Trend Czar

Was Tiger Rushing for Black Friday Deals?

Did you go shopping on Black Friday and line up at 3 a.m. at your local Wal-Mart or Penney’s? Did you get that great deal on something you or your family probably doesn’t need like the high definition TV which uses five times as much electricity as your old color set? Did you do your national duty and buy, buy, buy?

I can’t think of anything I’d rather not do over the Thanksgiving holiday than go shopping. But all the TV commercials and newspaper ads try to rev up business and the news shows tell us that’s where everybody goes. Tiger Woods was probably rushing to get in on the action when he drove into the fire hydrant—he was looking for just that special something for his model wife, I’m sure, and couldn’t race to Target fast enough to get on line in the wee hours.

Pay little attention to the Black Friday weekend sales volumes. They usually offer little guidance on overall Christmas sales figures. The early numbers were half a percent over last year’s or basically flat, and last year was an ugly holiday shopping season.

Clearly rising unemployment, tightened credit, and mountains of existing consumer debt add up to another dismal year for retailers. Industry spokespeople sound cautiously optimistic, but they don’t want to talk people away from the stores and be accused of creating a self-fulfilling prophecy. That’s just not good for their own job security.

Their hopeful talk aside, we’re told retailers have hedged their bets by not over-ordering and keeping product lines lean—they don’t want to be forced into marking down a bunch of Boxing Day inventory like last year. 

No matter what happens this Christmas season, we need fewer stores in America. And that’s even if sales pick up sharply and unexpectedly. Internet buying will inexorably eat into more bricks and mortar retail business. Internet sales currently total about 10% up from nothing a decade ago. And it’s not just echo boomers going on line at Amazon.com. It’s also working moms looking to save time and stay-at-home moms hunting for bargains. People become comfortable with the process and its relative reliability. One mid-fifties lady I know used to spend her days shopping the power centers and malls for stuff. Now that the family income is shaved and the big mortgage is worth more than the the big house, she shops online for what she needs—saving on gas and avoiding those costly spur-of-the moment temptation purchases.

The big store chains claim or should we say hope that they will keep internet shoppers buying through their sites, but increasingly it’s in the manufacturer’s interest to cut out middlemen and sell directly to the consumer, using fulfillment systems for deliveries.  And if department stores have trouble connecting to consumers, mall company websites won’t have much of a chance either.

Now malls and Wal-Marts are far from endangered. The majority of shopping will continue to happen in bricks and mortar formats. It’s just less and less shopping will go on in stores over time. And in the mean time, more Americans realize they don’t have the means to do as much shopping as in the past and understand they need to save more… Merry Christmas all you retailers.    

From the Road

Here are some thoughts from the road after three weeks of Emerging Trends speeches:

San Francisco: Relatively upbeat after a thorough pummeling, the market sees cash rich vultures start to circle in a flight to quality. Well-leased downtown properties find a floor and the apartment market could come back more quickly than other sectors. The worst is over.

Toronto: Locals sleep easy despite downtown office overbuilding and weak industrial markets brought on by carmaker woes just south of the border. Well-heeled institutions own most of the downtown properties and offer stability while developers back off ample condo construction—units get bought up in move-back in trends. A lackluster economy looks comparatively good next to U.S. woes. Everyone is relieved they didn’t overleverage and stuck to conservative practices with a heavy dollop of government regulation in the banking sector. The big worry is contagion from the U.S., including the weak greenback, which cuts into exports.

Boston: Happy to rank higher in Emerging Trends than anywhere else but Washington D.C. and San Fran, Hub players know they still have to take their medicine and work their way out of a giant hole. A barrier constrained market and brainpower center offers better prospects for quicker recovery than most other places.  

New York: Transaction pros sense buyers may be coming back, sensing an approaching market bottom. Any quality deals attract plenty of attention especially from foreign investors. The prospect for flush Wall Street bonus checks also helps lift moods--maybe a new rush of funds will help refloat the capsized condo market. But that may be too much to expect with rising local tax burdens needed to offset yawning state and city budget gaps.

Philadelphia: Since this slow growth market never got overheated, any drop has been more restrained and locals aren’t overly shell-shocked. They know D.C. and New York will bounce back faster—the market long ago settled into a semi-permanent malaise.  Still this great American city has some entrepreneurs with chutzpah.  At 30th Street Station you can get a great shoe shine for a lofty $8 charge-- and the shine man knows he’s good, intermittently muttering “spectacular” in heavily Greek-accented English as he swipes and strokes away. It would be offensive not to add at least a $1 tip. 

Chicago:  Too many condos, overbuilt industrial, and an office blood bath in the suburbs were bad enough, but losing the Olympics was the big gut punch that deflated the Second City’s ego. Some leaders start thinking about an Obama presidential library as a new world wide attraction to gin up attention and restore local stature.  At least the guy in Washington might think that idea amounts to jumping the gun--he (probably) hopes he doesn’t have to consider that prospect for another seven years.  Real estate pros just hope the market doesn’t take that long to recover.

Vancouver: North America’s Shangri-La for real estate, this city’s commercial cap rates continue to hover in the 6s and housing markets have bounced back to record highs as the Winter Games approach. Harbor view condos fetch seven figure pricing and local investors out bid institutions for the few available commercial deals. Brokers lament they can’t find more to sell—everybody wants to hold onto a piece of the place.

And have a very Happy Thanksgiving time. I hope I can get home in time.  

We can only hope for higher interest rates

We begin to see more headlines about workouts and loan restructurings. Donald Trump is left with 10% of his name-branded Atlantic City casinos, the most recent buyer of the New York Times building near Times Square got left holding the bag and takes a bath along with some big name lenders. Bankers give up on extend and pretend and foreclose on a Chicago retail developer. Simon, the number one mall REIT, circles General Growth as the number two mall REIT moves closer to emerging from a deflating bankruptcy. The logjam in the credit markets slowly starts to break down as both borrowers and their lenders begin to face up to their significant losses. Many such days of reckoning will consume real estate players in 2010 as they realize time and the economy won’t bail them out.

Some observers have been pointing to the stock market for rays of better times ahead—recent gains hopefully presage restored economic growth. But stock investors seem more buoyed and energized by the Fed keeping interest rates at near zero levels than any solid signs of business recoveries. Cheap money continues to be everyone’s elixir of choice, feeding hard to shake trading behaviors and short-circuiting more long-term investment thinking. But the continued low Feds Fund rate really should be everyone’s concern. Bernanke and company’s actions only signal their apprehensions over economic fragility and the long road back to spurring significant U.S. jobs growth. It actually would be good news, if the Fed finally started lifting rates—that would highlight renewed confidence by senior government policy makers that we are on the mend. Unfortunately, that confidence appears nowhere in sight as unemployment numbers rise—albeit at a slowing pace—and companies improve earnings mostly off of productivity gains (cutting costs) not meaningfully ramped up sales.  

At some point interest rates will start to revert to the mean—keeping upward pressure on cap rates, and limiting value gains as real estate markets move off bottom. Those who think this low rate environment will continue forever must be the same folks who bought into a secular shift in real estate pricing and forgot about market cycles.  And rising rates may not be left to the Fed’s choice if offshore T-bill buyers back off over concerns about huge U.S. government deficits and our (at best) sluggish prospects. China and other exporters slowly may come to the very reasonable conclusion that America no longer is their most reliable market for selling goods as we struggle out of our self-dug borrowing pit.

We need to hope the Fed feels comfortable enough about increasing rates soon—what might seem like bad news for the stock market could be a strong signal of support for a reviving economy. And any hike can’t happen soon enough.

Sleeping Better

I’ve been up in Canada over the past week, and it’s obvious Americans could learn a few things from our neighbors to the north. Canada’s economy appears to be (really) stabilizing after a comparatively mild downturn and commercial real estate markets should follow suit—value declines have been in the 10-20% range in contrast to losses in the U.S. headed on average well above 40%. Housing markets in Canada suffered mild buffeting, but prices in prime neighborhoods have more than held their own, and appear to be increasing again. Foreclosures, defaults, and dislocation aren’t part of the local landscape anywhere from coast to coast.

Vancouver ranks as the top North American commercial property market after Washington D.C. on the Emerging Trends survey. Toronto suffers from increasing office vacancy—a result of new development in the downtown core. But deep-pocket institutional owners are well positioned to ride out any market softness. This global gateway has also grown into North America’s largest condo market, as more people look to settle in and around its attractive urban core. Hot growth Calgary suffers from overbuilding and hopes natural gas prices ratchet up to bail it out. Elsewhere the real estate scene shows few signs of any distress. On the property sector front, the U.S. automaker morass drags down the Southern Ontario industrial belt and hotels suffer from markedly reduced business and tourist travel from the U.S.

In general, Canadian real estate investors appear buoyant next to depressed U.S. counterparts. “It’s really a tale of two cities or shall we say countries,” a major Toronto developer told me. “We’re sleeping much better at night.” So what’s put Canada in a better position? Abundant natural resources (oil, gas, water) certainly help. But Canada and its citizens have also been much more fiscally conservative and responsible. The country paid down its debts after a severe early 1990s recession through a combination of spending cuts and higher taxes. Banks and financial institutions are highly regulated—capital reserve requirements and other mandates kept lenders and investors out of exotic mortgages, overleveraging situations, and hair brained securitization structures. Homebuyers typically must put down at least 30% equity to get mortgages. And consumers never got out of control either—people live more within their means without resorting as much to plastic.

Canadians react with surprise when they hear that their socialized health care system is held up as something that Americans should want to avoid. It’s not perfect, but people get good care, and no one goes without seeing doctors or getting prescriptions.

In the meantime, any Canadian worries focus back on the U.S. If our economy stays down, their recovery will be stanched and the falling U.S. dollar makes the Loonie more expensive and hurts their U.S. exports. If more U.S. retailers go bankrupt after Christmas, stores could go dark weakening shopping centers. And Canada needs more U.S. travel to its big city hotels and resorts.

But your average Canadian can rest easy these days… unless that is he or she invested in the U.S.   

Musings before the release of Emerging Trends

Emerging Trends in Real Estate 2010 gets released on Thursday at the Urban Land Institute’s Fall Meeting in San Francisco.  I’ll have more to comment about the forecast, which I author, after PricewaterhouseCoopers and ULI unveil the report. But here are a couple of observations coming off several months of interviews (more than 900 industry leaders participated in this year’s survey—a record!) and writing the 2010 outlook:

The past decade of deal mania, owner flipping, securitized mortgage markets and ensuing bank failures has effectively delocalized much of the real estate business. Many borrowers no longer know who their lenders are, most CMBS bondholders don’t have a clue as to what assets back their bonds let alone where the assets are located. Many owners, who overpaid for and overleveraged properties, don’t have local roots in markets where they invest, and now scramble to cut losses and exit these markets no matter the local consequences.  And increasingly local banks become part of larger national and international institutions with no particular local focus. When real estate owners and lenders don’t have a stake in communities and neighborhoods, and use real estate investments as fungible assets to play against market cycles, the underpinnings and long-term prospects of these markets can be undermined.

Now tenants consider playing their own musical chairs, pulling up stakes and moving into new buildings to secure better rents and deals. But they must wonder about the creditworthiness of landlords and understand whether properties will be subject to battles among CMBS tranche holders, whoever they may be. Tenant heads had begun to spin with all the ownership changes earlier in the decade—now they must brace for bank takeovers or dealing with special servicers or maybe even the FDIC. It’s a tenant’s market all right, but who knows who your landlord will be.

And needless to say tenants need to be concerned about whether building services will be maintained. Given cash flow squeezes and the dire operating circumstances of many owners, repairs and basic maintenance may be delayed to cut corners. Forget about capital expenditures.  Properties are bound to show more signs of wear and tear, some may just turn shabby from neglect.

Clearly, owners with more liquid balance sheets and manageable debt service can poach tenants from compromised competitors. They’re in better position to negotiate deals, provide tenant improvements and other signing inducements, or just hold out until rents start adjusting up again. Obviously, the cash-rich will be in exceptionally strong position over the next months, not only in retaining and securing tenants, but also in acquiring distressed assets as they come to market.

And make no mistake--the next 12 to 18 months will be a great time to buy a cyclical lows—if you have the dollars to do deals. And for many players, that’s a big if.

See you in San Francisco!