Principles of rational investing still apply

Principles of rational investing still apply

Riggs, Kenneth P Jr



As America regroups after the September 11 attack on the World Trade Center and the Pentagon, investors are watching how terrorism and its aftereffects will play out in an economy that was already stagnant. As we go to press, we’re seeing reports of huge layoffs in the airline industry, in the auto industry, in durable goods manufacturing, and in hotels and restaurants. Gross domestic product growth, which had declined last quarter, seems likely to decline further. A recession, which was only speculative previously, now seems certain.

Given such an economic situation, many investment opportunities appear grim. The stock market continues its roller coaster ride with insurance companies, the airline industry, hotels, and other travel/tourism industry holdings now joining tech stocks at the bottom of the hill. Mutual funds, 401k and 403b funds, IRAs, and other favored investment vehicles, which had finally begun to stabilize earlier this year, are expected to lose ground. Even bond funds, considered less risky than stocks or other funds, are troubled.

This is the backdrop in which commercial real estate competes for investors. The spatial (supply/demand) fundamentals will be negatively impacted by recent economic events; however, commercial real estate capital players should view this as a long-run opportunity to seek a stable environment by investing in well-leased, well-positioned commercial properties. Regrettably, the commercial property types that will feel the full impact of recent events will be hotel and retail properties.

Temporarily, there was some doubt about the riskiness of commercial real estate investment in such an environment, too. Immediately after the September 11 attacks, some of the bigger real estate investment deals were being delayed, although many of these are now going forward. In fact, reports from federal bank regulators now say that few such loan requests are being turned down, and that money is available to investors with a rational business plan, appropriate collateral, and a good track record.

This is good news for investors because it seems that “rational property– level analysis,” which we have always recommended over the “bounded rationality” influenced by emotional factors (like fear), is still the key to sound investment. By focusing on the empirical data associated with a property and objectively evaluating a region’s economic condition and outlook (due diligence), investors are more likely to be able to reduce emotional influences (such as fear) in their decision-making.

Comparing the economy leading up to the Persian Gulf War 11 years ago with the one we are experiencing now, can also provide insight into the climate for real estate investment in the months ahead. For example, the consumer confidence index in January 1991 dropped to half of what it was in August 1990. Likewise, in September 2001, consumer confidence and spending, which comprises two-thirds of the American economy, fell to 97.6 from 114.0 in August 2001, the largest single monthly drop since the Persian Gulf War. Given the likelihood that economic growth will continue to decline, we believe that consumer confidence and spending will drop further as long as unemployment or fear of unemployment exists, thus negatively affecting retail throughout the holiday season.

As reported in the second quarter 2001 RERC Real Estate Report, the consequence of slower growth in an economy results in unemployment, and as people lose jobs or fear losing jobs, growth for commercial properties slows as well. An increase in unemployment, spurred on by the events of September 11, indicates that demand for commercial properties may decline quicker, especially in regions with a high concentration of unemployment. Even apartments are not immune. Looking back to 1990, apartments were in equilibrium with both vacancy and absorption rates around 6 percent. Apartment absorption fell to 4 percent in 1991, however, after the U.S. became more heavily involved in the Persian Gulf War. If history repeats itself, apartment absorption and return on investment will decline during the current downturn as well (except for apartment developers in regions with a high employment in growth industries such as energy or defense).

The willingness of the federal government to take a proactive stance in strengthening our economy is also expected to help alleviate the fear investors are feeling. Appropriating billions of dollars to help bail out the airlines and rebuild Manhattan; floating money to the banking system immediately after the tragedy; relaxing laws so companies can buy back their own stock; and taking on the responsibility for airline safety are just a few of the measures already underway. The Federal Reserve is doing its part to lift the economy as well, by reducing interest rates nine times already this year, including a 0.5 percent drop promptly after the September 11 tragedy and a second 0.5 percent drop in early October. Federal Reserve Chairman Alan Greenspan, reminding Americans that while they struggle to make sense of the attack and its immediate consequences for the economy, they should not lose sight of America’s longer-run prospects, which have not been significantly diminished. Greenspan has expressed his willingness to further reduce rates this year, if needed.

Despite the tragedy of September 11, there is much room for optimism in the U.S. economy and in real estate in particular. For now, commercial real estate located in employment centers that are directly impacted by recent layouts and property sectors that depend on travel are being negatively affected. However, investors interviewed indicated that properties outside this envelope that are well occupied and are situated in markets with solid demand fundamentals have yet to be negatively impacted.

Regardless of whether or not there is a recession, the U.S. economic structure is sound and the real estate market, with a few exceptions, is resilient and in a state of near-equilibrium. Unemployment, while increasing, still remains near historical lows; interest rates are the lowest in 30 years; the banking industry is generally strong, liquid, and responsive; and there are few, if any, signs of massive oversupplies in business inventories or commercial property. Although the economic and financial environment is evolving each day and investors are faced with a tremendous amount of uncertainty, we believe investment decisions based on rational analysis of properties and their markets will continue to serve well.


Ken Riggs, Jr., CRE, is chief executive officer of Real Estate Research Corporation (RERC). RERC provides investment criteria (cap rates, yield rates, recommendations, etc.) for nine property types on a national and regional level, as well as for 21 major U.S. markets. Riggs’s firm also publishes the quarterly RERC Real Estate Report as well as provides other reporting and online services. (E-mail:

Copyright American Society of Real Estate Counselors Fall 2001

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