Trend Czar

Waiting to go poof

The credit limbo gripping the real estate markets leaves some major developers in a Wylie Coyote mode. They’ve stepped off the cliff and freeze in suspended animation, realizing they have no chance of getting back. They know it’s just a matter of time before a sudden, quick descent starts leading to an ignominious crash.  It’s a delayed wipe-out.

And for some of these industry high-flyers, we’re not just talking about losing whatever money they put into the deals, which typically isn’t much. For whatever the reason, many recent vintage construction loans were recourse. These developers put their own personal wealth on the lines. A Texas developer, who got creamed in the late eighties with recourse financing, winces and wonders how some big names who should have known better didn’t learn his lesson. He mentions folks in Atlanta, Phoenix, Southern California, and Las Vegas who will be going down hard once the banks finally pull the trigger when their loss reserves are big enough to let them. Some marquee names on the hook with their personal guarantees head for bankruptcy.

On the lending side, an old hand shakes his head about bankers giving credit on a recourse basis. It may seem like the lender gets a better deal and has the developer’s attention, but recourse financing alone is never a good enough reason to make a loan. “A lot of these loans were made because they were recourse, and a bad loan ends up being a bad loan, the bank loses a lot of money either way.”

In the mean time, many of these developers smile the good smile and keep up the good front, may be hoping against hope that something, anything can bail them out. You hear the frustration about Lehman Brothers (“why didn’t the government save them”), Fannie Mae (“the government let them run wild”), TARP (“waste of taxpayer money”), and TALF (“when is the real estate industry going to get its share”). And then the bravado comes back about how “the project is going to be great”, “it’s one of a kind”, “it’s leasing up”, “everyone wants in”, “look at the finishes,” and on and on. The best line I heard recently was the one about the Mall REIT guy who “wasn’t overleveraged, it’s just too much of his financing rolled over at once.”

Many of these Wylie Coyotes haven’t dropped yet, but they’re on their way…poof. It can’t be a good feeling.      

Delaying the Inevitable

“Sales of newly constructed single-family homes spiked 11% in June to an annualized rate of 384,000 homes. The gain over May was much greater than expected. A consensus of housing industry analysts had forecast seasonally adjusted sales of 352,000. However, sales are still 21% below the levels of a year ago (488,000). Four years ago, during the height of the housing boom, the sales rate for June was 1,374,000, nearly three-and-a-half times higher than last month.” Wire service reports 7/27/2008

Housing led us into the economic pit beginning its slump three years ago. Now it appears housing is bottoming out ... finally. It’s good news if for no other reason that every day brings us closer to recovery. Hitting bottom usually delivers mixed messages and this time is no different. Homebuyers, who can afford to buy, signal that the time looks right to them. So, (a few) more people start to close on deals. Government mortgage incentives help and homebuilders continue to lower prices (down 3% from May’s median) albeit at a slowing rate, to entice more activity and move inventory. At the same time, foreclosures on existing homes continue to increase. That means more fire sales and auctions, which could lower prices further before we see a true firm up. It’s still not a time for homeowners to sell unless they have no other choice.

At least, we start to see the first signs of increased sales activity and some small attempt to clear the market at rather dismal pricing—40%, 50%, even 60% below peaks in some locations. At these levels, buyer equity can go a longer way and that’s necessary since lenders have turned understandably more parsimonious.

In the commercial market, we may be a year or more away from seeing any measure of transaction pick up. Equity sits on the sidelines, but as we have said before it’s not in the interest of owners, borrowers or lenders to recognize the depth of value declines. If they did, many borrowers would be wiped out and banks would have to face up to massive write downs on their balance sheets. So they dance around the realities.

Unfortunately for the dance partners, buyers know that time is on their side. The likelihood of a swift economic rebound to buttress property cash flows from higher occupancies and rents looks extremely doubtful over the next couple of years. At some point government programs like TALF and bailout funds will have added enough to bank loss reserves to let them dispose of their toxic loans. When that happens we’ll approach the stage that the housing markets seem to be reaching today.
Delaying the inevitable isn’t much to look forward to.    

  

Health Talk and Real Estate

However the debate turns out, it’s clear that healthcare is big business… very big business. It’s such a big business and so many companies, doctors, and lawyers profit off it, that the government has to reduce overall growth in costs or it could take us all down into a further pit of national and personal debt. We hear about waste and inefficiencies, and if you’ve been to a doctor or in a hospital lately you’ll get many object lessons. Controlling costs translates into paring back what health insurers, doctors, attorneys, drug companies and others who feed at the health care trough take in. In particular, the President clearly has health insurers in his sights. These companies’ overhead approaches 20% (compared to under 5% for the oft-criticized government Medicare bureaucracy). Then we have the malpractice lawyers who lick their chops over large contingency fees. The malpractice bogeyman in turn takes us back to the insurance industry—doctors conduct all sorts of cover their backside tests, seek second and third opinions from various specialists, and take out large insurance policies to protect themselves from lawsuits. The insurers hire tons of private bureaucrats to find ways to lower their payments to doctors or find excuses not to cover policyholders-us. All these people who operate in the healthcare industry fill lots of office buildings. Leasing all that space costs money too.

If the President and Congress are successful in reining in spiking healthcare costs, it means the various lucrative healthcare profit centers, mentioned above, will either not be as profitable or much more efficient. Of course, that’s a mighty big “If.” But if that happens some of these businesses could shrink and use less office space. And that’s why all the special interests fight so hard to protect their turf and profits—the health insurers in particular, who probably have the most to lose. Drug companies must feel the pinch too and maybe also their ad agencies who push out all those commercials touting expensive non-generic pills. Anybody have one of these companies as a tenant?

The graying baby boomer wave means that no matter what happens with legislation, we will need more doctors and hospitals. Older people just need more care. So if you are in the medical office niche, demand should steadily increase. The same goes, of course, for senior housing and nursing homes. A few less malpractice lawyers might not be a bad thing if they used their brainpower instead to become doctors or scientists.

Undoubtedly, any greater government involvement in healthcare will help out the Washington DC office market. Again the nation’s capital is proving to be the place to be invested when recession strikes. The federal government always expands… always.

And maybe, just maybe we’ll see our premiums and deductibles go down and not have to worry about losing coverage or going bankrupt if a health emergency ever confronts us. Those are issues our legislators never worry about since we taxpayers pay for their gold-plated plans.          

Property Sector Rankings

It’s a case of worse, more worse, and worst when it comes to assessing the condition of U.S. property sectors.

Multifamily has the highest delinquency rates and some markets are getting killed by all the failed condos turning into rentals. But unlike the other sectors, multifamily borrowers can find financing through Fannie Mae and Freddie Mac. That’s enabling more transactions and bucking up some owners who had borrowed responsibly earlier in the decade and can find a safe harbor for refinancing their cash flowing properties. Nearly everybody says apartments will rebound more quickly when the economy starts to improve. Doubling up and kids living with parents will reverse, and yes we know, we know—the demographics are very favorable.

Warehouse struggle with declines in consumer spending and the housing markets. There’s not as much stuff—materials, goods, clothing, toys, whatever—moving through the distribution system. Vacancies are at or near record highs, but institutional investors want them in their core portfolios and they tend to stay in better supply/demand balance over time. Well that’s better than office.

Investors bemoan the plight of office markets—demand has disappeared, and spiking vacancy rates don’t tell the whole story of mounting shadow space coming on the market. Values plummet and borrowers can’t find refinancing. Owners get ready to give back the keys unwilling to shell out for tenant improvements and other concessions to hold onto their occupancies. Their lenders face large write offs.

Retail, of course, is a disaster area. We’re back to the early nineties when lower quality B and C regional malls will go belly up. How long can some power centers hold up as their big box tenants go out of business? Too many leisure and strip shopping centers exist as Americans grapple with reality—they can’t keep spending on credit anymore and they need to come to terms with personal debt.

Hotels always get hit hard in economic downturns and get clobbered today. Wholesale defaults are coming on floating rate debt which bankrolled most recent purchases at over the top pricing. Occupancy rates sag below break even, but the bigger problem is dropping room rates. Businesses savage travel budgets and many people just can’t afford vacations with their personal finances in shambles.

Housing led the pack into the maelstrom three years ago and only now may be stabilizing with dim prospects for any rebound… That’s not good news for all these other sectors following behind.      

Another leg down

Goldman Sachs reported giant $3.5 billion quarterly earnings so suddenly we should all believe everything has turned around in bank and financial companies. The sector's stocks shot up in anticipation of the news.  Indeed Goldman was the best of the banking group at taking low interest government bailout money and investing it in trades at lucrative spreads. But these earnings numbers hide the fact that most banks aren't lending as much as building up their loss reserves.

The Goldman news aside most people I talk to sense the economy is about to suffer a setback--the stimulus programs stopped the free fall, but the still frozen credit markets fail to grease business expansions. People are saving what they can or paying down debt not spending. And the banks won't write down all their toxic assets for fear of creating more financial panic. The short-term trend outlook is dicey at best.
 
For those real estate borrowers counting on a near term economic recovery to cushion their down side, hopes fade along with all those economic forecasts about a second half upsurge. Yes, remember those fearless predictions from the beginning of the year? They can be tossed in the trash heap with the ones last year about economic recovery that should have started six months ago and those others about "soft landings." You get the idea--everything is getting pushed further out.
 
The mantra has been that economic recovery will track ahead of jobs growth, but the unemployment numbers get increasingly disheartening as companies ask surviving workers to pick up more slack with fewer benefits. Stimulus funds all those road construction projects that create traffic jam ups at 10 pm, but doesn't stop the free fall in office occupancies and rents. GM and Chrysler get through bankruptcy but then announce more job cuts. It's reported that the venerable "Business Week" is worth only a $1. I remember the days when pr guys got bonuses for placing executive interviews in that now obsolete publication.
 
As far as pr, Goldman continues to win plaudits off its trading acumen and AIG struggles with asking for government approval of more bonus payouts. Goldman's success comes at least partly at the expense of taxpayers who bankrolled their recent gains before the company gave back its TARP and bailed them out of AIG credit default swaps earlier in the year. It's a great business for the traders betting on spreads, but doesn't do much to capitalize future business growth. This is the same recent Wall Street model that sent us into our recent collapse. And AIG wouldn't exist without taxpayers, but since we bailed them out from oblivion and they think they are operating on the old bonus model so pay up.
 
These types of investment mindsets are indicative of why the economy will falter more before it slogs to any recovery. Until we start harnessing our public and private capital to fund long-term growth and get out of the casino, we don't have a chance. 

Lackluster Stimulus

Concerns grow about the lackluster results from stimulus funding as unemployment increases and more Americans face financial strain. Meanwhile, the real estate industry waits to be swept further down the rapids with the falls lying ahead—dropping tenant demand and rent declines threaten already dwindling cash flows in the face of frozen credit markets.

The problems with stimulus shouldn’t be a surprise. The tax cut part favored by Republicans has been stowed away in people’s savings accounts not spent. People are scared so they build nest eggs instead of spending in consumer land on things they really don’t need. Over the long term, a more frugal America will help strengthen the economy. It makes no sense to the average person to behave in a way that got us into this mess in the first place.

So the spending push must fall on the government. And as far as pushing out stimulus goes, the U.S. government lags well behind other nations, including China and the country some Americans love to hate—France.   The reason is we don’t have a national plan for major projects. China has engaged in long-term planning for national infrastructure—high speed rail, urban transit, port expansions, power systems—which will provide decades of support to economic growth. The Chinese can just speed up planning already in place. Here we fall back on the federal government sending funds to the states which spread the largesse out to counties, cities and towns for various ad hoc, disconnected projects. That takes time and is inherently inefficient. It also doesn’t address our huge needs for 21st century infrastructure systems. And we have no plan.

In fact, we learn in this morning’s New York Times that the states, as usual, short change their major urban areas where most of the country’s economic activity concentrates and plow the majority of their infrastructure stimulus into various rural backwaters. The money gets frittered away on road projects used by hundreds of people each day instead of on transport systems supporting hundreds of thousands. Indeed the stimulus amounts to earmarks on steroids, a pork barrel fest for governors and state legislatures dominated by rural interests at the expense of metros.

This bottom up approach threatens our economic viability not only in dampening any chance for a faster recovery, but also handicapping our competitiveness against other global powers with more modern infrastructure systems. The Feds must set national programs and priorities and push the states to get on board with clear guidelines and funding constraints if they don’t. The big gateway cities which generate most of our economic activity should get most of the funding. Sorry Montana and Arkansas you get a lot less and so do hinterland counties and villages in other states. There will be winners and losers, but the alternative is we all lose and that’s what’s happening now. 

Fireworks without Celebration

Fewer communities had fireworks this year, but there was no skimping on the displays I saw around the Northeast spread out over the past week. The Fourth offers everyone a reliable, annual celebration of our heritage--security, freedom, and prosperity. Unfortunately I find in my recent travels, our current financial distress takes an increasing toll, rattling people's confidence.
 
First off, young people struggle to find work. Summer internships are scarce--even the ones for little or no pay. I feel good about the college age nephew who runs the produce aisle at the neighborhood supermarket in Chicago. Kids scramble for the odd parking attendant job at the local golf tournament. Finding employment for recently released inmates and parolees--always a tough task--becomes more monumental and inner city youth unemployment must be rising to ever higher, more uncomfortable levels.
 
The New England resort business has been sketchy like everywhere else. In New Hampshire, rows of Franconia Notch hotels and motels were empty last week, just a few days before the Fourth. Now the miserable spate of rainy weather wasn't helping, but the absence of vacationers in early July was striking.
 
Homes aren't selling in the northern Adirondacks, a notably poor section of the country, unless you own lakefront or hilltop acreage. One local who has his place up for sale succinctly told me: "People don't have money."  So well put.
 
You hear anecdotes about friends and family whose credit cards are no longer accepted, who can't meet co-op maintenance payments, or are struggling with their health care deductibles, which thanks to company cutbacks can approach $5,000 or $6,000. And we were not talking about the 50 million Americans without any health insurance. Furloughs, the end to 401K matches (how temporary will those be?), and job cuts forcing longer hours on remaining employees were all part of the cheery Fourth discussions around the grill. Two brawny guys I know who worked construction in now moribund upstate New York Rustbelt cities apply to become nurses and correction officers (but states can't afford so many prisons/inmates and that gets back to finding jobs for the parolees who are pushed back on the streets early).
 
The stock market has run out of gas, and gas prices trend higher--today's small drop aside.
 
The fireworks were a nice distraction.
 
PS: Last week I attended a convergence of fellow members of the Citistates Group. Mary Newsome, associate editor of the Charlotte Observer, penned this column following the meetings. She gives an interesting perspective on the special challenges in hot growth suburbs, part of the legacy of uncontrolled homebuilding.
http://www.charlotteobserver.com/480/story/815414.html 

Chaos in the States

State governments around the country are in big trouble, ballooning deficits and dysfunctional legislators hamstring officials in confronting the financial crisis. That’s not good news for real estate players. Cutbacks hit slews of companies and not for profits, which depend on government contracts and grants to carry on business and rent space. Developers looking for support from government tax breaks or special consideration gain little traction in the chaos. Furloughs of state workers and hiring freezes portend potentially more permanent reductions in state services—when state governments have been one of the most reliable tenant sources in many markets.

Of course, plunging property values, increasing defaults and foreclosures as well as the feeble real estate transaction market all contribute to falling state government revenues. But the sad sack state of the states just digs a deeper hole.

And state government problems aren’t simply a result of depleted tax coffers. The current financial distress exposes systemic dysfunction and widespread corruption. The country’s two most important states with the nation’s biggest economic generators--California and New York-- desperately need constitutional conventions to revamp legislative process and anachronistic systems which gridlock in the face of emergency. Legislative districts need to be redrawn to reduce advantages for incumbent politicians, who comfortably play the system for their own financial gain without meaningful ethical strictures to rein them in. Earmarking run amok and legislator slush funds for local pet projects show an utter disregard for responsible budgeting.

In many states, including Pennsylvania and Illinois, rural legislators continue to wield power that siphons off funding from cities’ economic engines and disproportionally favors their less populated, lower functioning districts. It’s all part of a destructive Nero fiddling mentality.

Sales taxes, user fees and local property taxes have been increasing for years to fund all this dysfunction and now budget gaps reach scary proportions. Taxes have no choice but to go up more while services retrench to plug shortfalls. And that will stem any recovery momentum.