Historically, real estate has moved in cycles. Downturns are a normal part of a healthy cycle. These are five important points to understand about real estate and where the market is headed.
1. Inflation is coming: Economists generally agree that high rates of inflation come when money supply outpaces the rate of economic growth. The Federal Reserve Statistical Release from March 5 saw the M1 Money supply grow at a seasonally adjusted rate of 27.1 percent. Economic growth, on the other hand, is not growing. According to the Bureau of Economic Analysis, the fourth-quarter real gross domestic product decreased 6.3 percent. Although the U.S. economy is in a deflationary recession, at some point, probably late 2010, the tide will turn and we’ll see rapid inflation.
2. Moratoriums delayed the inevitable: Moratoriums were put in place during the end of 2008 on residential properties. Many banks were waiting to see if they would receive bailout money and have realized the money will come with strings attached. They are now proceeding with foreclosure. Markets will see a flood of residential homes likely peak in early 2010. This backlog of inventory will join an already large pipeline.
3. Commercial properties will take a hit: Since 1990, according to the National Council of Real Estate Investment Fiduciaries, or NCREIF, commercial properties have seen an average cap rate of 8 percent to 9 percent. (Cap rate equals income divided by value.) During market corrections, cap rates tend to overshoot the average before settling back into the historical equilibrium. Cap rates could go to 10 percent to 12 percent before settling at 8.5 percent. The higher cap rates climb, the less valuable the assets become.
The new tenant base has all but disappeared. Few tenants are expanding. In addition, property owners are finding it hard to refinance their loans. They are forced to sell at a loss. The commercial-mortgage-backed securities, or CMBS, market bottleneck is severe and will take years to untangle. Rating agencies are clueless. They haven’t been able to develop a model to value commercial property assets pools. Banks and life insurance companies are staying away. This leaves a huge hole in the lending pool. Leverage is all but gone. All of these factors add to a downward pressure on commercial assets. With the inherent lag effect in commercial real estate, the problems appear slowly and aren’t fixed quickly.
4. Real estate will rebound: According to The Long Cycle in Real Estate paper, published in 1997 by Ronald Kaiser, real estate has followed a rather predictable cycle that, absent from specific anomalies, has lasted 18 years. This downturn was very predictable and so is the eventual rebound. The market will bottom out, be stagnant for a few years, then begin to have price appreciation slowly, and then grow faster and faster until it overheats again … and the cycle will repeat. The factors driving all of these occurrences will be different and people will say “this time it’s different,” but the outcome and the results will be the same.
5. Opportunity of a lifetime: The housing market will recover and people will be kicking themselves for not jumping in. If intimidation is holding you back, hire someone to buy, renovate and manage your portfolio. If you plan on going at it alone, do your research. Be comfortable with inspecting a home and developing a financial analysis. Find a property manager or learn it for yourself. Find contractors to renovate the properties and be ready for the eventual midnight leaks.
Norm Miller is director of academic programs at the Burnham-Moores Center for Real Estate at the University of San Diego. Trevor Jensen is a graduate of the Burnham master’s program.
