Commercial Real Estate Bubble And Bust
Commerical Real Estate Bust Coming 2011 Near You
As I outlined in my Hub titled Imminent Economic Collapse, there are several ordered steps involved in the creative destruction process that turns a prestigious first world nation into total collapse. The first step is the collapse of our financial institutions (with the real estate bubble crash representing the financial collapse of ordinary citizens). The second step is the commercial real estate "bubble."
With the recent housing bubble burst and bust, a commercial real estate bust will certainly follow. Already I have seen indications of this in my region. The big box retail stores are doing fine, but the specialized shops in what was once traditionally middle class neighbourhood malls are all but vanishing. It's a sad situation to walk into what was once a beautiful mall space all but to see half of it closed and/or boarded up. When I was a teenager, these were prime locations to meet people and socialize accordingly, now they have become giant ghost towns with a sprinkle here and there of a few shops that have survived because they sell the only product in town to a very niche market.
For example, the Barrington Place Mall, located in downtown Halifax, I would go on to say that nearly 90% of the small independent shops are completely shut down, save one, and that is the bouillon/coin trading dealer. The owner of this shop is the only person in town that supplies this market and I trade with him frequently. I find this mall is a good snapshot of what is to come. When the only shop surviving in what was once a thirty piece shopping mall is the precious metal dealer who is the only guy in town, alarm bells should immediately start to sound.
The commercial real estate crash isn't a matter of if or when, it's already here, and we should feel the full effects of this crash come summer 2011 . . .
Is Commercial Real Estate A Bubble?
Perhaps a good question to ask is if commercial real estate is in a bubble that has now crashed. While technically commercial real estate is in a bubble that is currently in the process of crashing, we must understand that in any economic collapse, there are perpetrators of their own demise and there are bystanders who are truly victims. I would classify what has happened to small/medium sized businesses, outside the world of government lobbyists, as victims. You see, unlike the majority of banking and residential real estate, commercial real estate owners didn't deliberately put themselves into a bubble for speculative purposes. Indeed, no more than three years ago there was legitimate demand to meet what they had invested in place.
Of course, the past three years the laws of supply and demand have changed so profoundly that in the end, even business owners that have survived this crash would be better off simply liquidating as many assets as possible. The idea is to simply wait out what is a radical restructuring of the economy and then to reinvest the capita once the dust settles.
Understand that commercial real estate was forced into a bubble. Canadian and American businesses were forced into an immoral suicide pact with the banks. The atrocious lending practices of our banks led to enormous and impractical consumer debt. This consumer’s debt led to an irrational increase in demand. Businesses would have no choice but to expand to meet this demand in order to remain competitive. It's quite possible that the majority of business owners had knowledge they were deliberately waltzing into a bubble, but it's a case of damn if you do, damn if you don't. Thanks to irrational consumer debt, consumers temporarily had up two to three times the spending power than they normally would have. This means they could buy more products, and buy more products they did. Businesses would have no choice but to meet this demand immediately, or face losing all their customers to a competitor. There is nothing worse then telling a customer "sorry, we're out of stock," so they had little choice but to expand. They had to build more stores, increase distribution, had to build more warehouses, had to hire more people to build, maintain and run these establishments, etc. Sounds great, right? Only one problem, it's living a lie. That consumer debt will have to be paid back. When that happens, not only will businesses need to retract back to where we started before the consumer frenzy, but they will gradually start to shrink over the long haul. Why? Because not only does the debt need to be paid back, but it needs to be paid back with interest. This percentage of interest now represents what will be an overall negative equity across the entire commercial sector for years upon years to come, with no end in sight.
Small Business Creating Jobs? Are You Kidding?
When I watch the news, where I see Canadian Prime Minister Stephen Harper and USA President Barrack Obama speak of the small business sector possibly creating thousands upon thousands of jobs in the near future, I often wonder what the hell they're smoking? The small/medium sized businesses are struggling. They're facing threats to their businesses on two main fronts. The first front is the lack of demand. Demand creates jobs and increases hiring, not tax cuts or even profits. Hiring is simply an expense that must be undertaken to meet excessive workloads due to demand. Without increased demand, there is no incentive to hire. The second front, which is a pouring salt on the wound of the first, is that most businesses are simply bloated from the hyper inflated demand of three years ago. A competitive business of today will be looking for cost-effective ways to shrink, not grow, in a world of decreasing demand. There is nothing worse than spending money on something where there is no demand to be met.
Contrary to popular belief, a smart business will not be looking to axe jobs immediately when facing the dilemma of dealing with a lack of demand. They would hopefully understand the catch-22 of Fordism by cutting all their staff loose. Regardless, overhead must be reduced, and the best way to do that is by reducing real estate space. This results in lower expenditures for infrastructure costs and property taxes. That means more people in smaller offices, more jobs being done at home, and more people hired under contract rather than permanent positions. This could also mean leasing residential spaces for businesses, rather buying out or leasing prime commercial real estate buildings in the center of town. This is essentially what the commercial real estate bust is all about.
A second way of dealing with the new reality for such businesses would be to tinker the relationships with their suppliers. That supplier who offered what on the surface seems like a bargain in bulk, may become a liability in today's world. Excessive stock that cannot possibly sell is an overhead nightmare. Businesses will have to change a lot of relationships with their suppliers in order to better accompany our reality of decreasing demand.
A third way would be to come up with creative ways of reducing taxation on what is essentially the most taxed item in both Canada and the United States: payroll. Taxation on income is the highest around, but that only tells half the tale. You see, not only are your income taxes the highest in the land, but the tax is also being paid for twice: once by your employer, and a second time by you. In order to reduce such devastating taxation, employers have come up with methods to offer close to the same value/pay, by inserting what was formally handed out in dollars into assets. For example, greater benefits, more gift cards, shopping cards, gas cards, stock options, IRA and 401k options, etc.; but this can only go so far. In the end, employers must pay the minimum wage. The fact of the matter is an employer could hand you the equivalent of 20 dollars an hour in assets (rather than dollars) for your time, and still get charged with slavery. Providing for your employees without pay is considered slavery. If you don't believe me, read up the definition of slavery.
The fourth way would be to beg the government to reduce corporate taxation. This is the easiest path to take and many walk it. The problem is this does little to alleviate the concern caused by a lack of demand. The corporate taxes of both Canada and the United States are already pretty damn low compared to the rest of the world; yet no new jobs are being created. Demand is what creates jobs, not profits. A corporate tax cut, without the demand to supplement it, merely means existing businesses will invest mostly on improving their current establishments. Nothing wrong with this at all, but this does nothing toward creating any jobs. It does make the working conditions for those who already have jobs better, but in a world of increasing unemployment and more people relying on social services, enhancing employment conditions for people who already have jobs comes across as something to be done in an economic upswing rather than an economic down swing.
Finally, in the end, small and medium sized businesses will just have to cut staff to meet the lowered demand. You can only run the "lean and mean" model for so long until you starve a few people out. I wouldn't be expecting any new job creation coming from existing small and medium sized businesses any time soon . . .
Don't Expect New Businesses to Fill the Void. . .
The nail in the coffin for commercial real estate is that we won’t have any new buyers on the market. When the financial institutions collapsed, no longer will they be issuing out any loans that involve moderate to high levels of risk. Starting a new business falls into that category. The result is we will have tons of commercial real estate that is sitting vacant, but there won't be any new buyers, even at the severely reduced prices. The social, environmental and economical consequences will be devastating.
-Donovan D. Westhaver
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