Recovery Underway?

We are regularly assailed by perspectives on the current economy ranging from “we are on the verge of a double dip recession” to “no, recovery is well under way”. I am reminded of an economist who once described the members of his profession as having predicted nine of the last four recessions. So, who does know what is happening with the economy? Apparently, no one does.

Economists and others pontificate daily as they try to interpret the constant flow of data. Their messages swing from bleak to hopeful and back. As someone once said, “perception is reality”. What someone perceives or interprets from a given set of data often becomes their world-view for the moment. Compounding the problem is the fact that the perception often is driven by political or mercenary need for a specific scenario to be “real”. For example, the Obama administration and its supporters in the media and elsewhere need the public to believe that recovery is well under way.

The challenge for truth-seekers is to be able to read through the spin. For example, reports abound that the rate of unemployment, mortgage defaults, vacancies, and rent declines, while still falling, are doing so more slowly. Isn’t this akin to a person hearing from their physician that they’re terminally ill and have but 2 months to live; then seeking a second medical opinion that advises they actually have 4 months to live? Myopically, that’s great news – their remaining life span just doubled. But the big picture remains that they are terminally ill and will die shortly.

The Wall Street Journal may be a conservative, business-oriented publication, but it doesn’t use sensationalism or fear tactics to sell copy. Its reports often are understated and leave it to the individual reader to apply his or her own interpretation. Here are some examples from the WSJ Property Report of July 7:

·        Dividend Capital Total Realty Trust acquired a portfolio of industrial and office properties from iStar Financial for $1.4 billion. This is noteworthy because the scarcity of financing in recent years has made market rate large commercial real estate deals rare. But, before assuming that the credit crunch is over, look at the facts uncovered by the WSJ:

o   The buyer ponied up equity in the amount of 37% of the purchase price (compared to the 5% to 10% of a fews years ago);

o   The iStar is carrying about 8% in mezzanine debt;

o   The loan-to-value ratio on the underlying financing is only 55% (compared to the 80% to 90% of a few years ago);

o   The properties involved enjoy 99% occupancy on leases with very creditworthy tenants averaging 7.6 remaining years (compared to double digit vacancy rates nationally).

Clearly, this is not a typical transaction in the traditional sense, but is it a fluke or a template of deal structures moving forward?

·        Citing data gathered by LPS Analytics, the WSJ also reported that the rate of mortgage delinquencies accelerated in May following 2 months of declines. Is it temporary or a sign of worsening conditions?

·        Citing information gathered by Reis, Inc., the WSJ also reported for retail centers that vacancy ratios continue to increase while rent rtes continue to decline. The rate is slower than over much of the previous 3 years, but is it a temporary respite or a sign of slowly improving conditions?

·        The Journal also reported that spending on new construction was down year-over-year across all categories other than residential, which was up slightly from a year earlier.

These are just a few of the fundamentals that underlie economic activity for real estate development, but they are not cause for celebration. The real question is what do they mean in the context of the larger picture (longer-term)? The only reasonable interpretation is that recovery is not yet “well underway”.

The difficulty this poses for the real estate development industry - whether new development, redevelopment, repositioning, or restructuring, is in the interpretation of short-term data points for strategic application in what essentially is a long-term endeavor.