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Economist encouraged, but says nothing is safe

If Wharton School economist Sam Chandan has one piece of advice, it is that no real estate asset class is bulletproof.

Chandan, president of Chandan Economics, was in San Diego Friday for the 12th annual Trigild Lender Conference at the Omni Hotel adjoining Petco Park.

Chandan said if everyone rushes to any asset class, prices are artificially bid higher beyond their true value, setting the stage for future defaults later.

“We are at risk for paying too much for assets that don’t have the support,” Chandan said. “There are a finite number of assets, and if you have a seemingly unlimited number of bidders, that’s dangerous. There are too many core assets in gateway markets.”

Chandan says this is even true for that most favored of assets classes today — well located apartments. These may be particularly vulnerable if they are the type of trophy properties everyone seems to want. In short, a Class B or even a Class C property may be a better bet since those may not be as subject to the wild price swings experienced by the more expensive properties during the past four years.

Chandan also recalled that in the middle part of the last decade, apartment property defaults were happening more frequently than defaults on trophy office buildings. Many also tried to convert apartment properties to condominiums, but this plan had more than its share of failures as well.

Meanwhile, desires are changing. More people are postponing having children, they may like the idea of not having a mortgage, or can’t afford one, and may enjoy living in an urban setting such as downtown San Diego.

“Do you want to own a home? Do you want to own a minivan ? They will tell you ‘no.’ We are fundamentally becoming much more a nation of renters,” he said. “Ultimately young people will have kids and that will change again, however.”

Looking at single-family, Chandan said he is finally seeing an improvement nationally, and home values are climbing again.

“The amount of money a homeowner can make in a rising market is a heck of a lot better than a 401(k), but it’s also terrifying because we know what can happen,” Chandan continued.

Chandan suggested evaluating what a market will do is at best an imperfect science.

“The problem we have is we’ve not had the ability to measure risk,” Chandan said.

To do that, Chandan said economists will need to assess what the markets will look like in five, seven and 10 years out.

On the subject of filling what have been some very empty office spaces, Chandan said the problem is employers continue to be reluctant to hire more people, even if they have found themselves shorthanded as the economy improves.

“There’s a lot of risk aversion out there. Too many individuals are unwilling to make a decision, and that’s the weakest link we are dependent on,” Chandan added. “We have only begun to recover the jobs we lost in the office sector.”

For those buying office buildings — even for a long-term hold — Chandan said it is necessary to come up a formula for selling at the time of the purchase so when the time does come, the building doesn’t have to be sold at a loss.

“If you buy the largest office building in Pittsburgh, you’re not going to think about your exit strategy,” said Chandan adding that the long-term view is always a good idea.

Chandan said the good news for the office sector is “we don’t build new office buildings overnight.”

Another factor that could help with the older spaces is adaptive re-use. Chandan said when the Comcast Building in Philadelphia, which has more than 1 million square feet of leasable space, was completed in the mid-2000s, the signature Liberty Place just became another 25-year-old office complex. As a result, one of the office buildings was subsequently into a residential condominium.

Office rents may be a long way from where they were at the peak of the market in 2005-2006. Chandan said there are even places in San Francisco for example, where the office rents haven’t recovered to where they were in 1999 and 2000.

Chandan noted that the sector that continues to grow as baby boomers age is health care, along with increasing demand for additional space.

The economist who said we are likely to experience a mild recession in 2013 anyway, said the possible sequestration or “fiscal cliff” that could happen if a budget deal isn’t agreed upon by the end of the year, could make matters significantly worse. That possibility would result in huge cuts from everything from defense to entitlement programs, and Chandan says, “would end up taking huge amounts of discretionary income out of the system.”

“Even if that doesn’t happen, we’re nowhere near where we should be,” Chandan added.

Chandan also worries about the cost of capital — warning that what goes down will invariably go back up at some point.

“When interest rates rise, we (as a nation) will end up spending more than on any discretionary program,” Chandan said.

He also said that he isn’t surprised that lenders continue to be tight with their purse strings.

“You can’t extend credit where credit isn’t due,” he said.

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