Railroads and Commercial Real Estate

Drive around the cities of this country and what do you see: empty stores, vacant lots, acres of asphalt sitting unused. And, if you’re not driving, just check out deadmalls.com on the internet to get a feel for the issue. This country has a commercial real estate oversupply problem. Bernanke recently admitted this, "As the recession's gotten worse in the last six months or so, we're seeing increased vacancy, declining rents, falling prices, and so, more pressure on commercial real estate."  So, what can the current commercial real estate crisis learn from the railroad industry? Plenty.

In the past 20 years, this country has over-developed. Retail space per capita doubled over the past 15 years, while retail spending per capita has increased only 14%. Today, the U.S. has six times more retail space per capita than any European country. Approximately 10% of the retail space is vacant, and 20% is available for lease, and both percentages are growing rapidly. Internet shopping continues to take market share by growing at 10% - 15% faster than overall shopping. Vacant commercial real estate will get worse.

Like the commercial real estate market today, by the early 1900’s the U.S. had finished a major railroad investment program. Then along came the automobile and truck, and railroads began losing transportation market share. By 1940, it was apparent the U.S. railroads had way too much track and railcar investment. Rather than trying to keep all those assets, railroads focused on the utilization of their best assets, and systematically eliminated their over-investment. The result is the U.S. railroads are the most profitable and efficient of any in the world, and they have generated substantial wealth for the U.S. in terms of productivity, reduced transportation costs, and increased stock market revaluations.

Let’s look at some numbers. In 1939, the U.S. railroads had 365,000 miles of track, 43,000 locomotives, and almost 2 million freight cars. By the year 2006, track miles had declined to 162,000, locomotives to 23,700, and freight cars to 1,346,000, reductions of 56%, 45%, and 33%, respectively. Now, in spite of this major reduction in rail assets, traffic handled by the U.S. railroads has increased geometrically. From 1939 to 2006, railroad revenue ton-miles have increased from 333.4 billion to 1771.9 billion, an increase of 530%.

Productivity of remaining rail assets has soared. Track productivity is up 12 times, locomotive productivity has jumped 9.6 fold, and railcar productivity has increased 7.9 times. Today, railroads trade at 15 times earnings, better than IBM, and the total enterprise value of the major railroads is over $100 billion. The Federal Government and the Federal Reserve did not try and protect these excess rail assets by backstopping railroad paper in the 1930’s and 1940’s as they are doing today with mortgage backed securities. The country got rid of the physical assets! We tore up track! We maximized utilization of the best rail assets, and eliminated unproductive track.

Over 15,000 miles of those excess rail lines have been converted to trails, through the “rails-to-trails” conservancy. These linear parks are being enjoyed by millions throughout the country.

Current efforts to address the real estate vacancy problems have been directed at the “bad” paper assets behind physical assets. To date, the Federal Reserve and Treasury have committed approximately $13 trillion to support bad paper assets. But, like this country’s excess railroad tracks in 1940, why keep the bad real estate assets around?

Let’s do to commercial development what we have done to the railroads. Let’s eliminate the physical over-investment, so we can improve utilization of remaining assets. This can be done by the Federal Government providing funding to the cash-strapped cities and counties to buy excess development and then to build and maintain new parks. Funding could also be available to private developers willing to convert underutilized commercial properties to public parks. (It is worth noting here that the Federal Government has been the major cause of the excess development through its easy money policies of the last 10 years.)

Urban parks support public health, workforce development, the economy, the environment, education and community cohesion.  From mitigating the damage of storm-water runoff to providing sports programming that supports at-risk youth; from attracting tourists to increasing property values and property taxes, they are critical to the viability and sustainability of our nation’s urban communities where a majority of the population resides.  

If the federal government allocated $200 billion a year to a program of buying vacant real estate and building urban and suburban parks for the next ten years (remember $13 trillion has been committed to backstop Wall Street), the changes would be dramatic. In sunbelt cities like Atlanta, Dallas, Miami which have grown dramatically since the 1960's without substantial regard for public spaces, multi-year land-use plans could be developed, and areas could be identified that could make the cities more livable. Older cities like Detroit and Cleveland could be renewed. New great parks designed and built by local citizens for themselves would blossom.

Besides making the country a nicer place to live, the park initiative would have a major positive, secondary effect.  Capital would be available to buy underutilized retail space and other commercial property, providing REAL liquidity in the commercial real estate market.   The $13 trillion committed to Wall Street would go to Main Street where it belongs. Construction jobs would be re-ignited as demolition work and landscape architecture would turn into growth parts

Let’s learn from the railroad industry. Let’s stop backstopping bad paper while keeping the bad physical assets. Let’s eliminate the country’s excess development by building more urban parks. We’ll make the remaining commercial real estate more productive and the country a nicer place to live.

Michael G. Messner
Partner, Seminole Capital