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Disentangling the geography of finance and real estate: competing space-times of decision-making and uneven spatial development

Sabine Dörry and Michael Handke

Abstract

The versatile ‘city building’ processes are in the focus of this issue. The author’s papers deal with a plurality of related issues such as the complexities of the increasing transparency of local property markets or the tight relations between city planners and (inter-)national investors. As the built environment decides on a city’s economic prospect and determines future planning and development opportunities, the consequences of city building processes are multifaceted. Financial processes of urban (re)development, for example, are discussed at the cutting edge of a larger process of uneven development, which is rooted in the structure of the capitalist mode of production and fuels controversial debates on the ownership of the city. The current edition aims to attract further attention to the complex of financial matters and the production of the built environment with the intention to locate both more centrally within geography, planning, and economics. Against this background, this introduction spans the idea of the decision-making itself in financial and real estate markets, which can neither be limited to a singular moment nor be separated from the context in which they take place. Disentangling these market interdependencies and illustrating the context dependency of decision-making is a common theme in all of the papers included in this issue.

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Introduction

1Numerous articles have taken the recent real estate and financial market crisis as a starting point to critically examine real estate as a financial investment and its socio-spatial implications (exemplarily, Aalbers 2008, Ashton 2009, Christophers 2011, Engelen and Musterd 2010, Keil 2010, Marcuse 2009, McDowell 2011). What is obvious, on the one hand, is that decision-making in financial and real estate markets takes place in different space-times (MacKenzie 2011, Smith et al. 2006): Decisions about real estate assets cannot be limited to a singular moment and cannot be separated from the context in which they take place. They also refer to different temporal distributions of economic benefits (Clark 2011). On the other hand, close and reciprocal interdependences of the real estate and the financial industry generate new, diverse geographies: In an urban context, for example, the different yield expectations of investors regarding real estate assets can have significant effects on a city’s structure and, in some cases, cement uneven development (Henneberry and Roberts 2008). Collectively wrong decision-making concerning different but correlated risks in real estate and financial markets can lead to a severe economic crisis that unfolds differently according to geographical scales and places (Martin 2011). Disentangling these market interdependencies and illustrating the context dependency of decision-making is a common theme in all of the papers included in this special issue.

2The real estate market is highly heterogeneous and consists of numerous sub-markets that are separated from each other by space (national and regional) and function (residential, industrial, logistics, or retail). The production and life cycle of real estate as a commodity is relatively long in comparison to other economic goods. Thus, the construction industry mainly caters to existing markets and accumulates capital in space and time. Investments in real estate can function as a buffer to over-accumulation in contemporary capitalism (Keil 1987). However, as the real estate market is slow and only reacts delayed to over-investment, investment activities based on distorted incentives often lead to the development of financial bubbles (Glaeser et al. 2008). This has implications both for the organization of the markets as well as for the urban planning policy. Abrupt altered environmental as well as market conditions greatly challenge market and policy actors alike (Dörry and Werner 2009). Burst real estate bubbles reveal an oversupply of real estate, cause a drastic slump in market prices, manifest as financial risks of the banking industry, and eventually go hand in hand with subsequent risks for other economical sectors. At worst, vacancies, the deterioration of building stock, and the price slump have negative effects on each other and directly affect the socio-economic urbanity of populated areas in a downward spiral of cumulative causation (Belina 2012). This logic can be applied to the office as well as the housing markets, even if housing policy measures can distort real estate cycles within housing markets.

3It is relevant to ask whether it is possible to design urban geographies in such a way that even unplanned and (negative) long-term effects of market activities can be channeled productively. The current housing market crises in countries such as Ireland, the United Kingdom, or the US reveal the closely intertwined relationship between real estate, loan, and capital markets. The US-American subprime mortgage market crisis of 2007 and 2008, for example, developed into an international financial and economical crisis within a very short time. This was possible because the risk of local real estate markets was globally distributed through innovative financial products and mechanisms (financial engineering and securitization) and set against the backdrop of insufficient controls as well as unclear control responsibilities by sophisticated and well-connected financial agents in the local hubs of the world economy (Handke and Schamp 2011). Subsequently, this circulating risk was reinforced in the form of an international shortage of capital on the interbank market, ultimately affecting the local economies once more (Martin 2011).

4The collapse of the Spanish real estate bubble in 2008 serves as another good example to illustrate the principle of cumulative causation that is fuelled by the close interrelationships between real estate, financial and political actors. For a long time, the Spanish economy benefitted from a construction boom that fed the inland revenue of the Autonomous Regions and secured their financial solvency. Local politics, the construction industry and saving banks, as the main financiers, had strong incentives to approve and perform the soil sealing of entire regions. Ultimately, numerous investments turned out to be a pie in the sky by substantially failing to meet the set yield expectations. The real estate bubble burst; and today, vacancies and decay shape large parts of the built environment in Spain (Martinez-Fernandez et al. 2012). The resulting destabilization of the Spanish financial system is now also threatening the integrity of the entire Euro-zone.

5These crises perfectly illustrate the ideal of a smooth transition from the real product to the capital markets, which are based on the trade of risks and temporary property rights of goods (Christophers 2009). It exposes two essential interdependencies within the interplay of financial and real estate markets: On one side, real estate investors are dependent on the financial sector, as they almost always rely on debt capital to finance their projects. Prior to the liberalization of the financial markets, the enormous capital intensity of real estate investments posed a fundamental problem. Real estate, mostly financed by bank loans, tied up large sums of capital in the long run. Earnings, however, depended on factors that were difficult to predict, such as the local economic and workplace development in the services sector, which demands a specific office building infrastructure and whose performance in turn is closely linked with the global economic development. The financial risks of investments in real estate were thus divided between two actors: the owner, who relied on stable cash flows for the repayment of his loans, and the lending bank, which carried the default risk. This situation changed through financial innovations such as open-end and closed-end real estate funds. These funds obtain the necessary capital on the free capital market through private and institutional investors. In this way, the risk of lending capital shifts from the lending bank to the private investor (Huffschmid 2002), and real estate is converted into tradable financial investment products with clear yield requirements that at best can be liquidated at any time (Dörry and Heeg 2009). Large institutional investors have actively shaped the liberalization of the markets through political intervention and have eventually developed into increasingly powerful decision makers in local real estate markets around the world. The articles in this issue therefore focus on these powerful actors within a variety of real estate specific topics.

6Nevertheless, the real estate industry is not solely dependent on the financial sector. These relationships of dependence also flow the other way. An essential feature of the current growth-oriented, finance-dominated form of capitalism, for example, is to obtain loans and in the broadest sense gain capital through property rights of real estate (Binswanger 2006, Steiger and Heinsohn 2012). Houses are immobile, tangible assets linked with notarized ownership claims. Goods with a transparent ownership can be traded on the markets relatively easily. This is one of the reasons why banks preferably secure the loans they grant with immobile assets (Handke 2009). In case of insolvency, securities of the debtor become the full property of the bank. In turn, however, the liquidation of the debtor’s assets thus transferred requires liquid, i.e., functioning, real estate markets. Expanding on this notion, this also means that whenever it is not possible to persuade lenders of the value of a security or whenever markets are considered temporarily illiquid, loans become more expensive or even completely inaccessible (Banerjee and Duflo 2011, De Soto 2000).

7These interdependencies between financial and real estate markets have various, multi-dimensional, and occasionally opposing geographical consequences, which we examine from an actor-centered point-of-view. These interdependencies are shaped by the active efforts of international investors that penetrate new real estate markets and make use of the currently dominating rules of financialization. ‘Brick and mortar’ ownership titles increasingly circulate on the secondary financial markets. However, investor decisions to include such ownership titles in their investment portfolio have deprived the local real estate markets of many distinctive local specifics, leveled them out, and thus ultimately ‘de-territorialized’ the real estate. As only few ownership titles meet the investors’ high expectations uneven development of urban space is fostered (Henneberry and Roberts 2008). From another perspective, the interdependencies cause an on-going process of opening and closing of spatial windows of opportunities for global investors, and this process is guided by the local state. It mandates and authorizes, for example, sustainable urban development policies, and regulations of the investors’ activities accordingly. The decision-making logic of the local state is increasingly oriented towards neoliberal – and thus in turn globalised – types of policy-making (Swyngedouw et al. 2002) and consequently contributes to the intensification of the two above mentioned processes of ‘de-territorialization’ and ‘uneven development’.

The making of new markets

8The hierarchies of diverse spatial dimensions, based on which decision makers in both real estate and financial markets take action, are being breached. For example, once the loan request by a lender is approved by a bank and the property rights in regard to the assets deposited as securities are defined, the door to the monetization of trading these rights on specialized capital markets is thrown wide open. The local real estate markets (markets of the first order) are de-territorialized and therefore assigned to a globally valid investment and exploitation logic. The socio-economic implications of that logic are largely identical in different urban spaces. The US-American subprime crisis, for example, teaches us that in capital markets, where property rights are traded, the requisite local preconditions for the liquidation of real estate objects in case of an unviable investment were not always included in the investment considerations (MacKenzie 2011). Rather, the investors’ expectations of real estate titles were set against the collective risk expectations and behavior of other investors (anticipated expectations on markets of second order, Windolf [2005]). Consequently, a great number of investment decisions were made completely detached from the knowledge about the local markets, in which the real estate is embedded. As a result, the demand of brick and mortar titles on the financial markets increased and fuelled fatal incentive schemes for short-term debt financing (leverage) of new real estate investments on the real product market. Speculations in the financial markets were paralleled by speculations with construction activities. Asset bubbles developed as a direct consequence. The same holds true for urban office building markets (Dörry 2010, Dörry and Heeg 2009).

9For the time being, the boom in high-leverage loans with short maturities for so-called trading investors, who realize their earnings from the trade with these buildings, has been contained. Once again, institutional investors with a more conservative approach, such as insurance companies, pension funds, private universities or foundations, are currently spearheading investments in real estate markets. In order to succeed in investing in genuinely profitable real estate with high and regular cash flows (core investments), extensive knowledge on the global and the local market environments is indispensable. This knowledge, however, entails numerous aspects and is unevenly distributed among the actors in the market. The necessary processes of gathering information, of transforming this information into market knowledge, and the (controlled) distribution of knowledge have produced both new actors and new interdependency in an international division of labor. Project developers, financial investors, and specialized consulting firms cooperate in generating and reproducing spatially distinct “epistemic cultures” (Knorr Cetina 1999) within urban contexts, in which global and local dimensions of the markets are negotiated.

10Nadine Bitterer und Susanne Heeg (2012) deconstruct such ‘market-making’ processes of formerly ‘closed’ and ‘opaque’ real estate markets. On the example of Warsaw, they show how the unique combination of internationally and locally embedded information and knowledge transcends and eventually standardizes local markets. The authors argue that transparency and comparability are considered necessary preconditions for international investments; but they have to be actively ‘produced’. The Warsaw office market had been the new Mecca for international investors during the last decade. Based on initial regulatory stabilization processes by the Polish state to create market confidence and to encourage investments after 1990, Bitterer and Heeg demonstrate that not until the implementation of multiple knowledge practices and formats by the international ‘norm entrepreneurs’ – property consulting firms and other professional organizations – did the Warsaw real estate investment market undergo a maturing process and eventually attract international investments. In this vein, the authors illuminate how the actors’ underlying social practices and unique combinations of local and global market knowledge as well as standardization methods enabled them to convert local facts into internationally comparable figures and descriptions, which ultimately gained momentum towards multifaceted integration processes of this emerging (local) market into international market structures.

11Louise David (2012) draws a comparable conclusion in her analysis of different entry strategies of international investors in commercial real estate markets in the peripheries of the Mexico City metropolitan region. Similarly to Bitterer and Heeg, David underlines the relevance of precise local market knowledge for the successful development and commercialization of real estate assets. Her focus, however, is on the role of risk perception and risk strategies of different market participants. More precisely, she carves out the division of labor in risk-taking strategies between land developers and international financial investors. Her chronological description of the market evolution in the Mexican Cuautitlan and Cuautitlan Izcalli regions demonstrates that opportunistic risk strategies of first movers – in this case of land developers – progressively paved the way for market followers, i.e., more conservative institutional investors.

12Both papers carefully discuss the different strategies of various market actors in the interplay of real estate and financial markets. These strategies, it is shown, not only create windows of opportunities for investments but also actively (re-)shape them.

‘Safeguarding’ the city planning?

13City building is a versatile process, fuelled by the liberalization of financial markets and accelerated by the increasing transparency of local property markets. Tight relations between city planners and (inter-)national investors, developers, and other market-making actors stimulate this process. It is clear that by means of legislation and taxation levers, local politics can, to a certain degree, successfully direct the local construction and investment processes. This is reflected by the fact that (international) investors of global real estate transactions generally consider the local political environment in a due-diligence risk assessment. However, planning policies must, as ever, submit to the rationalities of economic profitability, which is clearly indicated by the neoliberal logic of city marketing (Heeg and Rosol 2007, Mattissek 2008). Especially in times of a high availability of capital, the contradiction between the embedding of real estate in a local urban framework and its simultaneous disembedding as financial asset on the global capital markets is particularly evident. Political and economic actors converge in the creation of urban spaces. Occasionally, windows of opportunity for market development and the redevelopment of urban districts are opened up simultaneously.

14Guilhem Boulay (2012) particularly emphasizes this fact. In his article, he analyzes the ‘market signals’ and their influence on the developments on the market for residential real estate. Taking the housing market in Marseille as an example, he identifies the fundamental effect of the local state’s noisy signals on the decisions of (inter-)national investors. In doing so, he challenges the widespread neglect of socio-political parameters within the discourse on potential price differences in the housing market rent gap (Smith 1982). Using a comprehensive, quantitative analysis, he argues that state intervention itself allowed for the speculation on rising housing prices in structurally and socially vulnerable regions and thus got the ball rolling for private investment activities. In Marseille during the 1990s, state-funded projects were intended to spur the development of urban districts in need of redevelopment (catching-up development). The very announcement of such redevelopment projects raised the expectations of future yield returns on the private housing markets. There is considerable evidence that these activities prompted significant price increases and thus initiated a gentrification process. According to Boulay’s line of argument, these socio-political parameters, identified as ‘potential land use’, ought to play a more important role in quantitative modeling, thereby expanding Smith’s rent gap theory.

15In this respect one may hypothesize whether a high and long lasting conformity between the incentives and rationalities of public actors and private real estate market participants can fuel the overheating and bubble building process in markets; especially when in times of a wide availability of capital the contradiction between the embedding of real estate in a local urban framework and its simultaneous disembedding as financial asset on the global capital markets is particularly evident (MacKenzie 2011). However, there is also evidence that conformity between private markets’ and the local states’ rationalities is purposefully established and used as a mechanism to normalize overheated real estate markets. The city of Frankfurt am Main, for example, experienced an exceptional capital influx until 2008, when suddenly it became clear that the window for successfully investing in the local office building market had been closed for some time. One year later, Frankfurt’s planning officials unofficially claimed that high office vacancy rates in certain city locations might be sending the ‘wrong’ signals to investors. In this situation, positive stories from the real estate market were highly welcome. Sole or anchor tenants of office buildings often identify with their property and create powerful stories about their tenant-building symbiosis. A specific location, the uniqueness of a site’s environment, or the history of the development and usage of a single real estate asset as marketed through the developer in charge can guide investors’ expectations. Such powerful stories like in the case of the Petronas Towers in Kuala Lumpur or the New York Times Building in New York City are found all over the world.

16As the built environment shapes a city’s economic prospects and determines future planning and development opportunities, cities have more recently embedded their redevelopment strategies and stories in an increasingly green and ecological line of reasoning (Farreny et al. 2011). Stories of ‘green buildings’ that implement the latest energy saving technologies and comply with sustainable social policies have recently drawn major attention from real estate markets’ stakeholders. One of the most prominent examples in the recent past has been the ‘greening’ of the Deutsche Bank’s Twin Towers in Frankfurt. On a more aggregated scale, cities compete for international recognition as being labeled ‘green’ (the ‘European Green Capital Award’ is only one example). While there are undoubtedly genuine efforts towards to apply sustainable social policies on a city’s scale, the controversial public debate about iconic ‘green buildings’ continues, critiquing the predominant aim of a brand and image boost of such companies. A number of related key questions await answers, for instance: Can real estate assets that yield expectations of capital markets on the one hand and multidimensional sustainable management practices on the other hand be reconciled? What kind of spatial consequences will ‘green’ investment strategies have?

17In their paper, Katia Attuyer, Antoine Guironnet, and Ludovic Halbert (2012) acknowledge that there is increasing social and political pressure as well as legal enforcement from the local state on building owners and international investors for more responsiveness towards established ‘urban sustainability agendas’. Their analysis of the French real estate market reveals that investors show a highly dissimilar awareness, heterogenic capabilities, and a distinct willingness to anticipate, anchor, and implement ‘green issues’ in their strategies. The authors argue – supported by rich empiric observations – that, against the background of the controversial ‘green but not sustainable’ debate, the investors carefully reassess their investment strategies. One of the strategic challenges for investors is the fact that legislation affects investment decisions on buildings in very different locations. The authors emphasize that it is the building’s location, indeed, that links with the exploitable investment revenues. It is thus expected that the ‘uneven geographies of sustainable development’ in metropolitan regions, in which marginal spaces get further excluded from the international investors’ radar, are reinforced.

Competing space-times of decision-making on risks and the reinforcement of uneven spatial development

18Decision-making by different actors is conditioned by very different time horizons and spatial frictions. One could easily conclude that the short-term pursuit of profit mainly by the financial investors heavily collides with the persistence of urban infrastructure, or a long-term perspective of urban planning officials (Harvey 1985). Real estate investors that participate in global capital markets, for instance, can easily switch their capital investments (Charney 2001), thereby further weakening “the nexus between local and location” (Bardhan and Kroll 2007: 2). A rigorous shareholder orientation demands highest capital mobility and hence fosters an ongoing spatial re-orientation of real estate investments (Christophers 2011, Fainstein 2001), as was the case between 2005 and 2008. The local state, in contrast, is bound to more time intensive negotiation and decision-making processes, since it is (and should be) more diligent towards its once approved planning politics, both in terms of time horizons and urban spaces. Their decision-making “generates spaces and times with variable reaches and intensities” (McCormack and Schwanen 2011: 2802). Such differences in space-times, however, heavily impact on the creation of new urban space, while the investors’ financial market orientation increasingly aids the local real estate markets’ susceptibility to crisis and uneven urban development (Beitel 2000).

19This comparison of short-term oriented private market participants and long-term oriented city planners, however, is too much stereotypical and would neglect a general “time-space myopia” (Clark 2011) inherent in all decision-making processes. Concerning ‘space’, in financial and real estate markets the illusion of self-control prevails (Hilton 2001). Participants in these markets often show overconfidence when their decisions are based on their own capabilities that are grounded on experience. Information that is gathered locally and that relates to quite specific aspects of a market is preferred over an appreciation of the larger context. This is true for private investors and the local state alike. With regard to ‘time’, not only financial investors favor “immediate reward over “larger but delayed rewards(Baron 2008: 478). This has to do with a general tendency of people to highly value immediate outcomes of economic decisions and discount future results. Even politicians are among those who display inabilities to credibly conceptualize their long term interests (Deeg and O’Sullivan 2009). This is especially true for demanding environments like financial and real estate markets “where customary or everyday modes of decision-making are typically not effective under conditions of risk and uncertainty(Clark 2011: 11, see also Clark 2008).

20Academic literature, so far, has largely neglected to link decisions on risk with the cities’ socio-spatial impacts and planning preconditions. Considering the various space-times of decisions related to risk and the knowledge involved can pose an important field for future research with a high analytical value: The concept of risk is accompanied by differing time perspectives (Beck 2006). Credit risks, for example, i.e., the probability of a loan default, increases with the lifespan of a loan. Long lasting real estate assets with a short amortization rate are evaluated differently than assets with slow cash-flow expectations. The contingency of events in the far future turns risks into uncertainty. This not only changes risk-related decisions but also the risk management that has to be applied. As information and knowledge are the main inputs for an efficient risk management, the context in which these are produced and applied gains center stage (Amin and Cohendet 2004).

21The special issue’s four paper contributions follow a genuinely actor-centered approach and elaborate sometimes directly, most of the time indirectly on selected risk aspects and knowledge elements of the intertwined real estate and financial markets. They describe different risk management strategies of private investors in the interplay of real estate and financial markets. Risk reduction through standardization and the creation of transparency constitutes the central line of argument regarding the opening of the real estate markets in Warsaw to international investors (Bitterer and Heeg 2012). The way the investors’ risk in formerly non-transparent ‘markets’ decreased over time due to an increasing information density and the locally specific accumulation of knowledge is well illustrated. During this process, value configurations for the creation of the built environment changed: New actors and new functions shaped the structures and relations within newly shaped professional networks and are subjected to a permanent adaptation process. Risk management also plays a central role in the assessment of market strategies by foreign investors in Mexico City (David 2012). Risk reduction is obtained through a division of labor between land developers and financial investors and the complementarities of different risk strategies. Direct state intervention on the pricing of housing markets in Marseille (Boulay 2012) as well as challenges of the new state regulations in the field of energy-efficient buildings (Attuyer et al. 2012) are closely related to aspects of risk bearing as well. In the former, the risk of slow urban redevelopment is reduced by public activities. These activities pushed private investments that jointly neutralized risk of sole first movers in drawing further attention from the market. In the latter, however, the state exposes private investors to new risks in defining new regulations concerning green development. First movers on that new market had to bear the risk of insufficient experience but certainly enjoyed high profits.

22The strong interdependence of loan, capital, and real estate markets has proven to be vulnerable to the accumulation of risks, whose ‘inappropriate’ handling can trigger major economic crises. Obviously, anonymous, yet powerful individual actors that operate on capitalized global real estate and financial markets not only decide on different risks concerning short-term profit-seeking. If their risk decisions are taken at the expense of sustainable models of real estate markets and urban development, they burden ‘risk’ on to society. While reading the papers in this issue, the question of the possibility of a sustainable future of the real estate markets lingers in the back of our minds (Brenner et al. 2012): If not for profit, for what, for whom, and how?

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References

Electronic reference

Sabine Dörry and Michael Handke, « Disentangling the geography of finance and real estate: competing space-times of decision-making and uneven spatial development », Articulo - Journal of Urban Research [Online], 9 | 2012, Online since 23 September 2012, connection on 20 August 2014. URL : http://articulo.revues.org/2149

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About the authors

Sabine Dörry

Sabine Dörry is Research Fellow at the Department of Geography, Centre for Population, Poverty and Public Policy Studies in Luxembourg. She holds a PhD in Economic Geography from the Goethe-University of Frankfurt am Main. Aside from her research interests in global value chains, global production networks and developmental studies, her current research focuses on two contemporary fields in urban economy and spatial dynamics: 1) the political economy of financial markets and in particular the tight (inter)relation between global financial markets and local real estate office markets in European financial centres; 2) the evolution of specialized financial centres and their contribution to and interaction with their respective urban economies. Email: sabine.doerry@ceps.lu

By this author

Michael Handke

Michael Handke is Senior Lecturer of economic geography at the Department of Geography, University of Heidelberg, Germany. His research interests are financial geography, resource economics and the mobility of risks in market spaces. Email: handke@uni-hd.de

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