Towers of Dabble

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TOWERS OF DABBLEMan’s long determined history of dabbling in the building of touted towers, surely not for his self-gratification, but rather to bring him closer to God, has rarely been met with benevolence. Maybe God doesn’t like man, who He created after all, attempting to smash through His glass ceiling. Consider, if you will, the first known example of such an attempt. Having heeded Noah’s warnings, a postdiluvian band of survivors just couldn’t resist taking a stab at the celestials, raising the Tower of Babel they were sure would be gloriously received.

According to preeminent Bible historian James Kugel, there would be no such reception, just rejection: “The real crime involved in the building project was the tower itself, which was intended for the purpose of ‘storming heaven’ or some related evil desire.”

Though the Old Testament’s telling leaves much open for interpretation, the idea of vengeance being associated with sky-piercing structures seems to have stuck, especially among financial market historians. Analysts at the British bank Barclays originally voiced the idea that if you build it, it will come, as in a financial crisis. That is, every time an erected edifice unseated its predecessor to become the newest world’s tallest building, economically upsetting times tended to follow. It’s uncanny how well that shoe continues to fit.

It all started at the height of the Roaring Twenties on that little 13.4 x 2.3-mile island we know as Manhattan. Walter P. Chrysler was keen to build a monument, namely to himself. But there was competition nipping at Chrysler’s heels with the simultaneous construction of 40 Wall Street, which would indeed be the world’s tallest, that is, for one month between April and May 1930.

On May 28, 1930, it took all of 90 minutes to secret a clandestinely constructed spire atop Chrysler’s building, thus trouncing his downtown architectural rival. Of course, the real victor emerged 11 mere months later when the Empire State Building opened in early 1931 presaging, by the way, the Great Depression. It would be nearly 40 years before a taller tower would rise.

The construction and December, 1970 opening of the World Trade Center would then coincide with the end of the second longest U.S. economic expansion which began in 1961. Chicago’s Sears Tower would go on to wrest away the reign in 1973, a top spot it held for more than two decades. It’s opening’s appeared to herald the nasty stagflationary recession that ended in 1975. Malaysia’s 1996 title sweep arrived alongside the Asian financial crisis. Most recently, the 2007 opening of Dubai’s Burj Khalifa augured the Great Financial Crisis.

Surely these episodes have been sufficient to appease the dieties. In short, quite the opposite. If frenetic skyscraper construction flags misallocation of capital, we could be in for a doozy of a correction in global commercial real estate. Consider the numbers in the aggregate. It took 80 years after the opening of the Chrysler Building to build the next 49 supertall skyscrapers, defined as 300 meters (984 feet) or more.

How on earth, or in the heavens, to put it more aptly, has the hundredth supertall just opened on Park Avenue? It might have something to do with the fact that in the short five years through 2015, a subsequent 50 supertall skyscrapers have been erected.

Economic historians could well have been shaken to their very foundations upon hearing news that financing to construct a historic colossus had been secured late last year. Rising from the sands and promising to reach the seraphs, Saudi Arabia’s Jeddah Tower is to rise 3,280 feet into the stratosphere. That’s 1,000 meters, as in one kilometer, besting the Burj by 591 feet. The question is, will there be economic repercussions?

Judging from the collapse in the price of oil, some might argue divine intervention has already come and gone. It is certainly the case closer to home that the oil patch blues have dragged down commercial real estate. The latest data on commercial mortgage-backed securities (CMBS) delinquencies reads like a who’s who of yesteryear’s shale boom.

Some 17 loans totaling $152 million became freshly delinquent in March, the largest one-month tally since November, 2012, according to a new Morgan Stanley report. Six of these gems are located in ‘oil boom’ territories including Casper, Wyoming; Odessa and San Angelo, Texas and North Dakota’s Dickinson and Bakken Shale regions. Another notch down the distress ladder, 14 loans moved to the status of “specially serviced,” when a new mortgage servicer takes over a loan that’s 90 days or more in arrears; 10 of them had low oil prices to blame.

The working assumption must be that the economic damage inflicted by energy’s woes will be contained. How else to explain the construction of a $1.2 billion mecca in the land of the Saudi kings? Unless, that is, it’s as simple as the money being there for the financing. Stranger things have been known to happen when interest rates are held at low levels for longer than imaginable by yield-starved investors.

History stretching back to Biblical times suggests there will be economic pain between now and the Jeddah’s scheduled opening in 2020.

The fine folks at Jones Lang LaSalle (JLL) would beg to differ. A new study released by JLL, the real estate investment management giant, forecasts real estate transaction volumes will crest $1 trillion by the end of this decade, rising from $700 billion last year. The enabler will be international money flows: JLL estimates $500 billion in annual cross-border activity by 2020.

The movement between regions will be catalyzed by demographics, according to the JLL study, which notes there will be more people over the age of 55 by 2050 than there were inhabitants on earth in 1950.

“This demographic impact will have a profound effect on real estate investment strategies with the amount of private equity capital targeting direct real estate set to increase by over 500 percent, much of it driven by increasing institutional allocations looking at higher yielding opportunities.”

Did you notice something implicit in JLL’s argument? It would seem lower for longer will remain the mantra for the foreseeable future, which suggests frothier markets and subpar growth will continue. The most interesting tidbit comes down to who will be doing the investing, that is private equity.

As it were, private equity “dry powder” directed specifically to real estate investments rang in the New Year at record levels. There is now $231 billion in dry powder available just for properties in the United States after $107 billion was raised in 2015.

For being six years into a recovery in commercial real estate, investors certainly remain enthusiastic, especially public pensions. Pensions have allocated some $207 billion to private equity funds since late 2012. Increasingly, allocations have targeted real estate funds with March of this year providing a perfect example of the merriment surrounding this asset class. Here’s a wee sampling with special notations if the real estate fund is of a particular bent:

Texas Teachers:                                               $500 million
State of Oregon’s Pension:                              $300 million
Pennsylvania Public School Employers:          $307 million
Ohio Workers Compensation Bureau:            $125 million
State of Minnesota’s Pension:                         $100 million (distressed);  $100 million (opportunistic)
State of Maine Pension:                                  $50 million
State of New Jersey:                                       $200 million (commercial)
State of Kansas:                                              $50 million
Texas Municipal:                                             $375 million

“Pensions’ chronic underfunding has prompted them to stretch to achieve unrealistic return targets,” New Albion Partners’ Brian Reynolds explained. Reynolds has been keeping a running tally of these allocations and is quick to point out that leverage is often needed to hit the bogeys, which are 7.5 percent or more. Bear that in mind when you consider the money being shoveled into these funds.

It really comes down to size, that is, of the pension system. In the early 1980s, pension liabilities amounted to about 50 percent of gross domestic product (GDP); today they are 100 percent of GDP. “Because of their growth, their investment flows have led to asset bubbles that have generated permanent losses,” Reynolds added.

Pensions flocked to hedge funds but that strategy blew up after Long Term Asset Management nearly took down the financial system. This strategy was followed by wholesale herding into commodities, which we all know ended is disaster.

The catch is the rate-of-return bogeys have barely budged despite Baby Boomers moving increasingly closer to retirement suggesting some risk should be taken off the table. (Rather than keeping you in suspense, it’s nearly an impossible feat to lower return targets. Less in assumed returns means states and municipalities have to pony up more money they don’t happen to have on hand. The State of Connecticut has reached the point where it is now taking a stab at taxing Yale’s endowment in a desperate attempt to top off its underfunded pensions.)

No matter how you slice it, most public pensions face a dire set of circumstances, which begs the question: Just what are they to do?

Reynolds’ reply: “They have turned to the last remaining asset class with high expected rates of return – commercial real estate. It’s as simple as that.”

Perhaps pensioners should begin praying the JLL report pans out. With commercial real estate prices declining in January for the first time since 2010, the latest data available, and investors balking at rich valuations, it just might take a miracle to keep profitable prospects alive.

In the meantime, all we can do is sit back and wonder what’s to come. Transaction volumes in the trillions and heights exceeding a kilometer – how do tomorrow’s architects top that? Is man’s vanity so great he will risk an even sharper blow to the glass in that celestial ceiling? If he does, what vengeance might follow? The best we can do is hope future history books don’t include records that give new meaning to that old warning, “Look out below!”