REAL ESTATE IN A SECULAR DOWNTURN
By Bert Dohmen, editor of the award-winning WELLINGTON LETTER
Many novice real estate “tycoons” never realize that real estate is an asset in a boom, but is a huge liability and cash drain during a bust. Leverage and debt is the destroyer.
In the U.S., the largest commercial real estate projects are being kept from defaulting only by the holders of the debt agreeing to refinance, extend, and take advantage of the Fed’s program to purchase hundreds of billions of dollars of CMBSs (commercial mortgage-backed securities). The game plan is to hold the properties until prices recover.
In the meantime, tenants are leaving, cash flow turns negative, and even the extended debt maturities are threatened. Eventually, the holders of the mortgages will find it attractive to let the properties go bankrupt and take them over.
Two of the smartest real estate investors I know are Sam Zell and Barry Sternlicht (Starwood). They have both commented recently that owner of buildings are still asking unrealistically high prices, while the potential buyers are offering today’s value. So, they are far apart and there are no transactions. Guess who will win this “stand-off?” My bet would be on the two individuals above. Sam Zell sold his giant Equity Office Properties in 2007, just before the bubble burst. He is one of the best timers I have ever known, although he has also made mistakes. Mistakes just prove he is human.
REITs have had a good rally this year along with the stock market, propelled by trillions of dollars of artificially created money. But that can’t last forever. I would not hold any commercial REITs at this time. The emergency financing efforts will end next year. This means that the “sigh of relief” that they have sidestepped big defaults, is nearing the end. The recovery will take many years. How many years can a commercial property be held with negative cash flow? Not many.
The problem is that Washington’s policies discourage small businesses expansions, and the banks have no incentive to lend. Without jobs and credit, there can be no sustainable recovery. As businesses fail, more office space will be vacant. And fewer people working means a surplus of retail space.
I would also shun apartment REITs. First of all, the unemployed can’t afford to pay $1500-2500 in rent per month. But even more ominous is something else: I believe that it’s only a matter of time before Washington considers national rent controls. When the U-6 unemployment rate, currently over 17%, goes over 20%, the politicians will see a chance to become heroes with rent controls on apartments. Of course, that will be another disaster for the economy.
The current consensus view of economists seems to be that the recession is over. How can that be with 10% unemployment, people still losing jobs, foreclosures hitting new highs, no credit availability, and now a number of states teetering on the edge of insolvency. The big job losses are still ahead when companies realize that the long expected recovery is nowhere to be seen. The average recession lasts 8-9 months. This one is 24 months old. Doesn’t that send an important message that this is a secular instead of a cyclical event?
NOTE: Representation by your peers is not quite what it used to be. The mean annual income across all occupations in the United States is $37,440. Compare this with members of the House of Representatives in Washington: Out of 435 members, 123 had an annual income of at least one million dollars.
Disclosure: no positions