May 23, 2024


Profitable business

Real Estate Outlook 2007: The Great American Iced Lemonade!

6 min read

Did anyone out there ever coined the phrase ‘The New Era Of American Socialism’ yet?

Well alright, that is unfair. After all Real Estate was sliding downwards even before the Democrats took over the House and Senate, and Nancy Pelosi became the Speaker to be. However, it can be safely stated that the recent mid-term elections have not exactly shed a ray of hope on the already faltering housing prices. So now, in light of the entirely new and revolutionary political landscape in Capitol Hill, what are mundane folks like you and I supposed to do?

Sure, the social agenda of the Democratic Party in general, and the personal ‘socialist’ agenda of Congresswoman and Speaker of the House Nancy Pelosi (D-Cal.) in particular take somehow the breeze out of the investment world, both as it relates to Real Estate and the Stock Market. But when it comes to Real Estate, however, there are some positive notes worth mentioning.

Housing supply is produced using land, labour, and various inputs such as electricity and building materials. The quantity of new supply is determined by the cost of these inputs, the price of the existing stock of houses, and the technology of production. Essentially, the production of real estate output depends on the accumulation of capital, which requires a constant supply of labour force that can conserve and add value to inputs and capital assets, thus creating a higher value.

The rationale behind this is that labour adds value by satisfying demand through production, since when people work and acquire income they tend to invest it, and the more people that work and acquire income the more people that tend to invest it. Therefore, there is a correlation between capital and employment in real estate or, if you will, between income and labour. An increase in levels of consumption sets forth an increase in prices caused by a corresponding increase in demand, in itself generated by a commensurate increase in the income-employment factor.

It follows, therefore, that growth is derived by the equilibrium of capital and investment with labour and employment. And since, furthermore, production is in direct function of consumer-spending which increases as unemployment falls, it follows that capital accumulation increases as employment rises and capital accumulation decreases as employment falls.

Therefore, seen from this perspective, the Democratic agenda of both increasing minimum wages and put people at work through more direct governmental intervention than the Republicans otherwise would like to see, finds in fact its long-term benefits in Real Estate. It is a statement of fact that, in retrospective, many workers in North America have missed out and are missing out on the rewards of globalization, so trumpeted about by both the present Chairman of the Federal Reserve System, Prof. Bernanke, as well as the former Chairman, ‘Maestro’ Alan Greenspan.

Rich countries have democratic governments, so continued support for the globalization process will depend in large part on how prosperous the average worker feels. Yet in the United States real wages have been flat or even falling these past few years while, at the same time, capitalists and large corporations have never had it so good. In America specifically, profits as a share of GDP are at an all-time high of about 15.5 percent, and Corporate America has increased its share of national income from seven percent in 2001 to thirteen percent this year.

In fact the primary culprit and cause of the slowdown in Real Estate is the ratio between wages and real estate market values. This ratio is entirely skewed to values. Whereas market values in metropolitan areas have appreciated an average of fifteen percent per year through 2005 inclusive – or a total of seventy-five percent since 2000 – salaries have increased an average four percent per annum – or twenty percent total. There is, therefore, a fifty-five percent gap, which accounts for the problem buyers are facing today when it comes to go to the bank and qualifying for a loan. In this sense, therefore, a redistribution of income from capital to labour is now due.

The flip side of the Democratic agenda, however, is that it is going to take a long time for government economic intervention to get a foothold in the economy, in order to make workers earn income sufficient enough so that they can go to the bank, get a loan and go shopping for real estate. Thus, it is going to take equally long for demand to jump and prices to increase as well. This is so because demand is in direct function of underlying personal income. An increase in personal income will encourage investment to a higher degree, which, in turn, will spur demand causing a proximate levitation of prices and subsequent economic expansion.

A second but equally important flip side is how foreign investors and debt-holding nations are going to view this sudden shift to the left of the American behemoth, and whether emerging economies such as India and China will continue to finance America’s spending habits. Confidence in the U.S. Treasury is out of the question, but how convenient is it going to be for foreigners to continue investing in an America tilted definitely to the left?

Many economists have long been expecting America’s widening current account deficit to cause a financial meltdown in the Dollar, and the main reason as to why this has not happened yet is that emerging economies have been happy to finance the deficit. In 2005 India, China, South Korea and Japan (not an emerging economy but a very important debt-holder nonetheless) ran a combined current account surplus of about USD 2 trillions, a large chunk of which was reinvested in American Treasury securities. It is all to be seen, however, whether the Asian Tigers will continue to find the convenience in investing their foreign cash reserves in American securities or if instead they are going to withdraw their support of the American capitalistic system, especially if such system will be perceived increasingly as shifting much too much to the left.

Buy purchasing Dollar assets the Asian economies and Japan are subsidizing American consumers, encouraging too little saving on our part and too much spending. But should they decide not to buy anymore and in fact to cash in, the American economy is likely to suffer a real hard landing. This is the reason why it is important to monitor and understand how developments in the world economies affect the balance between domestic demand and supply. Exchange rate movements tell something about economic developments that may be having a direct impact on aggregate demand.

By monitoring the fluctuations of the Dollar in the forthcoming months it will be possible, therefore, to anticipate whether the Central Bank will ease or tighten monetary policy by stimulating the economy through lower interest rates or by reducing the stimulus through higher interest rates. And, therefore, it will be possible to predict the impact that anticipated shifts in interest rates will have on demand for domestic real capital assets. Clearly, in the eventuality that demand for U.S. Treasury bonds will abate, the Federal Reserve will have no other choice under the present circumstances but to raise interest rates, so as to continue to attract foreign capitals and thus contributing to a further slowdown in the domestic housing markets.

Should a forced rate increase actually take place in 2007 to maintain the momentum with foreign debt-holders, that would really fly in the face of all those analysts and commentators who have assumed that a vote for the Democrats would contribute to a rate settling.

Certainly we are entering into a period of financial uncertainty, all the more remarked by what promises to be an economic – if not political – stalemate between a conservative White House and a liberal Congress. And should this stalemate translate into higher interest rates, the soft landing that Chairman Bernanke was mentioning only this past July may very well become in 2007 a distant, wishful dream.

Luigi Frascati

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