The notion of resilience is usually focused on ecological frameworks and the ability of nature to withstand significant events. It is increasingly the case, however, that the mechanisms and behaviors employed by ecosystems or species to respond, adapt or fail in response to outside factors are applicable to a range of fields of study. Among these are the realms of urban planning and real estate investment and development. In a broad sense, resilience of urban real estate markets is addressed with regards to the cyclical nature of real estate. The five stages within the typical cycle – recession, recovery, expansion, equilibrium and hyper-supply – represent revolving cause and effect scenarios that often times evolve to address the shortcomings of previous cycles. However, those shortcomings are not always adequately resolved and, even for those issues that are satisfactorily addressed, new conflicts arise with each passing cycle. But, some of the same issues are omnipresent, such as reaching a point of hyper-supply, in which the end-user market can not keep up with the built market.
While recovery and expansion are clearly the best times for investment, activity continues during all stages. This is representative of the fact that the individual components of real estate cycles are difficult to identify in the present. Although easier in hindsight, it is still not an easy task to mark the beginning and ends of each cyclical component. So, are we currently in recovery or are we still searching for market bottom? It depends who you ask. Regardless, the inevitable ups and downs require resilience on the parts of market players and participants.
In a recent article for Seed, author Maywa Montenegro identifies cities as hubs of good – innovation, creativity and wealth – and bad – crime, disease and environmental pollution. Montenegro links cities to the science of resilience based on the view of cities as “a highly ordered, complex state – commercial districts and neighborhoods, social networks and infrastructure networks, cycles of water, energy, and food consumption – reduced to a state of chaos and disorder.” It is this chaos and disorder, though, that makes cities both fascinating and maddening.
When applying real estate fundamentals to that ecosystem or framework, especially when in chaos, Montenegro illuminates the unknowns by recognizing the opposing states that can be reached – either “floating on a housing bubble” or settling “into a basin of recession.” Then, because real estate can be measured in tangible dollar terms, recognize The Wall Street Journal’s report to highlight the volatility we are now faced with in the real estate markets. In Philadelphia, the paper reported, the total volume of office deals done for properties valued at $5 million or more shrank to $99 million last year from $747 million in 2008. Or, in an entirely different realm of real estate, note a Denver Business Journal report citing a slide in real estate revenue at ski stalwart Vail Resorts from $67 million in the third quarter of 2008 to a paltry $205,000 in the third quarter of 2009. We are, indeed, in challenging times that will test the resilience of the real estate industry, in general.
In his 2008 working paper on regional resilience, author Todd Swanstrom addresses the questions that still await real estate investors:
“Properly functioning private markets are highly resilient because they motivate decision makers to respond quickly to changing technology and consumer preferences…Markets aid individual resilience by giving consumers more choice. For example, the ability of private lenders to put foreclosed properties back on the market as quickly as possible so they can be occupied and pay taxes is an important part of resilience in the face of the foreclosure crisis…On the other hand, markets can also get ‘locked in’ to patterns that undermine resilience.”
Whereas in the past issues of supply and demand imbalances or lack of diversified economies were the root causes of real estate downturns, this episode is one of questionable valuations and financial engineering, among other causes. It is less local and more systemic. However, there are still advantages to be gained by those regions that are able to embrace volatility and respond with increased flexibility. As Swanstrom states, “regions must reinvent themselves in the face of challenges. When industrial jobs disappear, regions cannot just reinvest in the manufacturing sector in the hope of recreating a prosperous economy based on heavy industry. Instead they must reinvent themselves to find a new profitable niche in the global economy.” Further, “metropolitan areas that fail to loosen tight connections that bound them to the earlier structures will remain brittle and lack resilience.”
Within the purview of resilience theory, then, how will investors, developers, lenders and other stakeholders respond, reorganize and adapt to what may (or may not) be a new world? Montenegro believes that the essence of resilience addresses the amount of shock a system can absorb before it transforms into something fundamentally different, and that change, from a resilience perspective, has the potential to create opportunity for development, novelty and innovation. This presents fundamental questions as to the future practices of real estate players and components.
- For lenders, what will be the new standards? And, when will activity truly resume?
- In the quest to obtain entitlements or approvals, will the public process become easier or more predictable? Or, will the opposite happen as public officials become de facto loan review panels, making judgments as to the financial viability of real estate deals?
- Will community stakeholders take the same potential approach as public officials and play a different role, not wanting to be stuck with vacant storefronts or empty residences in their community?
- Are end users going to be more modest in the face of limited financial resources? Or, will they be more demanding of landlords and owners to ensure they get more for their money?
- Will real estate investors change their analysis processes, devising different, if not better, methods to assess market projections?
- And, finally, will risk tolerance emerge out of the new real estate realm as sufficiently high to restart the market? Or, will risk tolerance be so low so as to prevent healthy deal flow?
The answer to our current real estate malaise is not yet obvious, but surely it will involve systemic changes, new approaches and as-of-yet untested strategies. This is the true mark of resilience, however, and cities will either continue on a downward spiral or emerge as renewed centers of innovation, creativity and wealth.