Trend Czar

Some bad wagers

This year Las Vegas provided a particularly appropriate backdrop for the annual ICSC Spring dealmaker extravaganza. If anybody in the real estate business needs a reminder that these are uncomfortable times this overextended desert market provides a wake-up call in spades.

A Dubaiesque building spree in the face of stalled demand suddenly hits the skids. Even in the best of times how many high rollers want to own condos along the strip? That scene may work for a few visits a year, but a regular diet of swarming tourists and eight lane traffic jams can get old pretty fast, except for a hardened few. Cheap land and housing attracted Californians wanting out of high prices and high taxes. Now housing values have tanked nearly 30%. As for all the new hotel rooms, when you hear sky's the limit talk about convention and tourist trends, you know developers are getting ahead of themselves. The tight economy comes at a very bad time for all those casino operators.

At least most other U.S. markets have avoided Las Vegas's development splurge. That will be their saving grace as cap rates continue to rise and values decline. Softening vacancy rates shouldn't increase dramatically even as demand slackens. This downturn should be relatively manageable.

Of course we have seen in recent weeks, how several high profile flippees in last year's Blackstone bacchanalia lost their shirts, paying and leveraging too much just before the game ended in lamentable credit crunch. Just like in Las Vegas, you have to know when to leave the tables. We're now beginning to find out who stayed too long.

The Talk of Summer

Hope you had a good Memorial Day Weekend. And so what was the hot topic of conversation at your barbecue?

Where ever I went -- I covered about 650 miles by car, visiting with relatives from Canada, the UK and seeing friends from various parts of the Northeast -- the number one topic was the price of gas. For starters, there were all the "jeez-louise" rolling-eyes looks from anyone peering at the gas pump price signs before they swiped their credit cards. I saw a price high of $4.59 a gallon on the New York side of the Palisades Interstate and price low about 15 miles later on the (tax-low) Jersey side of $3.76. If you have a big SUV sized tank, there's about a $15 price swing per tank-fill between the states. I paid $4.09 and $4.13 a gallon for my fillups. My London cousins were a bit blase about it all. First of all they revel in the cheap dollar and back home they pay about $10 a gallon. My Canadian cousins weren't that unhappy either -- given the strong Loonie and their familiarity with higher pump prices too.

Talk shifted to the rising prices for plane tickets which has supplanted the usual hurrumphs about typical summer airways snafus. 

Nobody in my circles was planning to cancel trips, but there were all sorts of pained expressions, and conversations about trading in bigger cars for smaller ones. It sounded like 1979 redux.

There were plenty of cars on the road, and some back ups at the expected bottlenecks. But on my routes it seemed there were smoother traffic flows than in recent years for a Holiday weekend. Nobody I know got caught in typical horrendous delays.

The big question no one can answer confidentially -- is this another temporary price spiral a la 1973-4 and 1979/1980, or are we ushering in a new era of more permanent price escalation.

The mood in my circles over the steak dinners was this is more permanent than fleeting. And the steak cuts were flank not sirloin.

The Feel Good Index

A great debate rages over whether the U.S. economy is in recession -- is growth slightly negative or just plain minuscule? On the ground, does it really matter?  Larry Lindsey, President Bush's former economic adviser, said in a presentation I attended a few years ago that growth in the 1.5% to 2% range feels like recession whether or not it technically is. This week's release of Fed minutes underscores the reserve bankers are not particularly optimistic, expecting higher unemployment and more inflation, fed by high energy prices. Stock market analysts sound more optimistic, playing up opportunities in companies operating in global markets where growth is better. Indeed many multinationals may produce better bottom line results from overseas operations that help stock prices, but as an Emerging Trends interviewee said to me last summer that doesn't necessarily boost jobs back home.  And if you operate a domestic focused business, "you're not going to feel real good," he said. How prescient he was.

In the past few days I got a couple of calls from friends who run US-based businesses. They are getting squeezed by rising fuel and material costs and reduced demand for their services. Both rein in spending in their businesses and for their families, while their anxiety levels head off the charts. And $5 gas seems like a real possibility before the end of summer.

In the short term -- shopping centers and hotels are in the crosshairs; consumers cut back to essentials and vacationers stay close to home. Businesses start to reduce travel. And who wants to pay to check bags on the airlines?

Let the economists and number crunchers debate all they want -- the "feel good" index is in the dumps with more room to drop.   

Some stats to ponder

Here are some interesting consumer spending stats culled from the Bureau of Labor Statistics:

About 42% of what we spend is on housing -- most of that on rent or rent equivalents. That includes 2.4% on hotels or vacation homes.

The second biggest spending category is on transportation -- about 18% of what we spend. Interestingly, (and probably no surprise) gasoline and other fuel is increasing in price more rapidly than any other consumer category, while we spend less on new cars and trucks than a year ago.

We spend 18% on food and beverages (3% in restaurants; 2.4% on fast food -- that's double the percentage 10 years ago; eggs have been rising in price faster than any other food category), 6% on health care, 6% on recreation, 6% on education and communication (cellphones are now 1% of spending), 4% on apparel (apparel prices have dropped nine of the past 10 years; women spend twice as much as men on clothing) and 3% on other stuff including 0.7% on cigarettes.

Now here are some recent census stats (from yesterday's New York Times) that reinforce what we've said has been happening in the nation's rural heartland -- more people are dying than being born and  places in Appalachia and the Great Plains in particular endure ebbing and graying populations. In Pittsburgh public school enrollment is only 30,000 less than half what it was 20 years ago. The city's population stands at 312,000 down from 423,000 in 1980, although the metro is more or less stagnant. In the Pittsburgh metro 24% of the population is 65 or older, more than double the national average. Other metros facing similar declines include Scranton, Utica, Buffalo and Duluth. Keep in mind the U.S. population has doubled in the past 50 years and we expect to add another 100 million people by 2040. 

 

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.