It’s Real Estate

With unemployment approaching 10% and underemployment almost 17%, many pundits are reviving James Carville’s phrase used during Clinton’s 1992 election campaign, “It’s the economy, stupid.” Many government actions are being directed to reverse the trends: government stimulus, record low interest rates, and major backstopping of the financial system by the Federal Reserve and Treasury. Yet there are no signs of unemployment falling or major job creation.

As Bernanke recently said, “Even though from a technical perspective the recession is very likely over at this point, it’s going to feel like a very weak economy for some time. That’s a challenge for us and all policy makers going forward.” Dean Baker, a director of the Center for Economic and Policy Research in Washington commented about the last job report, “It’s a good picture compared to where we were, which was just a free fall. But compared to anything else, this is just a horrible report. The rate of decline is slowing, but it’s not going to stop. We’re likely on a path toward more than 10 percent unemployment.”

The old way to jump-start the economy by cutting the fed funds rate is not working. Why is that? Because it’s not the economy as a whole … it’s real estate!! Lower interest rates encourage people to borrow to buy big ticket, leveraged investments, specifically real estate. But, this country has too much of this stuff. There are 19 million vacant housing units, representing 14.5% of the total housing units available. According to Amherst Securities Group, approximately 7 million new home foreclosures are about to hit the market. On the commercial side, the vacancy rate at neighborhood shopping centers has risen to 10% and 20% of retail space is available for lease. The Internet currently makes up 7.5% of all retail shopping and is expected to rise to 15% in the next ten years, according to Scot Wingo, CEO of Channel Advisor, an Internet consulting firm. Commercial vacancies will continue to grow.

As a result of this excess supply of developed real estate, prices are dropping rapidly. According to the Case-Shiller index, house prices have declined 30% from the peak and the Moody's/Real Commercial Property Price Index was 31% below year-earlier levels and 39% off the peak in October 2007. At the peak, the value of U.S. residential and commercial property totaled almost $30 trillion. The resulting decline in values has wiped out $7 to $10 trillion in the nation’s wealth (seel the attached charts). And, because real estate is so illiquid, homeowners and developers wishing to “cash out” of their real estate investments and redeploy their monies in more productive parts of the economy are unable to do so.

Real estate does not increase human productivity, so, intrinsically it is not a wealth generator. It is more like a cost to a society, as buildings need to be maintained, heated, cooled, and protected. Our nation’s economy has way too much of these costs. Philip Carret, one of this country’s great investors whom Warren Buffet once remarked had “the best long term investment record of anyone I know” advised me when I was a young analyst, “never invest in anything where you have to call the plumber.” This country has over-invested in real estate developments and is now having to call the plumber all the time.

How are we solving this problem of too much development … by supporting and backstopping the bad paper, and supporting the firms and bankers who created and distributed the paper. We’ve added new acronyms: TARP, TALF, PPIP, TGLP, CAP, TIP, and AMLF. Fannie and Freddie are now owned by the government, and the Fed is buying $1.5 trillion of mortgages. The estimates are upwards of $14 trillion that has been committed by the Federal Government to keep the financial system solvent.

But, these actions just kept us from going into a financial depression. They don’t solve the problem. These excess real estate assets are dragging down neighborhoods, local businesses and responsible homeowners, and burdening our country with real and opportunity costs.  We can learn from the U.S. railroad industry: more assets don’t increase wealth. It’s the utilization of assets that increases wealth. This country has eliminated 55% of the track in the last 60 years, 200,000 miles worth, enough for 30 cross-country double track lines. Yet, rail tonnage handled is up 530%, resulting in a 12 fold increase in rail productivity. Railroads have never been more profitable and efficient than they are today, and trade at 15x earnings, better than IBM’s 11 multiple.

As a country, we don’t need to accept the status quo. We can get rid of bad, non-productive assets and build good assets – PARKS. We can use the mistakes of the past ten years to create a legacy for the next 100 years. We can build parks!!! A $1 trillion federal program, say $200 billion a year, to buy underutilized properties and build parks would accomplish some major goals that the country is trying to address separately:

Capital would be available to buy underutilized retail space and vacant homes providing much needed liquidity in this sector. Homeowners wishing to "cash out" of their housing investment would have new buyers for their assets. Excess commercial real estate could find alternative uses. Construction jobs would be re-ignited as demolition work and landscape architecture would turn into growth parts of the economy. With more parks for exercise and outdoor play both children and adults would lead healthier lives. It would be a stimulus citizens could see and enjoy.
The changes would be dramatic. In sunbelt cities like Atlanta, Dallas, and Miami which have grown dramatically since the 1960's without substantial regard for public spaces, multi-year land-use plans could be developed, and areas could be identified that could make the cities more livable. Older cities could be remade. New great parks designed and built by local citizens for themselves would blossom around the country.
The stimulus would be transformational. Those empty strip malls of the 20th century could become the Central Parks of the 21st century.

Mike Messner, September 30, 2009
Seminole Capital Management
212-838-6055