Trend Czar

NYC:Down But Far From Out

New York is the world financial capital, the epicenter of global financial problems, and financial companies will shrink in size. So New York's prospects are poor relative to other markets. We've all heard that line of reasoning. A real estate consultant was throwing the New York demise scenario at me the other day on a shuttle trip to Washington. "You know where Morgan Stanley's commercial bank is located? he asked and then answered "Charlotte. New York is going to lose a lot of jobs."

I agree--New York will get taken down several pegs and deserves it. The Wall Street capital machine was built on a mirage and now the money flows coursing through the local economy have been slowed dramatically. For rent signs appear in store fronts. New condo projects look eerily empty. Street traffic is noticeably down. Restaurants suddenly close. And city and state governments cut back on services. It's not a great scene.

But New York will not be supplanted by any other U.S. city, and certainly not Charlotte, as the nation's premier center and most important real estate market.

First off, the government bailout money has probably cushioned New York more than any other market, keeping Wall Street firms and the banks from firing even more people. Recent figures suggest that layoff numbers are well below forecasts and now we read reports about how some financial companies are setting aside robust bonus pools. A stricter regulatory environment can be expected to constrain transaction and trading activity in the future and the leverage game is over for a while. But fortress finance, though smaller and less profitable, is far from collapsing.

And the brainpower bankers and finance types who run money won't be leaving New York for cheaper places like Charlotte although they may place more back office there instead of Jersey City.
You see, New York is a primary global gateway city and principal destination on global pathways. It's much more than a financial center. It's one of the most important places for where the world does business. It's got two large international airports and one of the nation's biggest ports. It's also a world media center and cultural capital with many of the country's best medical centers and a coterie of top universities and research facilities.

If you live in Charlotte, you still need to take an extra flight to Atlanta or New York to get on a jet to Europe. It ain't even on a global pathway. Bank of America still has  headquarters presence there, but for how long? Wachovia, its once cross town rival for banking supremacy, is now owned by Wells Fargo, headquartered in another 24- hour gateway city, San Francisco. If B of A's capital problems don't lead to a buyout by a Wells Fargo like acquirer, once the old local boys who ran NationsBank (which acquired B of A) leave the scene, Charlotte's hold on the company will be tenuous.

Rents and land prices, meanwhile, are falling in New York, but from ridiculous levels to merely steep prices relative to other parts of the country. The geographic barriers to entry in Manhattan--it's an island and fully built out--will continue to protect the market from over development, and at least the place is becoming cyclically more affordable again.

Obviously, if you bought an office building or a coop apartment two years ago in the city with a lot of financing, you're not feeling too good right now. But where do you feel more secure about your real estate investments? I'll take New York over Atlanta, Miami, Phoenix, Dallas, Denver, or anywhere else in the country for that matter. And that most definitely includes Charlotte.   
   

What happened to the cushion?

Remember the one about all the "dry powder" opportunity capital poised on the sidelines to "cushion" any market fall? That was a favorite line from the industry savvy back in 2006 and 2007. The only problem was those same people were still investing, using ample leverage and spinning markets out of control. Now, it seems like forever since people have been saying they are primed to invest in bad debt, buying loans and CMBS positions at cents on the dollar, and making RTC style killings as the markets recover. And sure, there are some funds out there with capital ready to deploy. But my sense is certainly not as much as advertised, and those capital pools are shrinking.
 
The past two years have taken their toll. Opportunity funds are up to their necks in bleeding values made worse by borrowing strategies that have backfired in declining markets. As typically happens when returns collapse, pension funds and other institutional investors turn risk averse and focus on asset management not new investments. They pull back from past commitments after not getting back what they expected from earlier investments--or put another way not getting anything back.
 
Many advisors reconcile that they will not be able to raise money until institutions are convinced that markets have hit bottom. Optimists point to autumn as the earliest moment that could happen, and they really are not counting on that. Realists like my old boss have the more dire take: "Our industry will shrink in half, values will decline on average by 50% peak to trough--30% of it was never there any way, retail and office vacancy will hit 20% and hotel occupancy will fall to 59%-- HANG ON."
 
Yep, hang on. So much for that cushion. 

Where’s the Plan???

The good news is that states and cities have begun fixing bridges, paving roads, repairing subway tracks, and upgrading sewage treatment plants.

And it’s clear -- throwing stimulus money at ad hoc projects, generating jobs in a serious recession, can add value, especially when the funds are targeted at refurbishing aging systems which otherwise might break down or even collapse.

But let’s not pretend this short-term, ad hoc spending remotely addresses America’s infrastructure needs. The United States desperately requires a forward-looking plan for 21st century infrastructure that can support and sustain renewed economic growth and accommodate 100 million more Americans over the next 40 years.

Our last game-changing national infrastructure initiative dates back more than five decades ago to President Eisenhower’s interstate highway system -— nearly 50,000 miles of sleek freeways, which spurred dramatic suburban growth and enabled long distance car and truck travel.

The problem is that once most interstates were completed in the late 1970s, we essentially stopped paying attention to infrastructure planning.   Today the road-based model is an anachronism -- unsustainable in a new century.

Since 1980 vehicle miles traveled has doubled and more than half of Americans, about 155 million people, live in car-dependent suburbs.  That’s as many people as lived in the entire country in 1950.  Many of those highways we built a generation ago reach the end of their effective lifecycles and just can’t accommodate the 200 million plus cars on our roads.

And while many of our fastest growing metros neglected mass transit over the past 30 years, we built only one new international airport (in Denver).

Is it any wonder why most of our major metropolitan areas face mounting traffic and even gridlock?  The resulting congestion causes more than frustration and angst. Lost time constrains productivity and saps our economic competitiveness by increasing costs for moving people and goods. Driving-related expenses now equal or eclipse housing costs for residents in some markets.
At the same time, the nation’s gateway ports and airports will be stretched to accommodate forecast shipping requirements and airline passenger growth.

So where’s the strategy? Funding myriad local transportation projects can’t pass competitive muster when Europe builds transcontinental transportation networks to link commercial centers and China spends trillions of dollars on integrated road, rail, transit and airport systems.  Even Canada has initiated a concerted, joint national-provincial program to rebuild transport infrastructure around key national hubs and gateways.

In Infrastructure 2009: Pivot Point (click here for full report), a report I just authored for the Urban Land Institute and Ernst & Young, we recommend a new approach for getting America out of its deep ditch, the federal government taking the lead. 

Key elements:
Identify National Networks: The President and Congress must identify new interconnecting national transport networks—rail, road, and air.  Corridors for high speed passenger and freight rail must link to surrounding regional markets and merge into cross national networks.  Innovative transit schemes, connected to airports and train stations, must help reduce car dependency, prevent bottlenecks in commercial centers, and decrease pollution.

Plan Holistically: Transportation policy and funding must integrate closely with land use planning and housing policy.  Planners need to encourage development of more compact, pedestrian friendly neighborhoods tied into transit networks, connecting to commercial hubs. Separate schemes for roads, subways, and subdivisions won’t work anymore.

Consolidate Government Management: Federal, state and local governments must restructure agencies responsible for transportation, housing, water, and energy so that they manage and execute infrastructure policy in concert. The White House should develop national infrastructure strategy, working with a high level commission of policy experts, to identify national networks and select merit-based projects which fit objectives. States must break down silos between various transport agencies and local land use authorities to formulate long-range regional plans, which tie into national networks and coordinate with federal programs.

Change Funding Approaches: New infrastructure networks and necessary repairs will cost trillions of dollars over the next two decades. Funding burdens must shift from taxpayers to users, because depleted government coffers will not sustain initiatives.  There’s no choice: we need higher gas taxes and more toll roads.  Innovative user fee approaches like vehicle miles charges should be implemented, using new transponder technologies.  Not only will these fees raise revenues to pay for new systems, they also will help people adjust behaviors to realize more economically efficient travel.

Federal funding to states and local governments must link directly to carrying out national objectives.  The much talked about Infrastructure Bank is a no brainer to help finance national networks and attract more private capital, including advancing public private partnerships.

The ongoing economic dislocation has been a rude shock to Americans, who suddenly question whether we can maintain our living standards and lifestyles.  But neglect of sound infrastructure planning will threaten the nation’s ability to recover and hobble our economy for generations. The Eisenhower model has seen its day. We need a new national plan -- now!    

High Speed Rail is Only Part of the Answer

President Obama made a big deal late last week about high speed rail and pointed to $8 billion in stimulus spending to get some projects going.

The President is right to highlight the nation's need for high speed rail. But bullet trains are only part of what the U.S. needs to bring its deteriorating transport infrastructure into the 21st Century. And $8 billion won't take us very far on high speed rail. California's planned line between San Diego and San Francisco budgets out alone to $80 billion and that is likely a low ball figure.

What the U.S. desperately requires is a national infrastructure plan which identifies necessary future national transport networks--high speed rail, interstates, freight rail--and links them with regional systems--roads, mass transit, airports, and ports. Even more importantly, these national and regional infrastructure systems need to integrate with land planning, including most importantly housing. More people need to be able to move more seamlessly from their homes to work and commercial districts without depending on cars or else we will fall further behind in our ability to keep our economy literally moving. 

This week, the Urban Land Institute and Ernst & Young release a report, which I authored, covering in some detail how the country should develop a 21st Century Infrastructure Plan. Called Infrastructure 2009: Pivot Point, the report focuses in detail on how we need more top down federal planning much the way President Eisenhower approached building interstate highways in the 1950s and 1960s, the last time we initiated a national infrastructure policy.

I'll have more to say about the report later in the week.

But back to high speed rail--the U.S. is 50 years behind Japan and decades behind Europe in building bullet trains. China leapfrogs everyone right now, constructing thousands of miles of high speed rail to link its major cities, and airports to center cities. I have no doubt we will catch up--we really have no choice if we are to relieve airport and road congestion in our major 24-hour cities and link secondary cities efficiently to global pathways. But then we also will need to get people to high speed rail stations from where they live and work as well as from airports. It won't work if everyone has to drive. That's where new transit links come in. And in turn new housing needs to cluster around transit stations. If it all works interstates will be less clogged and airports will be better able to handle increased flight volumes.

If we don't do anything our economy will grind to a halt. And you think we have problems now.

Banks Twist and Turn

General Growth finally succumbs to a Chapter 11 filing. The gargantuan City Center project in Las Vegas sits on the edge. Scores of other investments and developments hit the skids. And we have been warned for years to brace for refinancing carnage once the generous terms of recent vintage loans burn off. That day is coming fast. The worst is yet to come in commercial real estate.
 
Meanwhile, some of our major banks issue happy talk press releases about first quarter earnings. And our leaders offer qualified hopes that financial markets may be stabilizing. We can only hope.
 
But on closer scrutiny, the banks just continue to twist and turn and avoid dealing with their piles of troubled assets, hoping (there's that word again) that time will be on their side. They pray in board rooms that markets will recover soon enough so they can sidestep sizable writedowns. They lobbied Congress hard to push the accounting board to revise the mark-to-market rules and help buy time. And they are using billions from low interest federal credit lines to keep their trading operations humming as they go through pr machinations about giving back TARP money, suggesting all is really better than it probably is.
 
Some of these same banks, who want to give back TARP and safeguard their executive compensation, gladly received multi-billion payouts from AIG which were funded in effect by taxpayers. The AIG money helped cover losses on risky trades that went bad so the banks wouldn't have to take further hits to bottom lines.  By the way the banks are not giving that money back to the government.  With help like that General Growth wouldn't be in bankruptcy.   
 
At the same time, banks have not been lending more the whole idea behind TARP. We really don't know what they are doing with the money except maybe shoring up reserves so that they can pass government stress tests. And the Feds are trying to figure out how much they can say about the tests without spooking markets and depositors.  We notice that foreclosures are ratcheting up again. That should be no surprise because the bank moratorium on foreclosing properties is ending. At the same time, credit card losses and yes commercial real estate problems have only begun to hit the fan.
 
Let's face it, hope is still about all we have right now.
 
 

Black gold

Keeping your powder dry? Good idea, because it will be some time before the commercial real estate markets settle into a bottom. You'll probably be waiting well into next year or even later depending on how long it takes for the economy to regear. And for all the happy talk around the stock market, it's much more appropriate for real estate investors to watch employment numbers, which will continue to track down for months to come.

So where do you put your money? Bank stocks still seem like a dicey proposition--the financial institutions have done nothing yet to address their toxic portfolios, require bailout bucks to cushion themselves, and will deal with more losses from credit card problems and, oh yeah, commercial real estate debacles.

Tech stocks are a possibility, but it may be some time before companies and consumers get in a spending mood again.

Corporate bonds look reasonable--they provide excellent coupons, unless you think everything will tank and then it almost doesn't matter where you have your money.

The doomsday scenario players look to gold and precious metals. Things are bad, but not that bad.
Oil and energy stocks make the most sense to me. Oil prices are heading back up. Sub $2 gasoline can't be sustained. For all the talk of energy independence and alternative fuels, it will be years before new technologies make a dent in our energy and driving appetites. All we need is some incident in the the Middle East to send prices skyrocketing. The odds for that happening in the next couple of years (unfortunately) are as good as the Yankees or Red Sox making the baseball playoffs this year. And once the world economies get untracked oil demand will push up prices more.

Black gold, Texas tea--Jed Clampett scored. Oil and energy stocks beat real estate and just about anything else right now.  

Developer Agony

The irony is commercial developers and construction lenders had been relatively disciplined in the recent run up. There was little pure spec office development. It was hard to build new hotels. Big projects especially were difficult to finance even when lenders were throwing money at just about anybody with their hand out.

But that doesn't matter now. Land values continue to drop while prospects for meeting project proformas have been shattered. Prime office tenants--financial companies, law firms, media companies--chop bodies left and right and vacancies shoot up. The always volatile hotel business suffers through a particularly sharp decline. Anybody with a spanking new project ready to open must be under water.

You know things are really bad when contractors and labor unions cut prices to get some projects off the drawing boards. But how low will they have to go to make it worthwhile for developers to take the chance?

Pre-leasing isn't in the cards for office developers. Will lenders go along in the current credit environment? No way. Anybody ready to build a hotel today should be taken out of their misery. That's a non-starter.

Of course, condo product is in freefall. The debacle which started in places like Miami, Las Vegas, and Atlanta now hits New York, Chicago and other big cities. Any recently completed project bleeds red ink. These places won't need new residential highrises for five years or longer. In the meantime, does anybody need an apartment at a cut rate?

The contractors and labor guys should start focusing on infrastructure projects. That's where the action will be over the next five to ten years. And the government will be paying the bills.
      

What's the future of mortgage securitization?

Mortgage securitization had been touted as wunderkind gamechanger bringing unparalleled liquidity to the real estate markets, allowing banks to lend more, enabling more people to get residential mortgages so they can own homes, and providing greater flexibility in transactions for commercial owners and dealmakers. Some observers say that only when securitization markets revive will commercial real estate markets have a chance to recover.

But arguably securitization markets created the current mess. Banks had more to lend, because they were able to clear their balance sheets by securitizing loan portfolios. Making good loans didn't drive profitability, making more loans did. The slice and dice structures mean nobody really knows who owns what or what pieces of which loans have gone bad. Risk transfer from institutional lenders to millions of ill-informed bond holders perpetuated moral hazard and eventually debacle.

Will it be enough to fix rating agencies, which proved totally incapable of assessing offerings? Of course the ratings firms were also totally compromised, profiting from fees from bond sponsors. Touted transparency in the securitization process was trumped by the volume of transactions and ultra complicated, Rube Goldberg structures.

You would think we would want a system where the original lender has skin the game and is always focused on underwriting quality. Would bankers have allowed loans with little equity down and crazy quilt structures, if they didn't have securitization outlets?

And will taxpayers want to keep backstopping private entities or quasi (now essentially public) entities like Fannie and Freddie.

Dealmakers want the securitization machine turned back on, but how can we afford to let that happen? And how can it be retooled to avoid another ugly breakdown and all its horrible consequences?

Our sad state affairs delays fixing the securitization engine, if it can be fixed at all.
        

Glimmer of hope

The forward-looking stock market has been on a bit of a roll lately, offering glimmers of hope. For the lagging commercial real estate industry downward trends follow employment numbers, bankruptcy filings, and delinquency rates all of which get worse.
 
Everybody pins their hopes on a housing recovery--low mortgage rates will help spur new sales and stop price declines. Certainly low rates can't hurt. But it's a new world order where homebuyers need to have real equity and good credit in deals. The price spiral was set in motion over the last decade, because neither buyer equity nor credit soundness were high on banker agendas for making loans.

Today, many wannabe homebuyers have lousy credit and little or no equity to put down courtesy of the bad economy and dicey jobs picture. Others can't trade up, because their home-refinancing stratagems have left them under water on their existing homes. Foreclosure sales begin to ramp up in earnest, which continues to put downward pressure on home prices. If people have cash, low mortgage rates will help them find good bargains--but there just aren't a lot of these folks. Recent stock market gains make some people feel better about their investment portfolios, but after 50% losses, they're a long, long ways from feeling comfortable about making big ticket purchases. Leaving investments in stocks right now may be the best place to enjoy near-term gains anyway... In short housing still has a ways to go before markets stabilize. Low mortgage rates will not be nearly enough to jumpstart buying.

As we've said before, commercial real estate trails all other asset classes on the downside. The grim jobs numbers continue to pour out. That translates into poor retail results, more office vacancies, lousy hotel revenues, and reduced portfolio incomes. Values will continue to drop, leveling off by year end when the employment picture looks less grim. 

The stock market offers that hope.