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IF U.S. RESIDENTIAL BUBBLE BURSTS, WHAT HAPPENS TO RETAIL?

By Donna Mitchell

There is talk about a possible correction in the U.S. housing market, and every syllable is making its way into retail real estate circles.

“When Donald and Ivana Trump decide to build competing condo towers in Las Vegas, it’s a sure sign there’s a correction ahead,” quipped Kenneth T. Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at the University of California Berkeley. He was speaking in jest to the attendees of ICSC’s annual Research Conference last month in San Francisco.

But Rosen’s message for the retail real estate industry is serious enough: The residential market is headed for a downturn over the next two years, and it will affect retail investors and developers as mortgage delinquencies rise.

The Federal Reserve Board estimates that outstanding home mortgages in the U.S. total about $8.5 trillion. Thus, a significant number of residential mortgage delinquencies would cast a pall over the capital markets in general, says Jeffrey H. Newman, vice chairman of the real estate department at Sill Cummis Epstein & Gross, a Newark, N.J.-based law firm.

“If any element of the financial markets roil — in this case consumer defaults and bankruptcies — that has to have an impact on the cost of money to everybody,” said Newman.

In some markets, particularly California, residential real estate valuations have risen as much as 20 percent year-on-year for several years, a trend that boosts retail spending as home owners sell properties and direct the profits into other consumer purchases. Such growth is unsustainable, however, Rosen told the conference.

Some retail real estate analysts agree. As interest rates continue to creep upward, home refinancings may drop off, leaving consumers with less disposable income to spend on retail goods, especially furnishings and home improvements, says Dan Fasulo, director of the market analysis group at New York City-based Real Capital Analytics.

“That affects retailers’ bottom lines and, eventually, it could have an impact on their expansion plans,” Fasulo said. “The demand for retail real state might be lower and, indirectly, that could have an effect on rents.”

The situation would weaken landlords’ negotiating positions, as fewer retailers would vie for shopping center vacancies, says Fasulo.

“Only 14 percent of people in California can afford to buy a median-priced home,” said Rosen. Further, he said he is 90 percent certain that residential property values will be 25 percent lower within the next two years. When interest rates go up, as predicted, there will be a double whammy and a very substantial correction, he said.

The ratios of home prices to salaries and rents are too high, he said, and “home builders refuse to believe this.”

Normally, 11 percent of home buyers are investors rather than people who intend to live in the property, he said, but today the portion has doubled — some 22 percent of home owners are investors hoping to cash in on the boom.

A proliferation of negative-amortization mortgages, which are “loved by speculators,” is contributing to this trend, he said. These kinds of mortgages are only appropriate for very wealthy individuals, he said, but they are being given to people who are less affluent and less organized about their money and are “guaranteed to be a problem.”

Rosen pointed to Bakersfield, Calif., which has seen the state’s highest gains in housing values in recent years. About 45 percent of the new housing there is owned by speculative investors from Los Angeles and San Francisco, he noted.

In Las Vegas, another high-flying residential market, as many as 75 percent of new properties are unoccupied and owned by speculative investors, Rosen said. “It’s an accident waiting to happen.” n