First, there’s the obvious reason: It’s the sheer scale. The total value of the US residential market hovers around $20 trillion. There simply isn’t anything close to it (add up all the cars in the US—maybe 250 million—and give each an average value of $10,000 (8+ years median age), and you only get about $2.5 trillion). The home is the single largest purchase any American will make in his/her life time.
But the reason residential real estate (and real estate in general) drives people crazy is for the less obvious reasons.
Unlike other products in the market, real estate is impacted much more severely by supply (than demand). Why? Because it is immovable.
Once real estate—residential, commercial, hotel, or retail—is placed in service, it cannot be packed up and moved to a different location if the “market isn’t there.” It must sit, wait, and perhaps be repackaged, but it will never be relocated.
In the 1980s, when I ran hotel market studies, we measured demand by counting occupied room nights. But that was simply a measure of how filled the hotels were. Imagine if McDonalds measured its own performance based on how many hamburgers were sold out of the ones they made.
Every day, they make the same billion, and every day, a different number is sold. A lot of waste, isn’t it? That’s real estate.
You may say that airlines face similar issues, but they do have the option of moving aircraft around, canceling unprofitable routes, or otherwise managing their yield. The single scariest event for an old hotel is to find a new competitor opening up next door. It can’t decide to go look for a better location. And an unsold home in Florida doesn’t have the option of moving to Manhattan where the market’s a bit stronger. It is stuck.
Many economists are comparing what is happening to the US to the “lost decade” that hit post-bubble Japan in the 1990s. I was there helping Japanese banks work out their non-performing loans.By the late 1990s, when the US economy was roaring back, there was one state that found its real estate market still in the tanks—Hawaii.
Why? Because a large chunk of Hawaiian real estate was still held by Japanese banks and companies that were still being rescued. In the hotel business, if you can go in cheap, you can win. If a property that cost $500 million comes up on the market for $200 million, you may think, “Great Deal!” But what if the property next door, which cost $300 million to build, is sold for $30 million? Someone buying that $30 million property could underprice your room rates by over $150 a night, and the tourist may not see the difference between a hotel that cost $500,000 a room vs. $300,000 a room.
The same was true in the residential marketplace, where significant patches of land and empty homes were held by Japanese investors and institutions. People shied away because in an uncertain market, there is always a better deal if you wait. So the market simply sat, with no action, no activity, no path for a way out—much like what we are witnessing in the residential market today. Only after the assets were disposed by the banks, or stable operators found, did the market recover in Hawaii.
Back in the US, the latent demand for housing is still here.
The US population did not drop in half in the last six months. Given the tax policies and the generally accurate hypothesis that home prices increase in the long run, buying a home (that the occupier can afford) is still a good investment. Few people doubt that.
The US today is behaving like Hawaii in the 1990s. The big question is whether the actions taken by the Obama administration will set into motion the wheels that will help move supply—banks willing to take losses, servicers trying to make deals, loan officers willing to negotiate with home owners. Political arguments about how the rescue package rewards stupid people lead us to the Promised Land of Doom. After all, lecturing the engineer who designed the Titanic while the ship was sinking wouldn’t have saved a single life.
One thing is for sure, though. Those unsold homes aren’t going anywhere real fast. And the associated problems we face simply won’t go away until we deal with it. And that’s why real estate matters.
Related in the GBR
What Happened to the U.S. Housing Market? by Peggy Crawford, PhD, and Terri Young, PhD
Risk and Return in Public and Private Real Estate Markets by Abraham Park, PhD
Will the Sub-Prime Meltdown Burst the Housing Bubble? by Peggy Crawford, PhD, and Terri Young, PhD