Mobile Edition
Print
Get the Mag
Weekly UpdatesThis article is developed from CRE Richard A. Hanson's presentation made at MIPIM in March 2008. The presentation addresses U.S. real estate development patterns and investment in view of current market challenges, global energy consumption and population growth.
AN INDUSTRY IN CRISIS: OPPORTUNITY OR RISK?
There are many factors which compel real estate professionals to use caution when investing in the residential sector in the United States. Today, the U.S. housing industry is in crisis. Land value, homeowners, construction workers, investors, banks, school districts, and appraisers: all have been adversely affected by the declining real estate market. The municipalities that depend upon jobs, home values and tax revenue linked to U.S. housing are now confronting deficits, budget short falls and social deterioration.
The crash of the U.S. housing market (Figure 1) and the subsequent drop in home prices are affecting the U.S. economy. The crisis and its causes are complex but can be summarized as a drop in buyer confidence, followed by an increase in foreclosures--much of it the result of unbridled lending and imprudent borrowing. Exactly when we will return to a time of normalcy and confidence in the real estate market isn't known, but it is unlikely to be any time soon. Real estate's importance to the U.S. economy is profound: homebuilding is a major source of employment in America.
[FIGURE 1 OMITTED]
REASONS FOR HOPE FOR THE U.S. HOUSING MARKET/INVESTMENT
News reports regarding markets for U.S. housing are negative and grim today. The media provide little confidence for potential investors in housing stocks or related financial instruments. Yet there are indicators that the weakened perception of U.S. residential markets may be more psychological than technically true.
GROWING NEED FOR HOUSING IN THE UNITED STATES
The U.S. population is growing at its fastest pace in 40 years. This is the result of both high fertility rates (births) and immigration. Immigration rates remain consistent, and the U.S. birth rate is boosted by newcomers who are having larger families.
Despite the current bad news and slowdown in U.S. real estate market absorption, the U.S. population is expected to increase by 130 million by 2050 (Figure 2). Such a rise in population growth will create an enormous demand for housing. A report prepared by Virginia Tech estimates that as much as half of all real estate development projected by 2025 had not existed in 2000. This increase represents more than $10 trillion dollars of new investment for residential structures and more than $23 trillion in non-residential facilities (roads, schools and infrastructure). (1)
[FIGURE 2 OMITTED]
BENEFITS OF HOME OWNERSHIP AND INVESTMENT
With the rapid and consistent increase in the U.S. population, housing prices have also increased, doubling in the past ten years alone. This has made home ownership one of the best investments over the short and long term:
* U.S median home prices increased nearly 100 percent from 1997-2007.
* From 1997-2007, the Dow Jones Industrial Average increased 51 percent.
American home ownership is a foundation of the U.S. economy, representing more than $21 trillion dollars in value, with nearly $10 trillion in equity in those homes.
Home ownership represents a significant portion of American net worth (assets/liabilities), with 35 percent of assets positioned in home equity. As Figure 3 suggests, the value of a home purchased in 1997 may have doubled by 2006.
Clearly, U.S. home investments during the past 10 years have been a wise investment, yielding more than 20 percent in annual returns (Figure 4).
Figure 4
Returns on Investment in Home (assuming a 10 percent down payment)
1997-2001 = 24.5% annual return
2001-2007 = 29.2% annual return
1997-2007 = 22.0% annual return
Despite the increasing cost of energy and construction, owning one's own home has outpaced inflation. Those who have failed to increase their net worth:
* never purchased a home;
* purchased in 2006 and sold in 2007 or 2008;
* borrowed up to 100 percent of the equity in their home in markets that have now seen declines in home values, and are forced to sell.
Home buyers who speculated on the continued rise in home prices are a large part of the problem in our current real estate crisis. Investors increased demand beyond any true market level. Many abandoned unsold units, heaving them onto the marketplace, exerting more pressure on a bloated inventory and further lowering prices. The good news is that most of those speculators are now gone, and the additional demand they "created" is being absorbed.
Considering a 100 percent increase in real estate value from 1997, one may wonder: what's wrong with a downturn in real estate values, if you "made" 100 percent? The trouble began when banks permitted homeowners to borrow against their increasing equity. Borrowers used the proceeds to advance their lifestyle, purchase a new car or buy a bigger home. Banks have corrected these practices, and it is increasingly difficult now to borrow both first and home equity loans in the U.S.
U.S. EMPLOYMENT ENVIRONMENT AND IMPACT ON INVESTMENT IN REAL ESTATE
Employment and job creation are critically important factors in determining demand for and pricing real estate. Employment data is one of the most carefully tracked, reported and often misunderstood indicators, as it relates to real estate. The past decade saw a strong growth in jobs in the U.S. However, national statistics fail to capture the more significant local market conditions that have a greater impact on local market conditions and investment.
The strength of U.S. employment (Figure 5) suggests that the housing market should be strong, at least through early 2008. To the contrary, it is weak. Since March 2007, the employment picture has become increasingly negative. Popular perception now is: will I have a job? can I pay my bills? And this absence of confidence has transferred to the housing markets, evidenced by people NOT making a decision to buy or sell--further depressing an already ailing market.
[FIGURE 5 OMITTED]
LOW INTEREST RATES BENEFITED INVESTMENT IN REAL ESTATE
U.S. investors and homeowners have benefited from historically low interest rates for the past two decades. Low rates enabled large numbers of investors and individuals to purchase homes with low cost financing. Homeowners and investors combined the low cost of financing with double-digit home price increases to use highly leveraged financing strategies to purchase bigger homes. With employment fears abated, loan affordability made it possible to finance a home.
As financing requirements tighten, and home values soften or even decline, many of those homeowners are now financially challenged. Exotic mortgages widely used in a flush and expanding real estate market are resetting at rates higher than many homeowners can reasonably afford (Figure 6).
[FIGURE 6 OMITTED]
MIGRATION TO OR RISE IN URBAN LIVING IN AMERICA
In the larger picture, we should be confident in the return of the U.S. housing markets and the increasing advantage of urban housing demand, a market sector that has experienced the least decline. But our real estate markets in the States are not immune to events occurring across the country or around the globe.
The past four decades saw a migration from America's urban centers to outlying suburbs (Figure 7). Challenging the economic and social fabric of many of America's largest cities, most urban centers suffered population declines, failing to capitalize on the growth in population. But in the 1990s, the quality of life and community in urban centers became highly desirable, reversing the trend in urban centers. Many cities saw a reversal of migration out of the cities, and began to capture a greater percentage of growth, primarily in dense, high-rise buildings.
[FIGURE 7 OMITTED]
Today, with rising energy costs, home buyers have more incentive to choose urban living. No longer will Americans simply consider how much home can they afford. Now they will be more thoughtful in choosing the location of their home, based on the cost of commuting to work.
It is in this environment that we see urban housing and greater density in tall buildings as choices for a better investment arena. This investment, though, must be made with the understanding that there is a greater concern about the availability of energy and food supplies in the face of exploding world populations.
RESPONDING TO THE GLOBAL ENVIRONMENT AND ENERGY COSTS
Our world does not have unlimited energy supplies.
Even before the U.S. housing crisis and steep rise in energy costs occurred, U.S. cities and governments began implementing policy decisions and initiatives to conserve energy, reduce greenhouse gases and improve commercial and residential building practices in aneffort to reduce the impact of development on our global environment.
The impact of global population growth combined with an almost unfettered thirst for a dwindling energy supply makes the uncontrolled development of raw lands unlikely. Neither communities nor developers/investors can afford the infrastructure investment in roads, utilities and schools--assets that already exist in our cities. Finally, the commute work is, on average, more than an hour, and consumes more energy than the buildings that commuters work in.
As our population, employment and housing grows, we foresee that growth and opportunity may be limited not by financial or housing market demand, but by the availability of energy sources. The U.S. marketplace witnesses similar limits to development in our western states like California and Arizona because of a shortage of water sources.
FEED