Peter Linneman, the founding head of the Wharton School real estate department, gave the keynote at today’s ULI Trends Day event in Phoenix. For those of you not in real estate, the Urban Land Institute is the professional association for high-powered real estate people.
There are two kinds of real estate economists, dry and funny, and Linneman is a funny one, who opened by saying he has been trying to do a deal in Phoenix for about five years, during which the gap between the local market’s valuation and his valuation of the same deal has shrunk from 10x to 10%.
He told the group that he predicted the US was on the verge of a “typical recession” in 2006. A typical recession, except for the one in 2001, centers on housing and auto and their financiers; by 2006 everyone knew there was too much supply of housing, cars, and money.
When we go into a typical recession, housing and auto, which normally account for 5% of GDP directly and another 10% spillover, are usually the sectors affected. A drop in housing and auto production can cut normal GDP growth and typically triggers losses of 1.5-2 million jobs. That’s because we hire both to replace people and to deal with future growth. When a recession comes and we lose faith in growth, companies always think they have too many people.
But the recession in 2008 was not just a typical recession; it turned out to be a Super Recession. People began losing home equity, which is a key driver of consumer confidence.
We’ve had three of those, however: 1973-5, 1980-82, 2008-2009
All three Super Recessions have been complete disasters.
–excessive fall in housing and auto
–broken housing finance system
–enormous political uncertainty (Nixon resignation)
–panic
–destroys the housing finance system as we know it
So all this has happened before. We have even destroyed the housing finance system before. Each time, some new fix comes out of it, and we go on to destroy that.
What changed our most recession from typical to Super? Panic. The Fed panicked and said the world’s coming to an end one Friday in September 2008. People believed them and took their money out of the banks. The ensuing panic wiped out 2.5% of the GDP.
The people who should have lost jobs were in housing, autos, and the people who finance them. All the other job losses in the non-center of the storm ( hiring freezes in pharmaceuticals, tech education and health care), and came from people who responded to the Fed’s panic with their own. Thus, job losses of 1.5-2 million common to a typical recession ballooned to the 7.4 million we have today.
The good news is that almost every metric of the economy hit bottom between Feb. 2009 and July 2009 (except jobs). We have had rising profits in business for 4 quarters, so Linneman believes jobs, a lagging indicator, will start to come back in June. And just replacing the people who retired, died, or left their jobs during the hiring freezes caused by the Super Recession should create about 3 million jobs a year. In Linneman’s eyes, we don’t even need to grow to generate those jobs. They will be in health care, pharma, and energy.
As soon as jobs begin being formed, young people will move away from their parents, where they have been hiding while unemployed, and form households. And that will take care of the housing surplus naturally. But, you ask, aren’t there19 million vacant housing units in the US?
Well, yes, but…
4 million are rentals (1.6m above the norm)
5 million are seasonally vacant
8 million are abandoned (uninhabitable)
There are about 2 million legitimate single family home vacancies, which is “only” 625,000 above the norm. Most of them are in Vegas, Fort Myers, Phoenix, and the inland Empire.
On the commercial side, real estate lags coming in to a recession and lags coming out. The first jobs just fill the empty desks. We are 9 million jobs short to get back to the office rents and absorption we need. We will get back there in 2014. In the mean time, there is nothing to be developed.
And in the mean time, the big problem is the threat of inflation. Our budget deficit has gone from 2-3% of GDP to 12%. What do countries do when they run big budget deficits? Raise taxes? Cut spending? Float bonds. That’s what we’ve been doing. How long can we float an additional 1.5 trillion on a 15 trillion economy? The Chinese will stop buying our bonds.
If that happens, the only hope is to print money. We are creating a serious bias toward inflation.
Now that asset prices have stopped falling, the banks have plenty of money to make loans. When they start, the Fed has to pull all the recent stimulus measures out of the economy. How do they unwind that? No one knows. This has never happened before.
We are going to have a huge budget deficit problem, and nobody sees a way out. In our country, we are going to have a “don’t hurt me, hurt them” battle among conflicting interest groups.
There are also a few even less cheerful scenarios: Iran could go nuclear; the Fed could mismanage monetary policy; we could have trade wars; we could have another a confidence crisis event like 9/11.
So, Linneman ended blithely, real estate is closer to good times than bad, but since the cost of money is going to go up before demand does, many people will have trouble staying afloat
