I spent several hours yesterday with some pastors who preach to large congregations in Middle America, primarily talking about a deal I am involved with them on. However, we had a long talk about the attitude of everyday Americans, how they see things and the future. The comments hold a number of major lessons for real estate investors and developers. There seems to be a general loss of hope or feel good across the country that results from the sense that Washington is just a bunch of people who prefer to score points, but who do not do anything useful to solve the country’s problems. They hate the constant political bickering and showmanship, and complete lack of leadership. As opposed to 2006-2007, there is no feeling of I can spend, I can have a bigger house, I can shop, the world is great. And that is not going to change anytime soon.
We now have a reality check where there is serious unemployment and under employment, and not a lot of hope this is getting much better any time soon. House prices continue to decline in many mid America cities. The dangers of the world continue to pile up and it only seems to get to be a more dangerous world. Middle class and working class incomes are going nowhere, and gas and food costs rise making it harder for the average American family to do some of the things they had gotten used to in the mid decade.
What does all of this mean to real estate. There seems little hope in the next couple of years that house prices or new home purchases will increase materially. It will be a long slow slog. Likely good for multi family and not good for land and new subdivisions. There will surely not be much, if any real pricing power for new home construction in many areas of the country for several years until the demand starts to outstrip the supply of new and foreclosed homes. If you are buying land, make sure you know the demographics of the submarket and that you have a long term horizon for exit. There may have been some good land price increases recently in some places, but generally it is going to take time.
Retail is not likely to see nearly the expansion we saw. Maybe never. Between the general reluctance to spend and the rapid increases which are coming soon in online shopping, large scale retail has risks. Although online retail has been a threat for several years, what many do not realize is that the 15-25 year olds are just beginning to be consumers, and they live online. They are very different. That wave is just beginning to build. Now we have the double issues of the parents are afraid to spend a lot, reluctant to eat out as much, and the kids are doing everything online. This combination is not one which inspires long term investment in major retail. It will not mean the decline of retail in any short run, but it means more retailers will struggle, there will be much less demand in many markets for new construction of malls and power centers, and rents will be hard to raise materially as things generally take time to improve.
While the hotel business continues to improve, there is some question as to what happens as business travel starts to level out from its recent growth and if the general public will be taking as many or as expensive trips as they once were. Likely not. It will feel a lot better after the depression of the past couple of years, but it is far from clear how high up is up from here. You need to watch real dollar improvements and not percentages. Hotel pundits love to tell you revpar is up 7% or 10% or whatever number, but up from nil is a big number in percentage, even if in real dollars it is not a lot. The hotel business will continue to get better, but like many other things, it will be a slow trek back up to where values really cover debt and where development makes much sense other than a couple of places like Manhattan.
Office I commented on last week as entering a new world where younger workers demand very different working styles and space and where companies are shrinking space needs over the next ten years.
By now you think I have trashed the real estate industry and all is bleak. Not true. I just think we all need to understand the realities of what are the long term implications of the general mood across middle America, the impact of the smartphone generation, and the general economic and political realities. What this all means to underwriting, investing and returns. There are still good profits to be earned and good investments to be made. You just need to really work at it now, you need to really understand your submarket, and you need to readjust your return targets down and hold periods to be longer. Back to fundamentals, but now the metrics are changing and you need to really understand those changes. Be happy to make 15% and have a solid investment. Be ready to hold for five years or longer. Forget the ego deals. It is now down and dirty hard work again, and really understanding what you are doing. If you are in the development or construction business, you have a really long hard slog ahead. You would be better to morph to renovations, and things like sustainability upgrades, energy savings and things like that. Building big buildings or malls is just not in your future in most cases. Stay smart and careful and you will be fine.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
