News and Publications

Tallal’s Tips

A Publication by Joseph (Jody) Tallal, Jr.
Volume XI, Number 1

November 4, 1992

An explanation of how real estate moves makes the transistion from Bust to Boom cycle.

It should be obvious by now that the recession in Dallas has finally come to an end. Due to the J.C. Penney relocation, the Super Collider announcement, GTE's, Exxon's, and Fujitsu America's recent relocations, the rest of the investment world is once again looking at Dallas as a place to be.

This newsletter will focus on the crucial transition period and market dynamics of an economy moving from a severe recession into a boom period. In Dallas we have just endured, first hand, the opposite side of such a transition. We have seen how swiftly the good times can replace the bad. The biggest boom in modern history took only from August, 1985 until December, 1985 to turn into the biggest bust.

If we plot the market value of real estate during this transition period, we can see that the market first became totally illiquid, then gave way to a downhill slide of the values themselves, averaging from 1% to 2% per month in actual market value reductions. During the last 5 years, values for Dallas/Ft. Worth real estate have declined from 30% to 60% depending on the type of realty (apartments, land, residential, office buildings, etc.). It is most important, however, not to be fooled into thinking that this pattern of decline serves as an example of how the market will respond in the upcoming expansion. There is a natural inclination to assume that, if the market first became illiquid and then declined at a rate of 1-2% per month, it will take an equal 60-month period just to return to pre-August, 1985 market values.

I would like to illustrate the fallacy of this assumption by using an analogy concerning duck hunting. Successfully buying real estate during a feverish boom period is much like going duck hunting. Success requires a special combination of knowledge, skill, and some luck. If you analyze the process of duck hunting, you can see that the hunter needs to follow specific procedures and rules to have a good chance of succeeding. First, he must begin his preparations well in advance of his hunting trip by locating an appropriate hunting sight (usually located around a body of water). Then he must build a duck blind, or scout for a place which provides adequate cover, because ducks have excellent sight. Next he has to learn how to use a duck call, set decoys, and train a dog. Finally he is ready to go hunting. On the day of the hunt he must rise well before dawn, get dressed in full camouflage clothing, and go to his pre-selected hunting location. Then he will need to set out his decoys to attract the real ducks.

At this point he is finally ready to hunt. To recap the situation, it should be just before dawn; the decoys have been properly arranged; he is hidden in the blind and fully dressed in his camouflage with his trusted (hopefully well trained) retriever; and, he has checked his duck caller to be sure it is fully functional. Those of you who have been through this entire procedure know too well that doing all this does not necessarily mean that you are going to have a successful hunt. To the contrary, even after everything has been done properly, most hunts yield meager results. The simple reason is that duck hunting is as difficult as trying to find good real estate buys in a boom market period. Unfortunately, during the other end of the economic cycle, a recession, this is not the case.

During a recession, most real estate investors are hurt economically. Their banks usually will have cut them off and their personal cash flows will have been severely curtailed. Since the market is completely illiquid, all they can do is hope and pray for the turnaround. However, one by one, as their money runs out, they are forced to sell, quite often at a substantial loss. As one person is forced to sell for, let's say, 20% less than he paid during the boom, that price quickly becomes the "current" market value. As a result all other investors are immediately expected to sell at a similar price if they want to succeed. As the situation becomes more desperate the market continues its fall.

The healthy property owners will refuse to sell at a loss and prepare to hold their property until the favorable market returns. The longer the recession continues, the further the "current" market value declines. Since only the most desperate are selling, the buyers quickly become expert "bargain hunters".

This scenario is like hunting wounded ducks. A wounded duck is grounded on a pond and cannot fly away; the hunter knows that the duck has no way of escaping. Hunting wounded ducks requires absolutely no skill or preparation. You do not need a blind, decoys, camouflage or duck calls. You really don't even need a dog because, once shot, a dead duck is usually blown to shore. You simply walk around the pond and shoot the wounded ducks. This is very similar to buying real estate in a recession. The deeper the recession goes, the more wounded ducks there are. The healthy ducks won't go near a pond if a hunter is fully exposed and shooting wounded ducks...just like healthy property owners won't sell their properties at ridiculously discounted "current" market values. If a particular location gains a reputation for having an abundance of wounded ducks, the word quickly gets around to the other hunters and they all flock to the place that offers the "easy pickin's".

This analogy has been given to help illustrate what will occur during the transition period which follows a recessionary economy moving back into a boom. Using our duck hunting illustration, we can track the market as it returns to normal conditions.

Once the market begins to expand due to strong economic occurrences, it will take some time for the new word to get around. As more and more investors enter the market, things quickly begin to firm up. However, since there are still wounded ducks on the pond (financially desperate sellers), there will be a short slaughter period to remove them during which prices will continue to fall.

The next set of described occurrences are extremely critical and are responsible for developing the fever which will become the upcoming boom. Once the wounded ducks are cleared, the market almost immediately will return to the pre-bust prices. This is because the healthy property owners who had previously refused to sell at the distressed market prices now become the true market. Since there are no longer any desperate sellers: the only ones remaining are the healthy. Obviously, if they refused to sell at distressed prices during the depressed market, they aren't going to lower their prices now that the market is strong. This amazingly results in an entire market, in a very condensed time frame, returning to the previous highs of the pre-bust days. This rapid escalation in values produces very real profits for the bargain hunter who wisely bought at the right time. His profits and the rapid growth in property values become front page news and immediately attracts others who are interested in similar opportunities.

This process begins escalating and is responsible for creating the boom. At this point we are back to duck hunting as normal, which requires all the efforts and paraphernalia previously described. Most investors will miss this important transition period, expecting things to take as long to reverse as they did to occur in the first place. But unfortunately, most investors are usually following the herd and arrive after all the easy ducks have been shot.

Let's close with a word about the Dallas/Ft. Worth real estate market. As covered in previous editions of Tallal's Tips, this area's economy has been out of sync with the national economy since approximately 1978. In late 1975 the nation's economy, as well as DFW, entered a recession. The rest of the country recovered within a couple of years, Dallas did not. Dallas' real estate recession went deeper and deeper, with all the available supply of realty in the market place being consumed before investors returned. As DFW was finally turning itself around in late 1979 and early 1980, the rest of the country, which had been experiencing a boom, was beginning to move into a recession.

The normal rapid growth and investment opportunities that occur during any turnaround period began in Dallas just as other areas in the country were going flat. This created an incredible phenomenon. Dallas' good news was hitting the investment public at the same time as the rest of the country's bad news. This left Dallas' growth statistics standing alone against a backdrop of national gloom and desperation. This greatly enhanced the picture of opportunity available in this area. Money began flowing from virtually everywhere into this region and, due to the lack of competition, Dallas quickly became the focus of the world's investment community. Investment capital spurs growth and, since there was little competition, the biggest real estate boom of modern history began.

The amazing part of this story is that it is not over. Dallas, due to the over- building created by the last boom, entered a severe recession in 1985 which was once again out of sync with the rest of the country's economy. This occurred as both coasts were experiencing major booms. New York, Boston, Orlando, San Diego, Atlanta, etc. have all basked in the limelight of prosperity for the last 5 years while Dallas and the Southwest have been buried under an avalanche of negatives.

Currently, Dallas has climbed out of its hole faster than most other Southwestern cities due to its more diversified economic base. It is entering its next economic boom period just as the rest of the country is due to begin its natural economic slowdown. Therefore, I predict that the next economic expansion will dwarf the last.

It is important to note that the last boom was triggered by American Airlines' corporate relocation and movement of approximately 1,700 new employees to the DFW area. J.C. Penney has just created 3,500 new jobs, with GTE creating an additional 4,500, and Fujitsu America expected to produced an additional 5,000 - 6,000 more. Now the Super Collider is a reality, it is next to impossible to forecast its true economic effects on this community.

What is amazing in this whole situation is how perfectly this cycle is paralleling the last even down to the looming energy crisis. Rarely do so many economic factors line up in such consistency as to duplicate the reoccurrence of a previous set of events. Such a situation is occurring at this time.

It is important to remember how quickly and dramatically real estate prices can escalate during a boom period. I believe that the next economic expansion in Dallas/Ft. Worth, and later the rest of this state, will make the previous economic boom look pale in comparison.

Jody Tallal