Focus on the economy: The end isn't near...but repent anyway!

Real Estate Issues, Winter 1999/2000 by Kelly, Hugh F

Real estate professionals do well to attend to the total economic picture, good and bad. Real estate is best conceived as a residual product of economic activity, receiving its value from the ability to provide functional, well-located, pleasing, and economically appropriate facilities. Real estate exists to house people and their interactions at work and play, to provide a place to fabricate, store, distribute, and sell goods. The very term "economy" comes from the Greek oikos, meaning "house." I have found that real estate, with all its tangibility, is an excellent vantage point from which to view the economy as a whole, since property value so intimately reflects economic demand stemming from every conceivable sector.

If I have my reservations about the current good feelings about the economy - based upon the factors I've listed - I still do not see any immediate stumbling block that would end the successful run of GDP gains in the near future. We have too much momentum thus far in 2000 for any sudden contraction to be likely. Industrial production figures started to improve last summer and the National Association of Purchasing Managers Index for November was solidly positive. Real personal income is advancing smartly and consumer confidence is high. Thus, we have just had the best holiday sales season in more than a decade, both in stores and on-line. After-tax corporate profits have doubled since 1990 and are up 5.5 percent in the past year. We have a Federal Budget in surplus, giving the government plenty of ammunition for economic stimulation should it be needed. And we already have a high real interest rate - the spread of short-term rates over the CPI - that gives the Federal Reserve tremendous monetary flexibility should it be needed, as it was in late 1998.

No wonder that there is snickering at any suggestion that "the end is near" for this cycle. Our biggest danger might be complacency, the optimistic belief that growth will go on forever. Real estate analysts know what this unrealistic faith looks like: revenue projections that grow faster than inflation throughout the cash flow projection, coupled with an aggressive discount rate to calculate Net Present Value.

In fact, we don't know which of the numerous economic risks lurking out there might tip the economy into recession. It is important, though, to recognize that the risks are real. During the long and very impressive cycle of the '90s we dodged a couple of exceptionally serious troubles, including the threat of a commercial banking collapse in the U.S. between 1990 and 1993 and the potential for a severe global decline in 1998. Our hope in continued expansion is the likelihood that many of the weaknesses listed above are already in the process of correction. But the economy gives us no guarantees.

Don't be too dismissive of that old gentleman or his sign. As is so often the case, there is great practical benefit in a biblical injunction: Be watchful. You do not know the day or the hour. The best insurance against the ill effects of a recession, after all, is to anticipate that you will one day need to cope with the downturn. The best time to start that planning is now.^sub REI^