Rising U.S. Vacancies: Real Estate Is Headed Down

Two pieces of data on U.S. vacancy rates (one commercial, one residential) show in unequivocal terms that house prices are going to continue lower, while the more-recent collapse in commercial real estate will continue to accelerate.

The U.S. vacancy rates for rental apartments has just hit its highest rate in 23 years – and is set to continue moving higher with new construction vastly outpacing sales. This guarantees that rent prices will drop (especially in an environment of rising unemployment and falling wages). It is equally certain that falling rent prices will translate into falling prices for U.S. residential real estate.

Falling rent prices make buying a home relatively more expensive (not to mention the risk of defaulting on a mortgage should the buyer lose his employment). This will continue to put downward pressure on U.S. house prices – adding to the downward pressure caused by rising unemployment, record-rates of foreclosures, more than 20 million empty homes (including millions of foreclosed properties being held off the market), and the need for retiring baby-boomers to sell real estate to fund their retirements (see “U.S. pension crisis: the $3 TRILLION question”).

The momentary stabilization in U.S. housing prices is nothing more than a combination of months of relentless propaganda proclaiming a “bottom” in this market – along with the minor boost to the economy from the Obama stimulus package, and the normal “seasonal strength” of this market in the summer.

Almost certainly these prices will resume their downward march in the next few weeks. The only thing which could alter this picture is if U.S. inflation (which the government pretends doesn't exist) should accelerate so rapidly that “up” becomes “down”. In other words, if U.S. inflation (currently around 7% in the real world) should heat-up to double-digits, we could see small nominal gains in U.S. prices – which in real dollars would still be steadily depreciating.

Meanwhile, in the commercial sector, the vacancy rate just hit its highest level in 5 years (reflecting the fact that this market hasn't been collapsing for as long as the housing market). It is a certainty that this rate will continue soaring higher – given that both corporate revenues and corporate earnings are still plunging downward at double-digit rates (see “Crash warnings abound for U.S. markets”).

This means that U.S. banks can expect sky-rocketing losses on their commercial mortgage portfolio (in this $6 trillion market). As I have pointed out in previous commentaries, U.S. banks have virtually nothing set aside for these losses. This was echoed by a presentation from the Federal Reserve to banking regulators last month – and is an “instant replay” of what happened with U.S. banks when the housing market crashed.

The main difference between this new source of mounting losses on this category of bank loans is that unlike with the crash in residential real estate, this crash comes at the same time that all other categories of U.S. debt are already at or near record-levels of delinquencies (i.e. loans where the banks are not getting paid). The combination of huge losses these banks must absorb on commercial defaults while they are not receiving payments from record numbers of borrowers in all other categories of debt, and having virtually no reserves to cover these losses creates a very painful dilemma for the banksters.

As I have stated unequivocally on numerous occasions (and which George Soros just echoed in a recent interview), U.S. big-banks remain insolvent. With new, rising losses and tiny capital cushions, it appears that some or all of them will be forced to get in line for their next series of government blank-cheques. The problem is how can the Wall Street crime syndicate beg for more hand-outs from the government while these fraud-factories claim to be making “profits”?

Once again, the perfect “recipe” for Wall Street appears to be to induce a broad, general panic – which could frighten both the spineless politicians and the American public enough for them to capitulate to more bankster blackmail. Given that most recent, U.S. economic data has still been terrible (despite what media spin-doctors would like us to believe), it would take nothing more than telling the truth to “pop” the U.S. equities bubble – and begin another fear cycle.

As a reminder, John Williams' “Shadowstats.com” (the most widely-accepted source for real numbers on the U.S. economy) has calculated current U.S. unemployment at over 20% (and still rising rapidly). Meanwhile, the fantasy-world presented by the propaganda-machine continues to pretend that things are getting better for the unemployed, and soon-to-be-unemployed.

This disconnect cannot continue. The absolute end-point for the fantasy-rally in U.S. equity markets is early December – the time at which it will be clear that this year's holiday shopping season will be a big disappointment for this consumer economy. However, there are an endless number of possible triggers between now and then (including the banksters proclaiming they need more hand-outs). For those who have continued to ignore six solid months of rising insider-selling, it's time to take your money and run.

Comments

[davidbdc:]

In Commercial real estate, banks will not take as big of a hit. Those properties that produce enough cash flow to service the loans coming due will be extended (with the banks attempting to take a pound of flesh for the extensions). Banks won't move to take over those properties.

For properties that don't produce enough cash flow, banks will take possession and then sell to other CRE investors. They will take partial losses. But that is what should be happening. Take assets from those that run them poorly and put them in the hands of those that run assets well. Its too bad we didn't do that with the banks.

Too much doom and gloom in this article. There will be winner and losers in CRE but its all not going into the garbage bin.

Oct 11 07:01 AM

[Tack:]

CRE defaults are currently under 3%, but projected to rise to a 5.4% peak by 2011 (www.bloomberg.com/apps...).

As usual, what's missed in all the hysterical "meltdown," "collapse" and "Armageddon" claims is that even if such a peak is achieved, it will only be as bad as 1992, when we had another typical real estate recession. No Armageddon, no Great Depression, no once--in-a-lifetime collapse, just numbers similar to all-too-many previous pullbacks.

At the same time, commercial lenders and REITs have seen their prices collapse (the only thing that's really collapsed, in fact) by 70-95%, all in anticipation of supposed world-changing events that aren't going to arrive -- are not even forecasted to arrive. Most lenders, too, have dramatically increased their CRE reserves, having seen what happened on the residential side of things, and paid down debt, extended maturities, sold assets and raised cash, so they're better prpared than ever to weather the slump.

What this means for the investor focused on the facts, rather than the histrionics, is that many CRE-related entities are vastly undervalued and present an extraordinary buying opportunity.

Oct 11 09:16 AM

[Shishir Nigam:]

CRE has been singled out as the next shoe to drop for a while now. Tack makes a very good point that the projected default numbers seem high in absolute but relative to previous instances, they're just normal. I think the important question to ask is how dependent the financial sector is on the CRE market? How big of a portion of bank balance sheets do CRE loans comprise?

The crunch time for REIT's is sometime next year when A LOT of debt is coming due. The potential effects of that crunch have been alleviated a little during this market rally when the REIT's have taken the opportunity to get lots of new financing through both and equity, with help from the likes of Merrill.

For more analysis, check out my blog: youngandinvested.com

Oct 11 11:41 AM

[John Gault:]

@Tack

I don't even know where to start with your convoluted and incorrect assessment about the "undervaluation and extraordinary opportunities" in CRE. As a matter of fact, the only thing you got right was that lenders are extending maturities in order to not foreclose on the properties.

1. Just because Real Estate Econometrics predicts a 5.4% default rate, does not make it so. Just as Hank Paulson assured us that housing bottomed in 2007 and Ben Bernake pretends to want a strong dollar. And the Anderson school said there wouldn't be a housing crash or a recession in California. While I'll grant you an artificial low in defaults because of the "pretend and extend" culture now infecting our banks - this will only cause a malaise which will put us on a Japanese style trajectory for the next 10 years.

2. In 1992 we were not approaching 17% real unemployment; which is why this time it's different. We, as a country, were less socialistic and federalistic; which allowed for some states to remain healthy and help pull us from our recession. It's not gonna happen that way this time.

3. Reits are not down 70-95%. The IYR is about 50% off its all time high - which was achieved when desperate people were "reaching for yield" and crazy private equity consortiums were paying $1,500 per square foot for buildings that are now trading at $300. Most savvy investors were aware it was a bubble, and understand that the IYR is trading above NAV - which makes it over priced, not under priced considering today's state of affairs.

4. Lenders don't "pay down debt" nor have they reserved adequately for the impending collapse. It would be impossible to reserve for $1.5 trillion in reduced values. However, the FDIC has produced a stay of execution and eliminated mark-to-market for these real estate loans. These "defaulted" loans will be extended a great number of times (just as Japan has done since 1989) so that the banks will not have to reserve for the losses.

5. The Fed is purchasing CRE CMBS so that they will not have to foreclose on the defaulting properties. All in the hope of firming a market that is inexorably broken.

While I'll give you the point that the Fed will do everything possible to prevent Armageddon, it won't prevent CRE from gangrenous stagnation over the next decade. Higher vacancy, higher property tax, higher insurance, lower sales per foot, lower demand, lower rents.

Oct 11 10:07 PM

[Jake2:]

"Too much doom and gloom in this article . . . " masquerading as insight and intelligence. Somebody pass this guy the Kool Aide.

Oct 11 11:59 PM

[Gregman2:]

Jeff, great article. But hey, there's never been a better time to buy. Think Hiroshima just after the blast...excellent buying opportunity, right? Think post-Katrina New Orleans...nothing like it in our lifetimes, right? Some see horse manure and just see poop. Others are like beetles...and see a meal. Thanks for this.;-)

Oct 12 01:08 AM

[Jeff Nielson:]

John, thanks for the superb rebuttal to the "Don't worry, Be happy" crowd.

I would like to ask those critics how they think I am being an alarmist, when the Fed's own internal report shows inadequate reserves - even for their own under-estimates of losses?

Keep in mind that during the housing crash in the U.S. that the first thing we were promised was a "soft landing" - with no "spill-over" into the broader economy.

This was followed by these "experts" all looking like complete idiots as they were forced to revise their expectations downward on virtually a weekly basis.

One would think with the SAME group of liars and fools once again talking about a "soft landing" for this NEW crash that people would simply tune them out.

All reports I've heard is that U.S. regional banks have proportionately more exposure to this market than the oligarchs. Not only do those banks have totally inadequate reserves, but they lack servants in the federal government willing to write THEM blank-cheques the moment they shriek for help.

...and as John pointed out, at some point the "pretend and extend" game must come to an end, with the current crash in this sector the likely catalyst to force banks to "call in" these loans,


On Oct 11 10:07 PM John Gault wrote:

> @Tack

Oct 12 12:14 PM

[dragonpaw:]

"..zero interest on short-term gov't bonds as far as the eye can see.."; thank you Timmy and Benji. "Happy days are here again...as long as we can extend and pretend". Pretty catchy, if only the market-place for b.s. could get any deeper, my hip-waders ain't gonna do the job. But, hey traders out there, keep trying to catch that falling sword.
All you got to loose is a hand or arm or maybe an ass here or there.
Jeff, look out. Instead to thumbs down, you may be in line for a few more middle fingers up.
But isn't that the fun of the game?

Oct 12 11:18 PM

[George Dave...:]

The US housing market has not hit bottom and, depending on which view you take, has quite some room to move down further. The truth is that we are still in the middle of a historic crash. “There are four items in place that are tricking people into calling a bottom, when in fact three of these items are temporary. The result is an artificial restriction of supply and artificial pumping of demand.
1) It’s the seasonally strongest buying season
2) There’s a foreclosure moratorium about to end
3) Federal tax credits offered for 1st time homebuyers
4) Historically low mortgage rates (this may or may not change soon)”
Read more.
www.housingnewslive.co...

Oct 13 01:58 AM

[fredmg:]

A sucker is born every day. All the suckers born over the past 2 years did not buy houses because prices were falling so fast and they couldn't get loans. But this summer the Govt. and real estate cheerleaders went after the suckers now we have this small rise in house prices.

Oct 13 09:33 AM

[samo:]

George...very correct on your 4 points. Though #4 won't help prices much...as economy recovers in 5 to 10 years, supply demand equation will firm up on real estate, so prices will look to rise a few %s, then Fed will increase rates, and price of real estate (all assets) will soften as a result...causing flat line prices for years.

Oct 13 12:06 PM