Industry scrutinizes eggshell economy

Real Estate Weekly, Jan 17, 2001 by Natalie Keith

The $3 trillion question: soft landing or R-word?

Wall Street isn't the only place where the stock market is being closely watched these days.

New York City real estate professionals, who have long recognized the link between a bull market and a thriving real estate market, are also keeping close tabs on the daily fluctuations of Nasdaq and the Dow.

But even though everyone's watching, no one can agree or what the market's volatility means. Some argue it is indicative of an economic slowdown, if not a full-blown recession. Others take a more sanguine stance, saying even if the economy slows down, the fundamentals of the real estate market are still strong and the market will weather this shakeout.

Michael Zemer, principal of RAK Group LLC said a slowing economy can result in fewer lease transactions due to companies laying off workers or putting expansion plans on hold.

"Commercial real estate users are less likely to expand because of the atmosphere of uncertainty," Zerner said. "However today we find ourselves with excellent supply and demand dynamics which offers some counterpoint."

A slowing economy can also put a damper on the residential market, with people less likely to buy when the stock market is down, added Neil Binder, principal of Bellmarc Realty.

"The buyer generally makes purchases based on the economy. There's less of a desire to liquidate portfolios when the stock market's in a valley. People want to hold onto their stocks and recover some of the losses," Binder said.

Joseph Tahl, president of Tahl-Propp Equities, admits that his view of the current economic circumstances is less optimistic than most. He foresees a looming recession, in part because of the irrational exuberance over the Internet in recent years. In the past few years, the Dow Jones and Nasdaq have seen huge increases that were based on hysteria over dot-coms, not on earnings. In 2000, when the Internet bubble burst, stock values dropped, resulting in a lost of $3 trillion in wealth from the economy, Tahl said.

"The stock market overreacted to dot-coms and the Internet. The increase in valuation was hysterical and unreasonable, it is not sustainable," Tahl said. "I don't think the stock market downturn is over yet."

Tahl recalled that when construction on a certain Upper East Side tower started in 1989, units were pre-selling for $1,000 per square foot. By the time the building was finished in the early 1990s, units were selling at under $500

a square foot.

"In this cycle there is an even greater chance of the condominium market being cut in half," he said.

Steve Swerdlow, managing director of the eastern division of CB Richard Ellis, said it is too soon to determine the stock market's impact on the economy. Unless the economy drops precipitously, he anticipates the real estate market will stay strong, he added.

"By the end of the first quarter, it should be clear," Swerdlow said. "Unless there's a very hard landing we expect the market to stay strong."

With the future of the economy in question, the Federal Reserve Bank two weeks ago took the investment community by surprise by cutting its benchmark interest rate by half a percentage point, from 6.5 to 6 percent. The stock market surged after hearing the news, but has since lapsed back into mediocrity.

Many in the real estate industry applauded the rate cut saying it has an immediate and positive impact on business. Interest rates for floating loans, which companies like RAK Group use to finance capital projects, dropped when the Federal Reserve Bank lowered interest rates, said Zerner.

RAK Group specializes in buying "opportunistic" properties that are in need of improvement such as enhanced telecommunications infrastructure, upgraded HVAC systems, or cosmetic work. Capital improvements programs like these are financed with floating loans, he said.

"The rate cut has an immediate positive impact. If a company has floating loans, then the cut can result in large savings in debt service," he said.

In the residential arena, a rate cut spurs home buying because of the perception of lower cost loans, Binder said.

"Buyers become more stimulated to buy because they perceive that the rate cut will lead to better economic conditions and lower interest rates," he said.

Tahl was less skeptical of the impact of the rate cut, saying it can help spur the economy during slow times but cannot put the brakes on a recession.

"It can help shorten a recession by making personal and corporate borrowing cheaper but, in my opinion, it can't prevent a recession," he said. "The recession this time is going to be led by a decline in consumer confidence, not by overbuilding."