Prognostication

                                                       Entering 2008: The Real Estate Market

                                                                                    by

                                                                      Dr. Mark Lee Levine

 I.         INTRODUCTION:  With 2007 behind us, many of our prior 6-months’ projections for 2007 as to performance in the market were on target, while some prognostications were off target, and some resulted in mixed conclusions.  An economist might conclude that the overall real estate market in 2007 was staged for good performance in the U.S., assuming that major events did not occur (such as substantial rise in interest rates, escalation of war, breakout of new conflicts, more terrorism, etc.).

            This overview consists of economic predictions, prognostications, and other projections, and including complex interactions of multiple factors that influence, direct, and impact performance of all global economies. However, two (2) specific real estate projections garner a good deal of agreement:

1.      The U.S. residential market, overall, is not doing well; and

2.      The U.S. commercial market will show signs of slowing in 2008.

           Terms employed by economists may euphemistically refer to noticeable changes in the economy as “fluctuations,”  “hedging” and/or "corrections."  However, terms for substantive changes within the marketplace may include “recession,” “depression,” “recovery” and/or “expansion,” among other terms.  When the direction of the market is generally down, the phrase might often be characterized as an “adjustment.”

@   Copyright by Dr. Mark Lee Levine, Denver, Colorado 2008.  All rights reserved.

II.        THE GENERAL MARKET:  BROAD SCOPE:   Many subsets in the real estate market include major divisions between residential real estate (single-family or multi-family), and commercial real estate (offices, retail shopping centers, hotels/motels), etc.  There are further divisions within each of these areas.

         In examining geographic areas with the U.S. market, overall real estate market prognostications for the Western part of the U.S. might perform well, while some markets in the North Eastern part of the U.S. may be performing very badly; the opposite positions may also apply.

         The following comments  may give some insight as to what the Author generally concludes as to the overall current market conditions for the coming months.

III.    THE U.S. RESIDENTIAL HOUSING MARKET:    Regarding performance of the U.S. residential real estate market, it is very clear that indicators from the National Association of Home Builders (NAHB), National Association of REALTORS® (NAR), and many other leading sources, show signs of significant slowing and/or decline in various areas.  When comparing market data from the last few years in the U.S., these areas include increasing inventories of unsold new and existing housing, a slowing of the issuance of permits for residential construction in most areas of the USA, poor performance of the sub-prime lending market, more real estate foreclosures—in absolute numbers and in percentage increases in foreclosures, and an overall slowing of the residential real estate market.   Many reasons suggested for this slowing in the marketplace include an oversupply of housing, reduced demand for housing, changes in the mortgage market (increasing requirements to qualify for loans), etc. 

           Although reported core inflation has been “down” (excluding food and energy), the market is not free from concern of rising inflation, along with the other points noted above.

IV.    CONSUMERS—CAN THEY KEEP THE ECONOMY MOVING?

             It seems doubtful at this stage that the average consumer will be able to continue spending at 2007 levels for 2008.  During the last few years, many consumers, especially homeowners, refinanced their real estate with Adjustable-Rate-Mortgages (ARMs), and they are now facing, in many instances, the need to repay such borrowings.  However, many consumers have found that they are not able to repay the debt with rising interest rates.  Or, if the debt can be repaid, it is with much pain—and constraints on the consumers’ pocket books.

            Increased foreclosures in residential markets are apparent throughout the U.S., e.g., Colorado, California, Arizona, Nevada, Florida, and Texas, among others.  Some of these foreclosures are followed by or involve concurrent bankruptcy filings.  Such positions do not embolden additional borrowing and additional consumer spending. 

V.        U.S. STOCK MARKET:   As much as one can say on the negative side for housing, it is very clear that the U.S. stock market (and markets in other parts of the world, e.g., China) has fluctuated significantly up and down, setting new performance records, with the DJIA in the range of 13,000+, NASDAQ in the area of 2500, and the S&P close to the 1500 mark.

            The U.S. stock market overall remains very strong, despite these fluctuations.  Does this foretell a positive position for the real estate market?  Some argue it does, as this provides capital in the marketplace and a positive outlook.  However, some funds will move to other markets in the form of cash, stocks, bond, or other areas; but, surely, some of the funds will move to real estate, to balance the portfolios of the investors, large and small.

            As I said in an earlier Note on this web site:

            A recent Survey, undertaken by the National Real Estate Investor and Marcus and Millichap Real Estate Investment Brokerage Company, noted that 7 out of 10 respondents in the study indicated they want to increase their investments in real estate in the next 12 months, “notwithstanding lower yields.”

            “Alternative investments are lacking in many instances; therefore, there is attraction to the real estate position, including the hoped-for position that lower interest rates are attractive when coupled with the potential of appreciation in real estate values in a few years.”

            Surely, a strong stock market can prove to provide other funding in the real estate arena.

VI.  THE U.S. COMMERCIAL MARKET:

            As the residential market has weakened in most parts of the U.S. in the last year, the U.S. commercial market over the last year has been very strong.  Most sectors of the commercial market, including office, retail, hotel, apartments, industrial or other investment segments of the commercial field, have been strong.  As for 2008, with the normal hedges having been stated—that is, with all else remaining about the same, it is likely that the commercial market will level or decline in 2008.

            The commercial market is competing for part of the capital market which is utilized for generation of return on the investment.  Investors (large and small) need to invest capital, with proper diversification, in various portions of the investment market that will produce the greatest returns, balanced against the concomitant risks in investments.  Thus, as long as capital is seeking a home to generate return, there is interest to invest in U.S. markets, since returns in some categories of real estate produce returns that are better than or equal to other choices for investing capital, considering balancing the risks.

            In summary, commercial real estate in the U.S. will level out or slow in 2008

VII.     SO, WHAT ARE THE CONCERNS?

            In a prior Note on this web site, I noted a Study indicating some of the areas of concern in the real estate market.  It has merit to consider these factors on an on-going basis.

            The areas of greatest concern to respondents involved in the above-referenced Real Estate Investor Outlook Study?  

            1.         RISING INTEREST RATES:  This is the most important concern by about 62% of the respondents.

            2.         UNFORESEEN SHOCKS TO THE ECONOMY:  Similar to the interest issue, this was very close to the same percentage area of concern by the respondents, namely almost 62%.

            3.         SLOW PACE OF RENT GROWTH:  This area was third, followed by concern with HIGHER VACANCY RATES, ISSUES AS TO THE CREDITWORTHINESS OF TENANTS.

          4.       VIABILITY OF INSURANCE, LAGGING PRICING, LOAN DELINQUENCIES and SECURITY OF BUILDINGS:   These issues were also of concern.”

VIII.    CONCLUSION:

            Many economists—in prior years-- have predicted a strong economy, when often the economy was heading in the opposite direction.  The test is to determine which of the predictions are actually on track, as opposed to which prognostications are blinded by a desire with only the hope that the general economy will do well.

            I found it very interesting to compare the positions of many economists, with hindsight, of course. In an earlier article on this web site, I cited the position of one study that noted that 95% of the economists surveyed in 2001 said they saw a wonderful, growing economy.  But, in hindsight,  AT THE TIME OF THE PREDICTIONS, the economy was already in a Recession!  This gives us little faith in not only the economists, but in our own ability to forecast macro positions for the economy.  But, micro positions for one’s own business may provide a better opportunity to reasonably forecast the economic future.

              Because there is a great deal of capital waiting to be invested, and because investors have more recently been willing to accept a lower rate of return, at least from a cash-flow standpoint (with the hope for appreciation), there may be sufficient support in the commercial marketplace, at a reasonable pace, to have a “soft landing” for those areas that will face a reduction in activity.

@ Copyright by Dr. Mark Lee Levine, Denver, Colorado 2008.   All rights reserved.

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            As a professor, my general approach has been to attempt to grade many areas within the marketplace.  Part of this grading for the market follows:

 GRADE:  FOR CURRENT POSITIONS:  SHORT-TERM:

 C-         RESIDENTIAL (SINGLE-FAMILY, CONDOMINIUM, TOWNHOUSES, etc.): Sales of single-family homes have slowed in many areas throughout the United States.  There are weaker pockets for some housing in U.S. markets.  The increase in foreclosures, the slowing of sales and the reduction in those seeking building permits all point to reduced activity in the residential market.

B       MULTI-UNIT RESIDENTIAL PROPERTY:  Vacancy rates have increased in many areas, but other areas are seeing a leveling, or even a slight dip in vacancy rates.  It is anticipated that these rates will continue to drop in many markets in 2008.  If interest rates continue to rise, the affordability index for home purchases will fall – as has been the case in the last several months. This means apartment vacancies should drop somewhat.  Clearly, the reduction in activity in the residential home purchase market spells the potential for activity in the apartment market.  In most markets, look for a good 2008 for the multi-family area.  (However, look for more single family homes coming on the market for rental use.)

B+       OFFICES:  The office market seems to be improving in many areas, thus garnering for sellers fairly low capitalization rates.  However, these rates are on the rise.

B+       RETAIL/SHOPPING CENTERS:  Retail space seems to be surprisingly resilient.  However, Consumer confidence remains one of the big keys to success in this area.  Recent activity seems to support the position that consumers will keep spending in the retail area, assuming  jobs are strong.  And, on this point, the job market has been very strong, with a national unemployment rate very low in the 4.5% range.

B+       INDUSTRIAL/WAREHOUSES:  Industrial/warehouse space seems to show a reasonable pattern of occupancy.  Although some pockets have increased vacancies, occupancy seems to be holding.  As long as the market in general keeps moving on a strong basis, such as a strong job market and good retail spending, the industrial area seems to be in fairly good shape.

B       HOTELS/MOTELS:  Hotel and motel vacancy rates are dropping.  Some recovery is taking place at this time with hotels and motels, with increasing travel. However, if oil prices continue to increase, and, therefore, travel is impacted, this may adversely impact this area.  Currently the room rates seem to be moving up and more leisure and business travel is predicted for 2008.

 B        SPECIAL-USE PROPERTY:  Other special-use properties, such as in resort areas, continue to be reasonably supported as a result of some increasing consumer confidence. 

B+        FINANCING RATES:  Lower interest rates remain strong and favorable, despite a slight increase in interest rates.  Affordability is more difficult in many markets, even though housing prices on the national level have been dropping from their highs of only less than a year ago.  Of course, the sub prime market is down, substantially.

A-        REFINANCING RATES:  Likewise, refinancing rates remain favorable and are supportive of a general, good economic outlook.  However, a good deal of refinancing in the residential market has taken place, with increasing interest rates in Adjustable-Rate-Mortgages (ARMs); therefore, there will be weakening volume in this area.  Interest rates should generally increase, despite fluctuations, at a fairly slow rate, absent major problems in the market, such as conflicts in Iran, continued escalation of the war in Iraq, etc.  Underwriting will have stronger requirements.

            IN SUMMARY:   THE QUESTION:  “What will happen in the U.S. real estate market in 2008, given oil prices, the war, interest rates, deficit spending, and slowing in the housing market?"  The answer, as usual, is:  “It depends on ….”  But, overall, the first part of the 2008 real estate market looks weak for residential, and “O.K.” for commercial property,  

Comments by:

Dr. Mark Lee Levine
Director/Professor
Burns School of Real Estate and Construction Management
Daniels College of Business, University of Denver
2101 S. University Blvd. Room 380
Denver, Colorado 80208