Trend Czar

A Talk With My Contractor

I have a place in rural America --beautiful north woods where the locals are hard working, older, white and not terribly prosperous. The caretaker on my property, let's call him "Frank", fits the bill. He's 70, a Democrat, winters near Tampa in a trailer, and works at least part of all days on various jobs for area homeowners. Down in Florida he keeps busy as a clerk in a Home Depot.

Frank and I were checking a roof on the property and Frank had plenty to say as usual in a cheerful banter. First of all, no way is he voting for Obama. Why not? He was a big Kerry supporter and a local Democratic committeeman. "Not my kind and I'm not racist, but don't trust him." He went on to tell me how the locals coming into the Home Depot called Obama a "c---" (a highly inflammatory word for black) and one guy even said "the Klan would take care of him." Frank said "He hadn't heard talk like that in years." He didn't subscribe to that sort of extreme thinking, "but I served in the army with (blacks) and they're all the same."

Then Frank segued into gas prices. He's limiting trips into town, a 20-mile round trip circuit in his red pickup. He carefully plans out what he needs to get, and if he forgets something too bad. He won't make a special run. Food is getting expensive too, he says. So he and his wife aren't eating out or going to the movies like they might have last year. He's fed up with the war and has no use for the Republicans.

I said, "Frank, maybe you'll end up voting for Obama." He laughed and said, "No way."   

So I had a couple of takeaways from my conversation with Frank. All this palaver about Obama's trouble with blue collar, rural whites is really code for tip-toeing around hardscrabble racist attitudes, still embedded in many parts of American society. Many whites like Frank just will not vote for an Afro American. This election will bring that reality into sharp relief by November. It won't be pretty.

And all this talk about mild recession or even no recession in comfortable Wall Street conclaves doesn't register out in the hustings or at JC Penney and Macys for that matter. The average American is cutting back out of necessity. We're buying less of everything and turning more frugal. The credit crunch was last year's news. A consumer nosedive will be this year's, and don't confuse the two.

When I got back to the city, my white shoe lawyer neighbor with the SUV said he discovered something about gas tanks at the fill-up station this past weekend. He told me the pricing dials don't have enough slots to register charges above $100.  We've broken through another barrier. No wonder Frank is taking fewer trips into town.      

Leftover Business

A leading real estate consultant who tracks appraisal trends doesn't see net operating incomes increasing enough to support existing values. This company expects cap rates to move up and values to head down give or take 15% before bottoming. That's not terrible given the significant increase in prices over the past decade. But again, for the late buyers and their lenders, it's not what they were betting on.

A pension fund advisor with ample funds to allocate says they're having trouble finding deals. Sellers are holding out for top dollar, while buyers see the writing on the wall (see above).  "It's hard to get anything done. Sounds like what was happening in the housing market about 12 months ago before reality set in.

An executive from a major financial company says borrowers are getting leeway: "A lot of people owning loans don't want the assets that are underwater so we are forebearing." The absence of headlines about owner defaults speaks to how many lenders and their borrowers are working in frenzied states to stay of out of the newspapers. "I hope I can survive, " says one bleary-eyed banker.

If you are interested in finding out more about the sorry state of American infrastructure, you can link into the report I authored for the Urban Land Institute. Click here and you will find link on the Miller Ryan homepage. It's called Infrastructure 2008: Competitive Advantage and is available in hard copy through ULI.

And last week I was giving some developers a hard time. Here's a project in downtown Denver, 1800 Larimer, that feeds into the city's resurgence and reinforces both the city and state's push for reducing the region's carbon footprint. (Note Miller Ryan represents Westfield).      

For Love of Money--Part III

So I'm familiar with a project in a major U.S. city where the local government has agreed to give a big name developer more FAR in return for incorporating performing arts space into their development, which is mostly condos, apartments and some retail. The developer would much prefer to install a health club or restaurant into the project rather than some not-for-profit, but the city stands in the way of greater cash flow from more view space up top.

From the city's standpoint -- the mayor wants to expand arts facilities in a neighborhood at the edge of an arts district, promoting a major attraction in the city and creating a more vibrant community. But what a pain for the developer: putting some prominent theatre or dance company into space that could provide better cash flow with chain dining or another "swingles" workout gym. Sure they gain a lot more from the additional FAR, but performing arts space won't help market the building and by itself won't help enhance the NOI numbers when they plan to flip the building in a few years.

So the developer puts the squeeze on prospective arts tenants almost for the sport of it -- nickle and diming artistic directors on lease terms and build out contributions with typical negotiating histrionics. You want our nice space -- well we'll try to take something out of you so we can put some more relative pennies in our pockets and our out-of-town money partners.

And what about the betterment of the city and a cultural contribution that just might improve land values in surrounding blocks for longer-term benefits of everyone in the community?

Well, what about it?

For Love of Money Part II

Build, flip, and who cares what happens once you're out has always been part of the developer mentality. But in recent years a combination of the wave of Wall Street and institutional money, the rise of equity REITs, the decline of local banks, and the emergence of national development companies rips at the fabric of local developer-owner-citizens, who were more likely to build and manage real estate with the long-term interest of their communities in mind. Developers, investors and lenders today often have limited or no local roots -- projects pencil out entirely for their IRRs, not furthering any particular civic good.

If local government fails to provide sound vision for land planning, these outside business players certainly have little incentive to fill the void even at the margins. And if a project goes bad, they may be more likely to bail out, cut their losses, and leave the locals hanging. If property values take a hit as a result, hey it's not their problem.  Their responsibility is to clients and shareholders, not the community. And they are out of there.

Local bankers, meanwhile, might have been more willing to renegotiate loans or give local borrowers more leeway in working out problems to avoid further harm to local markets from defaults and business failures. Bank consolidation and securitization mania eliminates opportunity for forebearance based on local interests. It's much easier for some national bank or special servicer to drop the hammer without the context of community relationships and fallout to consider.

Long distance investment and short-term ownership horizons also abrogate contributions to the community chest. If you don't plan to be around when the civic improvements get completed why contribute in the first place. And out-of-town asset managers redline charitable giving to the local hospital drive or theatre company without hesitation. Where's the return on investment? 

As buy-and-flip has been stopped in its tracks by the credit crunch and real estate markets head into full bore decline, many far-off owners with little equity down hold buildings in places they don't really understand or care about and some developers get that uncomfortable feeling about half completed projects with mostly empty leasing rolls.  We may see a host of players getting out of Dodge and then what happens when the out-of-town banks or special servicers get in the game. It may not be pretty for local markets or civic interests.

For Love of Money: And Not Much Else

Stating the obvious, we all know the driver for most people in the real estate business is making money, lots of it. Nothing wrong with that. And there have always been some developers, who push the envelope. They would gain FAR or other benefits to increase project size and then build uninviting concrete parks, back alley canyons or worse to meet the letter of the law. They make money, but maybe at the expense of lasting contributions or good citizenship.

And there have always been examples of developers with secondary motivations -- place making, improving their community. They'd actually invest in public art, provide space for the performing arts or create attractive public spaces in bids to leave a mark, while not so coincidentally improving the long-term value of their projects. They were typically locally based, owner-developers, who made a business of managing their properties.

It's increasingly hard to find commercial owner-developers today. Most developers are merchant builders, who use Wall Street money seeking immediate returns. They want to lease up as much space as possible at the highest potential rates and flip out as soon as they can, using other people's money. They may hire big name architects and plop sculptures in lobbies to provide cache and help leasing, but they favor health clubs or restaurants to gallery space, theaters, or, heaven forbid, park space. They've got to squeeze out every inch of cash flow to maximize their quick reversions. They're not in the business of long-term community interest. And since many of these companies or the money they represent are not rooted locally, the long-term interests of the community are not a part of their mindset.

So what are the consequences...? To be continued.