Recent events raise the question: are commercial real property markets at a turning point? The events concerned include spillovers from sub-prime lending problems in housing. The near collapse of two residential sub-prime lenders rescued by loans from owner Bear Stearns, plus bankruptcies of other sub-prime lenders, have apparently caused several big debt issues to be cancelled or reduced in size because of investors' negative reactions. Even mighty Blackstone's stock price fell below its IPO level! Is this a sea-change in the easy availability of low-yield debt that has fueled the immense run-up in commercial property prices since 2000?

When this article was written in late July 2007, the 10-year Treasury rate had just slid under 5.0 percent, still below its level one year earlier. In fact, nearly all rates were at or below their levels one year earlier. So interest rates have not risen much recently. But if investors are becoming more reluctant to purchase low-rate debt issues, that may alter the major basis for the huge increase in property prices during the past few years. Yet private equity funds keep on raising large amounts of money and buying out existing listed firms for huge sums. So nothing like the end of easy fund availability has yet arrived.

But one big change in real estate markets has been the significant decline in REIT share prices since they peaked on February 7, 2007. On that date, the NAREIT equity index was at 10,980.62, or 340.7 percent above its level on December 31, 1998. Also on February 7, the Dow-Jones Industrial Average was up only 38.0 percent over its value on December 31, 1998, the S & P 500 was up 17.9 percent, and the NASDAQ composite was up 13.6 percent. But from February 7 through July 30, 2007, the NAREIT equity index fell 23.3 percent while the other three stock indices all rose from 1.6 to 5.5 percent. Apparently, the long period in which REIT shares greatly outperformed the stock market in general has ended - another sign of a possible dramatic change in property market conditions. Perhaps investors are starting to shift some of the funds they pushed into American real estate after the 2000 stock crash back into other types of stocks or into real properties outside the United States.

It is too early to determine whether these signs will turn into major long-run trends. But at least a small pause in real property financing conditions has occurred - and it could become more than a pause. The basic factor driving real estate finance for the past six years has been an immense flow of financial capital into real property markets. That inflow drove interest rates and other borrowing terms downward and property prices upward. The inflow started before 2000, but received a major stimulus from the 2000 stock crash, which drove capital from stocks into real estate

The major impact of the subsequent inflow of capital was a huge fall in the cost of borrowing money to buy properties. That was augmented by more widespread securitization of all types of debt instruments, which reduced both their actual and their perceived risks. The combination of a huge capital supply and securitization slashed the cost of borrowing and reduced its covenant limitations, thereby encouraging purchasers of real estate to borrow heavily. This in turn gave rise to a rapid expansion of private equity firms, who used cheap borrowed money to buy out firms listed on the stock market, including some REITs. Since most REITs had been constrained from high leveraging by pressure from Wall Street investors, private equity firms were able to outbid such investors and REITs by using high leveraging financed with cheap debt, often public debt in the form of Commercial Mortgage Backed securities (CMBSs). The strategy of many private equity buyers of real estate transformed real property firms from their traditional category of long-term, heavily management-oriented investments in large portfolios to the short-term, break-up, sell-and-run category.

If the cheap debt, rising-property-price, very-low-property-yield environment that has dominated commercial property markets from 2000 through 2005-2006 were to continue, many investors and developers would shift from buying existing properties at very low yields to developing new properties at what they hoped would be higher yields. If that happened, it could start a new development boom that, if continued for 1.5 to 2 years, would undermine the prosperity of all real properties, new and old. That is what has time and again generated cyclical movements in commercial real property markets. If it happened again in the near future, it would soon end the huge capital flows into property markets that have dominated real estate since 2000.

But if debt costs to borrowers start significantly rising - which has not yet happened at a large scale - that could cut off prospects for a new development boom. That would in turn insulate the prosperity of existing commercial properties as long as the U.S. economy in general remains strong. So far in 2007, general prosperity has suffered from falling new housing construction and a related slump in retail sales, which home owners can no longer finance by borrowing against rising home equities. But the U.S. economy is likely to come back in the last half of 2007. And both Japan and the Euro area are moving toward much stronger prosperity than they have enjoyed in years. That bodes well for the general prosperity of commercial property markets around the world in 2008 and perhaps beyond.

So one of the two most likely predictions is continued easy availability of cheap debt and other funds, which will start a new U.S. development boom. That will eventually overbuild our markets enough to slow or stop the massive flow of capital into real estate. The other likely prediction is continued strong prosperity in commercial property markets but higher borrowing costs that will also slow the flow of inexpensive capital into real estate, but not through overbuilding. A third but much less likely possibility is some type of economic crisis. It might be a massive breakdown of key hedge funds and buy-out deals, or a revolution in another Middle Eastern nation causing a huge surge in oil prices, or big problems in the Chinese economy, or something else that disrupts the steady forces of expansion now dominating the world economic scene. Altogether, these remain interesting times!

May 2006 - The huge rise in U.S. housing prices in the past decade has created immense increases in the wealth of U.S. homeowners in the form of larger net equities in their homes. Householders treated such equity gains as both income and savings. But the official national income accounts do not recognize either as such, because purely financial home equity gains do not involve direct production of "real" goods or services.

In theory, the home equity gains amount to a potential redistribution of future claims on society's existing real wealth to home-owners from non-home-owners. That is true because home-owners can ? potentially ? monetize their equity gains and use them in the future to claim real resources from others. But non-home-owners cannot participate in that process. Since non-home-owners will have to give up real resources when home-owners actualize that potential, rising home-owners' equities reduce the wealth of non-home-owners as a group. So increases in home-owners' equity do not represent true additions to society's overall real wealth. Rather they potentially redistribute that wealth.

These abstractions may seem too esoteric to be meaningful, but their essence is fully understood by most home-owners. They are very well aware of the potential benefits they can derive from the larger equities in their homes generated by rising home prices. That is a key reason why so many more households have sought to become homeowners during the past decade. The share of households owning their own homes was 64.4 percent in 1980 and declined to 64.2 percent in 1990. But then it rose to 66.2 percent in 2000 and 69 percent in 2005. More and more households wanted to get on the "escalator" of rising home prices to enjoy its clear benefits. How fast did this "escalator" actually ascend?

According to the National Association of Realtors, median housing prices for single-family homes in the entire U.S. in current dollars rose 47.9 percent in the 1980s, 51.1 percent in the 1990s, and 53.2 percent from 2000 to 2005. That is a compound annual growth rate of 8.9 percent from 2000 to 2005, vs. 4.1 percent from 1980 to 2000.

It may seem unwise to base the above computations about home equity on the median home sales prices in current dollars reported by the National Association of Realtors (NAR). Those prices do not correct for changes over time in the quality mix of homes sold each year. Since new homes have been steadily getting larger, some of the increases in prices NAR data show over the years were due to higher quality rather than a "true" change in price. But Freddie Mac also publishes a home sales price index based on resales of the same homes over time. So this index is implicitly corrected for quality changes (except those due to remodeling the same homes). The home price series published by Freddie Mac shows an overall increase in U.S. home prices from 1980 to 2005 of 296.6 percent. That is 27.4 percent larger than the 232.8 percent increase in the NAR median price measure over the same period. In fact, annual percentage increases in prices calculated for both series are 70 percent correlated with each other. Therefore, I have used NAR data in computing some of the home equity trends described above.

Federal Reserve Board balance sheet data show a rise in U.S. household assets in real estate (in current dollars) from $12.5 trillion in 2001 to $19.1 trillion in 2005 ? a gain of $6.6 trillion, or 53 percent. In the same period, households' disposable income rose by $1.6 trillion, or 21 percent. That was 76.5 percent less than their gain in real estate values, which is almost all in owner-occupied homes. Homeowners' borrowing against their real estate equaled 44.9 percent of their home values in 2005 vs. 41.8 percent in 2001. So the net equity of homeowners rose from $7.3 trillion in 2001 to $10.9 trillion in 2005. That was a gain of $3.6 trillion, or 50 percent in four years. That gain in net equity was 2.25 times larger than households' gain in disposable income.

In further contrast, median household incomes (in current dollars) have not increased much recently. In 2000, the median was $41,990; in 2005, it is estimated to be $45,000. That is an increase of $3,010 in five years, or 7.1 percent. It amounts to an average income increase of $602 per year. In contrast, the typical U.S. home-owning household had an average increase in net housing equity wealth of $9,264 per year, or 15.4 times as much, in the same period. If the median home was worth $139,000 in 2000 and $207,000 in 2005 (National Association of Realtors data), the homeowner could have borrowed 45 percent against its value in 2000 (the average percentage of mortgage and home equity financing in Federal Reserve Board balance sheet accounts) and received $62,550. If the homeowner refinanced the same home in 2005, again borrowing 45 percent, the loan would have been $93,150. After repaying the first loan, the owner could have taken $30,600 of the loan proceeds and used that amount for consumption.

A considerable amount of the "cashed out" wealth from rising home equities has been used by households to increase their personal consumption. This conclusion is based not only on countless anecdotes, but also upon personal consumption and national income statistics. Total personal consumption spending (in current dollars) was between 67 and 68 percent of gross domestic product (GDP) in every year from 1990 through 1998. But then it rose to 70.8 percent in 2003 and remained at 70.6 in 2004 and 2005. Personal consumption spending also rose faster than person al disposable income in constant-value (2000) dollars; it was 92 percent in 1992, rose to 94 percent in 2001 through 2004, and hit 98 percent in the third quarter of 2005. In relation to wage and salary payments (in current dollars), personal consumption was 146 percent in 1995, but has steadily risen to 152.5 percent in 2005.

The recent dramatic run-up in American home prices has been a major factor stimulating the expansion of the overall U.S. economy. Not only did record activity levels in housing construction increase employment and incomes, but also a huge increase in the wealth of American home-owners helped them expand their personal consumption spending to record levels. Since consumption accounts for over two-thirds of our total national income, this has been a major factor sustaining American prosperity while we were fighting a war abroad.

But the generally expansionary economic force of American housing markets is about to lose a lot of its force in the next year or two. As interest rates rise, new construction and sales will slow down, and home prices will not escalate as fast, if at all. Demands for housing that have already been met by home-buyers "getting ahead of the game" through easy financing terms will no longer be available to push building and sales upward. Consequently, the market balance between buyers and sellers that has long favored sellers will shift as more sellers try to "cash out" and fewer buyers employ the favorable financing of the past five years. As one observer put it, "The whip of controlling housing market terms is about to change hands from sellers to buyers."

This shift will almost surely NOT be accompanied by any widespread collapse in housing prices, as doomsayers who predict a "bursting housing bubble" have predicted. But the multiple impacts of slowing housing markets will have a similarly slowing impact upon many other aspects of the American economy, especially personal consumption. It will not be a catastrophe, but it will definitely be noticeable.

April 2005 - The financial investment community has recently undergone a profound change of outlook towards real estate. Rather than continuing to regard real properties as a highly speculative and marginal form of wealth, the world's major financial investors have in the past few years shifted to accepting real estate as a separate asset class in which they should keep a significant share of their total assets. This fundamental change of views has had profound impacts upon all real estate markets. It has essentially flooded those markets with tons of investment capital trying to buy good-quality real estate.

Why has this happened? The answer lies in the relative advantages of real estate - including real estate investment trusts (REITs) - in comparison with the major investment alternatives: other stocks, bonds, and cash. Back in the mid to late 1990s, when REITs and other real properties were doing very well in terms of profitable operations, investors ignored them because the surging internet boom made the stock market seem a lot more attractive. But then came the Crash of 2000, and stocks dropped through the floor. In response, the world's central banks lowered interest rates and increased liquidity in order to offset the impact of falling stock prices on sagging economic activity.

These changes made real property seem a lot more attractive, especially because it was not collapsing in price. And bonds were losing appeal because of falling yields as interest rates plunged. In short, real estate was clearly outperforming both stocks and bonds. So capital flooded into real estate markets, both residential and non-residential.

The impacts were two-fold. First, housing prices soared throughout the developed world, as more households rushed to buy homes at low interest rates and low down-payments. Housing production soared too. Second, non-residential markets experienced an atypical disconnect between worsening fundamental conditions in space markets (rising vacancies, falling rents) and strong demands in investment markets (rising prices for well-occupied properties). That drove cap rates to record low levels, partly in keeping with very low interest rates. Now that the recession has ended, space market conditions are improving, but demands by investors to buy well-occupied properties remain extraordinary.

There are several other reasons why real estate has gained so much more favor among investors than in the past. All those reasons have to do with the relative attraction of real property vs. the alternatives. One reason is that investors are heavily influenced by their recent past experiences - even though Wall Street likes to claim investment markets are "purely rational." Hence many investors remain leery of stocks, having been so badly burned from 2000 to 2002. Second, there is an unusually high degree of uncertainty about economic conditions around the world, thanks to terrorism, the Iraq war, North Korea, soaring oil prices, and Iran. This helps keep most stocks moving more sideways than upwards, making them less attractive as alternatives to REIT shares and direct ownership of real properties. Third, the threat of rising interest rates stemming from Federal Reserve policy and federal deficits makes bonds look risky too. And today investing in real properties is easier than ever because of greater transparency and more types of investment vehicles.

Finally, real properties and REIT shares provide larger dividends and cash flows than most other investment vehicles, and current income is becoming increasingly attractive to retiring baby-boomers and the pension funds who must support their retirement. That is one reason the appeal of real property is likely to remain strong.

True, the Federal Reserve has embarked on a policy of raising interest rates as part of its long-term anti-inflationary behavior. But there is still so much capital flowing into real property markets that the Fed's pushing short-term rates up has not had much of a similar impact on long-term real estate borrowing rates.

One implication of this "Niagra of capital" flooding into real property markets is that this is a great time to sell real estate. No one can know the exact moment when any property market hits its peak, but real estate markets are surely close to their peaks today. When investors are clamoring to pay record prices for even hum-drum properties, that is the best time to sell. True, if you own a property that pays terrific returns, and will continue to do so indefinitely, it might be unwise to sell. But if your property is near its peak earning capacity, or needs renovation, or is just run-of-the-mill, this is a terrific time to consider selling it. No, I don't know what you should do with the money you receive; I have no other high-paying alternatives in mind. Perhaps you should just sit on such funds until market conditions change and something else becomes attractive, as will surely happen.

How long will this flood of capital into real estate last? It would slow dramatically if the value of the U.S. dollar dropped sharply, or if some international disruption occurred, such as fundamentalist radicals taking over Saudi Arabia's oil supplies. Then U.S. interest rates would rise suddenly. The capital flood might also slow if true peace "broke out" in the Middle East between Israel and the Palestinians and in Iraq, which might cause uncertainties to fall and stocks to rise again at high speed. And in the long run, the impacts of soaring federal deficits and trade deficits will surely put upward pressure on interest rates.

But right now, real estate markets remain dominated by the huge inflows of financial capital into them looking for properties. So take advantage of these favorable conditions while you can.

October 2004 - The U.S. economy is in the midst of a general expansion, but it is moderately weak so far. Real Gross Domestic Product grew at an annual rate of 4.5% in the first quarter and 3.3% in the second quarter, and job gains have been below those in previous recoveries. Our economy is being influenced by a major change in the long-run economic climate, plus several foreign developments.

This major change is a shift from continual and prolonged declines in interest rates to a period of rising interest rates. Interest rates were pushed sharply upward in the late 1970s and early 1980s to slow inflation. Freddie Mac's fixed 30-year rate peaked at 16.6% in 1981 and began a long decline to 5.8% in 2003. But the Fed has now decided to reverse this long-run decline and started to push rates up to check inflation. However, rates in money markets have not yet begun to move upward much in response, though I believe they will eventually do so.

Real estate in general has benefitted enormously from falling rates during this 23-year period. The latest result of falling rates has been a flood of financial capital into real estate markets. That capital came three sources: (1) a flight from the stock market after 2000, (2) investors' search for "decent" yields non-real-estate returns fell very low, and (3) the "carry trade" of borrowing at very low rates and re-investing in real estate.

The result of that capital flood was upward pressure on property prices, even though vacancy and rents were deteriorating, especially in office and industrial space. This pressure has lowered capitalization rates and stimulated speculation. But now the situation will change, though probably gradually.

Commercial property prices will stop rising and many will begin declining. I do not expect cap rates will rise as fast as short-term interest rates rise, or even as fast as long-term rates. And negative impacts of higher cap rates will be partly offset by lower vacancy as the economy expands. And because most commercial markets today are dominated by investors with low debt ratios, there will be no massive wave of defaults and bankruptcies as in 1990.

Also, some capital will shift out of real estate into other uses. These include commercial lending as business firms borrow more to finance their prosperity. This shift of capital will gradually diminish the overhang of capital in real property markets. That will also raise cap rates. But right now, there is plenty of debt capital looking for mortgages, so debt spreads on major commercial properties over Treasuries are remaining at low levels.

In housing markets, new construction and sales of existing units will decline and price appreciation will slow down. Fewer households will shift from renting into buying homes. And home mortgage lending will fall sharply. In some condominium markets, recent "bubbles" of soaring prices will collapse. This change in housing is important to retail too because rising wealth in homes has been a key stimulant to retail spending by American households.

Except for the condo "bubbles," these changes in real estate are likely to occur gradually, not in any dramatic collapse of prices or activity. Yet the shift from falling rates to rising rates is a fundamental change in conditions that is not terribly favorable to real estate in general.

The pace of this economic recovery has been slow partly because of uncertainty about global conditions. The war in Iraq and the general rise of terrorism worldwide have created generalized fears that are slowing down the enthusiasm of both investors and entrepreneurial firms for engaging in all-out expansion like that of the mid-1990s. This is clear from both rising oil prices, which spring from uncertainties about the availability of supply, and the lagging performance of the stock market, which has traditionally been a leading indicator of economic expansion.

This uncertainty has benefitted real estate, both as a direct investment and in real estate investment trusts, because real property has been seen as a safer place to put money than stocks in general, and especially high-tech stocks. Real estate stock yields have been much greater than those from most other stocks, and REITs have done better than the other major stock indices since 1999.

The American presidential election is also a source of uncertainty. Neither major candidate is facing up to the emerging problems from large federal deficits, huge future federal spending increases in retirement and medical costs, and defense. President Bush has asked Americans to assume more spending burdens than ever, including more defense, rebuilding Iraq, fighting terrorism, adding prescription drugs to Medicare, and improving education. But the only sacrifice he has asked for to pay for these new burdens is accepting lower taxes - not just right now to counteract a recession, but permanently!!

John Kerry is promising he will spend more to help every group and pay for it solely by taxing the rich more heavily, while easing taxes on everyone else. Neither candidate is talking about huge future federal spending increases that will come from Baby Boomers retiring soon, and how to pay for them.

Even after the election is over, a lot of uncertainty will remain because neither candidate has really shown the electorate what he would do if he wins. However, if the situation in Iraq should become markedly more favorable, that will help reduce American uncertainties about the outlook, and speed growth.

In this election, a lot has been said about the impacts of our losing manufacturing jobs overseas, with Kerry claiming this is very bad for America. Yet the expanded employment in China and India that we have heard condemned have had extremely beneficial impacts upon U.S. real estate markets - both commercial and residential.

U.S. manufacturing has been losing jobs for the past 25 years. Our manufacturing jobs peaked in 1979 at 21.0 million. From then until the end of 2003, total jobs in manufacturing fell in 16 years and rose in only 8, for a net loss of 7.1 million jobs, or 33.8%, down to 14.3 million. Most of this large job loss came from improved productivity in U.S. factories, but some involved shifts of low-wage jobs overseas.

China's and India's relatively recent entry into the world's industrialized labor force has had enormous impacts upon worldwide wages. There are about 6.4 billion people in the entire world, of whom 1.2 billion are in China and another 1.0 billion in India - or one third of the whole world's population in both combined. If one-fourth of the Chinese and one-fifth of the Indians are in the modern labor force, that is 500 million workers. Among the other 4.2 billion people in the world, about 800 million are in Africa, which is mostly outside the modern global economy. That leaves 3.4 billion world residents excluding China, India, and Africa. If half of those residents are in the modern world labor force, that is 1.7 billion workers, in this very rough calculation.

When China's and India's 500 million workers entered this labor force over the past decade or so, that was a 29 percent increase in the world's whole modern work force - and these newcomers were at relatively low wages.

This giant increase in the world's industrialized labor force has kept world wages down and prevented manufacturing firms from being able to raise prices. In other words, it has been a major force keeping world inflation at very low levels. This is best illustrated by Walmart, the world's largest retail firm. Walmart gets a lot of its merchandise from China, and Walmart has kept American retail prices low.

Low and falling inflation has permitted the central banks in modern nations to generate declining interest rates over the past 22 years. And falling interest rates have been the foundation for a worldwide boom in housing markets in industrialized nations - including the United States. True, we lost 2.7 million manufacturing jobs since 1994, many to China. But since 1994, we also added 1.8 million jobs in construction, 1.1 million in finance, plus 2.2 million in leisure and hospitality and 1.5 million in retail trade - all gainers from low inflation. And commercial real estate has benefitted enormously from low interest rates.

Thus, the impact of low Chinese wages and expanded Chinese manufacturing employment upon world financial conditions through lower inflation has greatly benefitted American households because it increased the values of their homes. And home values are the biggest source of wealth for most American households. True, stock values are larger in total, but they are not as widely distributed as the values of homes. And rising home values have been a key source of purchasing power for American households that they have spent in shopping centers.

In the future, the beneficial impact of China on world economic and monetary conditions will moderate. The Chinese economy has been growing so fast it has begun absorbing large amounts of food and raw materials, putting upward pressure on some world prices, including oil. Even so, the huge Chinese labor force has still not been fully absorbed into the world economy. So its downward pressure on wage rates will continue to be a check on rising inflation. That means we are not likely to get the kind of strong inflationary pressures that pushed interest rates so high in the United States in the late 1970s and early 1980s - at least not for quite a while.

A second major implication of low-wage foreign labor is that we need to improve our performance in educating young people in big city school systems. Our African-Americans and Hispanics are concentrated in those systems, and both are not doing well enough to remain fully competitive in the global high-tech economy. Yet those two groups form large majorities in most big-city school systems and will be key parts of our future labor force. By 2020, our population will grow by about 30 million. Over 80 percent of our future labor-force growth will consist of ethnic minority members. We cannot afford not to have this large fraction of our future workers getting properly educated. This may require encouraging movement of many more such Americans into suburbs for better schools.