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I've enjoyed reading the opinions of everybody on all these gloom and doom
subjects, but there's a few facts you left out. In order to keep these
messages brief, I'll send one "myth exposed" message a day to the list for a
few days.
Real estate bubble:
Real estate bubbles begin and end in the commercial real estate sector
(which includes large commercial/industrial buildings and large
residential/apartment complexes). This is for two reasons. First, it is
this segment of the market that has traditionally engaged in too much "spec"
developing, where investors develop a piece of property on the "build it and
they will come" theory. They are simply hoping to rent the property out
once it has been completed. The second reason is that the construction
loans made to developers of such projects are almost always on a
non-recourse basis, which means the only collateral the lender has is the
property itself, the developer/investor has no personal liability.
It's not hard to see why such a business environment can lead to bubbles.
If you're a developer and you can convince a bank to loan you the money to
construct an office tower on spec, what have you got to lose? If you find
high-priced tenants, you get rich, if it fails, the bank takes the building
back and you walk away with no liability (only losing the relatively small
downpayment).
Based on this, it is easy to see there is currently no real estate bubble in
the US for two reasons. First and foremost is the fact that even though
lenders have become much "looser" in their lending requirements, virtually
all still require developers to pre-lease a significant portion of the
project they want to build. Pure spec building is still very rare today.
The second reason has to do with the profound effect REITs have had on the
real estate (RE) industry. The reason bankers have had a bad habit of
making RE loans they shouldn't have is that they knew their depositors were
insured, and therefore had little to lose. REIT stockholders have no such
insurance. If you think the stock market has been bad over the past few
weeks, take a look at REIT stocks. They have been in the dumps since the
beginning of the year. The reason is pretty simple. REIT investors feel
the managers of these companies have been overpaying for existing
properties, and overbuilding in many markets (Las Vegas). These investors
have made this clear by selling their stock.
This is the sign of an efficient market at work- REIT managers have to
answer to stockholders who drive the price of their stock down when they
engage in overspending/overbuilding. The managers respond by curtailing
their reckless actions before the problem becomes severe.
The dominance of REITs in the US RE market has dramatically reduced the
chance of a bubble. They have essentially offset and replaced bad
government policy (depositors insurance, among other things) that instigated
bubbles in the past and essentially ensures any bubble in the future will be
small and have minimal impact on the overall economy.
Bruce
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