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$1.3 Billion Burj Khalifa 2.0 is Briliant!
Earlier
this week we saw reports that “Beijing
authorities plan to build a "seven-star hotel" modelled after Dubai's
Burj Khalifa -- the world's tallest building -- in a $1.3 billion joint project
with Saudi Arabia.” Yes, the same
building that symbolized Dubai’s $20-plus billion in malinvestments and
required a bailout by Abu Dhabi.
In
Russian there is an expression: The wise man learns from someone else’s
mistakes, the smart man learns from his own, and the stupid one never learns. You’d think I’d be putting the Chinese
government in the latter category – obviously the Chinese have not learned from
Dubai’s mistakes, and they don’t seem to want to learn from their own – empty
shopping malls and cities which, based on these Google Earth images,
are scattered all over China.
So
erecting a $1.3 billion “seven-star hotel,” when Beijing’s office vacancy rate
was over 20% just a year ago (I doubt it has changed much, considering how much
they’ve built in a year) would appear to be less than smart. Wrong! It is
brilliant! The report also states, “The Saudi
side was expected to foot the entire bill.”
The “Saudi side” will bear the eventual losses. The
construction of Burj Khalifa 2.0 is brilliant on so many levels: the Chinese
government gets the “Saudi side” to finance its objective of growth and full
employment at any cost, the Guinness Book of Records gets another entry with a Chinese
name, the Chinese communist propaganda machine has another news story for us
all to digest, and a few years from now Burj Khalifa 2.0 will be bleeding money
and the Chinese government will bail out the “Saudi side” at 20 cents on the
dollar. Brilliant! brilliant! brilliant!
I wrote about a year ago in Dubai’s
Shot to The Moon, an article that is as relevant today as it was then:
Virtually unlimited access to cheap money blurs lines
between what makes economic sense and what doesn’t. If it can be financed it
will be built. Dubai’s plan to diversify away from petrochemicals made sense.
Maybe it is even destined to become the Las Vegas of the Middle East, the Mecca
of business travel and luxury.
Dubai, however, is like NASA: both have proven that anything
is possible when you ignore economic costs. Many technological discoveries were
made in the process of putting a man on the moon; but the project did have, and
was expected to have, a negative return on capital.Dubai has followed a similar path. The absolutely impossible category may
not include building an
underwater hotel, or the
tallest building in the world, at a cost of $4.1 billion, or a covered ski resort in the
middle of a desert, but these projects surely deserve a place in the category
of economically impossible.
Like putting men on the moon, Dubai’s projects were destined to have a negative
return on capital. (At least NASA was up front about it.)Dubai’s construction wonders were made possible by high oil
prices and, more importantly, unlimited (at the time) global liquidity –
subprime global lending on steroids.
Today Dubai, a city/state that could do no wrong just a few
years ago, is defaulting on the debt it issued to finance its building boom.
However, what is happening in Dubai is just the most recent, most vivid example
of what took place all over the world until the economic crisis. Economically
impossible endeavors with negative returns on capital were everywhere, and
Dubai is just the latest to go bust.
Though everyone is talking about Dubai’s potential default,
the scope of the problem is greater. Think about how much energy (oil, coal,
natural gas), materials (steel, concrete), and industrial products (cranes,
tractors) – in other words, stuff – it took to build these economically
impossible wonders. China, the most populous country in the world, also masked
its share of economically impossible projects through the guise of “stimulus”
and at times outright censorship. China is the birthplace of the
largest shopping mall in the world, which is empty, and a city built
on spec for a million people that remains
mostly vacant. These two just scratch the surface. The rest of the world,
including the US (after all, we built a lot of now-empty houses and condos) is
swarming with economically impossible projects.
How many houses (or in the case of Dubai, mansions),
factories, hotels, skyscrapers, shopping malls, and railroads will not be built
because there are too many already built? And if this is not convincing enough,
funding economically impossible projects will be difficult for a while, as lack
of liquidity and insurmountable losses suddenly turn bankers into … bankers.
They find religion (at least for a little while) and start giving loans to
folks who are expected to actually pay them back.
Dubai is the exemplar of economically impossible activities
that have taken place everywhere, and why one can’t be optimistic that demand
for stuff will return to levels even remotely close to what they were in the
days when everything was economically possible and financeable.
Epilogue
My father lives a block away from my office. I stop by his
house a few times a week on the way to work. We have breakfast (my stepmother
makes a killer fake-egg omelet) and stimulating conversation. My father is a
true renaissance man; he is a gifted teacher, a scientist, an inventor, he
holds a PhD in electrical engineering, and to top all that he is a very accomplished artist. The
bottom line; he is a very wise man. This morning we discussed this Dubai
article.
He asked me, “But why would people in Dubai spend billions
of dollars on buildings if they have little chance of earning a return on it?” He
added, “I would think they’d have rational voices at the table pointing out
obvious holes in these multi-billion projects.” At first I tried to explain
that if things can get financed they’ll be built. I sensed skepticism. Then I
explained how groupthink works, that under crowd pressure, especially after
their predictions of the bubble bursting were proven “wrong,” as real estate
prices kept climbing, skeptics were either turned into believers, got quiet, or
got fired for being doomsayers and not being team players. My father started to
see what I saw, and then I told him a joke that I heard from Warren Buffet
years back.
A very successful oilman dies. He faces Saint Peter, who
says, “You’ve been a good man and normally I’d send you to heaven, but heaven is
full. We only have a place in hell.” The oilman says, “Any chance I could talk
to other oilmen who are in heaven? Maybe I can convince someone to switch
places with me?” Saint Peter says, “It’s never happened before, but sure, I
don’t see any harm in it.” The oilman goes to heaven, finds an oilmen
convention and yells, “They found a huge oil discovery in hell!” Oilmen are
stampeding out of heaven to hell, and our oilman is running with them. Saint
Peter asks him “Why are you going to hell with them? I have a spot in heaven,
you can stay.” The oilman answers – “Are you kidding, what if it’s true?”
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of upcoming The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here.
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economically impossible? if they exist, they were possible, just not efficient use of resources. But even things that return on the investment are not necessarily good in the sense of the maximum return for the common wealth.
surely burj 2.0 is sign that China real estate bubble is about to pop.
Wonder if they will blow it up after they complete it?
I wonder if this building will fall apart from the inside, like the Burj, or will it topple over, like the apt. tower in China I recently saw a pic of?
you know if Los Angeles builds a high school that costs 400 million dollars I'm not sure that 1.3 billion is a big deal for a hotel. Even if only the top 0.0001 percent can afford it in China that comes out to about 90000 people in China alone. And Asians are totally into raw displays of status so expect another 30000 to want to stay there also for prestige purposes when they visit China for business deals. Dubai never had the population or even the business travel to support it. a 500 bed hotel has about 182500 bed-days to fill. 80 percent occupancy is 146000 bed-days. I think they can do it.
Yes, but this time it will be different.
And compaired to the US and the EU:
THEY ACTUALLY WILL HAVE SOMETHING TO SHOW FOR THE MONEY THEY SPEND!!
Where's our chain of 7 star hotels next to the highways I beg to wonder!?!
Oh, there's lots of stuff in the US to show for the money. 19 million empty houses, for instance, and who knows how many empty strip malls and other retail space.
Right now, I'm staring at a 10 story, $17M parking garage that is going up (with 17,000 sq. ft. of retail space on the first floor, to boot!). It will be one of the tallest buildings downtown.
The best part? The bond payments are going to balloon in 5 years (and graduate the next 5), as they are currently paying interest only. Between it, another similar project, and police/firefighters pensions, it is guaranteed to bankrupt the city eventually.
This irrational groupthink tends to run worldwide. Main question then becomes, how do you stop it from running amok and destroying everything in a society?
You can't. It will only stop when the ideas behind it die.
Then, as the survivors go about surveying the damage and picking up the pieces, they will adopt a "won't get fooled again attitude." Next, in a few generations, vigilance dies down, as the freedom and comforts gained by their wise ancestors bring about hubris and groupthink once again.
There really is nothing new under the Sun.