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Separating the Wheat from the Chaff: Factors Affecting the Built Environment After the End of “Easy Credit”

2011 May 1
by Chris Fiori

Note: This article originally appeared in the Spring 2011 edition of Forum, a publication of AIA Seattle, one of the largest urban components of the American Institute of Architecture.

< Seattle; photos by Rodney Harrison >

The relative lull in development activity after the bursting of the real estate bubble has given us a chance to re-examine how changes in the economic climate may present opportunities to reshape cities.

Changes in the built environment are the physical expression of a complex web of factors that include demographics, politics, technology, and finance, among others. Even in our rapidly changing, technologically-driven world, most of the trends driving changes to the built environment have been developing for decades: increasing corporate globalization, increasing education and wealth in developing nations, increased use of technology to replace labor, an aging population in developed nations, and increasing demand for natural resources worldwide.

Some of these factors (though not all) have helped the U.S. economy grow over the past several decades. More recently, the unprecedented expansion of public and private debt—using the promise of future growth to pay for today’s needs—has masked the underlying, fundamental health of our nation’s economy. The end of the era of “easy credit,” a key enabler of real estate development of all kinds, should reveal many of the underlying trends that have been present, if somewhat obscured, during the past decades.

This downturn is not a typical recession, and as such, the path of recovery will be different than those of other recessions the U.S. has experienced. All recent recessions in this country have followed a cycle of business expansion, where typically the supply of goods rises to exceed demand, resulting in a recession as production slows, until eventually inventories of goods are consumed to the point where growth must once again resume.

The current downturn, somewhat inadequately termed the “Great Recession,” is not a cyclical business-inventory driven event, but instead was caused by a massive overhang of unserviceable debt built up over many years. The real estate bubble was the most widely visible expression of this excess.

When presented with a crisis that could lay the groundwork for fixing some of the fundamental problems impeding our economy over the past decades—including the mismatch in skills between workforce and jobs in this global economy, a transportation system ill-prepared for 21st century resource constraints, and reliance on consumer spending over industrial production for resource growth—government has instead decided to treat the symptoms as the problem.

The interventions being executed by the Federal Government could be termed the “bailout, stimulate, and print” plan. The “plan” basically entails supporting the financial system by transferring risks from private interests to the federal government, using federal spending to drive economic expansion, and inflating away the tremendous amount of public and private debt remaining from the recent bubble. In other words, growth of short-term GDP and preservation of a toxic financial system were placed ahead of real reforms that could have placed our nation on a better footing for the future.

The good news could be considered addition by subtraction. During a time of unprecedented financial constraint at the state and local level, and increasing pressure to slow the growth of federal debt, any public spending will need to be purposeful. Conservation will become a favored tactic. A massive misallocation of resources, such as the one that drove excess tract housing, strip malls, and vacation homes, is much easier when few restraints exist to building roads that perpetuate that paradigm.

< Seattle; photos by Rodney Harrison >

Key economic trends, thanks to the downturn
The downturn has produced several key economic trends that will affect our ability to change the built environment in response to underlying demographic and environmental changes.

1. Frugality will necessitate “Least Cost” alternatives, namely retrofits, re-use and conservation.
One of the outcomes of the long boom (1981 to 2001) and housing bubble (2003-2007) was the creation of real estate product not well suited by location or configuration to the demands of household size, environmental conditions, or transportation realities. Despite their sub-optimal locations, many housing units, shopping malls, and office parks could, in theory, be retrofitted for better environmental performance if certain sacrifices in mobility are made. Advances in technology should continue to make communications cheaper and reduce the need for travel, which could become more expensive as oil production diminishes. Taxes will increasingly attempt to capture the externalities of resource consumption. These factors could support rehabilitation of existing structures, both for energy efficiency and adaptive reuse.

2. Federal fiscal and regulatory policies will be imperative in shaping built environments
While the Federal government has taken a shotgun approach in using stimulus spending to support growth, a more effective plan would be to focus on setting tax, energy, and environmental policies that drive private sector growth in a manner in keeping with sustainable urban development. Gas taxes, alternative energy credits, alternative energy research and development investments, and targeted educational investments could all support such an agenda. New federal grants could merge transportation, housing, and environmental funding in support of progressive urban planning. Hopefully, cross-agency coordination can work in support of appropriately taxing environmental externalities (such as Senator Cantwell’s proposed tax-and-dividend plan to tax carbon consumption at the point of extraction), as well as rewarding investment in sustainable infrastructure and built environments.

3. Government intervention limits “re-set” opportunities
Government’s response to the downturn has, perhaps purposefully, limited the speed at which commercial real estate can reset to market clearing prices. Following the stock market nadir in 2009, many strategic funds were formed to acquire distressed assets. Untold billions of dollars are now sitting “on the sidelines,” most of which are going wanting for any distressed assets to buy. Large banks seem more motivated to extend existing debt, rather than foreclose and sell at a loss. Sellers, waiting for a rebound in the economy, have little incentive to sell at a loss; buyers, fearing a lagging recovery, are disinclined to buy at anything other than the “distressed” price. As a result, these funds are searching out new avenues of investment, often in “core” assets or value-added opportunities.

4. The cost of capital should decline for “Best In Breed” real estate development projects
Real estate is an attractive asset class, both as an alternative to a volatile, lower-return stock market and as a hedge against future inflation. The availability of capital for real estate projects should improve as expectations fall for high returns in asset classes such as equities. To the extent that well-located urban products are deemed superior to suburban product based upon demographic trends and projections of rising transportation costs, urban infill products should capture an increasing share of real estate investment capital.

5. Demand focuses on under-served niches favored by economic and demographic trends (multifamily, industrial and medical R&D)
With aggregate growth limited, market opportunities will be found in more specific niches. In the private sector, some of the best near-term opportunities for new construction are multifamily housing, flexible industrial buildings, and medical/laboratory buildings. Demand for multifamily is largely driven by employment growth, which has uncertain near-term prospects, but the echo-boom generation is favorably large, and home ownership will become less attractive with the end of the new homebuyer tax credit and slowly tightening FHA standards. In addition, the picture for manufacturing, for the first time in many years, looks encouraging. An eager domestic labor market, policies that weaken the dollar relative to emerging market currencies, and strong demand from emerging economies, all support future strength in manufacturing. Finally, healthcare spending shows little sign of abating, presenting opportunities to expand hospitals, satellite clinics, and medical research facilities.

The credit-driven growth of the past several decades supported investments both prudent and wasteful in the built environment. All real estate, whether fundamentally supported or not, generally performed well in an environment of declining interest rates and increasing leverage. In an era of relative economic thrift, flat interest rates, and decreasing leverage, real estate development will rely much more upon trends in demographics, environmental sustainability, and energy costs—trends that have been in place for some time. These trends, in conjunction with government fiscal and regulatory policies, will increasingly drive real estate development in years to come.


Chris Fiori is a Senior Project Manager at Heartland, LLC, a real estate consulting, investment, and development firm based in Seattle. He has worked with both private and public sector clients on a range of subjects including predevelopment financial analysis, project financing, regulatory policy, and public/private development negotiation. Chris recently finished serving on the Seattle Planning Commission.


3 Responses leave one →
  1. biliruben permalink
    May 2, 2011

    The interventions being executed by the Federal Government could be termed the “bailout, stimulate, and print” plan. The “plan” basically entails supporting the financial system by transferring risks from private interests to the federal government, using federal spending to drive economic expansion, and inflating away the tremendous amount of public and private debt remaining from the recent bubble.

    While I agree with much of your article, and the parts I hadn’t given much thought to I found interesting to consider, I think if you are expecting high inflation in the medium-term, you are going to be disappointed.

    We have a tremendous amount of under-utilized capacity right now, and until we see a large dent put into our vacant residential housing stock, which we will only see when our labor force gets back to work, we will see inflation trends below target.

  2. Matt the Engineer permalink
    May 2, 2011

    I agree this is a very interesting article. I think you’re right that our current political leaders are treating the problem and not the cause, and I think you’ve come a step closer to treating the cause. But looking several steps deeper, what’s caused everything from our trade imbalance to our massive debt to our credit problems to even our modern 2-worker families having to work overtime just to make ends meet (when the previous generation made ends meet with just one 8-hour worker) is the wage gap. Our rich are massively rich and pay little in taxes, and our middle class is shrinking. This lowers the number of people able to buy our goods and services. The real answer is to tax the rich and add government services to level the playing field, but that will take a huge change in mindset from the current no-new-taxes mentality.

    How does this apply to housing? Some of these new services can help transfer people into more affordable dense living. Perhaps we could use WPA-style rebuilding programs in our cities to help both add density and teach construction workers that are used to suburban stick houses how to build up.

  3. Dan Staley permalink
    May 3, 2011

    Hey Fiori: you set a high bar!

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