There was an ad a few years ago with a voiceover that asked, “Hey, where did everybody go?” That is the question I had in Borders recently. It was less than three weeks until “holiday” and there were no lines. Even last year, they had the rope line up to handle the crowd. Across the street at the Bridgewater Mall, even on pre-Christmas weekends it was still possible to find a parking space without too much trouble. As lackluster as that may sound, the Census Bureau indicates that retail sales jumped at an annualized 14% in the 4th quarter of 2010, which would seem to be good news since 70% of our economy is driven by consumer purchases.

How to explain this spending in view of high unemployment, high foreclosure rates and decreasing home values? There are a number of possible explanations. One is that the Fed’s low interest rates have goosed spending, particularly if low interest rates are viewed as temporary with high rates of inflation looming in the future. Some look at the increase in spending and conclude that income and employment are actually understated. In the fourth quarter of 2010, withheld income tax receipts did rise by 17%¹, possibly indicating an increase in employment . Another explanation is that the size of the underground economy is expanding. Evidence for this explanation is the increasing percentage of people who do not have bank accounts. People avoid bank accounts as government increasingly forces banks to monitor their customers’ accounts. As people see evidence that their elected representatives and government officials fail to pay taxes, or that they spend tax revenues unwisely, taxpayers feel like chumps, and may do more to evade taxes².

The underground economy aside, we lost 6.7 million jobs between 2008 and 2009. The BLS says 1.17 million private sector jobs were created between January and November, 2010, which sounds good until you realize how many jobs we need to replace the ones we lost, not to mention that the economy needs to add 250,000 jobs a month just to keep up with graduates and others entering the labor market. The labor participation rate is at a 25-year low of 64.4%. Shrinkage of the labor force from the usual 67 –68% probably accounts for the recent drop in the unemployment rate from 9.8% to 9.7%. At least the New York metro area has produced more jobs than any other market, with a net gain of 61,500 jobs YTD, due in part to the financial bailout of Wall Street.

Office cap rates are mixed with office and industrial properties being part of the tale of two cities; top tier properties are in strong demand by investors and have falling cap rates. CBD office properties are in stronger demand than suburban properties. Properties that are not top tier are plentiful but are considered to have too much risk by investors. Due to limited supply, REITS are even looking for quality properties abroad. In England, office buildings have appreciated 24% in the past year³. The object is to create a global brand for international tenants, which is fine as long as they know the nuances of foreign markets, which may be a big “if”. The good news with respect to industrial property is that nobody is bothering to build any right now. Smaller flex buildings are perceived to have greater risk than warehouses, and their higher cap rates reflect this.

Apartment complexes have always been in demand because single family homes are so expensive, a situation worsened by scarcity of land and the cost of regulation. Here again, quality apartment properties are in demand as is evidenced by cap rates hovering around 4 or 5% in hot markets like New York, Boston, and Washington. Apartments would appear to be the destination of people losing their homes in foreclosure. There were 110,000 homes foreclosed upon per month in the third quarter, compared to 98,000 per month a year ago. The number of homes under water has dropped to 22.5%, although the drop is attributed to foreclosure rather than any improvement in home prices.

If there is any one big change out there, post-bubble, it is that real estate should be viewed as an income vehicle rather than a growth vehicle. Each piece of real estate has its own unique risks and advantages, despite its having being treated as a commodity in recent years. There is a return to fundamentals. Investors should take their time and kick the tires before plunking down hard-earned cash.

^{1 No Job? No Income? No Problem for Consumers by Caroline Baum, Bloomberg Opinion, Jan 18, 2010 http://www.bloomberg.com/news/print/201101-19/no-job-no-income-no-problem-for-consumers-commentary-by-caroline-baum.html}

^{2 New underground economy; Key indicator: Avoidance of bank accounts, Washington Times, Feb 18, 2010 http://www.washingtontimes.com/ews/2009/dec/9/new-underground-economy}

^{3 REITs Going Global to Find Deals, Anton Troianovski, The Wall Street Journal, Nov. 10, 2010, http://online.wsj.com/article/SB10001424052748703585004575604903339756266.htm}