There should be a very substantial and sustained economic boom in the industrialized and emerging countries, largely fueled by the demand for capital in Russia and other eastern European countries. This boom will lead to a shortage of capital on a worldwide basis. This boom will exacerbate the shortage of housing already set in force by the tax reform of 1986.
The tax reform act of 1986 was drafted at the time a considerable boom in Real Estate was taking place. While family formation was increasing tax incentives and resulting syndication accelerated the real estate boom. I do not believe much thought was given to the impact (over the long term) that this legislation might have on the creation of housing. As the inventory of excess housing is worked off, there will be very few multiple dwellings added to the market. The entry level entrants and the poor will be put into a monumental squeeze with rapidly rising rents. At the beginning, this will skew people into purchasing housing. Therefore housing values will once again show a very substantial rise. This result would occur in any normal economic recovery, However, this will not be a normal economic recovery. (later)
The tax reform act of 1986 did two things that in the short and intermediate term will help create this significant shortfall. By lowering the tax rate from 60% city, state and federal, the reform act redirected some first time buyers into the rental market. Also, by lowering the tax rate from approximately 60% to 40%, it discouraged new investments into the residential market.
On a national basis there was substantial overbuilding. This overbuilding was both in rental housing and housing built for buyers. With this oversupply, numerous units built for buyers have come on to the rental market. Along with the oversupply, the current recession has reduced the rate of increase in family formation. Young daughters and sons without jobs frequently stay home rather than rent their own quarters. Even those with jobs stay home, fearful that they may lose them. In this second group, feelings that the economy is picking up and a heightened sense of security will send them into the housing market. Any significant economic recovery will send both groups back into the rental housing market. Supply will dry up and rents will begin to soar. In this scenario some renters will be redirected toward buying. The net result will be substantial increases in housing values as well. The impact of the tax reform act of 1986 should not be underestimated. Over the last 5 years the impact of the act has been camouflaged by the excesses created before 1986. Also, the lowering of the maximum tax rate redirected the market from individual buying to renting.
The coming economic boom will highlight the problems created by the tax reform act. Already, Eastern Europe has created changes in the market place. Germany , which had a balance of payment surplus of approximately 70 billion dollars a year ago has now slipped to a 10 billion dollar deficit within a year and it would not be surprising to see it falls to 50 or 60 billion within another year. Germany's redirection has created a tremendous opportunity for the other industrialized countries. Already, the U.S. balance of trade has been showing improvement.
Germany's absorption of the East Germans is and will continue to be a tremendous drain on their resources. Responsible estimates of capital needed to bring the east up to par with western standards runs upwards of one trillion dollars. In addition the Germans are paranoid about stability on their borders. This represents another drain on their resources. The Germans have already committed themselves to over 15 billion dollars to the Russians. The French and other members of the common market are also indicating that they will co-operate with the Germans in finding the capital commitment. This redirection of capital will set off a tremendous economic boom in the industrialized world. Over the longer term, the cost of capital will increase, resulting in higher interest rates. Again, this will limit capital coming into the housing market.
For those who own their own housing, this will be a bonanza. For those who don't, this could be devastating in terms of housing costs. All who are able should make it a point to buy within the next year. To address more explicitly what is happening in Eastern Europe: at the beginning of the fall of the iron curtain, there was great optimism that the capital needs of eastern Europe would fuel a boom. This boom has been slow in coming because of three basic infrastructural problems. The basic keys for a modern society are communication, transportation and processing. Another infrastructural problem is institutional: property rights. A third institutional problem would be education. This problem in eastern Europe and Russia is not quite so poignant as the first two, in the fact that the educational level is acceptable. All three of these items have to be in place for these countries to attract and absorb capital. Progress is being made at a slowly accelerating rate. At some point, a snowball effect should take place and a worldwide, unprecedented economic boom will ensue. The United States is preeminent in communications, food processing and is the equal in transportation to the other countries. We are well positioned to be the prime beneficiary of this boom.
Other areas where we should enjoy strong industrial advantages are: pollution cleanup and control, large construction equipment, building supplies of all kinds, oil explorations, oil development and distribution.