Could Government Policy Impact Commercial Real Estate More than Changes in Fundamentals?

 

There is no doubt that we are living in a time when there has never been a more closely tied relationship between politics, economics and real estate. In fact, the unprecedented level of government intervention has had profound implications for our real estate fundamentals. This has been true for both the residential and commercial markets.

In the residential market, the impact of government intervention could not be clearer. The government’s initiative to increase the homeownership rate in the U.S. from, the almost-equilibrium level of, 62% into the high 60s has been front and center. This one initiative, which created a platform to put people into homeownership who could not afford to own homes, provided the shove off the cliff for Fannie Mae and Freddie Mac, leading them into insolvency. The mandate to put people into houses that the could not afford to own them forced the GSEs to loosen their standards. They would buy almost anything in sight which encouraged banks to originate mortgages to anyone with a heartbeat. How could they possibly substantiate making those infamous “ninja” loans? You know, no income, no job, no assets……no problem. A strong case can be made that this one initiative was the tipping point for our current financial crisis, setting the stage for participants in the marketplace to do what they do best when opportunities present themselves. .

Today, the government is the most important influencer of the residential market. Between Fannie, Freddie and FHA, the government now guarantees approximately 92% of all single family mortgages in the country. Moreover, the government purchases most of those mortgages and keeps interest rates low by having the Fed purchase most of the mortgage backed securities and treasuries that are offered for sale.

The first time homebuyers tax credit (which has been expanded to include some non-first time buyers) has created a very unusual dynamic. The average home price in the U.S. is presently about $178,000. Most buyers are getting FHA loans today which require only a 3.5% downpayment. This amounts to $6,200. The tax credit is $8.000. So essentially, the government is handing buyers a deed and a check for $1,800 and saying “Go for it”. Haven’t we seen this movie already? If housing double-dips, it will not be a surprise.

In the commercial sector, government intervention has, again, played a leading roll. In order to get the credit markets unfrozen, TALF was expanded to apply to commercial real estate in the hope that it would stimulate the secondary market. The PPIP was created to essentially achieve the same objective. While neither program produced nearly the direct results that were expected, they served a useful purpose in that their sheer existence brought credit spreads in, helping to thaw the frozen markets.

However, the best thing that can be done for commercial real estate is for the government to focus on job creation. The relentless pursuit of other unpopular agenda items does little for CRE and, in fact, hurts our market. Job creation will help fundamentals get back to the point where we will see occupancy rates rise and rent levels increase. When I mentioned this at a conference I was speaking at recently, one audience member stated that when it comes to job creation, “We can’t expect the president to be a miracle worker”. Miracles we don’t need; just a little focus and some strong leadership.

A tax policy that can be relied upon would be a good start. Within the past two months, for instance, we have heard that the Bush tax cuts will be extended, that they will sunset and that they will be extended for some Americans but not for others. Is your head spinning too? Without anyone in Washington (on either side of the aisle) being able to show political will to substantively cut spending, how can we be lead to believe anything other than the fact that our taxes will rise significantly? Uncertain tax policy has been one of the major reasons employers give for not hiring, even when a current need exists.

Another job creator would be consumer stimulation. Why does the government increase taxes, process those dollars through an inefficient machine that removes some of the money in the form of waste, fraud and abuse, and then doles out what’s left in the form of entitlements and bailouts? Why not just cut taxes and have 100% of the money go directly to the consumer? Tax cuts have worked effectively in the past and both parties have used this tool. Not only did Ronald Regan use tax cuts to stimulate the economy but so did JFK. Few people remember that.

The president claims that doubling our exports would create over 2 million jobs, yet three trade agreements have been sitting on his desk since he took office with no attention given to them. It is unlikely this will change until after the mid-term elections (if ever) as union support is critical for this administration and organized labor does not favor free-trade. This is unfortunate as free trade agreements help open markets and expand opportunities for American workers and businesses as they can enter and compete more easily in the global marketplace.

Spending on infrastructure would seem to be another area in which job creation could be attained. Only 11% of the $787 billion stimulus was targeted towards infrastructure and much of that money has not been deployed yet. The idea of forming an Infrastructure Bank has been discussed which would create a public/private initiative to build, augment and upgrade the core infrastructure in the U.S. which is greatly needed.  

People point to “green jobs” as a possible answer. Thus far, the results have been disappointing. $5 billion of government money was allocated to weatherization programs with the intention of putting as many as 87,000 workers back to work “right away”. Many of these workers would presumably be in the construction industry, a sector in dire need of assistance. Thus far, only 2 of the 10 highest funded states have completed over 2% of planned units. In New York for example, we finished a whopping 280 homes out of the planned 45,400. California competed 12 out of 43,400 and Texas was unable to get anything done out of the 33,908 they had planned. Those three states have a total population of about 80 million and only 292 homes have been weatherized, hardly making a dent in that 87,000 jobs number.  

The biggest concern participants in the commercial real estate market should have is that we are now so closely tied to government intervention and policy. This is scary. The track record of Washington’s policy making and initiatives (created, implemented and overseen by both Republicans and Democrats) has been far from stellar. The U.S. post office was established in 1775 and is now insolvent. Social security was created in 1935 and it is insolvent. Fannie Mae was established in 1938 and it is insolvent. Medicare and Medicaid – insolvent. Freddie Mac – insolvent. The Department of Energy was formed in 1977 to lessen U.S. dependence on foreign oil. Since then, the department has grown to 16,000 employees with an annual budget of $24 billion. The result is that we import more oil than ever before. Is it any wonder that only 35% of Americans want the government running a business which represents 1/6th of our economy?

Simply put, Americans are concerned today. Concerned about government spending, taxes, deficits and where we will be in 5 years or 10 years. These concerns impact hiring decisions and consumer spending. And those things greatly impact the fundamentals of commercial real estate. Clear direction and sound policy would go a long way towards normalizing things. We all want our market to recover as quickly as possible. Let’s hope it happens more quickly than we expect.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,050 properties in his career.

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28 Responses to “Could Government Policy Impact Commercial Real Estate More than Changes in Fundamentals?”


  1. 1 Tony J. March 7, 2010 at 10:20 am

    Bob, this is a great but sobering overview of what government has done and could do. I feel like I should just keep my head down and pray that everything works out.

  2. 2 rknakal March 7, 2010 at 10:47 am

    Hi Tony, thanks for your post. To the contrary, we currently need to be more outspoken and, particularly when given the opportunity, should let elected officials know what would help us in our various businesses. If we are proactive, we may be able to change things for the better.

  3. 3 Steve March 7, 2010 at 12:39 pm

    Bob,

    Great articles, I always seem to be agreeing with 90% of your comments. I actually got to see you several years ago when I was at Columbia University and you would speak on the Roundtable Panel. (I think 10% has to be mainly the difference between Manhattan and living in Dallas, TX where there a differences in social, economic, government, that don’t apply broadly speaking)

    I’ve spent some time focusing on several of the issues above and some from several years back, but really haven’t pursued these on a big scale as I don’t have the infrastructure, voice or time to commit. However, there may be a few folks who can take this to the next level.

    These are based on individual instincts and analytical data to try and prove my thesis. Some of the studies include:

    • “Bank Recovery/Asset Repositioning Strategy” – written in November 2008, the study argued that banks would not be willing to sell these assets/paper for 30/cents on the dollar or even 50/cents, but that restructuring would be the key against both property values and Net Operating Income declines. This has been reviewed by ULI and if I cut the words down they said they would publish it. As of March 2010, I wasn’t ready to share it, but didn’t really pursue it either. It has proven to be correct assumptions and I believe the padded profitability provided by the Federal Reserve (0.5 FFR vs. 6.5% lending rate) will allow write-downs to occur starting this year mostly 3rd Quarter on and 1st Quarter 2011. –> I can go into more detail as “Restructuring” is broad, but there is a technique to salvage the original bank capital invested in many cases. (Case-by-Case analysis, but very effective when looking at aggressive proforma’s on cap rate or cash flow from operations perspective. Construction gets a bit more difficult and some assets are simply bad real estate to begin with.)

    • “Boutique Multifamily Value-Add Repositioning” – focused on urban infill older 1960s-70s courtyard style apartments, complete risk mitigation and should be used in either for-profit or non-profit affordable housing. Acquiring and renovating below replacements costs. (South and Southeast US very applicable)

    • “Alignment of Interests” – still in raw form, only the big picture, but talks about aligning the interests of Big Oil and our Auto-manufacturers in forming the commuter rail system (urban rail, light rail and bullet trains) so as to get the momentum and prepare our cities to compete infrastructure wise for the next generation. My theory suggests both Oil and Detroit have no interest in seeing rail take-off as they would “lose” those customers, but I contend that if the Oil companies built the lines and the Car makers built the cabs and they shared in the Operating Revenues with the municipality or government entity, they didn’t “lose” those customers, they keep that revenue in a new form. They can also gain through the real estate swell around the station and lines and continual maintenance operations of the lines/cabs. (TIF, BIDs, Value Capture applications) –> in the South this is very weak compared to the Northeast, Chicago and several other areas. We are a “drivers city” and rail is not utilized like the Tri-State area or Europe.

    • After reading Peter Peterson’s book, I thought about Social Security and when G.W. Bush proposed privatizing SS. While I was reading, I thought about how so many jurisdictions (cities and even states) want to redevelop areas or add infrastructure of some kind (telecommunications, solar, wind, natural gas and the pipelines infrastructure thereof) and have to issue bonds to do this. I thought about the yield that could be generated from taking on many of these intensive capital projects and thought, “why don’t the subsidized programs which are backed by the Federal Government invest in these areas to actually create an annual yield that is higher than the demand for those funds.” Then how to ensure them is first through the City or State who would back those bonds and the 3rd Default would be the Federal Government. With three layers of credit, it would be attractive and also allow for these massive projects to get underway and those yields pay for the costs of the program taking it off the balance sheet of the Federal Government. I don’t know if I’m off here, but I do think about these issues randomly.

    As you can probably tell my background is in real estate development, but I think these may hold answers to assisting in the cause especially pulling the insolvent programs off the books and using them as safe investment vehicles for growth and the goal to actually have money in those programs.

    Please fire away, I like to make my arguments bullet-proof, so those reading this find the holes.

  4. 4 Chet March 8, 2010 at 10:11 am

    You make a number of valid points. However, one of them is not:
    no one “forced GSEs to loosen their standards” so that more people could buy houses they couldn’t afford. What really happened is that people wanted to jump on the profit making band wagon and left their common sense behind when they did. Now we’re all paying the piper.
    More bad news will continue as commercial real estate loans begin to be added to the endangered species list like 666 5th Ave in NYC.

  5. 5 MB March 8, 2010 at 2:48 pm

    We own and (self manage) over 500 apartments in Queens.
    I have never seen the fabric of US culture, economics, politics, healthcare, government involvement, and all other social matters as intertwined as it is today. I can tell you that MCI is on the decline for us….not worth it anymore. We havn’t made a purchase in over 8 years and don’t see a need to make a purchase in this deflating climate. Fundamentals are poor but b/c millenials are tube-fed by mom/dad and pacified by ipods and iphones, riots are averted. Though, we predict a decade long deflation, we will be better off than other countries.

  6. 6 rknakal March 9, 2010 at 7:52 am

    Hi Steve, thanks for your post. You bring up several good points and I may use some of them for future StreetWise topics. Thanks for sharing your perspective.

  7. 7 rknakal March 9, 2010 at 7:57 am

    Hi Chet, thanks for your post. While I understand your perspective on speculation, this process would have been much more difficult if mortgage proceeds were not flowing like a raging river. That flow would not have been nearly as strong if Fannie and Freddie policy was different.

  8. 8 rknakal March 9, 2010 at 8:01 am

    Hi MB, thanks for your post. It is interesting and troubling to hear that your MCI investments are down. This is syptomatic of the fact that New York’s rent regulation system is fundamentally flawed, producing owner behavior as you mentioned. Policy makers simply do not understand the ramifications of rent regulation on our tax base and quality of our housing stock. My column in the Commercial Observer this week addresses this issue. The column is coming out today and should be available on line tomorrow. It can be accessed at http://www.observer.com/term/robert-knakal.

  9. 9 JGK March 9, 2010 at 12:05 pm

    The notion that the federal government under President Clinton created a “platform to put people into homeownership who could not afford to own homes” seems to oversimplify (at best) or demonize (at worst) the concept. Yes, it is helpful for people to own homes to give them more skin in the game in their communities, but noone is helped if they can’t afford those homes.

    Whether the ramifications of this policy were thoroughly considered, or whether proper protections were enacted to prevent the meltdown we experienced are fair questions to ask. However, I do believe it is counterproductive to ascribe false (and unsound) motives to this idea.

    Thank you for providing such a robust forum for discussion.

  10. 10 MJF March 9, 2010 at 1:02 pm

    Bob

    Excellent article as always. I agree 100% with your article.The Dept of Energy is right on. I have heard that argument made by others also in the past. I believe all members of congress and politicians in DC (both sides of the aisle) have created this mess over decades and decades of back room deals, special interest favortism, complete waste and utter mismanagment, continuing bikering and fighting. Make these politicians live by the same policies that they want to implement and force on us. No way, right? I think every incumbent shoud be voted out and have term limits put in place.

  11. 11 David S March 10, 2010 at 12:08 am

    Great writing Robert. I know this took a lot of time and you really were prepared with great back up and real facts.

    Great someone is out there writing this.

  12. 12 rknakal March 10, 2010 at 6:54 am

    Hi JGK, thanks for your post. While I believe the intention of raising the homeownership rate in the country was a worthy aspiration, the manner in which it was done was faulty. This initiative caused cracks in the GSEs which were evident as early as 2003. When stresses were brought to light to congress, Barney Frank, based upon the desire to keep pushing the homeownership rate up, famously said, “Let’s just roll the dice with Fannie and Freddie.” This roll of the dice could end up costing the taxpayers in excess of $500 billion before the dust settles. Sometimes a very simple initiative can have devastating unintended consequences.

  13. 13 rknakal March 10, 2010 at 6:56 am

    Hi MJF, thanks for your post. I believe many people in the country feel the way you do. It is interesting that few of those on the Hill who voted for either healthcare bill are willing to be subject to that same bill.

  14. 14 rknakal March 10, 2010 at 6:57 am

    Hi David, thanks for the post and the kind words.

  15. 15 Eric Ladden March 11, 2010 at 10:27 am

    Hi Bob

    As per usual, you were spot on in this week’s article. Government intervention and growth are shackles on the legs of growth. I think the most important issue we face regarding job growth rests in banking. On one hand, banks have been plied with cash and told by the Government to lend. On the other hand they’re being hauled in front of Congress and being chastised for careless lending. They have over $1 trillion in excess lending capacity, but won’t until the seas calm. Banks are more than happy to pad their balance sheets with the spread they make on buying Treasuries. The freezing of assets in this manner negates entrepreneurship. From past recessions have been born great technologies and companies that led our country to greater economic heights. The job stagnation we will see over the next few years, in our jobless recovery are the direct consequence of government intervention. Historically, over 70% of job creation comes from small business. I realize lending is usually a trailing indicator of a recovery, but without any credit availability the spirit of American entrepreneurship freezes, and with it any hope of jobs and real economic growth.

    Eric

  16. 16 r lobel March 11, 2010 at 11:05 am

    Hi Bob,
    Always a pleasure reading your blog. As usual, very much on target.
    While government is a necessity, unfortunately, so too are politicians.
    Sadly, politicians are in the primary business of getting re-elected and not ‘making things better/helping others’. Worse still, many of those politicians who created the housing mess in the first place are the ones that are now responsible for fixing that mess….same is true at most of our banks.
    As you know, the depth of the economic/housing/real estate melt down necessitates government intervention. Perhaps our politicians (and its up to us their constituents to ensure that they do what we want and need as opposed to what they want and need, for example, health care reform)) can take a page out of some of our international allies best policies and institute them: Specifically, the Australian Government (as well as the Hong Kong Administration) mandates that home mortgage financing cannot exceed 70% (or 75%) LTV’s…continually adjusted to market. The net result of this policy is an Australian Housing Market that is stabile and liquid.
    As we all know, we need much more urban infill subsidized housing: Building this housing will not only create many much needed construction jobs. As opposed to Fanny & Freddie continuing to give these ridiculous no-equity loans to first time home buyers (just another train wreck waiting to happen), perhaps the Government can give renters in subsidized housing a medium term option to buy and set aside aside a potion of the monthly rent (as an additional subsidy) as a ‘renters contribution to equity’. Once this equity contribution has reached a mandated minimum, say, 75%, then the renter can qualify for a Fannie/Freddy/FHA mortgage. Those renters will definitely treat their housing with a lot more love and attention. It will also, I believe, lead to more stable and safer communities with a greater chance of upward mobility. Just some food for thought for you and I to discuss at our next meeting.

  17. 17 Hooman March 11, 2010 at 6:23 pm

    Bob,

    I’ve read your last four posts and found them to be very well thought out and stated. While I, and the other readers who have posted comments obviously agree with most, if not all, of what you have to say, I am curious to hear how your clients react when you provide them with your opinions/facts.

    Have you been successful in using these ideas to turn owners into sellers, or do your sellers just happen to believe the same things you do?

    Thanks again for your postings and valuable information.

  18. 18 rknakal March 14, 2010 at 5:34 am

    Hi Eric, thanks for your post. You make some great points. The government wants banks to increase lending and increase loss reserves at the same time; tricky to drive while applying the gas pedal and the break at the same time. I agreee with you that small business job creation has led us out of the past 7 secessions but we cannot forget about big business either. While small businesses accout for 70% of new jobs, small businesses account for 99% of all businesses. Therefore, we need big business to thrive also. Lastly, you are correct that credit is needed to fuel the entrepreneurial spirit that makes America so great.

  19. 19 rknakal March 14, 2010 at 5:40 am

    Hi Robert, thanks for the post. Many valid points here. The need for affordable housing is tremendous and a system must be put into place to create this housing in a sustainable and economically sound manner. No equity loans are not the way to get this done. While other countries have significant downpaymetn requirements, they also have mortgages that are personally guaranteed by the borrower. Borrowers simply cannot just hand the keys back and walk away. This makes borrowers more careful and thoughtful and keeps speculation at modest levels.

  20. 20 rknakal March 14, 2010 at 5:54 am

    Hi Hooman, Thanks for your post. You raise some good questions. One thing I always keep in mind is that probably half of my clients are Democrats and half are Republicans. From my writing, many people would think I am very right-leaning. I am actually a registered Independent and tend to lean right on fiscal issues and left on social issues. I support candidates who I believe are best for the job, regardless of their party affiliation. Annually, I contribute to candidates from both parties. When I write, I am trying to advocate for the real estate industry and have jokingly said that I write from the perspective of a Realestatetarian, not a Democrat or a Republican.

    As far as my clients go, I think brokers must be cognizant of the fact that we are simply intermediaries. I believe property owners know what they want, and if not, will rely on input from many different sources. I try to give my opinions based upon as many statistics and as much market information as possible. I dont think it is my job to push a client one way or another, but to provide as much insight as possible and assist them in doing what they want to do, only if and when they want to take action.

  21. 21 MB March 15, 2010 at 11:34 am

    How can we vote out incumbents when the average American voter doesn’t even know what that word means? We live in a dumb sheeople society. Ipods and Iphones..that’s all they need.

  22. 22 Emily March 15, 2010 at 2:14 pm

    You have a really good point about the commercial real estate market. This was such a useful article for me. I especially enjoyed what you mentioned about increasing jobs to assist the commercial re industry during this potential bubble burst.

  23. 23 Carl Todd March 23, 2010 at 2:47 pm

    rk-
    Thoughtfull analyis. Another possible needed government action is pointed out in the Globe St. comment by CREs regarding the condition of the bank behind your pending deal.

    The origina FHA & GINEMAY agencies were government to aid and stabilize the residential loan market. When my cousin, Bill Seidman was head of the Resoltion Trust I recommened two changes.
    1. Sell the foreclosed properties with the buyer able to continue the accelerated depreciation schedles they had when foreclose.

  24. 24 Carl Todd March 23, 2010 at 3:05 pm

    rk-
    Thoughtful analysis. Another possible needed government action is pointed out in the Globe St. comment by CREs regarding the condition of the bank behind your pending deal.

    The original FHA & GINEMAY agencies were government to aid and stabilize the residential loan market. When my cousin, Bill Seidman was head of the Resolution Trust I recommend two changes.
    1. Sell the foreclosed properties with the buyer able to continue the accelerated depreciation schedules they had when foreclose. I bet they wouldn’t have lost a dime on them. Bill agreed with me but said it was a political impossibility to make happen. I dropped it then.

    2. Establish ans FHA style agency for commercial properties with solid underwriting requirements and required periodic re-inspections with enforcement procedure to prevent slum-lording.
    Bill never reacted to that but did advise me the I should avoid doing direct RT appraisal work due to our relationship that could result in adverse publicity for both of us under the appearance of nepotism even though my firm was recommended via local sources.

    Its now time for 2. – to establish needed funding to keep and continue our commercial properties viable. What the politicos forget the real estate is the platform for all human activities and the basis for all economic activities is done on and in commercial real estate.

  25. 25 Carl Todd March 23, 2010 at 3:14 pm

    rk-
    Thoughtful analysis. Another possible needed government action is pointed out in the Globe St. comment by CREs regarding the condition of the bank behind your pending deal.

    The original FHA & GINEMAY agencies were government to aid and stabilize the residential loan market. When my cousin, Bill Seidman, was head of the Resolution Trust I recommend two changes.
    1. Sell the foreclosed properties with the buyer able to continue the accelerated depreciation schedules they had when foreclose. I bet they wouldn’t have lost a dime on them. Bill agreed with me but said it was a political impossibility to make happen. I dropped it then.

    2. Establish a FHA style agency for commercial properties with solid underwriting requirements and required periodic re-inspections with enforcement procedure to prevent slum-lording.
    Bill never reacted to that but did advise me the I should avoid doing direct RT appraisal work due to our relationship that could result in adverse publicity for both of us under the appearance of nepotism even though my firm was recommended via local sources.

    Its now time for 2. – to establish needed funding to keep and continue our commercial properties viable. What the politicos forget the real estate is the platform for all human activities and the basis for all economic activities is done on and in commercial real estate.

  26. 26 rknakal March 23, 2010 at 7:50 pm

    Hi Carl, thanks for your post. I always appreciate your feedback. Clearly, accelerated depreciation would be a great thing for distressed buyers. Time will tell with all of these issues.

  27. 27 David Tunde December 13, 2011 at 6:39 am

    thanks for eye opening points

  28. 28 Timothy S September 20, 2012 at 2:39 pm

    Your second to last paragraph brings up some very valid concerns. The governments answer to problems is often to make a new department to take care of it or throw money at it, and more often than not it seems, it doesn’t work out.

    The government getting in with the real estate business while its so unstable is a dangerous game for everyone. It’s great if they can help and relieve some of the stress and burdens, but they might just stir up even more trouble.


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