I recognize that the internet is making important structural changes in the shape of the real estate market in the US.
The most clearly visible to me is that e-commerce is fast making lots of retail space superfluous. Many strip malls seem to me to be today’s equivalent of the old ghost towns of the Wild West that were all that remained after the local gold or silver mine petered out. At the same time, fast broadband communication means that a small, but increasing, number of workers are able to live where it suits them rather than near a specific piece of corporate property. Hence, the rising value of “vacation” or “destination” real estate. And, of course, in mega-cities like New York we’re beginning to see the presence of wealthy mainland Chinese buyers of second homes.
the business cycle development pattern
Longer term influences aside, there is also a distinct business cycle rhythm to the real estate industry, which is what I want to write about today. I think we’re at a cyclical turning point.
My experience comes from watching publicly traded real estate companies in the EU and in Asia, where–unlike the situation in the US–they can be important factors in stock market performance.
The pattern is easiest to see with urban office buildings, but it holds for residential and commercial real estate as well.
1. As the economy begins to expand, demand for space in prime office locations begins to rise. Vacancy rates shrink. Price discounting disappears. Rents begin to rise.
2. As rents continue to move up, new construction projects are launched. Some of these will be in prime locations. But builders also know that as prime areas are filled up, businesses will be forced to consider secondary areas. Land is usually more easily available there–and it’s cheaper, to boot. So the secondary locations are a big thrust of new development.
3. Companies in the central business district respond to higher rents by shipping some employees off to new, lower-cost office space that’s springing up in the secondary districts. Firms that formerly occupied the secondary districts respond to redevelopment and higher rents there by locating further afield.
4. Seeing these successive ripples of outward movement, speculators begin to anticipate the next iteration of the process. They acquire land and perhaps build in anticipation of a tide of firms moving farther and farther from the central business district in search of more reasonable rents.
5. The outward ripples stop–and the whole process shifts into reverse. At some point, the combination of new space developed in the central district + existing tenants shifting increasing numbers of employees to cheaper locations causes an excess of prime office space in the center. The economy may by this time be in cyclical slowdown, as well. Landlords in the central business district begin to lower rents to lure customers back from secondary locations. This kicks off successive waves of contraction, as lower rents and greater space availability move firms back to more convenient space.
6. On the extreme periphery, speculators are left high and dry. They’re stuck with raw land and, possibly, completed office buildings that they will be unable to use until–at the very earliest–when the next business cycle starts another outward pulse of development.
where we are now
The Wall Street Journal published a front-page article on Monday titled “US Farmers Reclaim Land From Developers.” In it, the newspaper reports that large amounts of peripheral agricultural land–it cites parcels lying 30 miles and 65 miles outside of Phoenix–are being rebought by farmers out of foreclosure at small fractions of what development speculators paid for them a few years ago.
This is typically the last shoe to drop in the real estate cycle.
I don’t imagine that a new outward pulse will begin in the US anytime soon. But it also seems to me that there’s virtually no potential for further bad economic news coming from the real estate sector.