Most people think that commerical real estate is unpredictable. Dr. Glenn Mueller proved this wrong, and was awarded the prestigious Richard Radcliffe Award for groundbreaking research by the American Real Estate Society in 2010. This is part 2 of his interview, and continuation of part 1.

 

RCFR:   You have a warning in your forecasts that sometimes things don’t move smoothly along the cycle. My hometown of Tampa was really close to tipping into the recession phase two quarters ago on your report. This quarter it backed up one step.  Do you ever see a market skipping forward dramatically as well?

 

Mueller: Once in a while but it’s not very often.

 

RCFR:  You’ve been tracking cycles since the 90’s. What’s the most severe backtracking that you've seen?  

 

Mueller:  It’s actually fairly rare. It happens with one or two cities moving backwards at one point of the cycle because the supply numbers didn’t pan out, or the employment rate was higher or lower than expected.

 

RCFR:  A new investor might look at the cycle model and ask “When developers see that there is too much supply, why do they continue to build and subject the market (and themselves) to a downturn?” What’s the answer to that?

 

Mueller:  It takes a long time to get things approved and to get things started. And developers make money developing.  So, once they start the process, get investors and receive approvals, they’re going to start building.  So, there is a lag between when they start and when they end and how quickly they can react to a risk. Once started it is hard to stop a project.

 

RCFR:  That makes sense. But what about when the cycle is just getting late (versus already in a downturn), when you’d think developers would start slowing down. A downturn hurts them too. What is it about the dynamics of the late part of the cycle that causes developers to roll the dice one too many times, when they should probably stop?

 

Mueller:  In your hometown of Tampa there is a lot of apartment building construction going on. And Tampa is growing by 10,000 people a year, but there are 15,000 new apartments this year. So, they're oversupplied in the market.  They won’t be able to get their projected rents on their pro forma projections, and will have to drop rents. They will end up stealing renters from older apartments and hurting the market.

 

RCFR:  But will this end up hurting them too? If they can’t make their projected rents that could weaken or wreck the whole investment. And then it will be harder for them to develop next time.

 

Mueller:   Right.   They projected $2,000 a month in rent and now that the market is oversupplied, they're only going to get $1,600 a month.   So, the returns on that investment are getting lower.

 

RCFR:   I was reading a blog posting and the guy in it was a big fan of your report. However, he says that the apartment report wasn’t accurate for Seattle, so he started analyzing it in depth.  He noticed that in the past, Seattle hasn’t always moved smoothly along the cycle, but was making a lot of large skips and jumps in different directions. And he claimed he contacted you to confirm your data sources, but when he ran them through your model he got different results.

 

So the question for you is: Does your model produce 100% of the results? Or do you apply some human judgement and modify the result to what looks right to you?

 

Mueller:    I don’t know what he was doing, so I can’t help you interpret what he says.

 

What my cycle report does is look at historical occupancy levels. And I watch them go up and down on each market’s own curve. And then I actually create a curve for each individual city and then I forecast where that is going: Up or down. When I do that I get at what point it is in the cycle. 

 

My cycle report says here is we are in the cycle and it will help you determine what type of rent growth you should be getting. The Seattle person may have used a different data source, or not understood my model process.

 

RCFR:   Does the model produces the final result, or is there a human judgment involved?

 

Mueller:  When I plug it in, it shows me the cycle curve and I can spot where it is on the curve. However I may say, “Well the last cycle was a certain size. Is this cycle going to be more moderate?”

 

RCFR:   So you scale it using your judgement?

 

Mueller:  Correct.

 

RCFR:  Other than that, is there any other judgment required or is that it?

 

Mueller: That’s really it. The length and the magnitude of the cycle are the only two things.

 

RCFR:   Let’s switch gears for a moment. How did you first become interested in researching the real estate market cycle?

 

Mueller:  I was hired out of Denver University to go work for Prudential in 1990 and that was when we had the big real estate crash.  So, as a researcher I was asked to  figure out what happened, why it happened, and whether we could either predict or monitor it going forward in the future.  So, that started [me off] looking into everything and seeing that demand and supply were the two key variables that drove the real estate industry.

 

RCFR:  Are there any other researchers that you admire, either in real estate cycles or real estate investment strategies?

 

Mueller:   Bob White of Real Capital Analytics is great. Also, Ken Rosen, who is from the Rosen Consulting Institutional Investor. I am also a big fan of Ray Torto and Bill Wheaton of CBRE.

 

RCFR:  How can readers get a free copy of your quarterly report?

Your readers can subscribe to the quarterly Cycle Monitor Report for free. (Editor’s Note: You can email Rhonda Tucker at rtucker (at sign) dividendcapital.com to subscribe.) There’s also a paid cycle forecast report that forecasts where the market will be a year from now. (Editor’s Note: Currently $1000 per year. You can contact Dividend Capital at the above email address for pricing information).

 

RCFR:   Your report covers only the physical cycle (income) and not the financial cycle (pricing). What do you recommend for investors to keep track of the financial cycle?

 

Mueller: There's a company called, Real Capital Analytics, that has every sale in the country on commercial real estate over 2.5 million dollars. The URL is  rcanalytics.com. And they can buy a single reports for their cities.

 

More on cycles 

To learn more about physical and financial cycles, as well as, how to plan for them in your portfolio, see our three part tutorial.