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| Real estate
developer Jeff Neal says, with regard to his own developments in the D.C. area, “we’re building into what we see as a huge, huge undersupply.” |
From the Economist to Fortune to the Federal Reserve, it’s the
hottest financial topic: real estate. Opinions on the subject are as varied as they are numerous, ranging from gloomy scenarios of catastrophic collapse to sunny forecasts of sustainable, long-term growth—and everything in between.
On Sept. 23, 2005, in an effort to gain some insight into this complex and important subject, McIntire hosted a panel of four experts for its Fall Forum, “Bubble Trouble? A Hard Look at Today’s Real Estate Markets.” The four panelists, all McIntire alums, were
Jeffrey Neal (McIntire ’85), Principal of Monument Realty; Bruce Wardinski (McIntire
’82), President and Chief Executive Officer of Barceló Crestline Corporation;
Earl E. Webb (McIntire ’78), Chief Executive Officer—Capital Markets of Jones Lang LaSalle Incorporated; and
Robert M. White Jr. (McIntire ’87), President of Real Capital Analytics Inc. The Fall Forum is designed to facilitate the discussion of challenging
business topics in an effort to enrich the McIntire community’s awareness and depth of understanding.
No Bubbles Here…
The forum began with comments from White, whose firm, Real Capital Analytics, tracks the commercial real estate capital markets by monitoring every commercial deal worth $5 million or more across the country. In 2004, that meant monitoring some $185 billion in transactions involving properties such as shopping centers, office buildings, apartment complexes, and industrial warehouses. For the past few years, White says, the value of such deals has increased by about 50 percent annually; this year he expects an increase of at least the same margin.
But White contended that this growth was neither unexpected nor irrational, given the cyclical nature of the real estate market. The current cycle, he said, started around 2001, with the dot-com bust and 9/11 terrorist attacks, which resulted in “a flood of capital into real estate.” And that flood, he said, hasn’t yet abated. “People got burned in stocks and bonds and wanted to own hard assets. They realized they were chronically underinvested in real estate—and that was everyone from the mom-and-pop 401K plans to the biggest pension funds out there.”
White also pointed out that in the wake of the Internet frenzy, commercial real estate had some catching up to do. The retail sector, he said, was essentially “shunned” in the late ’90s. “People were worried that there wouldn’t even be bricks and mortar retailing anymore,” he said. “So the retail sector has emerged from the basement.” Moreover, he argued, there’s still room to grow: “The real estate market still offers very attractive yields in comparison to the broader markets, which is why we’re still seeing a net inflow of capital.” But White was also quick to point out how very different the commercial side of the real estate market is from the residential side. “The appreciation in commercial prices pales in comparison to the residential market,” he said.
…No Bubbles Here, Either
Panelists Webb, Wardinski, and Neal also argued that the underlying fundamentals of the real estate market are strong, even on the go-go residential side. Indeed, the three pointed out, rising home prices are the result of a simple supply-demand imbalance and inescapable demographic trends. Neal, one of the most successful real estate developers in the D.C. metro area, offered some telling statistics. Nationwide, he said, there are roughly 1.6 million new households created per year—but only 1.3 million new housing units come onto the market. “There’s a 300,000-unit shortage every year in the number of homes delivered,” he said. “Prices will keep going up. It’s economics 101, simple supply and demand.”
Neal went on to point out that the U.S. population grows by about 2.5 million every year. And those 2.5 million people, he said, not only need places to live, but also things such as office buildings, restaurants, schools, and roads. “A city the size of Seattle is built every year,” he said. “It gets built in scattered pieces, but the demand is steady.” With regard to his own developments in the D.C. area, he added, “we’re building into what we see as a huge, huge undersupply.”
Likewise, Jones Lang LaSalle’s Webb pointed out that much of the housing demand, especially in the red-hot condominium market, is a function of sheer demographics. “Could you have predicted that condominiums in major metropolitan areas, sold largely to empty-nesters, would now be of tremendous value?” he asked. “Of course you could have, if you’d thought about it, because the demographics are there.”
Wardinski offered a somewhat more tempered assessment, though he stopped well short of using the b-word. “What’s driving real estate prices are debt costs and the availability of capital,” he said. “Prices have gone up and up and up, as debt prices have gone down and stayed down.” Moreover, he warned, “when there’s that much money out there, bad things can happen.” Wardinski went on to say that real estate is essentially a local business and that conditions vary across the country. Although there are some markets that he “wouldn’t touch,” he said, most were still worthy of investment. “I wouldn’t say there’s a bubble on the commercial side, but prices are high. You’ve got to be careful what properties you buy and in what location.”
To Be Continued?
Of course, for all its current vigor, the real estate market isn’t immune to risk. The panelists agreed that rising interest rates and oil prices, for instance, do pose some degree of threat, though not as much as the gloomiest real estate watchers would have you believe. When asked what would happen if the price of gasoline were to jump to, say, $6 dollars a gallon, Neal responded by saying, “The pricing mechanism works. If it costs me twice as much to build, but the market demands that I build, then rents or prices will double. The pricing mechanism is my hedge.”
What about the price of materials, such as concrete, steel, and lumber, and the pressure exerted on prices by the rebuilding the hurricane-ravaged Gulf Coast? For that question, Webb had a familiar answer: China. “The impact of China on construction costs is a thousand times more profound than the impact of the hurricanes and the impact of spending $200 billion in recovery costs. The Chinese now use 40 percent of the world’s concrete. Any building commodity you want to talk about, the Chinese are huge users, and that’s what’s going to drive prices.”
“We build a Seattle every year,” White said. “In China, they’re building an Atlanta every month.”
Click
here to watch a streaming video of the event.
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