Commercial Real Estate Finance

While attending RealShare Philadelphia 2010 recently, Dr. Peter Linneman, a renowned economist and UPenn professor spoke about the economy and its impact on real estate.  He made a very interesting observation regarding the stagnation in the economy, and subsequently, its strain on commercial real estate.

“How many of you watched the Super Bowl?” he asked. “What if when the Saints scored a touchdown, the refs decided to put up 6 points for the Colts?  What if when the Colts kicked a field goal, the refs decided not to award them any points?  What if the refs started making tackles and intercepting passes?  Would you bet on that kind of game?”  Rhetorically, he followed, “No, you would probably turn the game off after 10 minutes.  Why?  Because as entertaining as it may be, its a stupid game and impossible to predict the outcome.”

“Regulators enforce the rules of the game to be played, much like referees in sports. Right now”, Linneman says, “the Fed, FDIC, and Federal Government, all of whom are supposed to be regulators, and thus referees, are acting as players too.”

Just look for instance at the healthcare sector.  Hospitals have been delaying necessary improvements for the last 18 months due to the impending Obamacare legislation.  While they must perform some level of improvements at some point, meaning they cannot delay the inevitable forever, the healthcare industry’s mantra has been, “why do something now when we might benefit more by waiting?”  Or, maybe more appropriately, “why do anything now when the rules may change on us at any time, and we do not yet know what the new rules will be?”

To put this in a commercial real estate context, imagine if regulators decided today arbitrarily that no rents could increase on any commercial space of any kind until they say so, giving no indication of when that might be.  How would your pro forma look then?  What assumptions would you input into your Argus model? What percentage probabilities would you assign those assumptions to have?  Of course, the answer is that you would have no clue.  Velocity would fall off the face of a cliff (as if it already hadn’t) because the competitive advantage in real estate is much the same as the competitive advantage in any other industry….information.  If you don;t have any information, and have no reasonable way to ascertain even a best guess, you are going to be more likely to simply sit on the sidelines and do nothing until information becomes available.  Sure, some people may take a risk, but its a crap shoot at best, and a disaster at worst.

The bottom line is that regulators need to stop being players in this game.  They need to set rules, and then enforce them, and that’s it.  Let the players play the game and decide the outcome.  That is the only way a game, or an economy, can properly function.

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