The Falbey Report: November 2010

Monday, November 22, 2010

Density: Good or Evil?

Patrick Phillips, CEO of ULI-The Urban Land Institute, in an article published on GlobeSt.com, addressed the future of real estate development:

“What we learned from this phenomenon (migration back to urban centers) is that there is a market for compact, mixed-use design, smaller housing space, and transit-oriented development that minimizes the need to drive. But perhaps the bigger lesson--one we are still learning how to apply--is that there is a demand for at least some aspects of this type of development that stretches beyond downtown cores and into outlying suburbs” (emphasis supplied).

In addressing the use of land to achieve this development, he added: “Going forward, our decisions on what and where to develop will be guided not by a plentiful supply of land throughout urban regions, but rather how best to use the land that is left.”

The article has been reprinted in Urban Land magazine.

I commented on the original article when it appeared on FaceBook, as follows:

“I agree with Patrick that, going forward, new development and redevelopment will occur in greenfields areas as well as urban ones. The issue I see is that public sector planners, appointed planning commission members, and elected officials frequently don’t get it. Even when they do, they are aware that the electorate largely doesn’t get it. And the public sector necessarily is very sensitive and responsive to the wishes of the electorate regardless whether it is well informed. That is the real challenge for those of us in the land use and development industry.”

The point here, of course, isn’t that public sector officials and members of their staffs, as well as members of the electorate, are dull-witted. It’s that they often don’t easily connect the dots between more efficient use of land with less issues relating to sprawl and the resulting need for higher density.

You can build smaller, more compact residences on a given parcel of land, but only if you can put more of those smaller residences on it than the larger ones contemplated in the original planning and zoning. It’s simply a matter of number$ (if you get my meaning).

Suppose you can build X units on Blackacre (after all, I am an attorney) at a land cost of Y dollars for Blackacre, and sell those finished larger units at a per unit market price that includes an acceptable risk-adjusted rate of return on total investment. Suppose, however, that the market demand changes to smaller, less expensive residences. Now, in order to earn a return on investment, you must be able to build X+ units, assuming the price for Blackacre remains Y dollars.

Otherwise, the residual land value per unit (the percentage of the total cost represented by the land cost) will be too high to produce an acceptable profit, and Blackacre won’t be sold and developed, which means that needed, affordable residential structures (remember those days?) won’t be built. That, in turn causes demand to drive up the price of existing housing, which gives rise to other social, political, and economic issues. Bottom line: density is a positive thing.

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Friday, November 19, 2010

Real Estate Factoids, QE2, and Jobs

For starters, here is some of the news behind today’s headlines:

· Mortgage rates have gone up and the number of applications has declined (due in part to expiration of the home purchase-inducing tax credits and continuing uncertainty about the economy and the cost of debt exacerbated by the Fed’s QE2 policy-see below). Not surprisingly, the yield on ten-year Treasury notes has been rising;

· Housing inventories have declined (in theory due in part to frustrated sellers pulling homes off the market and some lenders slowing the sale of foreclosed properties due to irregularities in the foreclosure processes);

· Housing starts have declined, which is understandable in a market where there is a huge overhang of existing inventory and mortgage loans are hard to come by;

· Building permit issuance is relatively unchanged from its current doldrums, also understandable given the situation described in the immediately preceding paragraph.

On Other Subjects:

QE2 or quantitative easing, Round Two. The Federal Reserve has created $600 billion out of thin air ostensibly to buy toxic debt instruments (think residential- or commercial-backed mortgage securities), thus greening the economy. The reality of it? The total of goods and services available in the market at any point in time is a static figure. Simply creating additional dollars only requires the costs of those goods and services to be increased in order to avoid loss of their value.

This is because this “funny money” weakens the value of the currency. It leads, in turn, to higher interest rates in order to adjust for the increased reluctance to invest in dollar-backed securities, such as Treasuries. Ultimately, it disincentivizes investment that would lead to job creation. Higher interest rates on government debt crowds out capital for private investment.

Make no mistake about it. Higher interest rates are part of a zero-sum game. Savvy investors understand that any given asset has a finite value for a desired rate of return on investment in that asset. It’s simple: the more you pay for the cost of the money (debt) used in the acquisition of the asset, the less you can pay for the asset itself. Higher interest rates put downward pressure on asset values.

On their third quarter reports, banks in the U.S. disclosed that they were sitting on more than $1 trillion in excess reserves, that is reserves above and beyond the amount required. Why aren’t the banks lending that money? Could it be that they are afraid of further losses in the real estate sector - residential and, especially, commercial?

Finally, what’s the big deal with extending the Bush tax rates for all those earning less than $250,000 per year and filing jointly ($200,000 for those filing individually)? Just this: who do you think is more likely to have the capital and incentive to invest in business growth and expansion? Right, those who wouldn’t get the benefit of the extension of the Bush rates. And what’s one of the most crucial things needed by our economy today? Right again, jobs. The solution to that problem (there are others that need other solutions to be sure) is to permanently extend the tax rates across the boards. Eliminate the uncertainty looming over future years’ tax rates, including 2011. To accommodate the tax rates, cut government growth and spending. No one ever was entitled to a free lunch in this country.

Friday, November 12, 2010

Is Help On The Way For The Real Estate Development Industry?

Here's what we know:

The overall economy has been slammed harder than at any time since the Great Depression of the 'thirties;
Recovery seems to be imperceptibly slow to the point of stagnation;
Real estate development appears to have suffered more than any of the other industries;
The administration remains unchanged, but, thanks to a majority of the American electorate, the political and fiscal complexion of Congress appears to have moved somewhere to the right of where it has been for several years;
Profligate spending by the administration, as ably assisted by its departing cohort in Congress, has weakened the purchasing power of our currency, thus worsening the situation;
we depend on debt (through the sales of Treasury instruments) to operate our government

The Chinese, Japanese, Saudis and others are the principal purchasers of these obligations, and they have been threatening to slow or stop buying them because of the low rates of interest and the depreciating dollar as a store of wealth.

A proliferation of regulations on businesses and the looming threat of tax increases has created an environment of such uncertainty that the needed expansion of business, and the resulting creation of jobs, has not occurred;
This has aggravated the reluctance of lenders to provide the needed debt capital;
This uncertainty, high unemployment, and absence of debt capital dampen demand and make it difficult both to reduce the huge overhang of residential units and refinance much of the $1.4 billion in commercial real estate loans maturing over the next few years.
And, this doesn't even touch on the potential economic disaster represented by apparent irregularities in the mortgage-backed securities industry.

Here's what we need:

The Republican majority in the House to display some genuine grit for a change and dispel the uncertainty by:

Rolling back the plethora of centralized power-grabbing regulatory schemes enacted in the past few years - simply unfunding them if all else fails;

If lenders had clear regulations regarding reserve accounts and other matters jumbled by the Dodd-Frank bill and other legislation, they would be far less reluctant to lend.

Initiating permanent tax cuts - temporary ones or ones that benefit only the lower bracket taxpayers who don't create jobs - do nothing to dispel the uncertainty concerning the economic future;

permanently quash the death tax and the oft-proposed tax on carried interests;
lower the capital gains tax and the corporate tax rate;
create tax incentives that encourage investment and expansion.

These are but a few of the positive actions that could be taken to jump-start the economy. We'll discuss more in a future blog entry.

Thursday, November 11, 2010

Efforts to Limit Growth and Development

Over the past decade or so, several states have seen efforts by special interest groups to try to place constitutional limitations on development activity. The method used generally is to try to put a referendum on the ballot during statewide elections, such as the recent mid-term elections. The sponsors of these initiatives are those, who for various reasons, steadfastly oppose any further growth in communities. Never mind the tragic consequences that may have on the economy in that community. St. Pete Beach, Florida is a good case in point.

The goal is to force all new development proposals to be placed on the ballot for electorate in the affected jurisdiction - usually a city or county - to cast their respective votes for or against the proposal. In other words, what ordinarily is a task for the municipality's elected officials to decide becomes a matter for decision by the entire electorate.

These efforts often have compelling titles. For example, in Florida, the most recent effort was called "Home Town Democracy", also known by a more plebeian name, Amendment 4. The proposal was defeated by a significant majority of the voters in Florida, as has been the case in other states, so far. But the people sponsoring these proposals will continue to try to press their will on the public.

So, how exactly would this limitation work? If, for example, the one in Florida had succeeded, it would have required most proposed amendments to a municipality's comprehensive growth plan to be placed on the ballot at the next general election. Comprehensive growth plans (GMPs) are maps outlining in general terms how a city's or county's growth and development should occur over time. The principal idea is to insure that capital facilities, such as roads, schools, sewer and water, are in place to accommodate the growth rather than resulting in overburdened infrastructure and the resulting negative impact on the quality of life of the citizenry. Because these guidelines necessarily are general in nature and require flexibility to accommodate the unforeseeable changes and developments that are sure to arise over time, there usually is some process for amending the GMP.

As a general example, if a land owner wanted to change the land use designation for a parcel of property she owned from commercial to residential, she would seek an amendment to the GMP. Her proposal would be reviewed by the municipality's planning staff and sent to the governing body of elected officials with a recommendation for or against the proposal. The city council or county commission, with input from state agencies and after notification to affected landowners, would determine whether to grant or deny the proposal in a public hearing. It's worth noting that in areas where growth is occurring, it is conceivable that hundreds of these proposed amendments could be on the ballot in any given election. Are individual voters going to take time to study each proposal and give its due? It's very doubtful. The voting process involves lengthy lines and long ballots as it is.

Under this scenario, which exists in many states, these decisions are made by the public's elected representatives after various open public hearings, notifications mailed to affected parties, and input from a number of sources including the individual members of the public. Some jurisdictions even solicit public opinion surveys and questionnaires, as well as public hearings in various specific locations within the community. Sure sounds like representative democracy at work.

So, what is it the proponents of these ballot initiatives seek to achieve by taking land use decisions out of the hands of duly elected public officials and requiring the entire electorate to make decisions? Just this; they don't like a process that gives each proposed development activity an opportunity to stand on its own. By moving the decision making to a laborious and demanding process for each individual elector, it almost assures that the mass of proposals will fail. Other than Congressmen, voters rarely vote in favor of something complex that they haven't had time to sufficiently understand.

It is certain that these initiatives will continue to appear on ballots at the state and local levels anywhere there is healthy development activity. Just remember: when you stop growth, you impair economic activity, which in turn leads to decline and higher taxes to cover the resulting shortfall.

Wednesday, November 3, 2010

Reflections On The Election: Moving Forward

What messages does the recent mid-term election send, and to whom are they sent? The answers seem simple enough on the surface. The principal message was aimed at the Democrats: The majority of the American electorate “does not want to be governed from the Far Left”.

There were other messages to be sure. The election of a Republican to fill Obama’s former Senate seat appears to be the people of Illinois saying to Obama, “Goodbye,…and don’t come back.” So much for favored son status.

But the main message clearly was the reflection of the anger, mistrust, and disappointment the electorate has with the direction of the Obama policies. Much of that anger springs from the perception of having been duped by him in the 2008 presidential election.

There is evidence that in any election of national consequence 30% of the electorate consists of loonies, misfits, and sociopaths slavishly devoted to the Far Left’s promises of a statist nirvana where they are rewarded for their singular lack of talent and ability. That percentage is much higher in California, as was proved by the elections of those clueless twins, Brown and Boxer. Add to this, in 2008, the disgust with the ineffective fiscal and immigration policies – or nonpolicies – of the Bush administration, which drove the mass of voters in the center to buy into the Obama message of Hope and Change. The country thought it was ready for any change. It took Obama less than two years to disabuse the majority of the electorate of that notion.

The mean of the electorate is often said to be center-right. That certainly appeared to be true in the recent election, if not somewhat farther to the right. Remember, the Republicans recently held both houses of Congress and the White House, but lost it all through poor governance. It appears that the electorate, in desperation, is turning back to them principally through the efforts of the Tea Party and similar movements. The challenge now for the Republicans is to accurately take the pulse of the electorate and respond accordingly.

The message appears clear enough, as evidenced by the victories of Marco Rubio and other Reagan-style conservatives. The majority of voting Americans do not want big government, deficit spending, and the proliferation of regulations and bureaucrats. They want jobs, fiscal responsibility from their elected representatives, jobs, small government, jobs, a playing field on which entrepreneurial talents can take the shot at the brass ring, and…,oh yes, jobs.