The New Normal: Change

My Dad, a depression baby, used to tell me, “Boy, if you are not moving forward, you are backing up.” At no time in my life has this been truer than the last two years. The capital markets are in a shambles, residential real estate values have gone down by up to 50% in parts of the country and commercial real estate is about to realize huge resets. Banking has undergone dramatic changes and the energy markets have gone through drastic swings, both up and down. The federal government is considering the largest restructuring of health care in our nation’s history. The auto industries have been bailed out and are now being reconstructed. If you can name it, the industry has most likely been affected by the last financial destruction. And it isn’t over yet.

So what is “normal?” The best business schools will tell us that the markets hate uncertainty. This is certainly apparent in the health care industry today. We recently sold a 47 acre tract to the largest hospital in our region for several million dollars. I was ecstatic. What a great anchor for our little 200 acre development. But when I asked the head of real estate when they are going to break ground, he told me to ask Washington D.C. — not George! Even though the hospital needs the new facility very badly, they cannot break ground on a facility that will require about $40 million in infrastructure and two years to develop without “knowing what a hospital will look like five years from now.” Is the new normal constant change?

Joseph A. Schumpeter, the great Austrian-American economist of the 1930s and 1940s, coined the phrase Creative Destruction. He believed in corporate mutation; that we must destroy much of today’s growth-driven economy and many of the ideas we have grown so comfortable with and replace them constantly with new ideas. Schumpeter constantly competed with John Maynard Keynes and his ideas known as the Keynesian Theory. The way I simply put it is that Keynes thought that 1 plus 1 equals 2. If you have 50% of the market and I have 50% of the market, we collectively own 100%. But if you get 60%, I must, by the Keynes’ thought process, be reset to 40%. Schumpeter thought that 1 plus 1 could equal 3 and that if we both embrace change, we can grow the market to new heights. But to get to the new market, old ways of thinking must be destroyed and replaced with new ones — think about blacksmiths and automobiles; main frame computers and PCs; Encyclopedia Britannica and Google; Blockbuster and Netflix and now DVR. In every instance change took out the old and regenerated the new. What if the world had protected the main frame computer industry and had not allowed the PC to evolve?

So what does this mean to us today? Just as our financial advisors will tell us that we need to rebalance our stock and bond portfolios to take advantage of the rapid increase in recent stock appreciation, we need to be thinking about how to rebalance our business life, especially our way of looking at commercial real estate. The old days of having four hard-corners developed as retail on every intersection of four-lane intersections are over. There are many fewer grocery stores to anchor these retail intersections; Mom & Pop cannot pay $28.00 NNN per square foot and make a profit; the banks will not loan to Mom & Pop in their start up business as quickly as they did two years ago; the days of 7% CAP rates are over as well as the days of 5% – 10% equity put into the deal; and last but not least, developers and investors are not going to get financing on pro forma any more — we will be forced to have good tenants with balance sheets that make sense in order to get a loan. So am I saying that the days of commercial real estate are over? Not hardly. But if we are not taking a hard look at our corporate business plan my Dad would tell us that we are “backing up.”

So let’s look at what is going on today by looking at what happened in the Great Depression. My Mom and Dad were Depression Babies. My Dad bought one new car for my Mom in their 35 years of marriage; all the rest were newer pre-owned cars. The two of them only had two homes together in their entire marriage. Compare this to me and my wife, Tricia. We have lived in 10 homes in 35 years and we trade cars every few years and almost always get the replacement vehicle off of the showroom floor. I do not think of this as being extravagant but my Dad is probably rolling over in his grave. But Dad, I am moving forward!

This being said, will the latest bust cause us all to rethink our ways of spending – and saving? I think so. Will society go from buying what it wants to purchasing with it needs? Will we save more than before? What does this mean to retail sales which make up 70% of our country’s economic activity? I think it means the difference in the old normal and the new normal.

According to the American Affluence Research Center (http://www.affluenceresearch.org/), the wealthiest 10 percent of households, as defined by the Federal Reserve Board, have an average annual income of $256,000. They earn 36% of the income earned by all US households and control 70% of the total net worth of all US households. This small group of our nation’s earners drives much of the “want” retail expenditures. Look at the headlines of reports the AARC has published since May:

As the Verizon commercial says, “Can you hear me now?” If spending by the wealthiest accounts for 40% of all economic activity, what does it mean if our government increases taxes on the “rich” to pay for new benefits for the other 90%? Does this mean that the economy is going to go through a massive reset? If so, what does this mean for owners, developers and syndicators of commercial real estate assets? Are we going to have to change the way we think about our business model? As a recent candidate for national office said, “You betcha!”

One Comment »

  1. Bill, very nice article. Thanks for the insight!