WIN, PLACE, OR SHOW –
Looking Back at 2007 and the Outlook for 2008

It is that time of the year again…the time for forecasting the New Year. In fact, I was thinking about not doing it just to be different, but then I realized that we live our lives with daily forecasts, and we rely on them. Allow me to list a few that come to mind:

Weather Forecasting:
We usually start every morning watching or listening to the “weather guy” or the “weather girl” to give us today’s “outlook” and the “5-day forecast.”

Stocks and Economy Forecasting:
After the weather forecast, and while your still dressing for work, you switch to CNBC to listen to the “big brain” financial folks who tell us what is going to happen with the stock market or interest rates today, this week, this month, this year, and so forth. Each one is as serious and sincere as they can be. Each one sounds so right. I like Jim Cramer, the guy who gets mad all the time. I think that is why they call his show, “Mad Money.”

Sports Forecasting
You leave home for the office, turn on the radio and hear the radio announcer tells you the Monday Night football game forecasted “point spread” and what the experts think about the next horse that will “win, place, or show” at the Kentucky Derby.

Business Forecasting
For those of you involved in a business, you are generally always doing some forecasting. Managers get asked by their boss to do a budget, which is a forecast of revenue and expenses for the upcoming year. The Manager then asks the Marketing Department for a forecast of sales, and the Office Administrator for an estimate of spending (the wonderful world of toner cartridges).

The Environment
This seemed to be the year of global warming. I don’t know who is right, but there are a lot of people forecasting how fast the ice is melting at the North Pole.

Of course, there is the Grand Daddy of All Forecasters, Michel de Nostredame (you know him as Nostradamus), a pharmacist who lived during the 16th century, who made a series of predictions in his famous book, Les Propheties. The book is still in print. Talk about staying power!

A LOOK AT 2007

2007 reminds me of the famous book, A Tale of Two Cities, by Charles Dickens, who is among the English language’s greatest writers and storytellers. His 1859 novel begins with one of the most noted lines in writing:

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way….”

There is no doubt that 2007 will be one of those economic years remembered for a long time. Let’s reflect on what happened:

The Dow Jones Industrial Average hit a record high, and then it corrected 10% in a few short weeks. On any given week, there was a swing of hundreds of points.

Real estate stocks were among the big losers (the Dow Jones Equity All REIT Total Return Index was down 17.62% as of mid-December).

We saw the sub-prime market implode and have a ripple affect on the economy. The largest lender in the county needed to be bailed out. The largest bank and the largest stock brokerage firm in the county fired their respective CEO’s.

The Federal Reserve cut their benchmark interest rate three times in the last quarter of the year. They also injected billions of dollars into the banking industry.

The level of home foreclosures increased to an alarming level, causing the Federal government to use their jawboning influence on lenders to come up with a plan to freeze teaser-rate adjustments for five years. This was in the face of a prediction of two million residential foreclosures in 2008.

2008 FORECAST

2007 was not a lot of fun. As the French writer, François de La Rochefoucauld, cynically wrote sometime in the 17th century, “We all have the strength to endure the pain of others.” He might have been right, but the pain of the market affects everyone, regardless if you are involved in a transaction or not. I heard an interesting figure the other day that sums it up. The housing sector is 15% of the economy, but has an impact as if it were 30%. It is the ripple effect. When a person’s wealth is based on the increased value of tangible assets (stocks, real estate, etc), then there is a general feeling of economic well-being, which translates into higher retail sales and so forth. The opposite effect is also true, which is where we are now. Did you notice that the Christmas price discounting by stores started earlier than ever in 2007 in order to get people out shopping.

So, here we go with my 2008 predictions:

Inventory:
The number of Apartments that will be available for sale will continue to increase, which is consistent with the inventory of all investment properties and the housing market. If you are a buyer, this is good news. If you are a seller, you need to price you property correctly in order to see activity.

Interest Rates:
The pressure in on the Federal Reserve to continue cutting interest rates in order to protect the economy from the “r” word…“recession.” People generally like the clear and open style of Federal Reserve Chairman, Ben Bernanke, but they feel that the Fed has been slow to move rates down. Many now insist that a 3% Fed Fund rate is needed to do the job (down from the current 4.25%). That would get it back to the 2005 level (ah, the good old days). Unfortunately, the interest rate for commercial real estate borrowing has been creeping up because the indices used as benchmarks are not tied to Fed Funds. Rather, they are indexed to Treasury instruments, Libor, and so forth. Also, lenders are increasing their spreads between the index and the loan rate in order to make the loans attractive to the institutional buyers of these “pooled together” loans.

Prices:
The pressure on prices will continue to push downward. This is good news for buyers because prices will be back to 2003 or 2004 levels. The Gross Rent Multiplier (GRM) indicator will be between 11 -14, and Cap Rates will be 4.5%+ range. Santa Monica apartments will remain strong and a good investment.

Buyers and Money:
There is no shortage of investors for West Los Angeles prime real estate….never has been, never will be. All shapes and sizes: local, foreign, wealthy folks, TICs, small partnerships, institutional, pension funds, hedge funds, exchange motivated, first-timer, tall, short, and so forth. In down turning markets, seasoned buyers will write “lowball” offers to test the market and determine a seller’s motivation.

Borrowing:
The underwriting pendulum has now swung fully to the conservative side. The fun days of limited buyer verification, aggressive valuations in order to make a loan, and high loan-to-value ratios are over. Better be prepared to put 40-50% down to buy an Apartment property, especially in Santa Monica and the Westside. Plus, as mentioned above, the spread between the lender’s index and the loan rate will increase in order to keep the loan rate attractive to the institutional buyer.

Alternative Investments:
I think that many Apartment sellers, including those in Santa Monica, will look at other types of real estate investments as an alternative. I am speaking of commercial properties that are leased on a long term basis to a major tenant. There can be nothing finer than a property with a 20 year lease, 2-4% annual increases in the rent, a corporate guarantee, and no responsibility for expenses (this is called a “Triple Net” lease). It makes going on vacation a little more relaxing when you are not going to be called about the water heater leaking in unit # C.

The Economy:
I do not know if we are going into a recession. A recession is defined as a negative growth in the Gross Domestic Product figure for two Quarters in a row. Since that is a look-back statistic, we do not know if we are in a recession until we have been in it. Like you, I listen carefully to the experts. What is clear is that there is a widespread disagreement on the subject. This puts a lot of pressure on the Federal Reserve. Also, there is enormous pressure to strengthen the housing situation. Two million foreclosures in 2008 would probably trigger a recession. I was pleased to read that the National Association of Realtors issued a forecast in December saying that “….the battered housing market is on the verge of stabilizing and inched up its outlook for 2007 and 2008 home sales.” I hope they are right. Let’s be optimistic and just say that everything will be done to avoid a recession in 2008.

Presidential Election:
I have many friends and clients on both sides of the aisle, so I will not make a public prediction regarding who will win next November. I will say that it is important for the next President to deal with the economy in an aggressive manner. For one thing, budget deficits are inflationary, thus, bad for the economy. Foreign policy gets a lot of attention in the debates, but I want to hear more about taxes. I do predict that the next President will not tamper with the very favorable Capital Gains tax rate.

CONCLUSION

As they say in the movie business, 2007 is “in the can.” Now it’s off to the races with 2008.

It is not hard to figure out what to do in an up market. Doing nothing is often a good alternative, especially when we see a prolonged period of strength. The down period of a cycle is the tricky situation. Do you stay with you property? Do you sell it? Do you exchange? Do you refinance? Do you buy another type of property? All of these are touch questions, but they are also financial alternatives to analyze and discuss. Reviewing alternatives with market professionals is a good course of action because every situation has another side of the story, another way of thinking, or some alternatives.

The property owner ultimately makes the decision that suits their best interests. Real estate brokers are among the professional service providers that can assist and provide input about the market and the alternatives. Other members of the decision making team includes lawyers, accountants, and other trusted business confidants. The process of reviewing a property and its alternatives requires patience and skill. Don’t make a decision in a hurry– approach it as a deliberative process. Gather information, deliberate, and then make the decision that is the best for you.

By doing all of the above, if someone asks you in the future, “How was 2008 for you?,” you can say, “It was the best of times.”