Trend Czar

Flight to Quality

Amid all the talk about peak-to-trough value losses of 40 to 50 percent in commercial/multifamily real estate, some sectors in certain 24-hour cities may be firming up even as the overall market continues to sink—albeit more slowly. This very limited phenomenon embraces a classic flight to quality and appears to concentrate in Class A apartments and select high quality office in the primary coastal gateway markets.

Investors with cash—remember we’re talking cash buyers since there is little if any available credit—circle apartments, because they figure there will be significant pent up demand among young adult baby echo boomers who have been doubling up or moving back in with parents. As soon as, jobs activity and wages show some sign of upticks, more people will look to rent their own place. House-hunting won’t be in the cards because of ongoing credit restraints—the days of putting little to nothing down are over for the foreseeable future.

For now the investor attention concentrates on Class A apartments which appeal to a higher-income strata—baby boomer empty nesters who may be downsizing out of big suburban homes or the unmarried single/young couple without kids urban professionals who don’t have enough cash to buy, but do have enough income to rent a nice, hip urban residence. In prime coastal West Coast markets like San Francisco and down the Pacific in Southern California, upscale apartments start to fetch lots of buyer attention—even lowering cap rates. Can you imagine?

Foreign buyers, in particular, figure Washington, D.C., New York, and San Francisco office is ripe for the pickings at or near market lows. Investors believe these markets will not only be the first to recover, they think these places also will bounce back more quickly because of direct links into global pathways and world business markets.  If something high-end with strong occupancy comes up for sale, expect plenty of bidders helping keep a floor on value declines in these cities.

But the hot money is very focused and particular. There’s not much interest in anything below Class A- and no one knows how to value distressed product, which is totally hands off. In cities like Chicago, a glut of high-end condos adds more space temporarily into the Class A apartment sector.  New York developers grossly overdid condo construction too, which will keep downward pressure on rents for a while longer.

In a retail wasteland, the top fortress malls will hold their own as will the best community grocery-anchored shopping centers serving high-end suburbs. Everything else—is just ugh.

Class A space in totally overdeveloped, growth markets like Phoenix, Las Vegas and anywhere in Florida has little chance to show much firming in an extreme buyer’s market. And make no mistake, for the fifty or sixty-something boomer, who has some savings and always wanted that warm-weather second home or retirement place, this is the time to buy the beachfront condo or comfortable golf club hacienda in upscale resort communities.

The flight to quality is on…

   

Not So Exceptional

Ever since Ronald Reagan’s “Morning in America” optimism trumped Jimmy Carter’s attempt at straight talk about malaise, America’s leaders have been careful to latch onto the notion of American exceptionalism, the idea that our democracy and our way of life will prevail because we are somehow better than everyone and everywhere else. President Obama made sure to include a helping of America is better rhetoric in his Afghan War speech last week.  Politicians just don’t get elected in this country, if they even hint maybe some of our ways aren’t the best ways or we’re falling behind other countries.  They studiously avoid need-to-sacrifice, pull-up your bootstrap conversations with the American people and stick to the bromides—some formulation of everything will be solved if we lowered taxes, cut spending, and/or let our ingenuity create innovative industries and businesses—that next new, new thing.

Indeed we may pull the rabbit out of the hat. But make no mistake, America is falling behind from gross over-borrowing, a lack of investment in the infrastructure, and living off past prosperity. The best example of our falling behind is on the infrastructure front. The recession has temporarily eased growth in congestion at our overloaded airports, seaports, and on our roads. Getting around on the Thanksgiving weekend was a touch easier this year, because many folks just stayed closer to home and airlines cut back a slew of flights. But in the last 30 years, we have developed just one new airport (Denver), finished a lone major urban highway project (Boston’s Big Dig), and built zero high speed rail lines. Our once vaunted interstate system is now 50 years old, the age when overpasses, bridges and foundation supports need replacing.

China keeps building infrastructure—more than 30,000 miles of new highways over the past 15 years with another 20,000 miles in construction or on the drawing boards and plans to complete a 7,500 mile high speed rail network by the end of this decade.  Other countries in Europe as well as Japan have embraced bullet train technologies for years and already operate 7,500 miles of high speed rail lines. Again, we here in the United States operate none, zero, nada.

Our airports use 1940s era radar technologies to track planes instead of new GPS systems which would enable planes to fly closer together and improve air safety. Our electric grid dates to the Depression era and doesn’t sync or link with all those plans for solar panels and windmills.

Oh yes, and the federal Highway Trust Fund which bankrolls roads and mass transit is effectively bankrupt, because the gas tax hasn’t been raised in 16 years and politicians are afraid to toll highways like most other countries do to pay for improvements, including China.

And let’s not talk about aging water delivery and sewage treatment facilities, and crumbling dams—all built decades ago when the country invested in its future and gained competitive advantages against the rest of the world.

We were exceptional once. Let’s not kid ourselves about today.    

Was Tiger Rushing for Black Friday Deals?

Did you go shopping on Black Friday and line up at 3 a.m. at your local Wal-Mart or Penney’s? Did you get that great deal on something you or your family probably doesn’t need like the high definition TV which uses five times as much electricity as your old color set? Did you do your national duty and buy, buy, buy?

I can’t think of anything I’d rather not do over the Thanksgiving holiday than go shopping. But all the TV commercials and newspaper ads try to rev up business and the news shows tell us that’s where everybody goes. Tiger Woods was probably rushing to get in on the action when he drove into the fire hydrant—he was looking for just that special something for his model wife, I’m sure, and couldn’t race to Target fast enough to get on line in the wee hours.

Pay little attention to the Black Friday weekend sales volumes. They usually offer little guidance on overall Christmas sales figures. The early numbers were half a percent over last year’s or basically flat, and last year was an ugly holiday shopping season.

Clearly rising unemployment, tightened credit, and mountains of existing consumer debt add up to another dismal year for retailers. Industry spokespeople sound cautiously optimistic, but they don’t want to talk people away from the stores and be accused of creating a self-fulfilling prophecy. That’s just not good for their own job security.

Their hopeful talk aside, we’re told retailers have hedged their bets by not over-ordering and keeping product lines lean—they don’t want to be forced into marking down a bunch of Boxing Day inventory like last year. 

No matter what happens this Christmas season, we need fewer stores in America. And that’s even if sales pick up sharply and unexpectedly. Internet buying will inexorably eat into more bricks and mortar retail business. Internet sales currently total about 10% up from nothing a decade ago. And it’s not just echo boomers going on line at Amazon.com. It’s also working moms looking to save time and stay-at-home moms hunting for bargains. People become comfortable with the process and its relative reliability. One mid-fifties lady I know used to spend her days shopping the power centers and malls for stuff. Now that the family income is shaved and the big mortgage is worth more than the the big house, she shops online for what she needs—saving on gas and avoiding those costly spur-of-the moment temptation purchases.

The big store chains claim or should we say hope that they will keep internet shoppers buying through their sites, but increasingly it’s in the manufacturer’s interest to cut out middlemen and sell directly to the consumer, using fulfillment systems for deliveries.  And if department stores have trouble connecting to consumers, mall company websites won’t have much of a chance either.

Now malls and Wal-Marts are far from endangered. The majority of shopping will continue to happen in bricks and mortar formats. It’s just less and less shopping will go on in stores over time. And in the mean time, more Americans realize they don’t have the means to do as much shopping as in the past and understand they need to save more… Merry Christmas all you retailers.    

From the Road

Here are some thoughts from the road after three weeks of Emerging Trends speeches:

San Francisco: Relatively upbeat after a thorough pummeling, the market sees cash rich vultures start to circle in a flight to quality. Well-leased downtown properties find a floor and the apartment market could come back more quickly than other sectors. The worst is over.

Toronto: Locals sleep easy despite downtown office overbuilding and weak industrial markets brought on by carmaker woes just south of the border. Well-heeled institutions own most of the downtown properties and offer stability while developers back off ample condo construction—units get bought up in move-back in trends. A lackluster economy looks comparatively good next to U.S. woes. Everyone is relieved they didn’t overleverage and stuck to conservative practices with a heavy dollop of government regulation in the banking sector. The big worry is contagion from the U.S., including the weak greenback, which cuts into exports.

Boston: Happy to rank higher in Emerging Trends than anywhere else but Washington D.C. and San Fran, Hub players know they still have to take their medicine and work their way out of a giant hole. A barrier constrained market and brainpower center offers better prospects for quicker recovery than most other places.  

New York: Transaction pros sense buyers may be coming back, sensing an approaching market bottom. Any quality deals attract plenty of attention especially from foreign investors. The prospect for flush Wall Street bonus checks also helps lift moods--maybe a new rush of funds will help refloat the capsized condo market. But that may be too much to expect with rising local tax burdens needed to offset yawning state and city budget gaps.

Philadelphia: Since this slow growth market never got overheated, any drop has been more restrained and locals aren’t overly shell-shocked. They know D.C. and New York will bounce back faster—the market long ago settled into a semi-permanent malaise.  Still this great American city has some entrepreneurs with chutzpah.  At 30th Street Station you can get a great shoe shine for a lofty $8 charge-- and the shine man knows he’s good, intermittently muttering “spectacular” in heavily Greek-accented English as he swipes and strokes away. It would be offensive not to add at least a $1 tip. 

Chicago:  Too many condos, overbuilt industrial, and an office blood bath in the suburbs were bad enough, but losing the Olympics was the big gut punch that deflated the Second City’s ego. Some leaders start thinking about an Obama presidential library as a new world wide attraction to gin up attention and restore local stature.  At least the guy in Washington might think that idea amounts to jumping the gun--he (probably) hopes he doesn’t have to consider that prospect for another seven years.  Real estate pros just hope the market doesn’t take that long to recover.

Vancouver: North America’s Shangri-La for real estate, this city’s commercial cap rates continue to hover in the 6s and housing markets have bounced back to record highs as the Winter Games approach. Harbor view condos fetch seven figure pricing and local investors out bid institutions for the few available commercial deals. Brokers lament they can’t find more to sell—everybody wants to hold onto a piece of the place.

And have a very Happy Thanksgiving time. I hope I can get home in time.  

We can only hope for higher interest rates

We begin to see more headlines about workouts and loan restructurings. Donald Trump is left with 10% of his name-branded Atlantic City casinos, the most recent buyer of the New York Times building near Times Square got left holding the bag and takes a bath along with some big name lenders. Bankers give up on extend and pretend and foreclose on a Chicago retail developer. Simon, the number one mall REIT, circles General Growth as the number two mall REIT moves closer to emerging from a deflating bankruptcy. The logjam in the credit markets slowly starts to break down as both borrowers and their lenders begin to face up to their significant losses. Many such days of reckoning will consume real estate players in 2010 as they realize time and the economy won’t bail them out.

Some observers have been pointing to the stock market for rays of better times ahead—recent gains hopefully presage restored economic growth. But stock investors seem more buoyed and energized by the Fed keeping interest rates at near zero levels than any solid signs of business recoveries. Cheap money continues to be everyone’s elixir of choice, feeding hard to shake trading behaviors and short-circuiting more long-term investment thinking. But the continued low Feds Fund rate really should be everyone’s concern. Bernanke and company’s actions only signal their apprehensions over economic fragility and the long road back to spurring significant U.S. jobs growth. It actually would be good news, if the Fed finally started lifting rates—that would highlight renewed confidence by senior government policy makers that we are on the mend. Unfortunately, that confidence appears nowhere in sight as unemployment numbers rise—albeit at a slowing pace—and companies improve earnings mostly off of productivity gains (cutting costs) not meaningfully ramped up sales.  

At some point interest rates will start to revert to the mean—keeping upward pressure on cap rates, and limiting value gains as real estate markets move off bottom. Those who think this low rate environment will continue forever must be the same folks who bought into a secular shift in real estate pricing and forgot about market cycles.  And rising rates may not be left to the Fed’s choice if offshore T-bill buyers back off over concerns about huge U.S. government deficits and our (at best) sluggish prospects. China and other exporters slowly may come to the very reasonable conclusion that America no longer is their most reliable market for selling goods as we struggle out of our self-dug borrowing pit.

We need to hope the Fed feels comfortable enough about increasing rates soon—what might seem like bad news for the stock market could be a strong signal of support for a reviving economy. And any hike can’t happen soon enough.