visitors in my office (read once again: the Boss), who often drop by to ask me what I have read or what I know about the latest reports on employment trends, interest rates or property market performance. Lately, say over the past few months, the visits have grown more frequent, and the questions just a bit more serious.

"So," one visitor (er, the Boss) began, as he stood at my door, "are we there yet?"

"Where?" I asked, looking up, slightly unfocused, from my computer screen.

"Recession," he said, matter-of-factly.

"I'm having a little trouble getting a fix on that," I answered, "though the odds that we are headed that way seem to have increased in the past few weeks. Job growth is off. Spending over the holidays was a bit weak. And, there is simply no good news on the housing front. Debt markets are nearly frozen. And, to me, the very fact that the Fed is acting aggressively suggests that some concern may be warranted."

"I think we're gonna have a recession," he said and walked down the hall.

As I said, the visits are more frequent. The questions are more serious. And lately, when I answer the questions and write about the economy and the property markets, I try to do so as honestly and in as straightforward a manner as I can without:

* injecting too much optimism into the discussion;

* scaring the bejeezus out of those who ask the questions or read my reports (i.e., the Boss).

Thinking to myself that perhaps it would be useful to inject a little fresh perspective into my daily studies, I decided that maybe I should be the one who asks the questions for a change. At the end of December, and again in mid-January, I sat down to glean some fresh, additional wisdom from three of our best known and most respected thinkers. "What might Ray or Alan or Ken say if I happened to stop by their door to ask, "Are we there yet?"

BURLEY: Housing markets continue to crash. Financial markets are in turmoil. Employment is slowing. Spending is beginning to slow. The Federal Reserve seems a little spooked, trimming its official forecast for 2008, and aggressively easing policy. The dollar is at a new near-term low.

Recent dynamics in the economy have been tipped over, first by the deep slump in the housing market, with few signs of stabilizing and additionally, by significant stress in the financial markets, with equity markets swinging wildly, and debt markets in turmoil. It seems almost as though some of the financial innovations that helped fuel expansion in the past have suddenly turned on us--I'm thinking especially about the multitude of fairly new securitized debt instruments that have entered the market in recent years, like CDOs and SIVs.

Home sales have fallen to their lowest level in 28 years. Owner home equity fell in 2007 for the first time in 16 years, suggesting weaker spending and economic growth ahead.

Additionally, there is evidence that loans of all kinds are showing stress, from home mortgages to construction loans to auto loans to consumer credit. Delinquencies and defaults are up, it seems, across the board. Even student loans appear to be on the verge of slipping into crisis.

Consumers and businesses alike are growing more pessimistic. The Moody's Economy.com Business Confidence Index, for instance, is at its lowest level since its creation some five years ago, with components for sales, inventories and office space all deteriorating. The University of Michigan Consumer Sentiment Index dropped in early December, largely on expectations, to its lowest level since Hurricane Katrina and is at its second lowest level since the early 1990s. And, the Conference Board's index of consumer confidence is effectively at its lowest since 2003. While confidence measures are seldom very good indicators of spending behavior, we have seen some evidence that consumers are pulling back, with rather soft retail sales reported in the fourth quarter of 2007. Consumer spending slowed in December to its weakest pace in six months ...

What's your assessment of the state of the U.S. economy, given the slumping housing market, turmoil in the financial markets, a slowdown in employment and consumer spending, and pessimism among consumers and businesses? Are we headed into a recession? Are we already in a recession?

TORTO: First of all, the question is not whither recession but how slow will growth be and for how long? A positive growth of .2 or a negative growth of -.2 has the same negative effects for our economy.

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We are amazed at the resiliency of the U.S. economy. Consumers are still stepping up and businesses are posed to continue investments and serving the export markets. As long as we continue to create about 80,000-100,000 jobs a month, and businesses can borrow from the banks and markets, we expect to see slow but positive GDP growth.

The most insidious risk is the instability of the credit markets and whether we can get back to normalcy in first quarter of 2008 in these markets. We expect the overbuilding of the residential sector to be a drag on the economy until the end of 2009, subtracting from overall GDP growth. For 2008, we see GDP growth in the one percent range.

We will pull out of this slowdown when the housing drag is no more and as the export market for our goods and farm products continues to grow. The graph above shows the importance of housing to the overall economy, being as high as 6 percent of GDP in 2005, and now at 4 percent ... as housing starts fall, it will detract from GDP growth and offset the positive stories for business investment and business exports.

RIGGS: There are quite a few signs that the economy is at risk--record high oil prices, a weak dollar, government deficits, geopolitical risk, the subprime mortgage meltdown, and the global credit crisis--but no hard evidence yet that we are in a recession. The most recent measure of GDP growth, taken Dec. 20, 2007, indicates a final estimate of 4.9 percent for third quarter 2007, which is higher than the 3.8 percent growth in second quarter. Also, productivity growth of 6 percent, solid corporate balance sheets, strong demographics, low interest rates and the Federal Reserve's aggressive approach to cutting rates to stay ahead of a recessionary curve, and a weak dollar, all demonstrate the strength of the U.S. economy.

That said, however, many economists are projecting slower economic growth over the next few quarters. And, with continued high oil prices and high winter heating costs, slow job growth, a reduction in home building, and the continued negative hype associated with election year politics, it will feel like a recession to many, especially those in hard-hit areas of the country or in industries with declining growth.

Main Street, or the consumer, still comprises two-thirds of our economy. If employment doesn't slow too much, and consumers keep their jobs and continue to spend, the foundation for economic growth will remain solid. Additionally, growth in exports will continue to shore up the U.S. economy. During the second quarter of 2007, imports fell 2.7 percent, while exports increased 7.5 percent, which was due in great part to the weak dollar. Business and government spending in 2008 will also help to keep the economy growing.

BILLINGSLEY: I do not believe the economic fundamentals warrant a recession. Nevertheless, there is a high probability--about 50 percent--that we will get one in 2008, as a result of what I believe are overreactions in the equity and debt markets. A market psychology is setting in that could lead to more severe job layoffs, to more restrained hiring, and to fearful consumers, pushing us into recessionary territory. In any event, the choice appears to be between our base case of very weak employment and GDP growth in the coming year, versus a mild recession, with modest negative employment and GDP growth. In either case, a needed slowdown will allow us to recover from a "bubble" we created in asset prices and over-leveraged debt markets. Renewed growth would follow in 2009 and beyond.