Tuesday, February 21, 2006
Changes To Come
Three socio-economic events are currently in the making that will dramatically impact North-American demand for residential real estate products in the forthcoming years.
Predicting the future is always a risky business, often confused with prophecy. But whether prophecy is in fact in a broad sense the prediction of future events, it often implies the involvement of supernatural phenomena, whether it is communication with a deity, the reading of magical signs, or astrology. Conversely, in a scientific context, a prediction is a rigorous, often quantitative statement forecasting what will happen under specific conditions. This is the reason why Economists generally speaking prefer to substitute the expression ‘anticipatory forecast’ to the term ‘prediction’. Anticipatory forecasts enable Economists to make quantitative predictions on the basis of probability – and with no need to use a crystal ball. Economics is, afterall, the science concerned with the study of human activities involved in meeting needs and wants within the context of the equilibrium between scarcity and wealth. John Maynard Keynes (1883–1946) once remarked that "Economics is the science of thinking".
There are in the making at this very moment three socio-economic variables that are destined to forever change the way we think of residential real estate in North America. This is so because all these three events will profoundly impact consumers’ demand for housing products. Ultimately, the basis for the real estate market is the demand by households, businesses, governments and institutions for space and shelter to conduct activities. Consequently, as demand changes in direct function of human activities and economic and demographic variables, conditions within the real estate market change. The variables that will affect demand for residential housing products in the next few years are:
[ ] Cost of energy.
[ ] Aging population.
[ ] Globalization.
[ ] Cost of Energy
Prices of gasoline are higher today anywhere from twenty to twenty-five percent than they were in 2004 and there is looming on the horizon the expectation that price of crude will top the $80 per barrel in the relatively near future. Researchers peg the cost per bbl at a staggering US $100 by 2010. If this condition will occur, the average consumer will pay $50 for a tank fill up in 2010 as opposed to $25 today. Additionally, the oil industry anticipates that the world global output will have peaked by the year 2015, which then is a sure sign that from then on the US $100 per bbl. price tag will be there to stay for a very long time. Those dramatic increases, former Feds Chairman Alan Greenspan declared almost a year ago, will create a significant drag on economic growth
The silver lining, added Greenspan, is that as oil gets more and more expensive other technologies that use less oil will become more and more competitive. And that seems to be exactly the case. Hydrogen fuel cells, ethanol from vegetable matters, solar cells, wind power, synthetic gasoline from coal – all could make a dent once they are available in sufficient quantities. But the real question is: are we moving fast enough? As consumers we need time to make adjustments – often very expensive ones – to the new technologies. Not everyone can afford to junk a two-year old SUV to buy a new hybrid. Likewise, most people can’t afford to abandon houses built in developments 100 miles out in the countryside at a time when oil was cheap. And although governments, energy and power companies are investing in new technologies, they can’t create a massive new infrastructure overnight. The problem with the free market, as it has been always the case, is that while it may sort out things over the long run, people have to cope in the short run. As a direct and proximate consequence, therefore, the likelihood is high that we may have to endure a tremendous amount of economic and social hardship that could have been averted had we acted sooner.
In light of the foregoing, cities in North America, which are already energy inefficient, are destined to become even more and more so. It is going to cost too much to commute from one side of town, where you live, to the other side of town, where you work, even if you carpool or use public transit. It will become too expensive to heat and light 2,500 square foot homes when, in fact, most people can enjoy them only in their free time over the week-end. A recent study undertaken on behalf of the US Department of Energy details that home heating costs can be expected to skyrocket in the forthcoming years. For example, the Department of Energy predicts that homes heated with natural gas could see their fuel costs explode by as much as 48 percent by 2007. And the cost of home heating oil could surge by up to 32 percent.
It is the general consensus of those involved in economic anticipatory forecasting, therefore, that by the end of the decade consumers will mostly demand smaller living quarters, and more affordable.
[ ] Aging Population
Ever since the first baby of the post-Second World War generation arrived in the world, Baby-boomers have influenced every aspect of society and have pretty much had and done things their own way. But now the ‘boomers’ are getting old. In just five years' time 77-million Baby-boomers will start collecting Social Security benefits in the United States. In eight years they will start collecting Medicare benefits. By the time they are all retired the US will have doubled the size of its elderly population but increased by only 18 percent the number of workers able to pay for seniors’ benefits. The implications of all this for the real estate industry are staggering. For one thing most Baby-boomers will have become empty nesters with children already out of the house and, as such, five-bedroom homes will no longer be neither wanted nor needed. Which in turn means that large, sprawling cities are once again destined to become outmoded, as vertical construction (also known as elevation construction) will take strong precedent.
In Canada, a report of the Urban Futures Institute outlines that the aging Canadian population will consistently dominate real estate markets just about everywhere in the country. Unlike previous generations who were more likely to move into smaller homes, eliminate mortgages and cash in their equity as retirement approached, the Freedom 55 generation, as it is sometimes called, is more likely to upgrade to more expensive properties, while assuming new mortgages. More expensive but not bigger properties. There is a trend identified by the Institute for the boomers to make their way out of the suburbs and back into the city. The Urban Futures Institute prognosticates that as retirement age approaches they will trade down their large mansions in the suburbs for high-class downtown condo living, thus driving prices upwards especially in the most expensive category. More and more the adult lifestyle component will be the major force impacting how condominium complexes will be conceived and built. It will impact developers, architects and contractors alike, not to mention real estate agents.
The Urban Futures Institute report concludes that it is going to be both a lifestyle and a financial choice for the Baby-boomers — closer to downtown means closer to established shopping, restaurants and entertainment and boomers are of the mind the location will offer more liquidity in the long-term.
[ ] Globalization
Globalization is unquestionably a democratic concept that puts all mankind on the same platform. In Economics we have a special phrase to describe this process of equalization: we call it ‘Democratization of Wealth’. The distribution of wealth throughout all nations would be a flawless concept – in a perfect world, that is. But even at the risk of appearing a little too cynical, it must be said that a closer scrutiny reveals one great advantage as well as one great disadvantage associated with democratization of wealth. The great advantage is that as limited wealth resources are being democratically distributed throughout the planet, poorer nations become richer. The great disadvantage, on the other hand, is that as limited wealth resources are being democratically distributed throughout the planet, richer nations become poorer. Poorer and with aging populations too, it might be added, whereas developing countries all seem to be enjoying the benefits of the eternal fountain of youth.
There is a hidden cost to globalization that is beginning to manifest itself more and more in our daily lives. Increasing interest rates, which are now beginning to affect, first and foremost, the real estate market are possibly one of the best examples of it. The emergence of China and India as new players in the international economic arena comes with mixed blessings. China and India taken together represent close to 40 percent of the world’s population. The end result of a supply of outputs created in China and India destined to quench the huge demand of the pre-eminently American consumerism has generated large trade imbalances. The flip side of these imbalances has been a sharp rise in the net foreign liability position of the United States and a massive accumulation of foreign exchange reserves by the Asian countries. China has amassed more than US $450 billion of reserves. India too has seen a marked rise in international reserves, to roughly US $150 billion. Even more striking, as of the end of 2004, all of Asia (including Japan) had accumulated US $2.1 trillion in foreign exchange reserves.
Subtracting this quantity of Dollars from the economic monetary cycles forces the U.S. Government to borrow more and the Federal Reserve System to print and lend more money with the deleterious effect of diminishing the purchasing power of the Greenback by weakening the strength of the currency. Think of a glass of wine where you keep on adding water. Higher international demand for American Dollars created by outsourcing, foreign savings, fixed exchange rates and a huge trade imbalance account for a large proportion of the refueling of domestic inflation and the consequent interest rate increases, the effect of which will be patently felt all over real estate markets in North America in the forthcoming years.
In conclusion, the combined effects of the foregoing three socio-economic events in the making will impact the real estate industry to the extent that demand for inner core, smaller housing units – typically condominiums - will in all likelihood appreciate to the detriment of the single-family dwellings of the suburbs, which are expected to be in lesser demand. And consumers, investors and otherwise real estate market participants can anticipate that interest rates will be on their way up, although gradually, but continuously in the forthcoming years.
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