Today's Headlines Show Interest Rate Volatility, Sovereign Contagion, Geo-political Unrest & Double-Dip Recessions Coming: What's The Answer To Valuing Global Real Estate Through This Mess?

In reviewing today’s headlines, we come across the reliably
unreliable Eurozone statistician and forecasting figure failure, again: Euro Zone Economic Growth Below Forecasts:

The euro zone economy
grew at the same quarterly rate in the fourth quarter as in the third,
data showed on Tuesday, defying expectations of an acceleration.

The European Union’s statistics office
Eurostat said gross domestic product in the 16 countries using the euro
at the time grew 0.3 percent in the October-December period, the same
as in the third quarter.

Year-on-year, the expansion was 2.0 percent in the fourth quarter, compared to 1.9 percent in the third quarter.

Economists polled by Reuters had on
average expected increases of 0.4 percent quarter-on-quarter and of 2.1
percent year-on-year.

Of course, it is that expected (yet not actually achieved) growth
that was supposed to fund the deficits in many of the PIIGS group
austerity plans. Export was a major component of this, but if the
Eurozone is growing slower than anticipated (big surprise) and the EU
members rely primarily on trade with each other, then who will buy all
of the stuff to allow these states to pull each other out of the hole.
The kicker is that the individual countries’ forecasts are considerably
more optimistic than the economists’ forecasts, which in and of
themselves were simply too optimistic. This has been a pattern since the
markets collapsed three years ago. Referencing “Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!”
you can see where this is a pattern in country after indebted country
in Europe – both in and out of the Eurozone – Greece, Spain, Italy,
Portugal, even the UK. To wit…

What about the UK?

I’m glad you asked. We just finished our UK analysis (subscribers, see UK Public Finances March 2010 2010-03-24 09:32:01 617.23 Kb), and the Greek theme has continued into the land of the Brits.

It’s even worse when the more feeble
economies that don’t have their own printing presses get caught in the
disinformation (subscribers, reference Greece Public Finances Projections):

Revisions-R-US!

Speaking of the UK, one can expect rates to be raised any minute now.
I guess all of the Bernanke-ish QE cum ZIRP is starting to face
reality. From CNBC – UK Inflation Surges to 4%, Highest Since Nov. 2008:

The Office for National Statistics
said that the rate of consumer price inflation rose to 4.0 percent in
January, in line with economists’ forecasts, from 3.7 percent in
December.

The rise, which was driven by higher oil prices and increased indirect taxation, means inflation has been at least a percentage point above the BoE’s 2 percent target for more than a year.

BoE Governor Mervyn King will have
to publish a letter to finance minister George Osborne later on Tuesday
explaining why inflation remains so high.

Oh, that should be rich!

Previously King has blamed
above-target inflation on a succession of one-off factors, including
rises in value-added tax, the depreciation of sterling and spikes in
commodity prices.

How sure is he that these are one-off factors? The Sterling is not
going to depreciate any further? Britain will not hit the VAT bin for
revenues again? And here’s the kicker, commodity prices will spike no
more because Ben Bernanke has finished his exportation of input price,
food and commodity price inflation to the rest of the world. Yep, all
one-off occurrences.

Economists expect the BoE to raise
interest rates from their record low of 0.5 percent later this year,
and investors are betting a rise will come by May… On the month, CPI rose by 0.1 percent, the first time it has risen between December and January on record. CPI
typically falls in January due to post-Christmas discounting. The
retail price inflation gauge, which includes more housing costs and is
the benchmark for many wage deals rose to 5.1 percent, its highest since
May 2010.

Oh, there’s more:

• UK Economy May Be Heading for a Double-Dip
• UK Economy Suffers Shock Contraction in Fourth Quarter
• German, French, Italian Q4 growth below forecasts

As I have alluded to for some time, you cannot raise taxes and cut
spending amid a glut in debt and general global slowdown and expect to
grow your way out of the hole. This is common sense, reference Data suggests Portugal headed back into recession:

Feb 14 (Reuters) – Portugal’s economy
shrank 0.3 percent in the last quarter of 2010, reversing a
third-quarter expansion and reinforcing market expectations of a new
recession this year as public sector cutbacks eat into consumer demand.
The decline matched forecasts from a Reuters economist survey,
though Monday’s data also showed growth of 1.4 percent across the whole
of 2010, beating the government’s own prediction of 1.3 percent mainly
thanks to a rise in exports. Portugal’s economy contracted 2.5
percent in 2009 and analysts say it must break a cycle of chronically
poor growth and recession if it is to dig itself out of a debt crisis
that has made it the next candidate for an EU bailout. With the
government seeking to calm creditors by raising taxes and cutting public
sector wages to reduce the fiscal deficit to 4.6 percent of GDP this
year from around 7 percent in 2011, it is difficult to see where an
acceleration will come from in the short-term. Poor growth in
turn makes it harder to meet fiscal targets.

The odds are greater in favor of a Portugal restructuring than they
are against one. I can say this because I had my team take the time to
pour through the math, all of the math. All viewers should reference Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis
wherein you can find a complete workup of the Portuguese situation and
complete scenario analysis of haircuts, how much, how they should be
structured, and nominal and NPV losses to debt holders. This is the type
of stuff that simply cannot be found anywhere else on the web. I have
made available for free to exemplify the quality of work that we do
here.

It doesn’t take a genius to determine that Europe is going to see
some interest rate volatility in the near to medium term and the risk of
contagion is great.

This economic and financial contagion, combined with the upcoming
interest rate volatility (when rates are set at zero, what direction do
you expect them to go in the face of market turmoil?), will wreak havoc
on the anemic real estate markets both in Europe and the US.

Amsterdam’s VPRO Backlight and Reggie Middleton on brutal honesty,
destructive derivatives and the “overbanked” status of many European
sovereign nations. Start at 7:35 in the video. The essence of
Realpolitik is espoused at 11:00 in the video. Basically, “If you’re
pessimistic or optimistic, you’ll probably end up being broke very
soon!”.

Finally, a SOLUTION, at least for those interest in real asset classes!

We have come up with a solution to the pricing and valuation of said
real estate assets, taking into consideration the nuances, inputs and
risks coming from so many different geo-political, macro-economic and
financial directions. It entails taking the talents of objective
observation and rigorous, multi-discipline analysis and broaching the
problem from the most realistic perspective possible. For those that
have just started following me, this methodology has created an
outstanding track record of calling nearly every single aspect of the
2008 market crash, including real estate markets, specific REIT
bankruptcies (GGP), bank collapses (ex. Bear Stearns), etc. months in
advance of their actual occurrence (see the complete list and links to
substantiation at the bottom of this post).

To begin with, we have isolated risks of contagion and place probabilities on them…

… and taken cross asset and geographic correlations into consideration.

As you can see above, correlation across geo-political boundaries and
asset classes abound. So, where does this leave us in terms of our
proprietary contagion model.

What we set out to do was to adjust the pathways of apparent pure financial contagion with several, real world factors.

We then took this analysis and used it to build contingent pricing
mechanisms into cap rate and economic capital analysis, complete with
mechanisms for factoring the contingent risks of over supply.

One can consider this a derivative whose goal is to achieve clarity
and pricing transparency, which is ironic since much of the Street uses
derivative products to create opacity in pricing – which oft brings
wider profit margins. This is heady stuff for the traditionally staid
real estate industry, but we are in heady times.  The result is a
pricing and valuation mechanisms that takes into account the major risks
to the global real estate markets today -

1. economic/financial contagion
2. interest rate volatility
3. geo-political risks
4. excess supply due to overbuilding
5. weak macro factors
6. and of course, that oft-forgotten aspect – the core fundamentals.

I will be revealing more on this pricing of hard to value assets in a
time of potential turmoil as the keynote speaker for approximately 200
institutional CRE investors at the ING Commercial Real Estate
Conference in Amsterdam on April 8th. See www.seminar.ingref.com (or click below to expand). Feel free to contact me if you are interested in attending. I am willing to personally work with institutions of size on projects such as this.

For those who have not followed me throughout the Asset
Securitization and Pan-European Sovereign Debt Crisis, I have a
relatively respectable record for calling the reality of the situation,
including but not limited to….

1. The housing market crash in September of 2007: Correction, and further thoughts on the topic and How Far Will US Home Prices Drop?
2. Home builders falling and their grossly misleading use of off balance sheet structures to conceal excessive debt in November of 2007 (not a single sell side analyst that we know of made mention of this very material point in the industry): Lennar, Voodoo Accounting & Other Things of Mystery and Myth!

3. The collapse of Bear Stearns in January 2008 (2
   months before Bear Stearns fell, while trading in the $100s and still
   had buy ratings and investment grade AA or better from the ratings
   agencies): Is this the Breaking of the Bear? | After the collapse, a prudent bullish call as well… Joe Lewis on the Bear Stearns buyout Monday, March 17th, 2008: “The
   problem with the deal is that it is too low, and too favorable for
   Morgan. It is literally guaranteed to drive angst from the other
   side. Whenever you do a deal, you always make sure the other side
   gets to walk away with something.  If you don’t you always risk the
   deal falling though unnecessarily. $2 is a slap in the face to
   employees who have lost a life savings and have the power to block
   the deal. At the very least, by the building at market price and get
   the company for free!” | BSC calls are almost free and the JP Morgan Deal is not signed in stone Monday, March 17th, 2008 | This is going to be an exciting, and scary morning Monday, March 17th, 2008 | As I anticipated, Bear Stearns is not a done deal Tuesday, March 18th, 2008 [Bear Stearns stock goes from $1 and change to $10, front month calls literally explode from pennies to several dollars]

4. The warning of Lehman Brothers before anyone had a clue!!! (February through May 2008): Is Lehman really a lemming in disguise? Thursday, February 21st, 2008 | Web chatter on Lehman Brothers
   Sunday, March 16th, 2008 (It would appear that Lehman’s hedges are
   paying off for them. The have the most CMBS and RMBS as a percent of
   tangible equity on the street following BSC. The question is, “Can they monetize those hedges?”.
   I’m curious to see how the options on Lehman will be priced
   tomorrow. I really don’t have enough. Goes to show you how stingy I
   am. I bought them before Lehman was on anybody’s radar and
   I was still to cheap to gorge. Now, all of the alarms have sounded
   and I’ll have to pay up to participate or go in short. There is too
   much attention focused on Lehman right now. ) | I just got this email on Lehman from my clearing desk Monday, March 17th, 2008 by Reggie Middleton | Lehman stock, rumors and anti-rumors that support the rumors Friday, March 28th, 2008 | It appears that I should have dug deeper into Lehman! May 2008
5. The fall of commercial real estate in general (September of 2007) and the collapse of General Growth Properties [nation's 2nd largest mall owner] in particular (November 2007): BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming… (among over 700 pages of analysis, review the January 2008 archives or search for “GGP” for more research).
6. The collapse of state and municipal finances, with California in particular (May 2008): Municipal bond market and the securitization crisis – part 2
7. The collapse of the regional banks (32 of them, actually) in May 2008: As I see it, these 32 banks and thrifts are in deep doo-doo! as well as the fall of Countrywide and Washington Mutual
8. The collapse of the monoline insurers, Ambac and MBIA in late 2007 & 2008: A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton, Welcome to the World of Dr. FrankenFinance! and Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion
9. The overvaluation of Goldman Sachs from June 2008 to present): “Can
   You Believe There Are Still Analysts Arguing How Undervalued
   Goldman Sachs Is? Those July 150 Puts Say Otherwise, Let’s Take a
   Look”, “When the Patina Fades… The Rise and Fall of Goldman Sachs???“and Reggie Middleton vs Goldman Sachs, Round 2)
10. The ENTIRE Pan-European Sovereign Debt Crisis (potentially soon to be the Global Sovereign Debt Crisis) starting in January of 2009 and explicit detail as of January 2010: The Pan-European Sovereign Debt Crisis
11. Ireland austerity and the disguised sink hole of debt and non-performing assets that is the Irish banking system:
    I Suggest Those That Dislike Hearing “I Told You So” Divest from
    Western and Southern European Debt, It’ll Get Worse Before It Get’s
    Better!
12. The mobile computing paradigm shift, May 2010: More on the Creatively Destructive Pace of Technology Innovation and the Paradigm Shift known as the Mobile Computing Wars! »

Comments

[AN0NYM0US]

I am skeptical of contributors that have subscription sites. (sort of like Gartman publishing teasers on ZH). I read the article (normally I go to the end to read the conclusion and work backwards but the end of this article was a history lesson). I started watching the first video but the quality was poor and graphics unintelligible.

My takeaway from everything above as it relates to Real Estate is that

"This economic and financial contagion, will wreak havoc on the anemic real estate markets both in Europe and the US" and that “If you’re pessimistic or optimistic, you’ll probably end up being broke very soon!”.

For some reason I am left unsatisfied and am tempted to go to the subscription site to get "the rest of the story".  But before I do that perhaps Reggie could answer this question: How much do you pay to be a  contributor on ZH? Is it by the article or a flat monthly rate? I have to believe that posting here would be extremely lucrative.

[moneymutt]

all I know is Reggie puts lots of great stuff up for free and while it is promoting his site its a whole lot more valuable than an ad. Sure if you want real specific trading strategies and want to really evaluate his data closely you must subscribe, but he provides way more data, for free, than many of the big names whose analysis is posted and quoted on ZH all the time. I'm sure Reggie gets something from posting here, but really, I think ZH gets as much if not more, free content, good well-documented content, contrarian viewpoints that ZHers love etc...what is so wrong with that....if you don't trust, don't read Reggie's posts, I, for one, love them...always interesting, he often responds to valid criticism in the comments, and his calls have be a good as any ones, if not the best. 

[moneymutt]

Ireland's austerity ( to pay for their banks mistakes not their ordinary gotv spending) resulted in their economy dropping MORE than the cuts they made. As you say Reggie, you can't cut spending, pay down debt, and grow economy all at same time. Maybe one, maybe two, but no all three, unless you find a oil gusher under your capital.

Steve Keen, and others, say its the acceleration and decceleration of debt that matters to GDP. If your govt can't increase spending, in fact it must cut spending, your private debt/credit is vaporizing due to deflation of real estate...it's not remotely pedal to the medal for GDP growth. No way to escape it short of default, via haircuts and/or devaluations...since in Euro zone devaluation not option, as it was in Iceland, Argentina (those countries defaulted also), doesn't this mean the haircuts will have to be massive?

[Reggie Middleton]

Only massive to those who are owed the money. Remember, there is the nominal value of the haircut, and then there is the NPV of the actual losses. One can look much worse contingent on the restructuring was put together.

[moneymutt]

"Only massive to those who are owed the money"

great statement/point....too true

[Jack Sheet]

Very nice stuff Reggie I always enjoy your contributions. I'm a bit confused though - how do the sovereign restructuring risk and bank solvency issues in the EU plus the British inflation rate (only a temporary blip according to Mervyyn King, just like the 2.7% CPI inflation in the EU zone!) and valuation of US real estate all connect up? What bets are you placing? Best regards.

[Reggie Middleton]

It's actually European real estate, but the premise remains the same. Higher interest rates = higher cap rates = lower RE valuations.

[falak pema]

Reggie they should make you financial commissar of the EU. Maybe you'll come play jazz at the Montreux festival.

[Dick Darlington]

Nice GDP figures from Greece out today. In the last quarter of 2010 their GDP dropped more than 6% YoY. Uhhh, that's some heavy s*it. Would be VERY interesting to see an update on the report about Spain fudging their GDP which was done by the "anonymous blogger" last year. The copy of that report was also here in ZH.

[Reggie Middleton]

Listen, it is likely the entire PIIGS group will require restructuring. Its in the math. I posted an extensice, 30 page work up of Portugal for free just to prove the point. These austerity measures are built upon overly optimistic fallacy, and that's why they may have worked on paper. As a matter of fact, even if you went through the paper, they didn't work.

Once one or two states restructure, there goes that rate storm, and there goes those cap rates. And you thought real assets were in the doldrums now...

[Dick Darlington]

I hear You Reggie and I agree. It's funny to see those uber-optimistic growth projections coming down in Ireland after the bogus bailout. And the estimated losses in the fraudulent banks going up. It's all about smoke and mirrors to the bitter end. It's just sad that in the way the politicians are robbing the taxpayers blind.

[dick cheneys ghost]

saudi's say they will intervene in bahrain if things get worse. me thinks they are already there. the kingdom is scared shitless.

http://nakedempire.wordpress.com/

[bingaling]

I dont know Reggie ,everyone and their brother knows what will happen if rates rise and I am willing to bet whichever banker/finance minister is in charge of whatever country, rates won't be raised and any and all excuses will be used in order to do so . The alternative is severely deflationary and casino derivatives get unravelled etc .So this will go on until it can't .

Also I am wondering if the projected increases in revenue to gov'ts will come thru the rising prices .If the price of a loaf of bread doubles so does the VAT collected .That wouldn't be a very popular thing to say so politicians are probably pawning off revenues in those shitty growth forecasts. They are pretty good inflation forecasters though. Example : Forecast growth =Real Inflation

[Reggie Middleton]

I never said govts. would voluntarily raise rates, I said you will have volatility ex. rates will explode through the attempt to contain inflation - after its too late, of course - or through a grey swan event such as serial restructuring of several insolvent sovereing states, or China's bubble popping, or...

[bingaling]

 You have been right so many times before and you did say that . Sorry .

[JR]

For those that have just started following me, this methodology has created an outstanding track record of calling nearly every single aspect of the 2008 market crash, including real estate markets, specific REIT bankruptcies (GGP), bank collapses (ex. Bear Stearns), etc. months in advance of their actual occurrence…  – Reggie Middleton

I would just like to confirm the accuracy of this account as I have followed your analyses for some time, including your posts during the halcyon days of RGE Monitor.

[Reggie Middleton]

Thanks. There was a lot of intellectual talent and capacity on RGE's boards back then.

[velobabe]

reggie i watched your video and learned a lot!

your smart and handsome†

[Reggie Middleton]

Thanks. It seems as if you're smart, and have good taste too :-)

[falak pema]

More mumbo jumbo from Reggie who plays his horn like Miles Davis. Great diagrams showing the world is heading wherever you say it is. A self serving philosophy is the best medicine these days. Lay on Macduff...

[topcallingtroll]

Plug brazil into your model. Brazil looks great for real estate from my perspective. People discount excessively our southern neighbor.

[MrSteve]

The said excessive discount may not be tough enough. Hugo Chavez is slapping food peddlers for speculation and seizing beef producing ranches. How does this contagion avoid Brazil which already has 10% inflation, about half of Venezuela's rate? At 10% inflation the DCF value of your money is zero before you can get it out of the country. You'd need to export it in real assets and that may not be possible, despite Brazil's natural resource wealth.

Have you ever met a street food vendor who wasn't a heartless commodity speculator? Their 24/7 trading rooms are a sure tip off to their CBOE networks and giant cache of stored fruits and veggies waiting for higher prices, etc.