Trend Czar

Back to the SUVs?

Gas prices plummet towards $2.50 a gallon nationally--will we abandon notions of energy independence and wind energy, and climb back into our SUVs? We did that once before back in the early 80s after the Iranian crisis abated and gas lines disappeared. Cheaper gas led to the big sprawl wave--exurban growth, McMansions, more shopping centers and big vehicles to travel to and from them.

But U.S. home-grown oil resources steadily decline from early 1970 peaks (when we were the world's number one oil source)--the reality is more off-shore drilling won't make much of a difference in reversing that trend. And do we want to continue to be at the mercy of events in the Middle East and be compelled to send our military there to safeguard our interests at huge costs? Let's face it we are one terrorist attack on Saudi oil fields away from $5 a gallon gas.  Then there is the global warming issue--do we want to keep spewing out tail pipe pollutants with mounting deleterious consequences? And lastly, the reality most of us don't focus on at all is congestion in our metropolitan areas. These places are the nation's primary economic engines and they increasingly have been gridlocking, because their infrastructure systems can't accommodate all the increased traffic from more cars having to travel greater distances to get around between work and home.  The slow downs reduce gas mileage and increase pollution, while businesses and people get less efficient--time lost in traffic translates into lowered productivity. Cheap gas aggravates congestion problems--we need to become less car dependant, especially considering expected population growth over the next 30 years. More cars and more vehicle miles traveled aren't the answer even if we find a pollution-free energy source.

And let's not forget the reason for nosediving gas prices--an  unprecedented, worldwide economic panic, which has sent international demand for oil into a tailspin. Increasingly volatile energy prices could suddenly increase again when economies improve. And we're back in a price shock mess.

If we're smart we will focus on the energy independence goal--and over the long-term that includes changing where we live and work and how we move around. 

   

Submerging Trends

PricewaterhouseCoopers and the Urban Land Institute have just released Emerging Trends in Real Estate: 2009, which I have the privilege of authoring. This is the 16th edition of Emerging Trends I have written and now I feel like have gone through an entire real estate cycle -- and a long one at that. In 1993 when I started writing these annual forecasts my colleagues at Equitable Real Estate kidded me for writing about "submerging trends." We all were coming out of what amounted to the roughest period ever experienced for commercial real estate since the Depression -- a combination of overbuilding and recessionary demand sent values plummeting and created monumental dislocation for our clients. In fact, our insurance company parent almost went under, rescued by a sweetheart deal for the French insurer AXA. They bought one of the nation's largest insurers for about $1 billion. Sounds a little bit familiar.

Well today, commercial real estate isn't leading the charge into economic crisis -- this time it was housing. But now commercial real estate sectors are following the crowd over the cliff after the stock and bond markets with the recession providing an extra big shove. In Emerging Trends, the consensus of our survey respondents is that value writedowns off 2007 peaks will average 15-20%, hopefully less for trophy properties in the best markets, but likely much more for lower quality properties, especially in secondary and tertiary markets. And total NCREIF-core real estate returns will be well into negative territory next year.

After meeting with some of my neighbors last night, the discussion turned particularly gloomy. It was a well-heeled group -- whiteshoe lawyers, a couple of investment bankers. They talked about hedge funds collapsing and looking to sublease space, insurance companies tanking next, telling their grown up kids to expect a less generous Christmas time...

If anything our ET forecast may be a bit too cheery. Let's hope not.

If you want a copy of Emerging Trends contact ULI or PWC. See you next week at the ULI Miami Convention where Steve Blank of ULI and I will be presenting the report's outlook. I'm heading out right now to do an NPR interview on the "On Point" program, syndicated nationally.  Unfortunately, bad news peaks everybody's interest.

Really Scary

I got a call from my friend Didi the other day. She was on her cell driving her kids to a concert and wanted to know whether the real estate kingpin she is acquainted with is going to "lose it all -- it's been all over the papers." Didi was "scared."  She said she had just talked to her friend whose husband has made a fortune at one of the big surviving investment banks, but isn't expecting much of a bonus this year. Her friend told her "everyone is real down in New York" and "no one knows what's going to happen." Didi's hubby, meanwhile, is making ends meet consulting since being squeezed out of his big ticket job in a financial merger -- but job hunting has proved daunting and their laissez-faire lifestyle may need to go on hold. She says she wants to sell her posh house to raise cash, but "whose going to buy right now. It's really scary."

I tried to get a word in edgewise. The real estate kingpin was going to get taken down a few notches, I said, but would probably end up much better off financially than most everyone else despite screwing up and  probably getting bounced. In the end that's the benefit of being a kingpin... As far as New York is concerned, I dittoed her friend's comments and suggested she should ease up on her spouse. With the financial industry in severe contraction, finding high pay work is a steep climb these days unless you're a workout specialist or a bankruptcy attorney... Selling a property in the midst of the tailspin doesn't make a lot of sense, I reminded her, unless you're willing to meet buyers' low ball expectations. "Look," I told her. "It's time to put away the credit card" and spend only on essentials. "Put the kids first, " I advised.  She liked the sentiment "putting the kids first."

Then Didi confided she was depressed and didn't get out of bed the day before. Actually, she admitted she eventually got up and went out and bought several expensive pairs of designer shoes. "It made me feel better," she said.

Now that's really scary.

What is a Credit Tenant?

Next week PricewaterhouseCoopers and the Urban Land Institute release the 2009 edition of Emerging Trends in Real Estate, which I author. For now, just let me say don't expect an upbeat outlook. But I'll have a lot to report about on ET in coming weeks.

In the Emerging Trends interview process over the summer I was amazed by the still large number of industry pros -- especially on the private equity investing side of the business -- who were still pointing to "fundamentals" as reason to hope that investment performance would not be hurt too dramatically by the credit crisis. They weren't sensing the economic downturn either. Leasing rates seemed to be holding up okay. It wouldn't be too bad.

Well, these Pollyannas should be focused today on the jobs outlook. Many economists forecast national unemployment reaching 9% next year up from 6% now -- financial companies are shedding jobs, the automakers and other manufacturers are tanking, governments are slashing their own payrolls and more importantly contracts to many companies. The construction industry is in a swoon and retailers are cratering. Even Pepsi is laying off folks. There are new headlines every day about corporate cutbacks. Every company I know has put into place what is effectively a hiring freeze.  Even if the economy begins to recover by the middle of next year (and that may be too hopeful), typically jobs losses continue well into any turnaround. 

The jobs picture immediately exacerbates the ongoing consumer capitulation. People are cancelling vacation plans while businesses clamp down on travel budgets (AIG aside--what were those execs thinking??? I know--they deserved a break from losing all that money!). Landlords will be scrambling to hold tenants and keep up property cashflows as companies give back space. After WAMU, Lehman, and Wachovia, everybody is wondering just what is a credit tenant today?  Some law firms go out of business. And how about all those hedge funds who leased luxury digs at sky high rates a few years ago -- do we have any confidence in their staying power?  Those long-term leases may not offer as much protection to office owners as advertised.  Indeed in this environment, tenant rollovers assume an entirely different meaning.

 

Time to raise a tax

Thanks to plunging recessionary demand gas prices head under $3 a gallon -- bring back our SUVs and forget all that talk about alternative energy sources. In fact, given what happened almost 30 years ago, if energy prices were to keep going down, fervor could quickly abate for conservation and driving less.

Actually, now is the time to raise the federal gas tax 25 cents a gallon. Raise taxes! How outrageous when everyone has been wracked by the financial meltdown. Will it happen? Very unlikely given the political wave of bailouts, rescues, and tax givebacks pushing up our national debt to increasingly stratospheric levels.

But raising the gas tax would help on three essential fronts, providing short and long-term solutions to problems facing the country: (1) raise money to create jobs and repair our aging transport systems, (2) build new 21st century infrastructure that is necessary for keeping the nation competitive, and (3) restrain notions that we can slip back and do nothing about our energy dependency.

Just this morning New York State reported suspending $250 million in sorely needed road repairs, because the funding from tolls and taxes isn't available. Other states face the same conundrum and will initiate similar cutbacks. That amounts to tens of thousands of sidelined jobs rippling through an economy torpedoed by steadily rising unemployment.

As noted in this space, the country is smoking something if we think we can get away without rethinking and rebuilding our roads, rails and mass transit and that requires massive funding infusions. At some point, people will have to pay through a combination of higher taxes and user fees. And the sooner we start the better to reduce congestion, pollution, and the chance for catastrophic failures.

Over the long-term, energy prices can be expected to rise steadily, despite the current nosedive. When the world's economy gets back on track... eventually, demand will push prices back up. Our new infrastructure needs to be designed to help us use less energy and get around more quickly and efficiently. We cannot get trapped in any short-term complacency that we can avoid making adjustments in how and where we live and work.

The federal gas tax -- a measly 18 cents a gallon -- hasn't been raised since the early 1990s. Now the Highway Trust Fund which pays for road and mass transit projects approaches insolvency. States layoff construction workers and set aside projects and we all hit more potholes... literally.

If gas prices drop by about $1 a gallon, it's a propitious time to raise a tax that hasn't been touched for years and avoid the potential for deleterious results if we do nothing. Yes, it's an outrageous notion, but a necessary step to setting the country in the right direction.

Infrastructure, the Economy: Hello! — They’re Linked!

I recently wrote the following article for the Citistates Group, a  network of journalists, speakers and civic leaders which I belong to.  The group focuses on building competitive, equitable and sustainable 21st century metropolitan regions.

Visit www.citistates.com for more information.

Lost in the election scramble, bank rescues and heated debate over government bailouts is the simple fact that American needs to rebuild its wealth — we’re busted.

The national debt grows to over $9.8 trillion and climbs rapidly while the current $407 billion federal deficit has nowhere to go but up as the federal government grapples with a teetering national economy. The next president will struggle to recapitalize the country while hundreds of billions of dollars go each year just to service our prodigious national debt. For all the belt-tightening talk, eliminating $16.5 billion in annual earmark expenditures would make only a minor dent in the huge federal deficit.

So what do we do — when our Treasury registers empty and we confront so many other challenges?

In the first presidential debate, both candidates conveniently sidestepped the hard choices they will face. John McCain suggested a possible spending freeze and Barack Obama admitted some of his big ticket plans may need to be shelved for at least a while. At least, Obama made passing reference to rebuilding the country’s increasingly dated and inadequate infrastructure as an important priority.

In fact, a retooled national infrastructure will be an essential part of the solution to maintaining our economic clout and future prosperity, while providing the needed stimulus of a near-term jobs engine.

The challenges are huge: Our once-vaunted interstate system is overwhelmed by traffic around major gateway cities and along truck corridors. Our metro regions lack public transit systems robust enough to tame oil consumption and sustain future growth. The nation has literally zero high-speed rail lines and may need four or more major new airports. Major East and West coastal ports have turned into huge bottlenecks and our national freight shipping network needs radical upgrading. Chronic traffic jams, lost time, higher driving and logistics costs can only get worse as the U.S. population expands by an expected 100 million people between now and 2040.

We’ve responded before. In the 19th Century, the federal government jump-started commercial growth with canals and then the transcontinental railway. Early in the 20th Century we underwrote development of an electric grid to trigger a new industrial era. Post-World War II interstate construction and airport building enabled explosive national and metropolitan development.

Now we need a new generation of infrastructure building, led by the new president and Congress. And our approach needs to be truly strategic. We need to link critical goals — on the one hand, enhanced mobility and efficiency that enable us to compete with more advanced European and Asian networks, and on the other, reduced oil dependency and a “green,” lighter environmental footprint that matches the carbon-reducing demands of the times.

What are the cornerstones that can form a successful, wealth-producing, energy-efficient strategy?

- Use federal funds to Integrate systems and modes. Set federal funding guidelines to force states and regions to integrate their highway, mass transit, rail and airport planning, combined with local initiatives to reduce car dependency. We need smart, multi-modal, inter-regional solutions — no more single-shot “Roads to Nowhere.” The huge government deficits we face make the case for strong federal incentives — perhaps a national infrastructure “czar” to insist on integrated, economical approaches — all the more compelling.

- Promote continental connections that keep people and goods flowing. For example, world-class connections of the nation’s coastal economic gateways must be tied efficiently to primary interior cities and transport hubs such as Atlanta, Dallas and Chicago.

- For our major metros to prosper, insist that rail, light rail and subway systems efficiently link suburban development hubs to center cities, intercity rail stations and airports. High-speed rail lines should link cities within major multi-state regions, offering alternatives to air and car travel. More vertical, high-rise residential developments should be encouraged around rail and transit stops.

– Make users pay. Interstates and highways must be tolled not only to pay for new infrastructure, but also to provide incentives for people to find more efficient means of travel and cost-effective places to live and work. Freeways have subsidized car travel and trucking as well as encouraged sprawl by not charging drivers and developers for the cost of building and maintaining these road systems. Fully loaded driving costs and transit alternatives would encourage people to drive less. “Drill, drill, drill” is no answer when vehicles clog expansive arterials into primary metro destinations.

This new infrastructure model won’t come cheap. But an Urban Land Institute report estimates that more than 5 million jobs would be created if the U.S. invested the full $1.6 trillion needed over the next five years just to meet current infrastructure needs. A government commission has asserted we need at least $100 billion in additional yearly outlays to bring our roads, rails and airports into the 21st century.

The principle’s simply: to pay our existing bills, we need a growing economy. Infrastructure’s a lead way to do that.

Party Like It's 1999

Saturday night. Roof top 40th birthday party--Chrysler Building and assorted other skyscrapers shimmering over the cityscape in the distance. The host, a hedge fund guy, thanks everyone for coming "in spite of the tough week." Champagne is passed and a lemon scented birthday cake rolled in on a cart for his wife to blow out the the spritzing sparklers. The DJ played Prince's "1999" but most of the well-heeled crowd--mostly financial types--gathered around talking about what would happen next in stead of heading out on the dance floor.

Would the new condo project at 86th and West End sell out its multi-million dollar "pre-war" apartments. The word in the neighborhood is that sales are slow and slowing. The good news is a nearby project on the drawing boards won't block one partyier's views--it's been shelved. But she looked glum-faced anyway when she thought about how her own coop might lose 20% of its inflated value. And then there was her hubby's bonus--any chance he'd not get one?

It was a bit hush-hush but parent talk at the sushi table centered around how kids were being pulled from a top private school--at $41,000 the tuition and extras is hard to swallow when you've lost your job at one of the big banks.

A hedge fund marketing chief pondered all the hand-holding she'd face this week as Euro clients called for withdrawals. "We're very low leveraged, but it doesn't matter, everyone wants to pull their money out."

Nearby another hedge funder ("he's one of the most successful in the business") sat slumped in a chair, looking anything but festive. A woman bantered with his wife about going back to serving her son macaroni and cheese. "Maybe hold the cheese," she laughed after having one too many.

Indeed, the berried Persecos and peachy Bellinis went down awfully easily. A few couples started dancing to Nancy Sinatra's--"Boots." They mouthed the words "and one of these days these boots are going to walk all over you."

Indeed, "Party like it's 1999." Unfortunately, it's 2008.      

After The "Rescue"

Warren Buffett makes his bets (on GE and Goldman) and proves once again in tough times cash is king -- he's in a position to make what could be big scores. On the other hand if you are in a debt driven business or have used a lot of leverage on your investments you are more likely to be flat on your back. The Washington rescue/bailout package may prevent systemic collapse in the credit markets, but won't change dramatically the gloomy outlooks for folks who had been playing the debt game. Necessary deleveraging will take time and deeply pain investors who borrowed too much and surviving lenders who ramped up volume at the expense of underwriting discipline.

And despite the significant damage already suffered across the credit sector, commercial real estate has yet to take most of its lumps. Appraisers characteristically have been gazing in the rear view mirror. Just a few weeks ago, a well-known appraisal honcho was telling me about how income numbers were holding up in most institutional portfolios "through June 30." Well, how about looking at the next few months. Let's hope the credit scare abates, but no one should expect the lending spigots to flow again as unemployment ramps up and the government comes to terms with the fact that the country is essentially busted. The scary thing is that so many Americans have been living (large) off credit. The home equity lines, attractive car financing, the credit card deals --it's all over. Now what does everybody do to keep going when they are in the red and lenders out of self preservation start to turn the screws?   

As previously noted, more retailers will be toast. Office rents will decline. Warehouse activity sinks. And housing... please.  How many people will have enough equity to buy homes in this environment under normalized (stricter) lending guidelines? Not enough to spur any rebound. 

Let's not kid ourselves -- the last few months represent  an unprecedented crash of the debt markets and the way we have done business for the past generation -- borrow and consume. It was unsustainable. Now we must shift to paying off our debts, creating new businesses and industries, and adding value once again to the world economy. It may not take a generation to recover, but the next President has to hope things are looking better by the next election, and that's no sure thing.   

 

Alarming Numbers

Here are some numbers that put into perspective the sorry state of the federal government and our fiscal predicament:

Current National Debt: $5.4 trillion

Current Federal Deficit: $407 billion

Combined bailouts (to date): $1.6 trillion

Eight years of Wars: $790 billion

Social Security Payments (2008): $612 billion

Medicare (2008): $454 billion

Medicaid (2008): $202 billion

Interest on the National Debt (2008): $244 billion

Earmarks (2008): $16.5 billion

For all the talk about the ravages of adding on more debt and leverage, the government has no other choice but to take out the credit card so that taxpayers will incur even more staggering debt service costs in the future--$244 billion will look good next year.

And oh yeah, eliminating earmarks will make a major difference in the sea of red ink.

 

Stop Making Assumptions

Americans have been good at making assumptions--housing prices would continue to spiral, Fannie and Freddie would never need a government backstop, borrowing increasingly more would never come back to haunt us, and our major investment banks-managed by financial geniuses-- were impervious. One by one, our assumptions have been knocked down.

Politicians and bankers have also posited that international investors would always continue to invest in Treasury bills and U.S. companies, because American is a safe haven and the most powerful economy on earth. We could afford to run up our national  debt--now over $10 trillion-- and  our federal deficits--this year $400 billion plus and about to balloon, because the rest of the world would keep pumping money into us even when we lower interest rates to overcome economic weakness. The fail safe assumption is they have so much invested, they would only hurt themselves if they stopped banking on us.

Some economists have warned for years we shouldn't be taking anything for granted and that one day the rest of the world could view the U.S. as just a bad investment bet--sort of like a CDO full of subprime debt. Why  keep throwing  good money after bad? It's time to bail. Given our current condition that day may be fast approaching. According to today's Washington Post sovereign wealth funds sit on the sidelines, having been burned by investments they made in various banks earlier in the year. The German finance minister excoriated the U.S, in a speech this morning for putting  the entire  world  economy in jeapordy and suggesting the U.S. has lost its financial market primacy.

If the world stops investing here or more likely wants a (much) higher return for taking on greater perceived risk, interest rates have nowhere to go but up, way up. Our weakening dollar, meanwhile, helps ratchet up inflation (and oil prices). And you think we have problems now?

After the past month, don't assume it can't happen.