Trend Czar

The Denver Example

If there is one emerging high growth city that is handling growth relatively well, it's Denver. The Mile High City has an advantage over Atlanta, Dallas, Houston and Phoenix -- namely its smaller population, currently about 2.5 million. Suburban expansion (I didn't use sprawl) hasn't gotten totally out of hand. Rocky Mountain environmental consciousness probably also has helped.

Twenty years ago, Denver's downtown was going the way of downtown cores in Atlanta and Dallas -- ready to sink fast. Suburban office nodes in expanding suburbs had become favored business centers. Traffic was becoming a problem into downtown and local commutes were easier. Nobody lived downtown and there wasn't much to do anyway, except maybe have a cocktail at the bar in the Brown Palace after work.

But in 1986 city leaders put together a plan that would help downtown survive and eventually prosper. That led to the LoDo warehouse district getting turned into a destination entertainment and restaurant neighborhood with lofts and galleries buttressed by a new stadium for the Broncos and ballfield for the Rockies. More importantly the city and state decided to make downtown the hub of a new light rail system with spokes to key suburban centers. They turned a prime shopping avenue -- 16th Street -- into a pedestrian mall with a free shuttle, connecting to light rail. Now they are instituting a downtown shuttle circulator to extend the service, facilitating movement of commuters from an expanding Union Station to their offices. Many suburban developers, meanwhile, have switched from greenfield subdivision projects to transit oriented development around light rail stations.

Taking forward thinking one step farther, the state has mandated that energy companies produce at least 20% of their electricity from alternative energy sources like windpower and a big push is on for sustainable, green LEED development.

Denver looks like it will be able to accommodate a population increase to 4.5 million in 30 years, thanks to foresight and good planning. The region realized well before the reality of $4 gas that car dependency and unrestrained growth created an untenable future. 

      

Chilly outlook after hot summer

Gas vaults over $4 towards $5, Lehman Brothers signals more financial market issues, and last week's jobs report suggests consumer spending will slacken quickly once tax rebate checks are cashed. Some on Wall Street may continue to look at technical numbers and see slow growth. But on Main Street the stress-o-meter registers extreme readings, sort of like temperatures in the Northeast this week. One guy I know just went on medication to calm nerves, another learned his severe toothache results from grinding at night. These aren't subprime mortgagees. They are millionaires on paper with lots of debt, stock market losses, and diminishing prospects for year-end bonuses.

The gloomy jobs report reinforces outlooks that predict more people will face debt crises soon. As noted repeatedly here, many Americans not only over leveraged on homes and second homes, they must also cover car loans, student loans, and credit card payments. Those tax rebate checks won't go very far in this debt morass and as long as people continue to lose jobs -- defaults and bankruptcies have nowhere to go but up, and housing prices will slide some more too.

Then layer on the rising fuel costs. People either cut back on trips to the mall and vacation resort or have less to spend when they get there. The one-two punch of feeding debt service and filling gas tanks saps the consumer, which has been our primary economic generator.

Retailers and hotel owners stand in the crosshairs unless they cater to foreign tourists continuing to feast off the cheap dollar. CFOs start to cut travel budgets as airlines try to raise rates and cut flights in the peak summer travel season. But suspended job growth also means trouble for office owners -- tenants start to retrench and look to gain an upper hand in any negotiations. Not even the Wall Street optimists talk up quick rebounds or much chance for sudden corporate expansions.

Many real estate owners still hope they can dodge all the economic fallout. Managers, I talk to, expect  returns in the high single to low double digits for portfolios. It's still early.      

Odds on, this mighty hot start to summer leads directly into a Christmas chill.   

Less frothy industry compensation outlook

FPL Advisors, led by Bill Ferguson and Michael Herzberg, have just released their latest global business update which highlights how industry compensation levels lose some of their recent froth in the ongoing  market adjustment.

No surprise, FPL compensation studies indicate private companies will have an "increasingly difficult" time generating "the outsized returns associated with long-term incentive programs vis a vis project/equity participation" compared to the past several years. Since public company shares turned negative last year, equity grants, largely predicated on shareholder performance, will "slow" and "decrease." But the good news is "cash bonuses remain sound," given continuing strong operational performance.

Budget strictures should limit overall base salary increases to about 3.5% to 4% for all employees, according to FPL analysis.

Although the job market on the debt side of the business has stalled, FPL reports recruiting activity has  remained generally positive across all international regions, especially in Asia which experiences a continuing "shortage of Western-trained talent." The U.S. "remains surprisingly active", despite a "slowdown" in finance and development sectors. Europe has been hit harder, especially London. But the UK capital has also been buoyed somewhat by its pivotal role in global growth markets.

Interestingly, the Middle East emerges as the most active user of executive search, according to FPL -- Israeli developers expand into new markets and Arab Gulf states look to invest more capital worldwide.

View a pdf of the full FPL report below.

Download 2008GlobalBusinessUpdate.pdf (276.4K)

(Miller Ryan has an affiliate relationship with FPL) 

Friends and Money

In the real estate business, when plans don't work out like expected and various parties of the first part are involved with various parties of the second part you know that lawyers will be getting in on the action. The tangled webs of mortgage securitizations and credit default swaps whipsaw some investors who may be overleveraged in lagging markets. Developers and their lenders start to get more nervous as buildings come out of the ground and leasing falls short of projections. Money partners start to grumble. Project meetings turn more serious and reflective: Tight looks and folded arms replace backslapping bonhommie. 

During the last commercial real estate downturn, the circa 1990 market implosion, it was quite amazing to see business "friendships" torn abruptly asunder over various contract covenants, albeit exposure in some cases to tens of millions of dollars or more. Suddenly John or Jimmy or Tex "my good friend and business visionary partner" turned into "that s.o.b. who we "should sue into the ground." In the mid-1990s aftermath, the wisdom floated among institutional investors was to avoid joint ventures with developers, "who were only in it for themselves."

Well, time helps people forget and changes the players.  In the most recent cycle, joint ventures were called operating partnerships to make everyone feel better and money partners made sure that developers had "substantial skin the game" to align interests. But as everybody leveraged up to the hilt, substantial became less substantial even for the institutions. And the money partners--Wall Street bankers not insurance companies--were using other people's money in the transactions while taking out plenty of fees along the way.

The current slowdown probably won't result in the level of acrimony and bad blood leftover from the early 1990s period. But ill-feelings and bareknuckles will be more in evidence over the next 12 to 18 months. Where money is at stake, friendship can be fleeting. Let's watch to see how much backroom workout infighting devolves into actual in your face, headline-making litigation. Expect at least some.       

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).