Era of Less (Reprise: Part 1)

October 28, 2010

Last week’s version of Headlines (Week of October 17, 2010) had a posting called the Era of Less.  The Era of Less refers to the title of this year’s Emerging Trends in Real Estate written by the Urban Land Institute and PricewaterhouseCoopers.

The report is based on 875 confidential interviews and surveys with industry leaders.

This week I was able to complete my review of the report … all 79 pages, and wanted to share what I feel are some of the highlights and important take-aways from the report. 

Due to the size of the report, I will cover each chapter separately in a weekly posting. 

My comments follow each of the bullets.

Chapter 1 – Entering the Era of Less

  1. “Housing … remains mired in a dead zone of reduced demand: many Americans cannot afford new homes even with record-low mortgages rates and slumping prices” – No kidding. Nothing new here except to say that the Fed’s strategy to keep interest rates lower needs to stay in place or everyone trying to hang on will have to let go creating even more of a risk to our economy.
  2. “Investment managers and real estate investment trusts (REITS) with teams to lease properties and nurse asset income streams back to hearth can bulldoze aside many operator-light opportunity-boutiques, which had depended on cap-rate compression and leverage to reap appreciation.” – Couldn’t agree more.  The next ten years will be the decade of the asset and property manager, people with true real estate skills and management know how.  Not just financial engineers.
  3. “It’s very hard to get 15 percent to 20 percent rates of return without more risk and more leverage, and you can’t succeed on a sustained basis.  What’s wrong with delivering unleveraged, high-single-digit returns or low-teens performance for conservatively financed assets?” – The answer … there is nothing wrong with this approach.  The whole world is in a “deleveraging” mode.  High single-digit returns look fabulous when 10-year T Bills are below 3%.
  4. “Homebuilding and commercial real estate construction certainly do not offer much hope for jump-starting employment or the economy in the near term. We really don’t need much of anything.” – VERY true.  The only asset class the report lists as moderately attractive is apartments and to some degree warehouse space.  Apartments, since many people are losing their homes and still need a place to live; however, once things turn around, I would not want to own apartments.  As soon as people feel secure again in their jobs, the pent-up demand will be hard on apartments.  I think most people still believe in the dream of home ownership.
  5. “Eventually population growth will absorb the overhang in housing supply, but location preferences show signs of shifting away from bigger home on the suburban fringe to infill locations closer to 24-hour markets.” – Again, I couldn’t agree more.  I already see this happening in my former home town of Boston, a very livable 24-hour city. 
  6. “In the approaching cycle, the industry can expect to see more high-rise and mid-rise apartment, as well as townhouse project, built around shopping center and commercial districts.” – I believe the recent trend of “life style centers” (a shopping center or mixed-used commercial development that combines the traditional retail functions of a shopping mall but with leisure amenities oriented towards upscale consumers) is here to stay.
  7. “Despite widespread “extend and pretend” practices to avoid taking balance-sheet losses and force foreclosures on beleaguered borrowers, sill –undercapitalized regional and local banks totter with over weightings of failed land and construction loans.” – many of the banks taking this approach will fail this year and be taken over by the FDIC while other better capitalized banks will increase their writedowns and workouts as a prelude to disposing of assets in 2011.  We are starting to see this happen as the end of 2010 approaches.
  8. “… This painful deleveraging to lower values and disposition process could take until mid-decade to complete. But with FDIC, bank and special servicer sales, substantially more properties will hit transaction markets in 2001 and 2012, allowing the market to begin clearing and prices finally to reset.” – Let’s hope they are correct on this one.  Never thought I would long for the days of the strategy imposed by the RTC during the last big real estate “depression”.
  9. “Emerging Trends interviewees voice most concern about the shell-shocked U.S. economy and wonder if recent declines foreshadow a new age of diminished global clout and an ebbing standard of living.  In these seemingly “unchartered waters”, slackened demand of real estate across all sectors (except apartments) and near-record vacancies in many market signal a long and difficult period before developers and landlords can enjoy any renewed pricing power, and one in which investors exercise little control” – How depressing. More than once in the past couple of months I’ve heard the words “new normal”.  But someone will make a lot of money in real estate during the next decade.  Remember my statement above about the decade of the asset and property manager?
  10. “But if inflation is coming, real estate is the right place to be, and it’s time to get back in the game.” – Maybe, but how many times in the past six months have you heard the word “deflation” which is NOT good for real estate.
  11. Dealmakers, sales brokers, and mortgage brokers will not be in huge demand, although hiring is bound to pick up in 2011.  Many opportunity investment managers leave the scene; they cannot wring promotes from legacy disasters, and their prospects for new investments remain limited without a bubble market and easy financing.  Banks and special servicers still have trouble “building teams of experienced workout specialists”.  – Again, this is true. The future belongs to firms well heeled with broad asset-management and service platforms.
  12. Best Bets 2011
  • “Players who fill the gap on assets with lowered cost bases can obtain excellent risk-adjusted returns up and down the capital stack, including mezzanine debt and preferred equity, if not loan-to-own opportunities. Concentrate on good assets with bad balance sheets.” – Great strategy going forward.  There will be many owners seeking new equity capital that will be put in a priority position in an attempt to save the original equity investors as legacy debt comes due.
  • ”Buy well-leased core assets, looking for 6 to 7 percent cash flows”
  • “Twenty –something echo boomers want to experience more vibrant urban areas where they can build careers, and their aging baby boomer parents look for greater convenience in downscaled lifestyles.  Driving cost and lost time make outer suburbs less economical, while the gig-house wave dissipates in the Era of Less” – Remember the comment above about Boston and other 24-hour cities?
  • “Buy land – It will not get any cheaper than it is now”
  • “Buy Select Hotels – They’re the cheapest and will come back the fastest.  Target downtown full-service hotels in major markets.  No one gets excited about high-capex resorts or limited-service brands in commodity areas.”
  • “Buy Condos and Single-Family Housing – Now is the time to buy your dream house, if you have enough cash. … Do not expect a sudden future ramp-up in prices, except in the choicest urban neighbor hoods and waterfront location.  Avoid commodity, half-finished subdivisions in the suburban outer edge and McMansions; they are so yesterday.”

Posted by Scott R. Lodde

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