Real Estate and the Economy; A Year End Summary 2008
“Strength of mind or of character” is “the ability to keep one’s head at times of exceptional stress and violent emotion.”
Many intelligence reports in war are contradictory; even more are false, and most are uncertain.”
By Carl Philipp Gottlieb Von Clausewitz) (July 1, 1780[1] – November 16, 1831) was a Prussian soldier, military historian and influential military theorist. He is most famous for his military treatise Vom Kriege, translated into English as On War.
Uncertainty is the imperative of the day
As we close the year 2008, one thing is clear, that we are in stressful times where uncertainty is the rule of the day. Many reports from the news create an image of an economy out of control. Yet every day people go to work, go on vacation, buy Christmas presents and make plans for the future. There is confusion and an overload of information that makes it difficult for even the seasoned investor to understand the marketplace.
To address this economic uncertainty, the Federal Reserve has worked hard on reducing interest rates to almost zero to jumpstart the economy. In addition they are in the process of buying up, or cleaning out of the economy the “toxic “loans that are worthless. In this way the Federal Reserve is helping banks improve their financial statements. Once the banks are stabilized they will be willing to lend again at rates and with terms that businesses can use to grow into the future. In addition, President – elect Obama promises a massive back to work program, although as he points out it will take a while for the American economy to recover.
On one hand
On one hand this recession is a disaster. The Dow Jones (stock market) has dive bombed from a high of 14,000 (July 2007) to 8000 (Nov 19, 2008). http://www.cbsnews.com/htdocs/economy/markets/images/dowjones.swf. The real estate markets (residential and commercial) have slowed down significantly, because financing is hard to come by. Banks are more focused on improving their balance sheet positions rather than making loans.
On the other hand
On the other hand, this recession has been a wake up call for all Americans. Many Americans live beyond their means. This economic stress that has reduced the value of housing significantly, will be forcing many to make significant adjustments to their standard of living. In addition the tremendous increase in the cost of oil and gasoline earlier this year pushed our economy to the edge and nearly stopped it dead in its tracks.
The impact of oil
As a result many Americans have changed their purchasing habits. They also altered their transportation habits, which reduced the consumption of oil. This reduction in the demand for oil has also forced the price of oil down in markets world wide.
In the United States oil demand has dropped by 2.6 million barrels a day according to the US Department of Energy. Demand for oil has fallen to 17.7 Million barrels a day which is the lowest monthly level since October of 1995. An example of this oil oversupply is seen in the additional storage of pumped oil on oil tankers. According to Business Week (Dec 29, 2008 edition, page 32, Does OPEC Still Matter?) worldwide there are an estimated 21 ships holding 40 million barrels of oil. At the end of October there were only 5 ships. This means that producers have been “churning out 750,000 to 1,000,000 barrels a day for which there is no ready market.”
The very high oil prices in excess of $140 a barrel, in the summer and early fall of 2008 created an environment where alternate energy sources became more interesting to investors. Wind, solar, coal, and other sources of providing energy became the topic de jour. Then the bottom dropped out of the oil market to just over $40 per barrel, as Americans started using less oil, shocked as it were, by the $4 per gallon gasoline pricing on the street. The high cost of gasoline issued a warning to the American public. As a result, Americans don’t want imported oil to control the country, which created an impetus for increased purchasing of fuel efficient vehicles. Note: Due to the current recession, worldwide oil consumption could drop for the first time in 25 years, and will likely not recover before 2011.( www. International Herald Tribune.com. “With oil prices in retreat, OPEC struggles to maintain unity by, Jad Movawad, Sunday Nov 30,2008))
Containing Iran
With the reduction in oil prices we have also found a way to contain Iran. The reduction in oil income as a result of reduced oil exports has had a crippling economic effect on Iran. This gives the world wide defense establishment a breather, since this will also impact the funding that is available for world wide terrorism.
Global recession
Americans are at the front lines of a global recession. This makes us very nervous and conservative. We are holding on to our cash, praying that the recession will soon reach bottom. This recession has become particularly debilitating to investors in their 60’s and 80’s, specifically those who invested much of their retirement in the stock market.
This economic environment is encouraging Americans to live within their means, rather than to live “large” in a highly leveraged manner.
As we make adjustments to this economy, we should see the following:
- Smaller homes
- More people renting homes and apartments
- Smaller more fuel efficient cars
- Increased commuting using alternate means of transportation
- Increased bike sales
- Increased savings rates
- Higher taxes to pay for government programs that pull us out of the recession
- The continued push to live in cities
- As cities get larger there will be a greater demand for public transportation.
- Cities in America will look more like cities in the rest of the world, with better public transportation.
In addition we will be faced with the following economic influences:
American farmers will be making important choices, whether to plant crops and / or wind farms or even solar farms.
In Oregon the population is expected to grow at a slower pace. Based on current forecasts the population of the state will increase to 4,126,000 in 2015, with an expected growth rate of 1.2% per year from 2007 – 2015.
From Oregon Economic and Reserve Forecast Dec 2008, Prepared by the Oregon office of Economic Analysis
Oregon’s total fertility rate remains below replacement levels. Long-term population growth will stem from net in-migration of new Oregonians, who will want to work or retire here.
From Oregon Economic and Reserve Forecast Dec 2008, Prepared by the Oregon office of Economic Analysis
The annual growth of the elderly population will be nearly 3.7% as baby boomers near retirement age. Though, many might put off full time retirement as they wait for their stock portfolio to recover from the high tech bust and the current recession.
From Oregon Economic and Reserve Forecast Dec 2008, Prepared by the Oregon office of Economic Analysis
As the world population grows over the next 20 years by an additional 1.2 billion people, the costs of food, water and oil will increase. In order to accommodate this growth the world as we As the world population grows over the next 20 years by an additional 1.2 billion people, the costs of food, water and oil will increase. In order to accommodate this growth the world as we know it will have to change.
Investing in Oregon
Oregon investments stand at the forefront of the future. With a significant focus on recycling, alternate energy development and land use planning, Oregon will lead the nation. This is why Oregon investments will remain mostly solid.
Challenges lie ahead as retailers experience significant reduction in sales making it difficult for them to pay the rent. In the short term Landlords will want to negotiate with their weaker tenants to keep them in retail centers, (though a careful review of their financial statements is advised).
Apartments and local hotels will remain solid investments as fewer people are able to afford or qualify for loans to purchase homes and vacationers will not travel as far for recreation in order to save fuel.
Residential builders will be facing a slow down, but there is a bright spot in smaller homes and condominiums under $350,000 sales price. There will be some “opportunities” in the market place, especially as the banks lower their interest rates to below 5%.
Investments will continue as buyers look for opportunities with strong fundamentals.
Apartment vacancy rates will increase a few percentage points in 2009. Industrial and office vacancies will increase in the near term. Oregonians without jobs will leave Oregon and move to places they can find employment.
Summary
“Strength of mind or of character” is “the ability to keep one’s head at times of exceptional stress and violent emotion.”
We are bullish on the Economy and believe that the market will stabilize over the next 12 months. The additional FDIC insurance as well as the plans for focus on improved health coverage, and more jobs voiced by the president elect will create a sense of stability. There will be economic dislocation for many. It will take a long time for the stock market to recover.
We do though have some certainty and that is the inauguration of our next President Obama on the 20th of January 2009.
Now is the time to have a steady hand at the tiller. As the freeze of winter thaws into the spring we will create new, albeit more conservative opportunities, that will continue the growth of the American and specifically the Oregon economy. Real estate will continue to be a fundamentally strong investment vehicle. We encourage you to underwrite your investments in a conservative manner, just like the banks will in the near future.
We wish you a happy holidays and a fruitful new year, and remember to keep your head.
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