On a blustery Chicago day (is there any other kind in January?), 3,000 people crowded into the Sheraton Chicago Hotel to hear the President`s first formal announcement of his “Growth and Jobs” proposals.
The President spoke effectively and forcefully for about 40 minutes. With a reputation as a less-than-stellar public speaker, our 43rd President has clearly received some very thorough coaching and one could only be impressed with the commanding performance. He clearly enjoys his job, tough as it is, and realizes that the American people now need to hear some creative ideas from him on the domestic front, even while the international picture remains highly uncertain.
Taken together, the President`s proposals do not constitute a classic “stimulus” spending package. It was fitting that the President`s plans were formally announced a few yards away from the University of Chicago`s downtown campus. Near the birthplace of the Chicago School of Economics Whose two key tenets have been: 1. Only money matters—the supply of money circulating tells you more about current and prospective economic health than virtually any other feature of a nation`s macro-economy 2. Markets generally solve economic problems more effectively than government spending. we heard about a “Growth and Jobs” plan that relies much more on tax reduction and tax credits than on government spending to get the economy going.
The new head of the President`s Council of Economic Advisors, Steve Friedman, was in the audience and we heard a lot of the numbers that Steve`s team believes this package of proposals can accomplish.
á The proposals will put $675 billion into the economy Of course, it will also cost this much in foregone tax revenues. over 10 years
á 92 million tax-payers would receive accelerated tax relief
á 23 million small business owners would receive tax cuts
á 26 million married couples could take a larger child care tax credit
á 35 million investors would benefit from the elimination of taxes on stock dividend. á 75,000 workers per week who claimed unemployment benefits last year will have these benefits extended.
á 2 to 3 million “personal re-employment” accounts would be set up to help the unemployed find work, relocate and get job training.
The Council of Economic Advisors thinks that all together, this package of proposals has the potential to create two million jobs over the next 36 months and that $180 billion of tax relief can be delivered over this same time frame, assuming Congress goes along quickly.
Some quick thoughts:
á The timing of this announcement is very positive, coming on the first day of the 108th Session of Congress…this becomes the first order of business for the new and returning Senators and Representatives.
á In monetary and fiscal terms, the size of the overall package is really not that big ...for instance the tax relief package of 2001 was $1.4 trillion, by comparison.
á The ability of this package of proposals, or any similar package passed by Congress, to quickly boost businesses spending or to grow consumer spending will be modest, at best. This package does not really address systemic problems in the American economy (overcapacity, high levels of consumer debt, uncertainty about Iraq and North Korea).
á But, as always in politics, the optics are just as (if not more) important than the economics.
á The stock market responds as much to emotions and intuition, as it does to rational expectations, so a sustained positive response in the stock market, which restores lost investor confidence, could easily be the best part of the whole deal. Hotel REITs might be hamstrung by short-term volatility
á The REIT world is already buzzing about how the elimination of taxes on dividends will affect this important part of the hotel real estate market. It is generally understood that taxable REIT investors will have to pay taxes on REIT dividends, since REITs do not pay corporate income tax (thus, no need to eliminate double taxation). Many believe that the relative attractiveness of REITs would be diminished…the question is how much.
á LaSalle Investment Management`s REIT team believes that the after-tax ability of a REIT to produce dividend income will still remain far superior to the S&P, the Dow or the Russell 5000…and so one of REITs strongest appeals to taxable investors will remain largely intact. It is highly unlikely that any generic company would want to quickly boost their dividend to even half the level of a 6.5% or 7% yield of a blue-chip REIT, even if they could.
á But, it is true that the relative appeal of preferred stock from C-corporations and other high-dividend stocks could encroach on the demand for REIT shares.
á We believe that this effect will be seen on the thinnest of margins. While 50% of all Americans now own stocks…(and that means REITs, now that REITs are in the S&P), most of that money is held in tax-deferred 401K accounts or pension plans. No one is paying taxes on these dividends anyway.
á Offshore investors are not part of the proposal, and a lot of international REIT investors are therefore not affected.
á Potential short-term volatility could mean that hotel REITs will continue to be limited in their ability to acquire assets in 2003. These conditions could conversely give more fuel to C-corps in their portfolio building activities.
á There could also be an incentive for hotel REITs to switch to a C-corp structure as was witnessed when the paired share structure was repealed, which saw among others Patriot (now Wyndham) and Starwood Lodging Trust switch to this structure.
á A more far-reaching and longer-term impact of the proposal is that it may focus more individual and institutional attention on the importance of dividends in financial planning, and REITs will emerge as part of a secular trend toward finding the right balance in a retirement account between income production and appreciation of the capital base.
á On Monday, REITs were caught up in all the excitement and rose about 1%. The larger hotel REITs enjoyed similar gains. Yesterday, they gave it all back and then some, as more investors focused on the fact that REITs would probably not be affected by the elimination of double taxation.
Private and Public Hotel Investment Markets:
á In recent years, the larger institutional investors have all generally accepted the fact that they should be active in both the public and the private real estate arenas.
á Over the next few months, we would expect private strategies to grow in relative attractiveness, as any increase in REIT volatility will cause some institutions to avoid putting additional money there, even though we think the valuations actually look more attractive than the private market, in many instances. In our last Hotel Topics edition of 2002 we predicted that private equity players would dominate acquisition activity in 2003 and that REITs would perform only a limited role.
á The best buys in the private arena, will be strategies that are patient. We do not see a quick rebound in jobs or consumer spending coming out of this package. Friedman may be right about two million new jobs, but unfortunately, that number may be offset by another one million jobs that are still in the process of being out-sourced, down-sized or whatever euphemism you pick.
á The positive impact of the proposal on small-businesses is well worth watching for mid tier and limited service accommodation…but this sector will need more than just a few years to recover and an increase in the tax credit for small businesses is not going to cure anemic hotel occupancy and rate quickly.
á The most optimistic part of the proposal is that it may offer a much-needed boost to some Central Business District markets that feed on investment bank activity. We expect to see a lot of I-bank business created out of the elimination of dividend taxation as preferred stock gets issued, advice on the balance of debt and equity is changed, leading to changes in companies capital structure. This should most directly benefit upper tier lodging in major financial precincts. A rebound in the stock market in 2003 would only help this scenario and would obviously translate into a broader-based lift to overall hotel performance levels. New York City and to a much lesser extent downtown San Francisco and Chicago leap out as the immediate beneficiaries.
Overall, it is still way too early to draw conclusions on what the whole package will look like by the time it gets through Congress. The good news is that there appears to be a good head of steam to move quickly. The bad news is that we can`t expect this or any government action to fix the underlying structural weakness in the US economy quickly.
The lodging industry will be among the first to benefit (given its leader effect) if the U.S. economy can start to create jobs again, which it could well do (even without this package) by year-end. The ability of the President`s tax relief proposals to accelerate this process is very real, but has more to do with producing a much-needed shift in sentiment (consumer, stock investors and businesses) than in any real multiplier effect of an annualized $60 to $80 billion in tax relief in a ten trillion dollar economy.
As it relates to hotel real estate, as goes GDP or economic growth, so go increases in hotel demand. As such, a kick-start for the economy earlier than would otherwise have been experienced will obviously precipitate a faster recovery in demand. And with supply growth constrained and operating expenses in check, hotel profits should escalate quickly making hotels a favorable investment alternative. Yet 2003 remains rife with uncertainty. To help our clients navigate this environment and respond to its varying challenges and opportunities, we developed the Hotel Investment Strategy Annual (HISA). Look out for its release at the end of this month.