The source of the current economic mess has often been attributed to real estate, especially the residential kind.
Why does real estate matter?
First, there’s the obvious one. It’s the sheer scale. The total value of the US residential market hovers around $20 trillion. There simply isn’t anything close to it. (add up all the cars in the US—maybe 250 million, and give it an average value of $10,000 (8+ years median age), and you only get up to $2.5 trillion). The home is the single largest purchase any American will make in his/her life time.
But the reason residential real estate (and real estate in general) drives people crazy is for the less obvious reasons. Unlike any product in the market, real estate is impacted much more severely by supply, rather than demand. Why? Because it is immovable. Once real estate—residential, commercial, hotel, retail—is placed in service, it cannot be packed up and moved to a different location if the “market wasn’t there.” It must sit, and wait, perhaps repackaged, but never to be relocated.
In the 1980s, when I ran hotel market studies, we measured demand by counting occupied room nights. But that was simply a measure of how filled the hotels were. Imagine if McDonalds measured its own performance based on how many hamburgers were sold out of the ones they made. Every day, they make the same billion; and every day, a different number is sold. A lot of waste, isn’t it? That’s real estate. You may say that airlines face similar issues, but they do have the option of moving aircraft around, canceling unprofitable routes, or otherwise manage their yield. The single scariest event for an old hotel is to find a new competitor opening up next door. It can’t decide to go look for a better location. And an unsold home in Florida doesn’t have the option of moving to Manhattan where the market’s a bit stronger. It’s stuck.
Many economists are comparing what is happening to the US to the “lost decade” that hit post-bubble Japan in the 1990s. I was there, helping Japanese banks work out their non-performing loans. By the late 1990s, when the US economy was roaring back, there was one state that found its real estate market still in the tanks—Hawaii.
Why? Because a large chunk of Hawaiian real estate was still held by Japanese banks and companies that were still being rescued. In the hotel business, if you can go in cheap, you can win. If a property that cost $500 million comes up on the market for $200 million, you may think, “Great Deal!” But what if the property next door, which cost $300 million to build, is sold for $30 million? Someone buying that $30 million property could under price your room rates by over $150 a night, and the tourist may not see the difference between a hotel that cost $500,000 a room vs. $300,000 a room. The same was true in the residential marketplace, where significant patches of land and empty homes were held by Japanese investors and institutions. People shied away because in an uncertain market, there was always a better deal if you wait. So the market simply sat, with no action, no activity, no path for a way out—much like what we are witnessing in the residential market today. Only after the assets were disposed by the banks, or stable operators found, did the market recover in Hawaii.
Back in the US, the latent demand for housing is there. The US population did not drop in half in the last six months. Given the tax policies and the generally accurate hypothesis that home prices increase in the long-run, buying a home (which the occupier can afford) is still a good investment. Few people doubt that.
The US today is behaving like Hawaii in the 1990s. The big question is whether the actions taken by the Obama administration will set into motion the wheels that will help move supply—banks willing to take losses, servicers trying to make deals, loan officers willing to negotiate with home owners. Political arguments about how the rescue package rewards stupid people or unwise people lead us to the Promised Land of Doom. Lecturing the engineer who designed the Titanic while the ship was sinking wouldn’t have saved a single life.
One thing’s for sure, though. Those unsold homes aren’t going anywhere real fast. And the associated problems we face simply won’t go away until we deal with it, and that’s Why Real Estate Matters.
Joseph Lee is an independent consultant and executive coach. He is also an Adjunct Professor at both the Peter F. Drucker and Masatoshi Ito Graduate School of Management and Pepperdine’s Graziadio School of Business and Management where he teaches second-year MBA courses in Management Consulting. In addition, Mr. Lee is also an author, writing International Business Thrillers, including his debut novel The Sky Burns Red (赤く燃える空) which was published in Japan. A sequel is scheduled to be released fall, 2009.