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The Last Gargoyle
Many people are a little puzzled about the Fed's fear of imminent inflation. One, large part of the economy is about to complete a reversal of an eight year trend, and resulting scarcity does have some inflation potential.
Commercial and multi-family real estate has been in a condition of oversupply ever since about 1986. Insane lending policies and non-economic tax avoidance schemes produced an amazing inventory of empty buildings. These empties were known as "see-throughs:" no tenants, no interior partition, and you could see right through 'em.
In the black humor typical of disastrous markets, other architectural descriptions came into play, the leading ones being variations on "overhang." Unsold and unrented buildings were said to overhang the market.
A form of overhang on a building is a gargoyle, the nightmarish sculpture attached to high ledges on European churches, and many a traditional office buildings in places like New York.
Gargoyles have a habit of falling off their buildings during minor earthquakes, when a large truck goes by, or as a result of poor construction or old age. Sudden detachment has a predictable impact on passersby, below.
The number of unsold gargoyles overhanging a given market was a matter of serious interest to your average pedestrian investor. You never knew for sure when you were going to get hit.
This uncertainty about the magnitude of unsold inventory is unique to commercial real estate. In nearly any other market, if product is for sale, it's for sale. Not commercial property. In that market, there is the institutional embarrassment factor.
A financial institution, insurance company, or investment fund may carry a property on the books at its acquisition value for a long time after its true value has fallen. At least until some convenient moment, or when forced to recognize a loss by regulators, accountants, or stockholders. To sell is to recognize true loss.
This overhang of "distressed," "troubled," and "non-performing" real estate made it though to find a buyer or tenant for anything. An investor might search the Houston market for a building to buy, and buy the best deal available, and then discover to his horror that another 327 buildings amounting to five million square feet of see through space was headed for the market, but not yet there.
It has taken a while, about eight years, but those overhanging gargoyles are almost gone. A combination of excess supply and credit crunch has meant hardly any new construction, and the market just had to wait for enough buyers and tenants.
After all this time, it's strange to discover that the wreckage of the S&L bailout is all cleaned up. There has been no fireworks display, no ticker tape parade, and no memorial service at the National Cathedral. It's just over.
Don't believe it?
When was the last time you read a story that a big bank's earnings were hurt by new foreclosures? When was the last time you heard about all unsold property held by that wonderful whipping child, the Resolution Trust Corporation? (Whitewater doesn't count.)
Cushman & Wakefield, the commercial brokerage firm, says that overall commercial vacancies nationwide are back down to 18% from highs at 30% to 40-plus. In several of the worst urban markets, vacancy rates are the lowest since 1986.
However, before prices and rents can rise, and bother the Fed, there is one last gargoyle to crash. It's on its way down right now.
Remember when people were worried about investors from Japan "buying up the American heritage?" We were going to "sell our birthright to Japan," right?
Well, the real estate accounting firm of Kenneth Leventhal & Company says that of the $77.3 billion worth of real estate bought by Japanese investors since the early 80's, roughly 40% will have been sold, or "restructured" by the end of this year. ("Restructuring" is the boardroom term for loss of shirt.) Around $17 billion worth of property will be unloaded in some way this year alone.
It's adding insult to injury, but only the least capable investors buy at the top and sell just before the rebound. The Fed probably has some time before it's annoyed by a too-hot commercial market: only once a generation does an investor show up who is as inept as the owners of this last gargoyle.
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