Real Estate and the Economy - 1990 and Beyond
Miles, Michael E., Journal of Property Management
Real Estate and the Economy--1990 and Beyond In some ways, the state of the real estate markets has seemed relatively unchanged for several years; everything is overbuilt and the Oil Belt is bleeding. We say the same things every year.
But there is a very important evolution taking place. When a larger number of developers and owners in the Oil Belt went under at once, it attracted a great deal of public attention. But today you see a whole series of unpublicized mini-Texases, all over the country. The pain and suffering that began in the Oil Belt five years ago has now spread to every market segment in almost every part of the country. Today we are seeing foreclosures, deeds in lieu of foreclosure, wealth destroyed, people living on the edge in every geographic region.
The pain in the real estate industry will continue into the near future. There are still quite a few office buildings coming out of the ground. Tenants have become more sophisticated and aggressive at pursuing their own interests. That being the case, some people in real estate will continue to suffer.
Eventually real estate returns will begin to rise, but it will not be in 1990. It is hard to tell when the corner will be turned, but it is definitely measured in terms of years. If you have bad cash flow for a year or two, you may have the reserves to weather it. But only the institutions and "hold money" can survive several years of negative cash flow.
Institutions will continue to expand in real estate, despite these negative cash flows and low, short-term yields. The smarter institutions are in real estate more for diversification than for immediate returns. There has been no new evidence that real estate returns are correlated with stock market returns. In fact it is just the opposite; the stock market has been booming over the last two years and real estate has been doing badly. As a diversifier, real estate still holds its place.
ERISA requires pension funds to diversify, and diversification means seeking a low variance of portfolio returns. Some institutions may pull back because of lower short-term real estate returns, but large institutions that have to commit large sums of money over a long period of time will remain active in real estate. Some will even become more active as they see targets of opportunity.
The impact of regulation
Regulation is the other factor in today's real estate market. As regulatory controls get tighter, higher costs will reduce supply and eventually improve rental rates. This restrictiveness will probably take the form of a much more encompassing impact fee for all developments. Communities in all parts of the country who do not think they have other ready sources of revenue to fund infrastructure will try to get everything possible from developers. (In addition, heightened environmental concerns are going to drive up costs and slow down the development process.)
The voter sentiment nationwide is clearly behind higher impact fees; most people feel that added speculative development is wasteful and has a negative effect on lifestyles. Insufficient infrastructure is a great excuse for people who want no growth. Only the poor and the developers want growth because it increases their opportunities. Almost everyone else wants no growth.
Concern over the environment will also contribute to the no-growth trend. The pollutants in the ground are a very serious problem today, so water quality will be a growing concern in the next decade.
Long-term, a clean environment is going to become a consumable good that the American public buys.
We are a very affluent society for the 80 percent of the population who have any money at all. In the next decade, many consumers will be willing to pay higher prices to clean up our environment. After all, how many Sony Walkmans can anyone buy; everyone already has three. …