Envision future realistically

June 26, 2010 

Five years ago when the national real estate market was in the midst of rapidly increasing prices and demand, I wrote a column describing two outlooks on the future of real estate. One outlook saw the boom as a permanent change in the market; the other thought things had gone crazy and the market was going to crash.

In another column, I quoted Harvard psychologist David Gilbert from his book "Stumbling on Happiness": "Most of us have a tough time imagining a tomorrow that is terribly different from today, and we find it particularly difficult to imagine that we will ever think, want, or feel differently than we do now." If you are full it is hard to imagine being hungry; or if happy, being sad; or if fearful, being confident. I call this straight-line thinking.

The two market outlooks I described are examples of how straight-line thinking can get you into real trouble. Very intelligent and experienced people honestly believed prices could only go up, even though history showed this had never happened.

I described the first outlook as Theory X. In this theory, commercial investment real estate was experiencing a paradigm shift as an investment vehicle. The result was a permanent increase in demand that significantly reduced the risk of lower prices.

This shift was due to less faith in the stock market as an investment vehicle; the stock market was seen as too unstable and provided too low a rate of return. As a result, managers of large investment portfolios were reducing the portion of their investment portfolio in securities and increasing the portion in real estate. This created a seemingly permanent shift to a higher level of demand for investment real estate.

At the time, demand from buyers was greater than supply from sellers. This difference in supply and demand combined with low interest rates to cause prices to rise sharply. Many investors and lenders thought it was smart to buy at very high prices with high debt and low return because, they reasoned, prices would continue to rise and that the high price of that moment would be low compared with future prices -- it would all work out.

Does this sound familiar? This same belief -- that prices could only go up -- is one of the major reasons Wall Street got in so much trouble with home loans.

Those who ascribed to the other outlook, Theory Y, were the party poopers. They saw nothing new in real estate investing and said nothing had changed in the real estate market, except the market had gone nuts. Interest rates would rise and when they did, prices would fall -- just like always.

Theory Y saw no paradigm shift to higher demand keeping prices aloft in the face of higher interest rates. They said those buying at ridiculously high prices in the belief of ever-increasing prices were going to get creamed. Theory Y's advice was to sell, hold your cash, wait for the market to tank, and then make your move.

Currently, the national economy is showing slow recovery, but employment is only beginning to turn around. The stock market has been very unstable but has come back a long way from earlier lows. Offshore oil development is in question because of the BP Gulf of Mexico oil disaster.

The Anchorage economy is currently down only slightly and the commercial real estate market here is flat. Space is tight, yet both lease rates and prices are generally holding. There is a great deal of uncertainty and a wait-and-see attitude.

How do you think we will be doing five years from now? Can you envision the future being different from current conditions?

Chris Stephens, CCIM, is a local associate broker specializing in commercial and investment real estate. His opinion column appears every fourth Sunday.

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