JULY 2008
The Real Estate Market—Softer by the Day!
by
Dr. Mark Lee Levine
I. INTRODUCTION:
With half of 2008 behind us, many of our prior 6-months’ projections for 2007
and part of 2008, 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 and in to 2008 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.” — This may be one of the more understated
comments of the year for the Residential market; and
2.
“The U.S. Commercial market is
beyond possibly showing signs of slowing in 2008.” The Commercial Market
has slowed in many areas of the field; and, look for more problems later in
2008! Some of the concerns in this area are less with focus on the real estate
and more with focus on the financing issues and the continued focus with the
weak residential market, the mortgage market problems, consumer confidence at a
low level, higher prices for energy, uncertainty on the political scene, the
volatile nature of the stock market, concern in the international markets, the
weak dollar, the continued state of war, problems in the Middle East, the
environment, major storms, and much more. And that “much more” brings into
consideration the issue of inflation, stagflation, and the interplay of many of
the other items, noted above, such as the weak dollar. The continued USA deficit spending and
overall deficit will attract the eye—and purse strings—of the government,
investors, consumers, and financial interests in the international markets.
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 hopefully provide 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), and many of the reasons, noted above, that have impacted the entire
market, residential and commercial.
Although reported core inflation has been “down” (excludes food and energy),
the market is not free from the concern of rising inflation, along with the
other points noted above. The most
recent data released shows that inflation is on the rise. And, the negative implications from such
inflation are causing adverse reactions in many markets in and outside the US.
Of course, as the market continues to decelerate in the Residential area, there
are many concomitant adjustments that tend to pull the market back up to a more
positive outlook. The lowest interest rates in decades have, in the U.S.,
moved lower, with the advent of a series of rate reductions by the Federal
Reserve. However, there is concern as to whether this lower rate will
move up, especially given the issue of inflation.
The
opportunity for a buyer to acquire a home, with a good selection, at a reduced
price, with a low interest rate, and “extras” (incentives) provided by builders
and sellers of existing homes can act to entice the somewhat reluctant buyer to
consider a home purchase. Recent tax benefits provided by Congress and
the President in February, 2008, provide additional incentives and funds for
consumers to encourage consumer confidence and business activity. However, if unemployment and the fear of
unemployment continues to rise, consumers (and
lenders) will not support the home purchases, even with the low interest rates,
incentives and other benefits noted.
IV. CONSUMERS—CAN
THEY KEEP THE ECONOMY MOVING?
It seems doubtful at this
stage, even with the 2008 tax incentives, that the average consumer will be
able to continue spending at 2007 levels. During the last few years, many
consumers, especially homeowners, refinanced their real estate with
Adjustable-Rate-Mortgages (ARMs) and short-term loans. Many are now facing,
in some instances, the need to repay such borrowings as the loans have come due
or are adjusted, upward, as to the interest rate and thus the monthly
payment. Many consumers have found that they are not able to repay the
debt with a higher interest rate. Or, if the debt can be repaid, it is
with much pain—and constraints on the consumers’ pocket books. Hence,
other discretionary spending has been reduced.
Increased foreclosures in residential markets are apparent throughout the U.S.,
e.g., Colorado, California, Arizona, Nevada, Florida, and Texas, among
others. Often these foreclosures generate concurrent bankruptcy
filings. Such positions do not embolden additional borrowing and
additional consumer spending. The current state of thinking by most
economists that I read in the real estate market is that foreclosures will
continue to rise in the latter part of 2008; that is, we are NOT at the end of
the foreclosure cycle.
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, have fluctuated,
significantly, up and down, setting new performance records. However, not
all news is Bull news. In February, many markets in the US and outside
the US hit a brick wall and suffered substantial reductions. The
DJIA moved in the range of 12,000; the NASDAQ was in the area of 2,200, and the
S&P found itself in the 1,200 range. True, there were moves up—as
well as down. However, the robust market of 2007 seemed to be a thing of
the past, at least in part of the first quarter of 2008. Although there was some good stock market
movement in the second quarter of 2008, much of the steam for that improvement
was lost toward the end of the 2nd quarter of 2008.
The U.S. stock market, overall, remains encased in 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, bonds, or in other investments; but, surely, it has been argued,
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.”
But, maybe we should not be so sure that the funds will be moving to the real
estate side, given recent slowing in the commercial market, especially because
of more difficult underwriting requirements and uncertainty in other areas, as
noted above.
VI. THE U.S. COMMERCIAL MARKET:
As the residential market weakened in most parts of the U.S. in the latter part
of 2007, the U.S. commercial market over 2007 was very strong. Most
sectors of the commercial market, including office, retail, hotel, apartments,
industrial, and other investment segments in 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 seemed likely that the commercial
market would level or slightly decline in 2008. However, given events in
the latter part of the first and second quarters of 2008, it is clear that the
words “slightly decline” may be too mild. It appears that the commercial
market is slowing much more rapidly than many of the leading economists
suggested. Why? Some argue that the many factors noted above, coupled
with elections, election uncertainty, and the uncertainty of U.S. Leadership
has added to the issues of concern. The weakening dollar, the continued
concern with the Iraq war, inflation, and numerous other factors continue to
create doubt in the minds of U.S. and foreign investors.
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 the balancing
of the risks.
In summary, activity in commercial real estate in the U.S. has been slowing in
2008 – and such slowdown will continue 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. There is 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 included:
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 an important
concern by the respondents
3. SLOW PACE OF RENT GROWTH,
ETC.: This
area was third, followed by concern for HIGHER VACANCY RATES and 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—over the years-- have predicted at a given point that we had a
strong economy, when often the economy was heading in the opposite
direction at the time of the prediction!
The test is to determine which of the predictions are actually on track, as opposed
to which prognostications are blinded by a desire of the hope that the general economy will do well.
It is very interesting to compare the positions of many economists, with
hindsight, of course. In an earlier article, 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. (Micro positions for one’s own business may
provide a better opportunity to, reasonably, forecast the economic future.)
Many commentators in the real estate market have argued that because
there has been 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 bet on a “soft landing” for those areas that will face a reduction in
activity.
I am not a pessimist. I am a realist. And, given this proclivity
toward realism, I doubt the “soft landing” will be without a good number of big
bumps. (Many would call this description euphemistic, translating the
comment to one of a hard landing.)
IF the war, higher oil prices, lack of consumer confidence, uncertainty in the
markets, the weak dollar, the decline in the residential market, import/export
deficit, inflation and a few more negative factors continue, as noted above,
the “hard landing” folks have the better side of the bet.
@ Copyright by Dr. Mark Lee Levine, Denver, Colorado
2008. All rights reserved.
mxaPRO-2 Quarter-Prognostication
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
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:
D
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. This slowing will continue so
long as there are financing issues which inhibit acquisitions, greater
unemployment, the war, a negative consumer attitude, and other negative factors
as noted earlier.
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, but for sellers the 2006 low capitalization rates are
moving up.
B RETAIL/SHOPPING
CENTERS: Retail
space was 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 are slowing their spending in the retail
area. Retail sales are impacted by job growth. Unemployment, though
not high, has been moving up in 2008.
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 industrial 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 (in
the $140 a barrel), and, therefore, travel is impacted, this will adversely
impact this area. Currently the room rates seem to be moving up.
B SPECIAL-USE
PROPERTY: Other
special-use properties, such as in resort areas, may be negatively impacted by
the cost of auto travel. However, some
consumers will choose more local vacations and pass on the more costly travel
vacations.
A- FINANCING
RATES: Lower
interest rates remain strong and favorable for borrowers. 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 subprime market is down, substantially. Underwriting is
more difficult. More foreclosures will
follow in 2008, thus encouraging lenders to reconsider many loans.
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. Therefore, there will be a 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, slowing in the housing market, inflation,
politics, consumer confidence (or lack
thereof), etc….?" The answer, as usual, is: “It depends on ….”
But, overall, the first half of the 2008 real estate market looks weak for residential,
and “O.K.” for commercial property
