Trend Czar

At least Detroit has the Final Four

The ouster of GM boss Rick Wagoner (great name for a car company honcho) and the ultimatum to Chrysler (sign a deal with Fiat or go bankrupt) signal conclusively that the Midwest-based U.S. car industry will shrink dramatically. Any autoworkers or Michigan pols who were holding out hope for a different outcome--like let's pretend it's still 1970--have nothing to grasp now. Effectively, both companies are bankrupt anyway.
 
Institutional real estate investors have been (wisely) steering clear of the manufacturing belt. The car companies have taken turns propping up Detroit real estate--both Ford and GM have owned the inaptly named Renaissance Center, and it doesn't look like Chrysler will get a chance. Now what's left of the market bottom will likely fall out.
 
Some observers like to point to Pittsburgh as an example of how a manufacturing city can refashion and retool into a brainpower-oriented economy. But Pittsburgh with hindsight started more than 50 years ago, reclaiming downtown steel mills along its riverfront and converting them into parks and office buildings. Today Carnegie Mellon and the University of Pittsburgh act as urban anchors--attracting bio-tech and medical facilities. The city has cleaned up and stabilized, and has the Super Bowl Champs. But no one is confusing the Allegheny area in Southwest Pennsylvania as a growth zone. Attempts to turn the airport into an international flight hub floundered more than a decade ago. The metro area population has essentially stagnated since 1970, while the city population has declined by nearly 200,000 in the manufacturing makeover.
 
Unfortunately Detroit and other Midwest car towns have been in denial for many years, banking on businesses that have been in obvious decline for decades, losing huge chunks of market share to overseas competitors, and building ridiculous products like Hummers instead of electric cars. Unlike Pittsburgh, they haven't prepared for this day, and Pittsburgh is just holding its own. Detroit is a sad sack story, which will only get worse. The union autoworkers will be worst off--hoist on their own petard of outlandish labor contracts. For blue collar jobs, the right-to-work Sunbelt states offer most of the future opportunities--population will continue to shift south and west at an accelerated pace despite all the talk of retraining workers for new century jobs. FYI, solar heating plants won't be locating in the cloud bound Great Lakes area.   
 
The best thing Michigan has going for it right now is the University of Michigan and Michigan State in Ann Arbor and Lansing. And I'm not talking about the sports teams. It's brainpower centers which will power the nation's economy going forward, and these institutions offer a base from which to work and expand. Still, sports can offer a distraction at least for the next week. After recent developments, expect more of the nation's NCAA fans to be rooting for the Spartans this weekend and Detroit hotels will be unusually packed to accommodate the Final Four.  Well, at least it's something.  

Pay or else

In Chicago, frustrated motorists this week broke new downtown parking meters which charge up to $3 an hour--that's a bunch of change. Over the next six months the meter system will be adjusted to accommodate credit cards, which should alleviate the need to husband quarters. But what drivers are really fried about are the higher parking charges, doubling and tripling former rates.

 

In New York, the state legislature won't impose tolls on East River bridges or increase taxes on commuters so city transit fares will increase by 25% and some subway and bus lines will go out of service. Railroad and existing bridge and tunnel tolls will also ratchet up while sorely needed maintenance and capital projects will be delayed or canceled.

 

People are up in arms--their incomes are crimped or they've lost jobs. They don't want to pay more or can't pay more, and that may tie into other decisions they have made like living in a far flung suburban place, having taken out a big mortgage and having multiple car payments. 

 

The borrowing mirage and the tax cut fallacy lulled everybody into thinking they could live larger for less. But now the mirage evaporates into the reality of harsh economic decline. People start to realize that their lifestyles really are in for a big adjustment. And so some act out by breaking parking meters.

 

As it happens Chicago received $1.2 billion from a Morgan Stanley infrastructure fund in return for a 75-year concession on the city's parking. That's a whole lot of quarters which the city can use to upgrade transport systems and plug funding shortfalls instead of raising taxes. Or then again, the city could have scrapped higher meter rates and tax increases, taking the chance an L-train might crash one day into Loop streetscapes because of neglected track work.  

 

It's not just New York or Chicago, the big older cities that need funds to keep systems operating. Every state and city is glomming onto stimulus money to make up for shortfalls so they can maintain roads and bridges. Taxpayers aren't paying for stimulus yet so most elected officials are only too happy to grab at the funds so they don't need to raise taxes as much or delay necessary work. That can be their successors' problem. Of course, the stimulus bill comes due when taxpayers face paying debt service on all this mega borrowing.      

 

So what a conundrum, we either pay more user fees (road tolls, parking fees, transit fares), pay higher taxes, or just let our infrastructure go to pot or out of service Over the past 30 years we haven't paid enough in taxes or user fees. And now we don't have much of a choice. Breaking parking meters isn't the answer.   

 

  

"Low Visibility"

Here's a pastiche of conversations I had last Friday:

Ken Rosen, the UC Berkeley real estate economist and REIT fund manager, calls our current state of affairs: "The Great Recession."

Bill Ferguson, the leading industry headhunter and human resources consultant, hesitates to forecast market bottom let alone a start of recovery. He aptly characterizes any prognostications as "low visibility." 

Steve Blank, the Urban Land Institutes Senior Fellow for Finance, wondered with me about what our Emerging Trends interviews with industry honchos could possibly unearth this summer.

And Doug Tibbetts, the former President of Equitable Real Estate who is starting up TRECAP Partners to take over troubled institutional property portfolios, says he sees "plenty of opportunities."

A well recognized industry bear, Rosen forecast the crash. But it occurred later than he predicted and now it is more severe than he imagined. But who saw this coming? "The Great Recession" sounds on the mark.

Ferguson's comment brought to mind getting pushed out of a plane into a cloud bank without a parachute. You can't see the ground, don't know when you will hit, but know it won't end well.

Blank and I concluded that our ET interviewees will still be in free fall in the third quarter, enveloped in doom and gloom. It will be a complete reversal from two years ago when many industry leaders were still in heady denial about the possibilities of a correction--subprime that was an isolated housing problem. But extreme melancholy may be a sign of hope.

That's where folks like Tibbetts come in. He is ready to jump back into portfolio management after cannily selling most of his Florida development projects before the markets nosedived. With a clean slate, he figures he can help recover values. It's heartening to hear someone with a sunny view.

Still Ken's "Great Recession" resonates more right now, don't you think?  

Talk is Cheap

Criticized for a series of gloomy pronouncements, President Obama suddenly recommends investing in the stock market, and his economic sidekicks chime in about the "sound economy."  Fed Chair Bernanke, who badly missed the recession call, gets on the lift people's spirits bandwagon too, suggesting the downturn may end before next year. "It's all about restoring confidence," and getting people to spend again. Sounds almost like President Bush.
 
Putting on a brave face is one thing. Wishful thinking is another. I'd like to be able to endorse the well known retail broker's pronouncement a few weeks ago in a "Globe Street Spotlight" about how retail sales would start to rebound in the third and fourth quarter and how store leasing would pick up again soon. If I'm a retail broker, I'd want my clients to think I'm positive and can do too. But the consumer ain't coming back for a while. And travel to hotels and resorts won't be rebounding either.
 
And we're not just talking about the JC Penney or Target shopper flat on his back. Even Goldman Sachs is offering loans to employees who find themselves in hock. You see most people aren't hoarding cash or feeling guilty about spending because of all the negative press on the economy. They haven't been waiting anxiously for an official all clear signal from the President to open their wallets.
 
You see many folks, even the affluent, just don't have the cash to spend--their investment portfolios are shot and they are overleveraged on past spending sprees for homes and cars and vacations. Many babyboomers suddenly wonder whether they will be able to retire (that is if they still have jobs to retire from) given depleted 401K accounts. And you know the unemployment rate will keep going up (jobs growth is a lagging economic indicator), benefits will keep getting slashed, and bankruptcies will increase. Even those AIG bonus babies will be taxed out of their recent checks--no shopping spree for them.
 
The recent stock market gains are a relief (thanks Mr. President) and a good sign, but the banks still need to clear the decks of their damaged asset portfolios before confidence returns to the financial markets. And investors, businesses, and potential homebuyers need to get their credit in order before banks will start lending to them again. These will not be overnight events.
 
All the jawboning in the world won't help shopping centers or hotels in 2009. But the new tenor of political yacking may make us feel better and I'll take those stock market upticks. 
 
 

From the sublime to the ridiculous

What's going on here?  Financial institutions say they don't want any more bailouts. Citibank and Bank of America claim they are recently and suddenly profitable--but we still have no idea just how much toxic assets they have in their far flung and overleveraged portfolios.

Bailout king AIG can still pay execs in the group that essentially bankrupted the company hundreds of millions of dollars in bonuses. It turns out AIG in turn funneled much of their bailout money to other banks who had bought "insurance" (credit default swaps) from them. That's nice--so these banks don't have to take any writedowns on their bad investments.

Bank of America, of course, had conveniently turned a blind eye when its about to be acquired Merrill Lynch unit rushed out bonuses to its execs despite mammoth losses.

The only folks paying and not receiving seem to be taxpayers. Without taxpayers' money many of these companies would have collapsed in Chapter 11 or 7. Their execs wouldn't be receiving any bonuses and many of them would be just plain out of work. A bankruptcy court would have abrogated their bonus contracts in a New York minute. We need to give these people incentive compensation... for what--not losing more money? These companies and their execs would have been effectively six feet under without taxpayer help. At least they still have jobs.

Then there are the Bernie Madoff victims, who seek their own form of bailouts. They want the SEC to take the fall and have sued the government for restitution. The victims claim the SEC should have stopped Madoff--their auditors blew it. If government had caught onto him, they wouldn't be out all their life savings. Yeah and if the SEC, the Fed, Congress and the last four Presidents hadn't effectively deregulated financial services I might not have lost a lot of money recently too. We should all get the government to reimburse our 401Ks for letting all these shoddy investment managers lose so much of our money in their orgy of leverage and fee raping. I like that idea, don't you?

I guess this is what they call moral hazard. When you don't need to take responsibility or fear accountability, you do stupid stuff like leverage investments 30 to one, refinance homes to buy Corvettes and flat screen TVs, lend money to borrowers without a ghost of a chance of getting repaid, and stop saving.

Oh yeah, and don't raise taxes on private equity firms, hedge funds and execs making more than $250,000 a year. That would stamp out entrepreneurship and kill capitalism.   
    

Worse or Worst

You know that total gloom and doom have taken over when people start talking about how this real estate downturn is even worse than the early 1990s debacle, which was billed as an industry depression not to be repeated for generations. But that's the current vibe. Market psychology tips toward capitulation--"it's bad and its just going to get worse," says a former colleague at a major investment bank." Says another veteran at a well-known advisor--"This is definitely worse than twenty years ago, because everything is in the tank, not just real estate. It's a worldwide financial melt down."

The saving grace for some real estate pension fund advisors is "that real estate is a small part" of their clients' problems." Stock and bond portfolios, private equity investments, and other alternative investment forays have so far fared worse than property investments. In the early nineties, real estate value declines stuck out like a sore thumb for institutional investors, who threatened to swear off the asset class, and some did (until getting back in just as the cycle approached its peak).

The sharp turn around in fortunes probably exacerbates the despair. Only two years ago major advisors had queues of investors waiting to get into their open end core funds, which were throwing off mid to high teen returns.

Today industry players estimate pension funds are on waiting lists to pull upwards of $14 billion from these same funds, and returns have hit the skids in escalating writedowns. Losses will be greater in this round since some core managers pushed the limits on appropriate leverage in their most recent acquisitions and got caught up in the buying frenzy precipitated by even more highly leveraged opportunity funds.

Now some managers who were reluctant to start recording losses last fall push appraisers to register larger writedowns to get bad news behind and gain greater credibility with investors who anticipate the worst.

Most advisors have given up any hope of raising new money until markets reach bottom.
 

    

100 million

There's a good news number to hang onto:  One hundred million. That's the expected increase in U.S. population over the next 35 years. All these people will need places to live, work and shop, and obviously the country's existing building stock will not be sufficient to house them. So although most developers can barely raise a pulse today, they have a future here. That's not as true everywhere.

Rising population numbers are not a given in other parts of the developed world--Germany and Italy will suffer sharp declines over the next generation. Japan's population also is expected to drop by nearly 40 million over the next 40 years to about 90 million thanks to a low birth rate and low immigration numbers. These countries populations will also skew noticeably gray, profoundly changing real estate requirements, lowering overall demand and increasing need for senior oriented living environments.

As American developers resuscitate over the next five years, it won't be back to business as usual either. Edge development runs out of steam. Infill suburbs will turn more urban and vertical. The McMansion era recedes in favor of more compact infill development--apartments and townhouses. Town center and smart growth projects get mainstreamed--shopping environments integrate with residential and other commercial uses.  Planners and developers will orient projects around mass transit out of necessity. We won't be able to accommodate all those new people in major metros if people are car dependent. Highways are already too congested and there's no room for adding more roads--people will look for greater convenience and seek less car dependency. Not only will we lose more time on more gridlocked roads, but also driving will continue to become more expensive as government adds taxes and/or tolls to pay for deteriorating road systems and encourages greater conservation. And families may have noticed that keeping two, three or four cars now means that transportation expenses equal housing costs in many regions.  Cars won't be disappearing, but people living in metropolitan areas will want other transport options, including the ability to walk to grocery stores and other necessity retail.

Technology advances, meanwhile, will enable more working and shopping from home. That translates into more measured growth in shopping centers and office districts.

In short, people will be using less space per capita--less home space, office space, retail space, and road space. But if we plan and develop right, we will be able to accommodate more people--those 100 million--more efficiently and productively.

Developers have a future, but they will have to adapt to a new 21st century model.

A look ahead

Steve Bergsman, who has covered commercial real estate extensively during the past 25 years in major publications like Barrons, comes out with a new book next week, which forecasts the pace of market recovery--once it begins. AFTER THE FALL: OPPORTUNITIES AND STRATEGIES FOR REAL ESTATE INVESTING IN THE COMING DECADE scrutinizes the trend lines for individual real estate sectors, looking at recent history and events, current predicaments, and then attempts to discern where these markets will be headed. Here are some of Bergsman's predictions:

• Institutional investors looking at office assets will focus on major urban centers such as New York, Washington, D.C. and San Francisco. There will be little interest in second tier markets for a long time.
• While home prices in most cities will bottom out this year, recovery to historic appreciation levels won’t happen for at least another three years.
• Many residential and commercial developments financed with cheap money and constructed in the far reaches of the exurbs will become, at worst, ghost towns, or, at best, low-income neighborhoods.
• In-fill condominium markets in urban locations will recover much faster than condo markets targeted to the leisure or second home crowd.
• Senior housing demand and development will climb slowly but steadily through the next decade, than jump exponentially as baby boomers enter their seventh decade.
• The multifamily market should remain weak until around 2012; a lack of new construction in the intervening years will cause tighter occupancies and higher rents going forward into the middle of the next decade.
• The most optimistic expectation for the hospitality industry: nothing good until 2011.

In regard to issues like sustainability, the future for commercial buildings has actually arrived, Bergsman says. Most new office buildings today are LEED-certified and industrial and retail is following suit. What this means for investors is that LEED-certified buildings will be purchased at a slight premium in the near future. Also, at some point, older non-LEED certified buildings will have to upgrade, or fall off the list for major investors.
 
Bergsman's book should offer a good diversion on our way to hitting bottom. But first things first.

The South Can Rise Again

Once we get through the current economic mess, certain cities and places will emerge winners and losers. The government can pour endless taxpayer dollars to prop up the Midwest car companies, but turning Detroit around looks like a fools errand. The downward spiral began decades ago--precipitated by union unreality and management short-sightedness. Overseas competitors now set up shop in Southern right to work states, paying assembly line employees less in more state-of-the-art factories without cumbersome work rules. GM, Chrysler and to a lesser extent Ford kept lobbying and forestalling higher fuel efficiency standards, while building gas guzzlers in aging factories. These companies have been managed as if their leaders fiddle in a "That Seventies Show" time warp
 
People, meanwhile, will continue to move away from colder climes. Many blue collar workers won't be picky as long as they can find a job. And increasingly that means heading south to states like Alabama.
 
I was in Mobile, home to the original American Mardi Gras, over the weekend. Now the local economy is not hopping, but a German company is building a huge new steel mill north of town. The city still hopes to keep its share of the Air Force's contract to build midair jet fueling tankers (fighting off Boeing and Seattle). The container port has received a boost with new facilities and existing freight rail lines lead north. Folks are worried about the national economy, no doubt, but recent activity provides hope and some measure of buoyancy in these rough times, a real contrast to many other places today. If Mobile can link into regional global pathway centers like Atlanta or Houston over the next generation, it's fortunes could be enhanced greatly. High speed rail connections would be a boon.
 
The South can rise again--this once sleepy region certainly has better prospects than the Great Lakes Rust Land.