Norton On Real Estate: The best advice is to hunker down
After this very wet summer, the recommendation for the fall may be to batten down the hatches. In addition to a forecast for continued rain throughout the fall, there are economic storm clouds on the horizon as well.
Jeff Thredgold, economist from Thredgold Economic Associates, stated in his Aug. 6 newsletter, “The U.S. Commerce Department’s latest revision to prior economic data now suggests (at least for the moment) that the U.S. economy has finally experienced a quarter of declining gross domestic product.”
Even optimistic Jeff has now acknowledged that we are in recession. He continues, “While the economy has now strengthened during the past six months, such a pattern is not expected to continue. The economy is likely to slow during 2008’s second half … The nation’s jobless rate jumped to 5.7 percent in July, a four-year high. The construction sector lost 22,000 jobs in July, the 13th month in a row of decline.”
Most important is energy costs, he said: “Continuing declines in oil prices would be a key positive for the economy in coming quarters. Conversely, a return to higher oil prices could sap what little energy the consumer has left at this point. Seven consecutive months of job losses are not exactly a positive contributor to solid economic growth.”
Now this is not a doom-and-gloom media type. He is a generally optimistic economic forecaster. One point not yet covered is the tightening of credit. Banks and other real estate lenders are going back to the basics of equity in the deal, strong leases and recourse — not to mention leaner values on appraisals. One writer quotes an industry spokesperson, “Given the difficulty in sourcing cost, effective financing, combined with larger economic uncertainties, above market priced assets simply cannot be closed in today’s environment.”
The Royal Institute of Chartered Surveyors, of which I am a member, reports in its second-quarter Survey of Property Professionals “increased vacancy across the developed world. Tenant demand is falling faster in western nations. Rental expectations are most negative in North America and the weakest investment markets too were in North America.” Ugh!
Clearly, commercial real estate has had quite a boom in the U.S. since 1994, and a correction is due. But when the correction comes at the same time as falling employment, rising energy and transportation costs and a vague economic climate, it could turn out to be more than a minor correction.
So exactly where we are heading is far from clear. Jobs are critical to filling buildings or keeping them full. Occupancy costs are rising, especially energy costs and real estate taxes. Thus many markets are at a standstill as tenants take a wait-and-see attitude while owners hold firm on leasing pricing. The $64,000 question is whether this is a small blip/correction or whether this slowdown/recession will stretch out for four or more quarters. Time will tell. The key right now is to prepare for the worst and hope this gale blows out to sea.
Curtis Johnson put it well in his recent article, “Paradigm Lost, Can Americans Change Course?” when he wrote, “A historic $14 trillion of public and personal debt, a fourth of America’s bridges deficient, more than a fourth of adults obese, and nearly half of the nation’s youth not prepared for a 21st century economy — what do these baleful effects have in common? Each of these effects, and more like them, show what we got for a half-century of easygoing, profligate, low-efficient culture! Though only 5 percent of the people in the world, we Americans got comfortable with burning 25 percent of the world’s resources. From corporate practices to personal lifestyles, we shoved the consequences of waste on to the backs of the less well off and future generations. We provided schools but didn’t worry if half the students didn’t succeed.”
Ouch! No getting around it, that’s us. So there is much work to do. The silver lining in the clouds is that ownership and investment in hard assets such as commercial real estate can make a lot of sense in the coming years. Both high construction costs and constraints on development along with constrained availability of land mean real estate can be purchased for less than replacement costs, and if well managed, will hold its market value.
William Norton, president of Norton Asset Management, is a Counselor of Real Estate (CRE) and a Fellow of the Royal Institution of Chartered Surveyors (FRICS). He can be reached at firstname.lastname@example.org.