Comment of the Day Runner-Up: Cowards Shape the City

COMMENT OF THE DAY RUNNER-UP: COWARDS SHAPE THE CITY “. . . Has it ever occurred to you that developers (whose core competency is development) develop apartment complexes for long-term investors and operators? What you refer to as cutting and running is actually just an element of their business model. It is a hand-off of ownership from one entity preferring stability to another that demands it. Neither entity is assured of stability, however. A developer can’t pretend (with a straight face) to know what is in store for a nation, a metropolitan area, or a submarket over a five-year period of planning, permitting, financing, construction, the first year of lease-up, the second year of burning through concessions, and the third year of stability so that they can generate a reliable set of T-12 profit and loss figures. As it turns out, they have to make an educated guess about the future, close their eyes, hold their nose, and jump in. The business model may be different, however the same lesson is analogous for subdivision developers and home buyers, too. They can only try their best to make the right decision, then hope for the best. But eventually . . . they all sell. Everybody sells. The only consequential purpose in owning real estate is to be able to sell it. If selling something is cutting and running, then our entire society is founded on cowardice.” [TheNiche, commenting on Comment of the Day: The Shelf Life of Apartment Complexes]

11 Comment

  • For the record, when I brought up ‘cutting and running’ in the ‘Shelf Life of Apartment Complexes’ thread, I was not talking about the normal business of developing properties and selling them to long term investors. I was talking about the propensity of developers have to overbuild during the boom years, and skip town during the bust years. To be fair, not all developers do this, and I have all the respect in the world for developers who don’t. But enough do that it is an issue.

  • The challenge with your comment is that the development community isn’t some monolithic institution making group decisions. They all have individual motivations, financial situations and competency levels. And with the lead time involved in a project of this sort means that sometimes you get beat to the market by another project. Your project might be better, but it ends up as oversupply because 9 other companies had the same idea that you did. At that point in time you might be stuck with a project that your best exit strategy is to just cut your losses and get out of the project.

    Just part of the risk involved in real estate development.

  • To me, it’s a matter of course that developers will want to build until the money stops rolling in. If house buyers were more sophisticated they could protect themselves by only buying in a community where developers agreed to certain restrictions on development. But most people see a house as a house and only complain when they found out they bought in a development that didn’t have any restrictions on the developers and then can only complain after the fact. *shrug*

  • Drew,
    Note that it is not as simple as “cut your losses and get out of the project”. Developers have to take personal recourse on construction loans beyond a very stout equity investment. To be sure, some of the equity investment can be from outside entities, but a developer will have some personal money in the deal. Cutting losses means realizing losses, and it is seldom a small figure. One bad deal can wipe out several good deals from a balance sheet standpoint.
    I’m not asking for any sympathy for developers, but instead explaining that our profession is not as cavalier as you think it may be and certainly not as wild and open as it was in the 70s and 80s.

  • HOUS Land Man – I’m very aware of the personal stake that developers are generally required to take

  • “A developer can’t pretend (with a straight face) to know what is in store for a nation, a metropolitan area, or a submarket over a five-year period of planning, permitting, financing, construction…”
    A Houston developer of apartments is meeting a demand entirely fueled by immigration, so in that respect it is a bit disingenuous to suggest the future is at all murky. A libertarian regards this situation with complete equanimity, and so, as is often the case with libertarians, no very deep discussion is possible.
    As to the rest: I’m not able to see how an investment in an apartment complex is analogous to home ownership. A house, perhaps in part because the government has chosen to insulate lenders from risk, has been a generally good investment the past three quarters of a century. From reading Swamplot it sounds like apartments in Houston are always a rapidly, scarily depreciating asset. (True, very-recently-built houses where I live share that quality of having all the potential value of new cars just driven off the lot. I feel a little pang for their hopeful buyers, but perhaps they view themselves as more-or-less just renting, but with all the joy of home repairs.)
    It’s no crime to design things to be disposable, though of course there are many external costs (recognized by 87% of us) associated with doing so. The chief problem seems to be that disposing of huge disposable things turns out to be not very easily done.

  • @ luciaphile: International immigration policy and enforcement can change. That is a risk factor. Domestic immigration to the city depends on the city. It is not a foregone conclusion that Houston should continue to grow or that the rate of household formation per immigrant should stay the same. And even if the apartments can be filled, there are no guarantees as to rents or concessions.

    Also: That homeownership is generally a good investment is a myth. True, government intervention has distorted the market for houses and has assured price stability. OTOH, most homebuyers execute their purchases poorly (and their smiling, grinning, hand-shaking Realt-whores do not care). They don’t understand amortization, don’t understand the effect of insurance and property taxes, don’t know how to maintain a house, haven’t accounted for closing costs when they sell, and are a poor judge of their confidence in their future earnings opportunities, the location of their employment, or that the relationships that tie them to a property will endure.

    A household decides where it will live in the context of how that decision will affect its quality of life. It has a choice of renting or owning and it SHOULD be purely financial, not consumptive. (If there is a consumptive element to holding a deed rather than a lease, then that is the effect of multi-generational highly-intensive marketing that has permeated our culture and our values. But if that’s the case, then that we’re a society of chumps still doesn’t mean that I’m wrong.)

    Ownership introduces an investment component; and an alternative to that investment may have been to invest in stocks, bonds, or alternative investments…such as apartment complexes. And while it is true that individual homeowners receive a great deal of government subsidy, the same is also true for apartment developers. (Apartment investors can receive FNMA or HUD loans, get tax credits, Section 8 bonds. They can write off interest, but also depreciation; they can accelerate depreciation by getting a cost segregation study done.) The fact is, nearly all investment is distorted by government intervention. So yeah, they’re pretty much all the same thing. It’s a good analogy.

  • TheNiche, color me confused (also a little tired, the heat here was really enervating today). Fixed physical assets are generally not classed with consumption spending, so even after pondering a moment I don’t understand what is meant by a “consumptive element to holding a deed” and can’t follow. Do you feel that if marketing influenced a decision, then that spending was “consumptive?”
    You’re surely right that social instability undermines the promised benefits of home ownership, but I don’t see that the problem lies with home ownership per se.
    Yes, investing in a home entails an opportunity cost in that you’ll have less money to gamble (sorry, “invest”) in the stock market.
    Space junk could fall on my house and I would only laugh, but I do love, really love, my yard. (Hell, yeah, that’s a native prairie!) Some of us make emotional decisions about our homes. Some of us apparently get emotional thinking about other people’s irrational consumer choices.

  • @ luciaphile: Household expenditure on housing is a consumption item. A house or an apartment is a tangible depreciating asset with a viable secondary market for re-sale, but so is your car. (And just like your car, it is still consumption whether it is owned or leased.) The land that a house sits on is not a depreciating asset, however it is consumed according to its use and incrementally over time; regardless of its ownership status, if it is used for one thing, it cannot be used for another.

    A household that decides to own their home is essentially committing to pay more up front for an asset that can be enjoyed for a longer period of time. They may sell it off, and if they do then they might make money or lose money as compared to leasing the same product. But again, the same reasoning should hold true when deciding whether to buy or lease a car.

    These principles are widely recognized by economists of all stripes and even by the Fed and the Department of Commerce (although not by your congressmen or the IRS), so I am not just talking out of my ass…yet. Your Realt-whore may say differently, but that person does not actually care about your financial interests, only their commission.

    Okay, so now I’ll start talking out of my ass. Notice has been delivered. The reason that I characterize ownership itself as having consumptive value is that most people place a value on ownership that is irrational and not in keeping with rates of return that one would expect from traditional investment vehicles. They doom themselves to financial suboptimality as though it were by meticulous design.

    And for what? Someone attempting to rationalize their utter stupidity might point out that they like having the freedom to decorate the place however they want. Of course, in doing so they are causing it to depreciate. Someone else might attribute their decision to achieving the ‘American Dream,’ as though anybody else cares, tip-toeing around the issue that their deed helps them feel better about themselves. But for the most part, people are just financially illiterate and gullible, duped into an authentically ‘American Nightmare’ that they’ll never stop to reconsider.

    The amount over and above rent for the same type of home in the same sort of location is an amount that might be attributed to investment. However, if we are to calculate investment in these terms, then the difference between risk-adjusted returns on housing versus an alternative investment vehicle should be a consumptive amount associated with meaningless luxury goods, such as diamonds, expensive makes of cars that don’t perform well and aren’t reliable, country club memberships, bad art that you think you understand, or good art that you don’t understand.

    By and large, someone that intends to invest their money will do so according to preferences of risk and return. That these notions are typically abandoned by othewise intelligent people is the tell. It isn’t an investment. What is purchased is a delusion of grandeur.

  • I see that I’ve ventured where wiser posters forbear to go with you, The Niche, and now you’re blinding me with Dismal Science, but all I’m getting is: other things being equal, renting can be a more prudent financial choice than home ownership. This doesn’t entirely explain your vehemence against the latter. And as for hapless homeowners dooming themselves to financial “suboptimality”: if people haven’t the agency to make sound decisions about the value of their homes they are unlikely to have much better luck with a portfolio of stocks, bonds, and baseball cards. And if that home declines in value, well, you’ve got to live somewhere, and you’ve still got a place to sleep.
    Not being able to hold your sustained attitude of contempt for American consumers, I much prefer to think, “I don’t understand them, I’ll never understand why they don’t want what I want.” But I’m willing to grant that your contempt and my bewilderment are related, though coming from distant poles. However, of the dozens of reasons one might give for that contempt, I would never put the “delusion of grandeur” that is the impulse to be a freeholder of property, even if it is somewhat illusory and degraded, on the list.

  • Don’t get me wrong, I’ll be a homeowner again one day…but it’ll be a decision founded on a very narrow and exceedingly particular set of circumstances.

    Its not that I have nothing against homeownership in principle. I have a beef with the powers that be that prop it up, with a culture that promotes it as a goal unto itself, and with endemic financial illiteracy. All told, these factors compel otherwise reasonable people (that’d be competent enough at traditional investments) to do insane things. I was one of them once, not that long ago.

    And believe me, it’s not that I can’t understand consumers. Every time that I’ve ever cashed in on a decent bit of money or found that my life circumstances have changed for the better, I spend about a week perusing HAR’s listings. Then I pull up an Excel worksheet and run the numbers. And I think about what I could’ve done with my time in the past that had been spent bothering with repair and maintenance. Grudgingly, I fight my own nature and decline to make another purchase. It’s something I do with a distressed fortitude, like a recovering alcoholic refusing a drink.