Cursed By Knowing The Numbers

Commercial real estate’s epic fall from grace in 2009 is well documented in this markup of RREEF’s 2009 Real Estate Investment Outlook and Market Perspective.

I love this technique—the analyst actually went back and marked up their 2009 forecast at the end of the year with what actually happened. 

The downturn in San Francisco and Seattle, two traditionally downturn-resistant markets, was greater than forecast.

Pricing dropped 40% from its 2007 peak, and is forecast to drop another 10% in 2010.  NCREIF property returns were the worst in NCREIF’s 30+ year history.

The big conclusion of the markup?  2009 was the weakest year since the 1990’s—remember SURVIVE TIL ‘95?   I wonder what the new mantra is…

They are predicting a quicker return to zero or positive returns in 2010 than for the 1990s downturn—driven by cash on cash returns—with income getting re-established at sustainable levels.

Employment growth is expected to turn positive this year, with below long term GDP trend growth until 2011—performance tracking below previous recoveries.

The big thing they didn’t talk about?  What will the real estate banking market look like going forward?  The guys that threw the gasoline on the fire in 2005-2007—Lehman, Merrill, RBS, and Bear—are all gone.

The bottom line?  Commercial real estate, once viewed as a liquid, appreciating asset with the ability to carry a lot of debt as you rolled over the tenant mix, is now back to occupying its traditional role as a bond-like income producing investment with an inflation hedge.

Posted by Ted at 3:24 PM | Permalink

Sat in on a SF ULI Panel yesterday morning on gaining traction in the NorCal residential development sector.   This industry sector is still trying to sell into an ever dropping value market--absolutely the reverse of 2005.  Economics and sales tactics are now more akin to the used car business than the real estate business.  VELOCITY is the key principle.

Housing price declines appear to have stopped accelerating--stabilizing at a rate of decline of 20% per year.  The good news is that it looks like we are approaching a trough.  Bad news is that peak to trough is expected to be about ~40%.  Yowza.

Pulling the levers to achieve a 40% reduction in housing costs means that residual land value is negative.  Brother, can you spare some dirt?

Most interesting points made were about what is working today. 

The panelists had kicked the print advertising addiction--their two best friends were now signage and social networking.  They are starting to leverage the value of social networking--but at what price do your friends consider you smart when buying that condo?   And those broker open houses with the free trips to Hawaii?  Fuhgeddaboudit.

Is it time to start buying hard assets?

Posted by Ted at 11:31 AM | Permalink

Yowza.  From banks in the tank to property values falling off a table last fall.  We need to deleverage about $5T out of the economy, and real estate values are highly correlated with leverage.  The New Normal is about 40% equity and debt costs of ~6%.  Net Collected Rent and Net Operating Income on properties I am looking at have not started to deteriorate yet, but rising cap rates have given most assets about a 20% haircut on value.

Here is MIT's Center for Real Estate Transaction Based Index--although there are so few transactions you don't really know what the mark to market price is--and no transactions for the retail sector as an extreme example.  The results are showing a record price drop.

We are in the market right now buying apartments, so I am probing for a bottom every day--don't see one yet.  When will this end?  Repricing on compelled sales is happening now--question is getting commitment from our investors for what used to be good returns of low to mid teens on operations without construction and lease-up risk.

Not the type of curve that makes you want to jump back in the water, but demand may recover fairly quickly--unemployment is not THAT bad, no inflation, and the cost of debt is not unreasonable.

MIT's Supply and Demand index is another take on current market conditions--sell side is easily six months behind the buy side on pricing, and demand side pricing is off 30% from its high in 2Q07.  Demand spiked back up in early 07--don't believe we will see a repeat of that bounce.  Frankly, I don't know what is going to pick this market back up. 

Free Fallin'...

Posted by Ted at 10:23 AM | Permalink

RREEF went back and looked at their 2008 Real Estate Investment Outlook with the benefit of 2008 behind us.  Interesting commentary, indeed.  Their apartment commentary is dead-on.

Demand, wherefore art thou?

Posted by Ted at 4:10 PM | Permalink

Green building is demand led--consumers want it, and are getting smart about spending their construction budgets in a green way.  The range of materials--countertops, paints, flooring, carpets--mean that a lot of options are available that say "green"--giving the people what they want.

Materiality was the major advance in this show--that and the understanding that green building is an easy choice.  Suppliers are scrambling to fill the gap.  It used to cost more to build green, prices now seem at par with custom home prices.

Standards are in flux--degrees of greenness abound--LEED for Homes and Build It Green are the two big ones. 

Momentum is impressive, and understanding of what it means to be green--without materially compromising what is important--is occurring.

Press coverage has been ample--increasing both understanding and demand.

Next steps?  Getting banks on board with green mortgages, and jurisdictions requiring energy upgrades at time of sale.

My action item?  Getting much better at practicing  sustainable real estate development.

Posted by Ted at 7:53 AM | Permalink

...again, taken from Professor Peter Linneman's talk at my ULI multi-family council meeting last week.

Every year, the US needs about 2 million new homes.  1.3 million to house the 3 million new people who call the US home, 100,000 second homes for these people, and roughly 600,000 homes to replace demolished or obsolete housing stock.

Against this demand, our housing industry produces anywhere from 1.4 million to 2.4 million homes.

Today, there are about 600,000 homes held in inventory--about a six month supply.  Builders hold 300,000 nationwide, the other 300,000 are being held by investors/speculators.  The surplus of 300,000 should work itself out--either by sale, or by investors handing the keys back to the bank--by 2008.

Some markets are so supply constrained, so in demand, that recovery is upon us.  To wit:

Posted by Ted at 7:40 AM | Permalink

  ...in producing insanely great places to live.  And plenty of links to help you figure out what needs to be done in the New Year.

Elegant Green--building sustainably without  screaming green.  Daylighting, sustainable materials palette, fresh air,  and employing logical common-sense solutions on interior finishes, and energy use.  

Performance Green--

• Photovoltaics make sense to replace any power requirement that PGE is charging you 130% of baseline rates or greater.  This tariff is currently $0.23/KWh.  Photovoltaics pencil out at greater than $0.20 for homeowners, and at all investment properties where Owners cannot pass through electrical costs to tenants and can take advantage of the 30% investment tax credit and depreciation shelter.
• Bamboo--will become the "hardwood" [actually a very attractive weed] of choice due to its workability, sustainable growth, hardness,  and value.  I like working with it, and the meaning behind the material says alot.  Be careful where you buy it--the hardness of bamboo harvested at three years is a fraction of its hardness when fully mature (~six years).
• Green building materials--flooring, glass, steel, copper, will become more widely used as the carbon footprint is understood. 

Triple Bottom Line Development is the way I am underwriting all my projects going forward. 

Everyone starts to understand the economics of climate change. 

UMXD--land uses as encrustations around experiences--pull people back to 24 hour cities, next to water, alongside openspace to better capture the experiences of daily life.  Livable streets.  Make transit options to the SOV a better experience.

Residential Land--the crash and burn of the public homebuilders mean that there is land available--buy carefully, the public builders will be back, and they will need land. Demand should be lower now than in the foreseeable future.  Probably a three to six month window.

Construction Costs increase at a more measured level than the 20 to 25% of recent years, primarily due to the dollar's continued depreciation.  We are baking in 10% cost increases next year on materials and 8% on labor.  No further pop in trade contractor OH&P, which almost doubled in the last 24 months. 

Carbon Neutral Development--is a great concept, but I don't know if investors here in the Bay Area will really give a flying flip about how we spec and produce our product.  It all gets down to the numbers and how well our neighbors understand the economics of climate change, and leaving things better than they found them.

Demographics-- William Frey of the Brookings Institution recently produced

Two trends that are not happening uniformly across the United States.

Boomer Induced Aging--Fastest growing demographic segment will be the baby boomer gains in the 55-64 set.  Predicted to age in place.

The age wave of well-off,  young seniors continues to emerge in Vegas, Denver, Dallas, and Atlanta.

The Bay Area trends younger with recent immigrant driven population growth, and immigrant families (>20% of the population), becoming a "New Minority" locale.  The Bay Area, like California, Nevada, AZ, Texas, Florida and NY are both "aging" with aging in place Baby Boomers and "younging" with new immigrant minorities.  Different real estate products in a vibrant economic setting

Look for land use patterns responding to this generational segmentation--for example, Riverside CA has the greatest distinction--only 3 of ten children are Caucasian, while 7 of ten 65+ are caucasian.

Color--Pantone's interior paint color forecast for 2007.

Longer term trends:

 Competitiveness--Superstar Cities, as described in the NYT, are forcing us in the "insanely great places to live" industry to focus on the changing market.  Living in SF, NY, or London is now perceived as a "scarce luxury good", and demand is reflecting this.  Michael Bloomberg, Gotham's mayor, political pragmatist, and urban planning visionary has been establishing a vision for New York that accomplishes three things:

• Accommodates a 12% increase in population over the next 25 years,
• Rebuilds NYC's infrastructure--water, transport, communications.
• Transforms New York into a "sustainable city", including the pledge of New York having the cleanest air of any big city in America.

Housing Equity--providing a balance of housing options to meet our regional housing needs.

VLJs change high end travel patterns.  Eclipse Aviation is getting the bugs out of their glass cockpit avionics, and ramping up production.  Ability to fly in Class A airspace, 1200 mile range and 2400# payload at a total op costs of $352 per flight hour, create demand for this flight option with ability to land at over 10,000 US airports.  Initial cost of $1.5 million are driving the economics of this travel option--but wait till they get the glass cockpit technology straightened out.

Ground based ops at exotic locales--Angwin in Napa County--merit further study.

Big Urbanism-- where best to participate in this value chain-- where can my company utilize its tactical advantages, rather than laying siege to a large land holding.

Posted by Ted at 1:30 PM | Permalink

Starbucks Total Store Count, as of three weeks ago...

 
Find out how many Starbucks are within a five mile radius of where you are.  These guys aren't coffee purveyors, they are masters of understanding where disposable income and their targeted aspirational psychographics intersect.  First thing I check when doing research on a site.

OK, enough fiddle-futzing around, back to making another projected dollar...

Posted by Ted at 7:33 PM | Permalink

In this article in today's NYT, I came across a new term coined to fight infilling our existing urbanized areas--vertical sprawl--a higher density land use that causes increased traffic, parking problems, and the cost of supporting new projects with schools, water and other municipal services.  Key unique issue is building height, and shadows cast on adjacent properties.

Parking can be solved through adequate below grade parking--a matter of public policy, economics and soil types.  Traffic is a more complicated issue.  It depends on safe, time efficient, and convenient alternatives to SOV's (single occupancy vehicles).  Economics need to factor in the door-to door elapsed time and yuck factors of urban mass transit.

The costs of building type I--highrise--(c. $550PSF) are two times the costs of building lowrise--type V (c. $275PSF).  The cost of land and infrastructure does not offset these higher construction costs, which is why people still flock to the exurbs and ignore the transportation costs (for a while).

Housing costs are starting to be viewed as the combination of costs of housing plus costs of transportation to work and services

Here is the Brookings Institution study.

"Significant empirical evidence is beginning to point towards a tantalizing association of economic productivity and compact, centered, and efficient regions."

The Sierra Club  produced a white paper on sprawl and an interesting study--particularly the contrast between Portland OR and Atlanta GA--cities with roughly equivalent growth with widely varying effects on costs of providing services, traffic, and air pollution.

Posted by Ted at 11:01 AM | Permalink