Monday, May 14, 2007

A Fork In The Road

The great American Philosopher Yogi Berra once remarked that “when you come to a fork in the road, Take It.” This is actually more profound than it appears.

When the road forks, you can choose one way or the other, or you can decide to remain there at that point, stopped in the road. Dynamic markets, like real estate, do not stop at the fork. They continue on their way influenced by basic economic principals of supply and demand.

Past real estate moves can help us understand where the market will go from here. For example, when older towns have been revitalized after long periods of decay, they tend not to develop along straight trend lines. Visionaries see the potential of the dilapidated real estate and start to buy. New activity spurs new commercial and retail development and traffic.

Others, including speculators, see this early bloom and follow suit, and prices rise quickly. They rise based on the anticipation of what will be instead of the practical issues of how much income can properties generate. Existing tenants are forced out as their new landlords increase rents based on the costs of acquiring the buildings instead of the rent that can be supported based on existing retail traffic. A new group of retailers starts to move in, replacing the sleepy original tenants; but all struggle, as the town economic activity has not kept pace with the price appreciation or costs.

After a growth spurt, the market needs to pause and take a step back, permitting a new alignment of real estate prices with the underlying commercial activity to support it. The further and faster the real estate appreciation gets in front of the commercial development, the longer and steeper the re-alignment back to a sustainable long-term market.

The residential housing market is at this point of retrenchment. The rapid run-up in prices could not be sustained by the incomes earned here. Further, the “other expenses”, i.e. Insurance and Taxes, exacerbate the affordability problem. It will take a while for the market to adjust itself. It cannot happen overnight, but it will eventually. Prices will come down, expenses too. That gets us through the next few years. After that, we will have to see how fundamental issues play out. Issues such as: How our officials develop growth plans, infrastructure and taxes; and insurance. Those hard choices will help the market determine whether it takes the path of long-term economic health at the next fork in the road.

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