The Real Estate Economy
The Short Answer?
This is a very risky economic market. That was the conclusion of Dr. Robert Edelstein on the real estate economy at a recent breakfast meeting. Dr. Edelstein is the Co-Chair of the Fisher Center for Real Estate & Urban Economics at the Haas School of Business at UC Berkeley. Dr. Edelstein discussed the critical issues driving the economy right now, including the capital tsunami (no end to capital flow in sight), subprime issues (risk of contagion could affect new construction, real estate services and equity loans), globalization (look how fast and widespread the global effects of the Shanghai exchange collapse were) and privatization (public companies, including Real Estate Investment Trusts, being taken private), among other things.
Right now Dr. Edelstein thinks that the real estate economy looks “comfortable.” The economy is showing good strength, stability and resiliency. Population and economic growth are driving demand, while capital markets favor real estate. Lastly, there is a low interest rate environment. (When asked where rates are going, the professor said he would not be in this business if he knew that).
Why Privatization is Occurring?
Many REITs, such as Equity Office Properties (EOP), are being taken private. (He labels Blackstone’s purchase of EOP as a “high risk”, highly leveraged transaction premised on rosy predictions that may not come to pass.) There is an abundance of institutional and opportunistic capital, bountiful cheap debt, and the chance for arbitrage by the buyer with the “pre-sale” of sub-portfolios or key assets (again, look at the pre-sale of key assets in the EOP deal). On the sell side, the ‘alternative’ valuations and high price income multiples make selling very attractive. While some companies point to the increasingly strict governance costs for a public company, Dr. Edelstein downplays this argument since pension fund investors in hedge funds will often want more information, not less, than Sarbanes-Oxley and other regulations require.
What is driving (and will continue to drive) the U.S. economy?
Dr. Edelstein points to technology, defense and security spending, biotech, the next baby boom, retirement, health care, financing and securitization (and other financial engineering).
What is happening globally?
The growth locomotives of the world are the United States, China and India. He noted that China has an incentive to keep interest rates low in the U.S. right now, but wonders whether they will always think so. China also faces problems in that they are essentially ‘importing inflation and exporting deflation.‘ China is no longer the lowest cost producer for some goods and the one child rule is leading to a quickly aging population. He believes that China will be the next big residential securitization. (Did you know that there are 570 Wal-Marts in China?). He also finds it ironic that China is a meritocracy (a no one from the countryside can succeed in business in China) but not a democracy while India is a democracy but not a meritocracy (still vary caste oriented). In many countries, such as Thailand and Russia, businessmen are trying to compute a rate of “reasonable greed” (or “profits after stealing”) to work into their projections for government corruption.
How can things get worse?
Dr. Edelstein does not rule out a U.S.-precipitated world recession in which the consumer faces death “by a thousand pricks.” With rising energy costs, the Alternative Minimum Tax, unanticipated jumps in interest rates, fewer and smaller equity cash outs and the prospect that wage growth could lag inflation, these ‘thousand pricks’ may take the wind out of real estate performance. Again, Dr. Edelstein’s take home message from his talk: this is a very risky economic market.