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[Fee Simplistic] Short Term Thinking In Long Term Cycles

Fee Simplistic is a regular post by Martin Tessler, whom after 30 years of commercial fee appraiser-related experience, gets to the bottom of real issues by seeing the both the trees and the forest. He has never been accused of being a man of few words and his commentary can’t be inspired on a specific day of the week. In this post, teaches us to be wary of short term cycles and think big picture. …Jonathan Miller


One of the advantages of having toiled in the real estate valuation world for some 30 years is that you cannot help but develop an institutional memory and particularly a conviction that the market operates in cycles. As a young analyst with an educational background in real estate economics my involvement in a variety of consulting and appraisal assignments on income producing and corporate properties was always rooted in aspects of supply and demand. Grandiose plans by developer clients did not deter our drawing negative conclusions if poor market demand resulted in long absorption periods and economic infeasibility.

My first exposure to the chasm that could develop between real estate markets and client expectations in appraised value (these were the days of pre-FIRREA/USPAP) was in the early 1970’s. At that time the then nascent world of mortgage REIT’s was a period of very aggressive lending that could be characterized as “money chasing deals”. Many of the assignments involving new development did not seem to pan out to the scenarios or expectations of clients in terms of value or anticipated time horizons. Anyway, this was not our concern and one would have to assume that any shortfall in value or other expectations would have to be addressed in the underwriting by the lender. The aggressive REIT lending cycle of the early 1970’s was exacerbated and came to an end as a result of the first Arab Oil Embargo/Energy Crisis in 1974. This led to vast double digit inflation and interest rates and the term “disintermediation” -the word coined by PhD economists to explain the vast withdrawal of deposits from passbook savings accounts that were paying single digit interest. Financing for new construction all but disappeared in light of these cyclical conditions.

Fast forwarding to the late 1980’s saw a different phenomenon develop: aggressive lending by S&L’s and fraudulent valuations by unscrupulous appraisers leading to massive loan writedowns and foreclosures. To save our banking system the FED under Mr. Greenspan drastically lowered interest rates and Washington created the RTC (Resolution Trust Corp) to package the bad loans. Not the least of these reforms was the passage of FIRREA in 1989 and the adoption of USPAP. While this did not deter the miscreants entirely it did cut down on aberrational mortgage lending supported by such fraudulence.

Today, one cannot pick up a newspaper or turn on the TV without hearing how our housing market is crashing and bringing the economy down. Lost in this reportorial rhetoric is the fact that the housing market is not one mega-market but many individual local markets with varied demand based on employment prospects. Markets that have not caved are likely to be those where employment has grown or at least not declined. Using New York State data, housing prices have appreciated 73% over the past 5 years with median price rising 11% between 2004-5. Can this hot trend continue? Perhaps in the Manhattan market where booming Wall Street activity portends huge year-end bonuses and likely to drive demand. Will this spill over to the rest of the State not likely if one takes into account that Buffalo, Syracuse, Rochester and Albany are also in New York. Any market declines are likely to be localized and cyclical rather than nationwide. Applying a long term perspective to the market can bring into focus that we have been mesmerized by a short term cycle over the past 4 years and cyclicality and real estate are not mutually exclusive.

For those who believe that markets must always be on the upswing to higher values or prices it reminds me of the joking we used to do in the earlier days when Discounted Cash Flow (DCF) analysis first came into practice. We called it the 4th Approach to Value: “you tell me the value you want and I’ll tell you the assumptions you have to use to get there”.

Semper Fee Simplistc