Location X 3 right? With almost 100% certainty, every real estate broker and practitioner will tell you the single most important aspect for real estate is its location. Generally speaking, this is the accepted axiom as market demand for a particular property to a great extent is based upon where it is rather than what it is. Let’s discuss market dynamics though and how market influencers’ impact in a tangible way the value of a particular property at a given point in time. Market dynamics as defined from an economist’s perspective is the dynamic on consumer prices when the supply chain is disrupted with more or less product & services. For our purposes, we are defining market dynamics for real estate and how events impact value and pricing aside from the supply/demand dynamic.
Thus, market dynamics is the inter-relationship between real property value/price and the disruptive changes or events that occur in the market in which it occupies. These changes can be considered disruptive technologies although they are not all necessarily a new innovation that triggers a change in the status quo. Change emanates from a multitude of sources that can include regulatory and policy changes as a result of an election with a new government and agenda.
The Trump administration intends to propose substantial tax reform to Congress, something essentially left unchanged since the tax reform act of 1986. Undoubtedly, any revisions to the tax code will result in numerous disruptions to the way real estate and business transact. Some disruptions can and will be positive, some may be negative and have widespread causal effect across the entire economy. As was in 1986, the tax reform act changed a lot in the general tax code, depreciation schedules, brackets and so on, but virtually everything in the commercial and investment real estate economy was altered seismically and from that point forward. From a tax shelter perspective, everything was different. No longer could passive real estate losses be used to offset ordinary income. Passive losses could now only be used to off-set passive income and with limitations. This disruption meant real estate had to produce something. Real estate had to generate a use and/or cash-flow to be a viable investment or commodity. This was a disruptive, fundamental change that shook the real estate markets loose for a long while and likely led to the S&L crisis that soon followed.
Market dynamics can include new investment and developments entering a marketplace that influence employment factors, transportation routes, real estate taxation, housing absorption and so on. Market disruptions in one arena may affect entirely different and apparently un-related markets and sectors. When Boeing Corp. announced it was relocating its’ world headquarters from Seattle to Chicago back in 2001, the price of downtown housing rose in exuberant, speculative anticipation. The realizable impact on housing prices became quite disappointing to those that speculated when it was evident that just 200 white collar executives were relocating to Chicago, not the aviation giant’s labor force.
Change determines how buyers will acquire and how sellers will price as a function of interdependent market factors that influence supply and demand, population growth, employment, shopping, transportation, school districts and so on. These influencing market dynamics also determine how buyers will react to price increases, or how sellers will react to changes in demand and how changes to one supply-and-demand dynamic may affect other products, services or consumer sectors. In simple terms, the market conditions, area, prevailing trends, development activity, demographics, gentrification, and so on all play an integral role in the viability, value and consequently the pricing of a specific property type or asset class. This sounds like location right? No. This is market dynamics irrespective of location.
Market dynamics are macro and micro in nature as the dynamic event or change can have global effect or local effect. Macro dynamics for example could include the potential repeal of the 1031 tax-deferred exchange as part of Trump’s & Congresses tax code overhaul. Repealing the 100 year old 1031 tax-deferred exchange could bring seismic disruption to the real estate market and the general economy. Many economists and experts believe the 1031 tax-deferred exchange influences perhaps as much as 40% of all real estate transactions in the U.S. Also a multitude of other businesses such as aircraft leasing and construction equipment purchasers utilize the 1031-exchange routinely in their respective businesses. This vital tax provision creates liquidity in the markets as Sellers trade-out and Buyers trade-up. Can one imagine what would the economy look like with a 40% take-away of its transactional volume? If seismic, disruptive events like these occur, the harmful impact on real estate values and pricing will resonate across the market and economic spectrum. This would impact all of us that broker, buy, sell, lease, appraise, invest and use real estate and the incalculable collateral impact to every other business and sector across the U.S. economy.
E-commerce, certainly an impactful disruptive technology has brought profound change to every market none the least of which is the retail real estate market sector and in every aspect. Adaptation to the technology was/is required to participate in the e-marketplace opportunities and we are seeing multiple examples across the retail spectrum with companies moving to an e-sales format in concert with their brick & mortar stores. Similarly, traditional e-stores are developing a bricks & mortar platform, e.g. Duluth Trading Co. and Amazon. Ostensibly this is not a zero sum game, with winner take all. Coexistence seems to be the resulting reality after several years now where both retail formats can be viable.
Micro dynamics by contrast bring about a more localized impact and can include for example a new Amazon distribution facility announced into a suburban marketplace. Amazons presence brings employment, tax revenues, road construction, and new housing development. et. al. and even something less tangible but nevertheless equally dynamic, optimism. In real terms, if Amazon decides to build a distribution facility in a suburban locale, then this is a good area and good for all those that will benefit from its presence. A neighborhood that has been targeted for grant subsidy gentrification that may take the form of a TIF district (Tax Increment Financing) is another local market dynamic that can deliver significant, positive impact to a blighted community.
Market dynamics can occur swiftly and with little predictability. Dynamics can be triggered by elections, optimism, pessimism, acts of God, policy change, re-routing of freeways, availability of financing for a particular asset class, e.g. multi-family construction financing and so on, all impact real estate in many ways. Dynamics occur when a new development or retailers enter a market bringing profound collateral effect to the area businesses and real estate. Dynamics occur when subsidy capital flows into a sector that creates demand for a type of property or similarly when capital is depleted, e.g. when the green energy wind turbine subsidies were depleted, agri- land spec buying all but vanished and land was either farmland again or acquired for residential or commercial development, if then feasible. Market dynamics can be positive and negative influencers and emanate at any time from a variety of sources with causal effect.
When acquiring real estate for personal use and/or investment, an astute investor seeking alpha wants to be in front of positive market dynamics so he can acquire before price increases. Conversely, an astute seller wants to be in front of negative dynamics so he can off-load before forces negatively impacting the market occurs. You don’t want to be the last one standing when the music stops. Which brings us to the last subject in this article, predictability.
When can predictability and pricing be harnessed for accurate investment analysis and action? As stock pickers often use some form of a systematic approach to find value in the myriad of investment seminars, trend reports, charts & graphs, lunar cycles, PE ratios, earnings reports, quarterly forecasts et. al., a savvy real estate investor can use a similar systematic approach to finding value and opportunity in the real estate market. Tracking land sales in a particular county that is slated for interchange exits and/or government subsides, i.e. who is buying and why? Understanding the buying criteria/habits and deal flow of the chain stores can give insight to the investor may want to acquire cross-corner sites near a Walgreens or McDonalds for spec investment in a given demographic.
The swift nature of some disruptive occurrences cannot be foreseen and the market dynamic may be impacted positively or negatively for a period of time and/ or indefinitely. Be aware of the influences that impact the values of real estate as not all occurrences can be predicted or even understood until it has occurred and the impact is realized. Market dynamics occur constantly. Market knowledge and information are the best hedges against the unforeseen. Information comes from a variety of sources including your broker, appraiser and allied service providers/advisors. Be armed and be ready as the one predictable constant in the commercial real estate market is dynamic change. Much change can be positive, some negative but all change presents opportunity if it can be recognized, understood and acted upon.
By Paul Rogers, President, Inland Real Estate Brokerage & Consultng, Inc.