Real Estate Outlook Mid-Year

July 1, 2004
The USC Lusk Center’s Chairman Stan Ross Shares His Views on Demographics, the Economy, Jobs, and the Real Estate Outlook in an Interview with Buildings magazine
DemographicsQ: What are the top three demographic trends, and what do they mean to developers, builders, and the real estate industry in general?A: Of the three trends that have had a significant impact on the country and on real estate, immigration is first. It’s not just the incoming immigrants, but internal growth (last-generation immigrants that are of child-bearing age) from this population. The greatest influence has been on the Latino and Asian populations, and it’s been taking place cross-country.        
Second has been this aging piece of the population. We have a growing aging population, and they’re living longer, which has implications on job growth and to the workforce. What’s interesting, as part of this demographic, we [will] need to have a huge population growth to replace our existing workforce – and that’s true on a global basis. [As a result,] there will be increased competition for labor forces because of the demographic implications.
And then we have the demographic of redistribution of our population, in terms of cities, states, and areas of preference. It used to be that [people] went to the gateway cities; now we are seeing a re-shifting (a growing migration of the African-American population to the South, for instance). So that’s significant in terms of planning your facilities for plants, for offices, as well as the types of jobs and the population mix in the future. The monitoring of the demographic changes will be a critical part of real estate’s strategic planning as we move into the future.
The EconomyQ: What is your view about the economic outlook, especially with respect to GDP over the next six to 12 months?A: I see the growth continuing – not at the same level, but settling in at the four-percent level. And, I think we’ll continue to grow. Obviously, we’ll be impacted by interest rates to some extent; my own view is they will start moving up, but in short dosages. If I were pinned down, I’d say [to] a maximum of 150 basis points by 2005, as I don’t see us returning to high rates unless some major, major external factor affects us.Q: Any way for developers and builders to hedge against rate increases?A: Builders have to go through the quantification [project by project], each in terms of the effect and the cost of putting in some hedges, taking their floating rates and either swapping them out or putting caps on them. Right now, you’d think that hedging would be beneficial, but on a lot of the shorter-term debt, you may be okay just floating.Q: What about the global vs. U.S. economy?A: If you take a look at the global economy, the growth rate in some countries, like China and maybe India, will clearly continue to exceed us. There are other places around the world, obviously, that are growing off of a different base, but on a relative basis, [the United States] will still be a dominant factor in the world. [However], if you forecast it … over 25 or 30 years, some countries like China and India will be significant competitors in terms of their GDP. There is more competition for world goods because of these countries, which will impact our cost significantly (examples that affect builders: the price of steel, lumber, concrete, and other types of goods that have gone up substantially).Job GrowthQ: Job growth (new jobs that weren’t on payrolls before) is actually increasing? With all of the offshoring of U.S. jobs, specifically in manufacturing, how is this possible?A: A lot of people think that way. In March, we had over 300,000 new jobs; we also had a 200,000 job growth in April. First of all, defense was a good part of that. But then once you start the new job growth, what happens is your service sector starts to increase almost geometrically. But I think that’s going to level off; I don’t think it’s going to be sustained at that high of a rate.Q: At what level will it stabilize?A: I don’t think it will hold at 300,000 [or] 200,000. I hope it holds between 100,000 and 150,000. I can live with that.Q: What does that actually mean to the demand for office space, etc.?A: On the demand for office, I have an interesting perspective. First of all, we all know there’s a big overhang – a big vacancy. On the other hand, when you look at the math, that number is down significantly because we have not had a lot of new development – and that’s good news. So the supply side is way, way below what we were seeing in prior down cycles, which means that as the markets pick up, we’ll start to see some improvement in that office sector.         
The other part that I see as a positive – and the United States has always had this – is the small entrepreneur and small business growing. Instead of [one company] taking 10 floors in a building, we might see [a shift to] 20 entrepreneurs taking that space. It won’t happen overnight – we’ll have a long-term absorption – but with the supply side down, this increase in job growth will start using up some of this office space.
We’ll continue to offshore, but some of the companies have had some problems with the [work] quality of offshoring, so we may see some changes taking place there. Secondly, as foreign investment comes here, some of our office space will be used to service that foreign need.
Q: Are there certain sectors in real estate employment that you think will have job growth?A: You’ve got to believe the finance piece of real estate will continue to grow, with all of the capital out there – financing and refinancing. And all of the service areas: leasing, brokerage, and management. There will be less development – both management and workers. On the other hand, home building will continue on for another year, depending upon how fast those interest rates ratchet up; retail will continue; and then you’ll start seeing – in a couple of years – the apartment and the office [sectors] picking up.Q: Will the education and healthcare markets continue to grow fairly steadily?A: Healthcare fits in clearly with the aging of America, [although] we haven’t yet found the panacea in the real estate – retirement communities, assisted living, or homes for the aged. In education, obviously, there’s a strong need for the facilities.Real Estate OutlookQ: Which sectors will lead the real estate recovery?A: Healthcare and education will help, but I don’t think they’ll become the leaders. Rather, office, industrial, suburban, regional, and distribution will be out front. Retail will continue, as I said before, and homes. What happens with residential is if it’s not the for-sale side, then it moves into the rental side. You just don’t lose that market.Q: Are we a more productive workforce here in the United States?A: [Alan] Greenspan was the first one to forecast a jobless recovery, but he has [also] gone on record that he doesn’t think that level of high productivity can be sustained. Let’s assume he’s right; then that basically says that we’re going to need more jobs, [since] technology won’t continue at that same high rate. When you overlay that with more capital spending, replacing your inventory, which we’ve bled down, then we’ll see a positive implication in the job growth. So that’s one of the reasons we ought to see more jobs than we have in the past.Q: Inventories down is a good thing, right?A: That’s been terrific; I’m a big fan of just-in-time inventory. And with technology being the way it is, to let [inventory] drift down extremely low, there really was no harm in doing that. What’s happening, though, is there’s a little bit of an inflationary pressure going on now, first of all, because of the global implication – the competition for all the commodities. It’s not the wage inflation that we’ve seen in the past, it’s more the cost of goods inflation.Capital MarketsQ: Who are the leading investors in real estate at this time?A: Going back a little bit, when the stock market started to drop, everyone looked at their asset allocations. The major institutional players, like the pension funds, that only had only three or four percent invested in real estate, began to think about increasing their allocation to real estate – because the asset offered a current cash flow … a good residual value, and … the ability to exit out. Good returns, good values – so that was beneficial for the institutions.        
Then for individuals and corporations, there were tax benefits. For foreigners, real estate has proven to be a good return, and in some of the countries, like Germany, with some tax benefits. So, we have a whole group of new investors coming into the market.
Q: Is this a trend that will continue?A: It’s continuing. Every day when I look at properties and portfolios up for sale, I see the number of investors bid for the property, and it just continues [to grow]. It’s a fixture of every one.Q: What about the risk of more loan defaults and workouts throughout the remainder of this year and into the first quarter of next year?A: The risk of default is not as high as in past cycles for a number of reasons. First of all, a lot of the debt was refinanced relatively cheaply, and a lot of it was fixed or hedged, so it’s not floating up dramatically. If we’re right about interest rates – that they’re not going to move up five, 10, 15 points – then even with weak vacancy in the office sector, the [players] still have sufficient cash flow to service their debt. Now, having said that, there have been a couple of cases around the country, but I don’t see a big wave like what we had in past cycles.Q: Next year?A: Our economy will look a lot better. The big question marks will be: “Where do we stand globally? What’s the situation in Iraq? And how did the election come out?”Linda K. Monroe ([email protected]) is editorial director at Buildings magazine.

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