Washington Property Values and the Federal Defense Budget
November 21, 2010
An old adage inside the Beltway is that we are recession-proof, or, as it is often more delicately put, we are protected to a large extent from the cycles of boom-and-bust that affect other parts of the country more directly. The reason? Washington is the seat of the federal government, and much of the federal budget, once collected in the form of taxes every April, has a habit of remaining inside the Beltway—in good times and bad. Federal jobs and contracts support the local economy.
It is well known that the federal government is the largest employer in the region. But a cursory review of the top 100 corporations in the area reveals that the vast majority of these companies serve the defense industry or closely related fields. Indeed, the defense industry bankrolls much of the private sector in Washington, while accounting for nearly half of the federal budget.
Traditionally off-limits to deficit hawks, the defense budget has grown large and unmanageable because it is an excellent place to hide money. When one thinks of a bloated defense budget, images come to mind of the Air Force getting its bombers while your local elementary school holds a bake sale. But equipping and paying our uniformed service personnel—even in times of war—probably accounts for less than half of what is denominated as defense spending during the budget allocation process.
A substantial fraction (as yet unknown) of the “defense” budget is really nothing more than money—money used to grease the wheels of the broken system in Washington that every politician dutifully derides on the campaign trail. Moneys buried deep within the defense budget pay for lucrative contracts, a portion of which goes directly into congressional campaigns. Then the contractor doles money out to lobbyists, law firms, and media outlets, in order to protect its business against would-be competitors. Whatever remains goes to the salaries (and bonuses) of the contractor’s staff and executive board. The gravy train keeps running, and the budget axe looms large for any contractor who thinks he can ride for free.
This is a familiar tale, in that everyone knows that prosperity in Washington is linked to the federal budget. But it is the defense budget in particular, with its ability to conceal gargantuan sums siphoned off for use inside the Beltway, to which this area’s economy has truly become addicted. Take away the vast phalanxes of lobbyists and law firms wedded to this contractor or that, or the miles of hi-tech companies producing components of dubious value at outrageous prices, or the advertising dollars paid out to media outlets during the permanent campaign season, or the need to pay millions of dollars to get elected to congress, and property values here would drop as quickly as in Las Vegas.
Conversely, when the federal government pumps money into the system described above, property values spike (see graph below; for the first time, we offer Free & Clear readers our own original graphics). I have long been familiar with the contours of property values in the DC area. When I started looking at defense spending over the past 30 years, I noticed a shocking similarity in long-term trends.
I chose Bethesda—where I am from, for full disclosure purposes—because Bethesda, without a doubt, has its finger on the economic pulse of the Washington area. Note the two large real estate booms: in the mid-1980s with the Reagan Cold War build-up, and again following September 11, 2001. Note also that in the 1990s, after our success in the Cold War and the fall of the Soviet Union, defense spending dropped slightly due to decreased need; accordingly, property values remained frozen in time until 9/11 and the boom in homeland security kick-started the market.
Real estate professionals in Washington, therefore, should take heed: the sacred cow that is defense spending is now being eyed jealously in these times of deficit famine. The left wing of the Democratic Party has long opposed heavy defense spending. The fact that these politicians were largely shouted down during the Cold War, and then again after 9/11, has failed to dampen their spirit. In addition, and on the Right, elements of the so-called Tea Party movement have called for drastic reductions in the defense budget. For example, Ron Paul, father of Senator-elect Rand Paul of Kentucky, and intellectual godfather of the Tea Party, ran for President in 2008, calling for the defense budget to be eviscerated. Recently, in the 2010 midterms, Tea Party candidates (and/or those loyal to the principles of the Tea Party) gained numerous seats in the House, and a couple in the Senate. For the Tea Party to have any intellectual coherence, it must continue to oppose large defense budgets.
Like it or not, cuts in the defense budget are now on the table. Even a modest reduction in federal defense spending is likely to give the Washington real estate market a bloody nose. There is no other source of income, and nothing of value produced here, to support prices at their current levels. Every brick colonial on every tree-lined street derives a significant portion of its inflated value from current levels of defense spending, regardless of how directly its owner is involved in the running of the gravy train.
Cancellation, or even reduction, of certain key contracts could force many of Washington’s leading corporations into Chapter 11. With no new jobs, and many new layoffs, finding buyers who can qualify for loans in excess of 750K will become increasingly difficult. Foreclosures will continue to clog the mainstream market for residential properties, dragging prices down even further, despite the best efforts of title insurance companies to keep the two markets separated. The Washington real estate market, once thought safe, will take a hit like no one has seen in thirty years.
