Deflation

Advertising You Can't Buy: Even Re/Max Office Has Vacancies

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Can there be a morning after for U.S. real estate demand, if the market can make it through a night during which it capsized after being torpedoed by an iceberg? 

Semi-panoramic view of Re/Max Execs office at 2999 Overland Ave Los Angeles, CA.

We checked in on the state of residential real estate yesterday, and Reason has also been documenting the commercial real estate hyperpocalypse for a long time. 

In 2009, during heady days of hope and change, we tracked the CRE industry's heavy lobbying push in Washington (the capital), and we rode along as Jim the Realtor® patrolled the ghost malls of San Diego County. 

In 2010, as a grateful nation was gearing up for the first Summer of Recovery, we noted that one reason for the yelping about federal CRE intervention was the D.C. Beltway's concentration of distressed CRE. The greater Washington area at the time had the nation's heaviest volume of properties in foreclosure, bankruptcy, restructured or modified status, and lender REO. Also at the time, the very popular interventionist Elizabeth Warren predicted half of all CRE would be underwater (i.e., the current sale value of the property is less than the outstanding balance of the loan) by the end of 2010. 

The real estate market in Washington has since worked through more than half of that distressed volume and lost its dubious title as the nation's most troubled CRE market. And it looks like Warren's premonition was too conservative. Deloitte & Touche says 60 percent of CRE loans scheduled to come due between 2011 and 2015 due – about $1.7 trillion worth of debt – are underwater. 

As the Washington example shows, that's a problem with a solution at hand: Just keep cutting your price until somebody buys your inventory. No quantitative easing necessary. No Bernankean drivel about the risk of deflationary shocks required. No need for additional stimulus or Harper's Cuforhedake Brane Fude or eye of newt. In fact, despite realities that continue to exceed the nightmarish predictions of government apparatchiks, the current news is that there's a "mini-pop" in CRE. 

The imperative not to rescue commercial real estate is even clearer than it was in the case of residential real estate, because the state was an even more central player in inflating the original bubble. City, county and state governments spent heavily and worked hard to deliver tax-subsidized mixed-use ghost malls and New Urbanist dud-hubs all over the country. Now that these products have failed in the market, local governments could solve their problems by lifting zoning restrictions and allowing the real estate to be rented or sold, at attractive prices, for whatever purposes buyers have in mind. 

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  1. Armed Watsonville man pulled over for having dice obstructing his rearview mirror.

    Jose Luis Ortegon allegedly refused orders to get out of the car after deputies spotted him reaching for something in the back of the four-door Geo. Ortegon has prior felony convictions that prohibit him from having a weapon.

    He was booked on suspicion of six weapon- and ammunition-related offenses, resisting arrest, and a gang and drug violation.

    Nothing else happened.

    http://www.santacruzsentinel.com/ci_18014939

  2. I see those CBRE sign all over the place. I smell a Commerical real estate bust! That bubble never popped like people said it would last time around….

  3. Most American cities have had excess housing inventory for half a century and they still haven’t loosened zoning and regulations to allow new uses for those vacant lots. I doubt the suburbs will be any wiser.

  4. Oh yeah, I still see CRE crashing. Here in California, government redevelopment has spent years trying to turn every blighted, empty downtown in the state into a facsimile of Boulder. These are the New Urbanism dud-hubs Tim is talking about. But with the RDAs broke and about to be wiped out, a lot of these failing projects will go under.

  5. Looser regs? Government officials are looking to tighten them even more just to avoid hassles like the one in my township. Property zoned residential/agricultural allows for bars to be built. One guy wants to erect a barn that’s larger than neighboring resident (a lawyer, natch) thinks is appropriate. Zoning Board says it is a permitted use. Complainant now has threaten to tie the township up in court forever in order to make his point. Real point being: don’t move into neighborhoods where your sight lines may someday be ruined by permitted structures on a neighboring property.

    1. Property zoned residential/agricultural allows for bars to be built.

      Cool. So why would anybody build a barn instead?

      Real point being: don’t move into neighborhoods where your sight lines may someday be ruined by permitted structures on a neighboring property.

      Nah. Real point being: Don’t move in next to a lawyer. Duh.

      1. I can recall more than a few stories of people moving in close to shooting ranges which have existed for decades and then are shocked and appalled and try to get them closed down.

        So, unfortunately, the lawyer may be moving in next to you.

    2. This is why god created covenants and restrictions agreements and neighborhood boards.

      Do not give ever expanding zoning powers to the state or local government. In the end it will only fuck you.

  6. Now that these products have failed in the market, local governments could solve their problems by lifting zoning restrictions and allowing the real estate to be rented or sold, at attractive prices, for whatever purposes buyers have in mind.

    You are out of your fucking mind.

    1. because converting old light industrial to residential never worked, nor residential to commercial.

  7. Technically, you are torpedoing the iceberg.

  8. There’s got to be a morning after. Let’s cross the bridge together. It’s not too late, not while we’re living. We will escape the darkness.

  9. The real estate market in Washington

    First you conflate Realtors with real estate agents now you won’t even make a distinction between my beautiful state and the shit hole known as DC.

    You go to far sir!!

  10. “No quantitative easing necessary. No Bernankean drivel about the risk of deflationary shocks required.”

    It’s all about the rental rates–and it was always about the rental rates.

    At one point when the market was going full tilt, people come to you and question whether you’re the right guy to be running acquisitions–since you can’t find very much worth acquiring.

    Everybody else is doing every deal in sight: what do you know that everybody else doesn’t know?

    It’s always been about cap rates for me. The reason we started developing rather than just buying preexisting properties was because there wasn’t enough cap rate in the existing product to justify the investment–and development offered a value added opportunity to get to a 9% or 10% cap on the exit.

    When development deals got so the cap rate wasn’t there either–then the solution wasn’t to just keep doing deals because that’s what everyone else was doing…

    I wouldn’t do deals if the lease rates didn’t justify the purchase prices–that made me an oddball. It was like being a value stock picker during the dot-com boom.

    Question the value of dot-com stock because of its earnings during the dot-com boom, and everybody thinks you’re a walking anachronism. Anybody could look like a genius when the market was lifting all the boats–and when the market was roaring, it made a lot of people look a lot smarter than they were.

    Thing is, what I’m talking about isn’t really about being smart or stupid. It’s about character. It’s about when your partner and your investors all come to you and tell you that maybe you should be replaced with somebody else because you won’t ignore certain fundamentals–and you stand there and stick to your guns anyway. They deserve a lot of credit for listening–that takes character too.

    It isn’t about smart though. People smarter than we were made mistakes we consciously avoided. We didn’t avoid them because we were smarter…it was character.

    Anyway, yeah, commercial real estate doesn’t need any help–not so long as we can get a rent roll, a copy of the leases, a vacancy report, some absorption numbers, etc. to help us figure out what the yield on that investment is going to be relative to a bond somewhere. Most office leases are 3-5 years–so they’re rolling over already since 2008. If the sale prices on those assets are ultimately a function of the leases themselves–especially in times like these–then there’s no problem repricing those assets.

    Unless the government is scaring the hell out of the banks who are holding those assets–because the bank had them on the books in the asset column against outstanding loans for a lot more than they’re worth. In which case, the solution isn’t quantitative easing or Bernankean drivel.

    1. It’s about character.

      What?

      When the internet bubble burst and when the real estate bubble burst the buy everything in sight crowd went broke. Wary investors did not.

      What does this have to do with character?

      1. Joshua Corning wrote “What does this have to do with character?”

        lemmings, lemmings, lah lah lah
        lemmings, lemmings, ha ha ha
        root toot tooties root toot toot

        1. Exactly.

          The market typically looks great–just before it all goes to hell.

          When your investors and your partner–and the market–and everyone else in the industry all agree on one thing? That rental rates should no longer guide your thinking in terms of exit value?

          And they all have excellent arguments for why that is. …and everybody’s making money hand over fist while the sun shines?

          Then what do you call someone who ignores the market, what the rest of the industry is doing–and his own partner and investors, many of whom are also commercial real estate developers?

          Nobody calls that person a genius at the time. If you ignore all those people–and the market too?

          You might be an idiot–or you might just have character!

          If you were a portfolio manager in the mid to late 1990s, and you refused to invest in dot-com and telco shares because you thought they were overvalued? You probably got fired.

          Why is getting yourself fired the smart thing to do?

          Hindsight is 20/20. I promise you, the bubble wasn’t an obvious bubble until after it popped–no matter what the politicians say. If they think they can spot the next bubble, then they should quit politics, raise some money to start a fund and bet all their marbles with tons of leverage!

          I wasn’t sure it was a bubble. I knew there was a shortage of land in certain markets–markets where the lease rates still justified the cost of acquiring land and developing industrial and office buildings. I also knew that if everything went to hell in the 24 months or so between the time it takes to get plans processed and get phase I tilted… That if everything went to hell on sale prices in the meantime, that the value of the buildings would ultimately be a function of their lease rates.

          That’s not about smart. Everybody knows that in hindsight. Everybody knows stock valuations are ultimately a function of their earnings over the long run too. There’s no new insightful intelligent observation there–everybody’s known that for hundreds of years.

          How you stick to your guns on that when all the smartest people you know are telling you you’re wrong–just isn’t about smart. It isn’t about math or knowledge or any of that stuff…

          It’s stuff you learn from your coach, from John Wooden, from your church school teacher, from your grandpa or from your mom. There is no shortage of smart people in the world–not enough smarts isn’t the problem.

          In 2007, when Lehman and Bear Stearns bought those New Century portfolios out of bankruptcy court–at pennies on the dollar–with super heavy leverage? It wasn’t because they were stupid.

          Those were some of the smartest, most well motivated people the world had to offer–and buying those mortgage portfolios is what ultimately did Lehman and Bear in a year later!

          When people weren’t doing their due diligence on those subprime tranches, when they buy derivative products they don’t really understand…

          It isn’t about smart. It’s about character. Surrounding oneself with people who criticize your work in the best possible way–isn’t something everybody can do well. And it doesn’t happen by accident. So much of that just isn’t about smart.

          1. “Then what do you call someone who ignores the market, what the rest of the industry is doing–and his own partner and investors, many of whom are also commercial real estate developers?

            Nobody calls that person a genius at the time.”

            Just for the record, they don’t call you a genius in retrospect either.

            In hindsight, everybody expects you to have anticipated the bubble bursting anyway–so somehow there’s nothing special about someone who took steps to avoid the pitfalls beforehand.

            For what it’s worth, six months after having defended myself for doing so few deals–and after everything went to hell–I started getting questions about why I did the deals I did at the time!

            First it was that I wasn’t doing enough deals–then it was that I did too many?

      2. I would say that sticking to an investment discipline even when being browbeaten and/or tempted to abandon it takes character.

        1. discipline does not equal character.

          Also I think “character” is an anachronism when it comes to business.

          I guess i just don’t like ken’s use of the word. It makes him sound like some knight going off to slay dragons or some bullshit.

          Also when poeple are tempting you or brow beating you i would think that should raise suspicion of any skilled investor. Hell such behavior should raise the ears of a common consumer.

          It does not take “character” to be suspicious.

          1. So what do you call it when your old investors are mad at you because they want to give you more of their money to invest in one of your projects–and you can’t find enough good projects to do?

            Do you lower your project standards–so you can take more of their investment money?

            I don’t. And I can prove it.

            Is that smart over the long run?

            Maybe.

            But whether it’s smart or not isn’t really the crux of the matter for me. It’s sort of like the torturing terrorists thing for me. The crux of that issue isn’t really about whether it’s in our best interest to torture people either–I just don’t want to be the guy that condones torture regardless.

            So what do you call that?

            I wouldn’t cheat on a girlfriend–even if I knew I’d never get caught. ’cause I’d hate to be a liar or betray someone’s trust.

            What do you call that if not “character”? If the cops and the courts and the jails all disappeared tomorrow, and you still wouldn’t steal a thing from anybody, then what do you call that if not “character”?

  11. Tim,

    I have no idea if you read comments, and I hate to be a pedant, but I have issue with a rather mixed metaphor in your opening paragraph.

    How can a iceberg torpedo something? In the context of a sinking ship, a torpedo is something that is fired from another ship; an iceberg is a massive bit of ice that sits in the water. I’m sure the US Navy would have loved to fire 1.2km long lumps of ice at the Soviets during the Cold War though…..

    Yours faithful,

    Lee
    Blog Commenters For Better English (:P)

  12. Do you think there will ever be a Libertarian or independent president or will it always be someone from one of the two major parties?

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