Note: all links have been fixed. Enjoy and have a good weekend!
As I sit back and contemplate the content and delivery style that would be best suited for my upcoming keynote speech at the ING Real Estate Valuation Conference in Amsterdam (this is my first presentation to a large group where English is not the primary language), I am bombarded with news bits and bytes that confirm what I've been modeling, warning, fearing and preparing for - for nearly 2 years. That is almost 23 months to the date. What is it, you ask? It is the market's return to the adherence of fundamentals and global macro forces versus following the whims of the concerted efforts of central banks around the world to openly manipulate real asset, equity and bond markets on a global basis.
Really, sit back and think about it. Put some thought into figuring out how difficult it is to successfully manipulate real estate (commercial and residential), stock and bond markets in just one major country. Then give the same thought to how difficult it would be to do the same in nearly all of the developed nations who participated in this crisis. The mere attempt to do so has loaded them up with debt at a time of marginal if not negative GDP and economic upside, a disgruntled populace ripe to ripple from the causes of social unrest rising from the rife economic conditions that the aftermath of incessant bubble blowing has wrought, and last but not least - fundamentally overvalued investment markets.
Was it really worth it? Is it going to last? I believe, and am rather confident in this belief, that we will be FORCED to finish what was started in 2008 - and that is the (re)commencement of the down leg of a major asset cycle. We had several concurrent booms (real estate - both residential and commercial, credit, fixed income, and equity) and an incomplete bust that failed to totally let the air out of the bubble. To make matters substantially worse, governments (on a global basis, mind you) wasted the resources of their countries and taxpayers in an attempt to fight the markets and the normal economic cycle by both re-inflating said bubbles (all of them to some extent) while simultaneously indemnifying and pumping full of undeserved capital, the massive agents of leverage which initially were the conduits of the bubble blowing pressure. As a result of being the conduits, they were also the foci of the deleveraging forces that culminated in the bust. These agents, at least a very large portion of them, have proven themselves to be financially incompetent and undeserving to remain as an ongoing concern from an economic perspective. Their political and lobbying clout said otherwise, and they have siphoned capital and staying power from the public sector through regulatory capture and now the poison that was the over-leveraged, "new guard" FIRE sector has now infiltrated entire countries and sovereign nations.
Those who may not follow me may think this is naught but fancy prose on a down day in the markets. Well, I have been preaching this publicly since 2007 and before the markets broke. I have named, on an individual basis and months ahead of the event, those agents that should have fallen - and for the most part did fall if not for massive government intervention, ex. Bear Stearns, Lehman, GGP, Countrywide, WaMu, etc. - see Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?, and I am saying now that the last two years of faux, government/central bank "purchased" recovery is simply unsustainable while the majority of the underlying issues that caused 2008 to happen are still present, and most of them are worse now than they were back then.
The market collapse commenced in 2007, and gained momentum in 2008, maximizing its velocity and strength in the 1st quarter of 2009. This collapse was not the result of the indicators that we hear bandied about so often in the mainstream media. It was not borne from stagnating GDP, slow retail sales, lots of snow nor high unemployment. As a matter of fact, all of these factors were literally on fire in 2006 through 2007. The market collapsed because the overinflated real asset market had finally reached its peak. Since this overinflated market was financed primarily with debt, upon its deflation accelerated destruction of equity and capital commenced. Once you lose 10% of market value on a cash investment, you lose 10% of your equity as well. If you are levered 2x, that 10% market drop equated to a 20% wealth loss. 5% downpayment housing deals, equate to deeply negative equity values at a 10% market correction. So, if one were to sit back and realize that 125% LTV (or a negative 25% down) housing deals didn't just exist, they were relatively plentiful by historical standards, and derivative structures allowed certain corporate players (ex. the monoline insurers) to employ 90x+ leverage, there is no wonder what happened when the housing market dropped 36% and the CRE market dropped 42%. Believe me, dear readers. They are not finished falling.
Then .GOV got into the bubble blowing business, and all of a sudden all is well...
Commercial real estate is literally close to its bubble highs. Hard to believe, but just glance at the chart.
With the US, much of Europe and major portions of Asia stuck in a liquidity trap borne from a developed reliance on unsustainably low and highly manipulated interest rates, the direction of yields really have no way to go but up. If I am correct in that plunging real assets brought upon the recession and associated market collapses, and manipulated interest rates worldwide have no where to go but up while said real asset prices have been artificially elevated at levels that defy the fundamentals, then what happens if when said rates break the chains of their erstwhile wanna be masters and resume their march to the north?
"It's not a question of dissing the United States or questioning the credit of the United States, but simply a maturity reflection," Gross said. Treasurys are "mispriced relative to the inflationary environment and the growth we see ahead and there are better alternatives in order to capture yield."
Gross primarily based his evaluation on the reduction in yields caused by the Federal Reserve's buying of close to $2 trillion in Treasurys, with more slated before the second leg of the program—often called QE 2—comes to an end.
"When a trillion and a half dollars worth of annualized purchasing power disappears I simply question as to who will buy them and at what yield," he said. "We're suggesting at these yields it might be problematic."
Anybody who has the least bit of doubt regarding this assertion needs to read this article immediately: Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate. As excerpted...
As you can see above, CRE drops in value whenever yields spike more than the + delta in NOI. Looking below, you can see that US CRE actually runs to the inverse of the 30 year Treasury.
That visual relationship is corroborated by running the statistical correlations...
The relationship is obvious and evident! In addition, we have been in a Goldilocks fantasy land for both interest rates and CRE for about 30 years. CRE culminated in the 2007 bubble pop, but was reblown by .gov policies and machinations. The same with rates. Ever hear of NEGATIVE interest rates where YOU have to PAY someone to LEND THEM MONEY!!!
So, BoomBustBloggers, where do YOU think rates are going to go from here? Up of Down???
Put simply, residential mortgages become less affordable leading to housing becoming less affordable. Cap rates skyrocket, save a commensurate increase in NOI, which I really don't see happening in an era of rampant unemployment and stagnant economic growth.
What many may not realize is that the housing market and the CRE are inextricably linked. The 10 city Case Shiller index and the CoStar US Cap Rate Index have a startly -94% correlation. That's as close to perfectly symmetrical as one can expect to get (lower cap rates mean higher prices, and vice versa, while higher Case Shiller numbers mean higher prices). If CRE and residential real estate are really that tightly correlated, then realize what we are in for in terms of residential real estate, besides higher interest rates.
In preparation for the ING conference, I have codified and modeled all of the various elements that I discuss on BoomBustBlog, namely the import and export of financial, economic and sovereign risk contagion. We adjust the pathways of apparent pure financial contagion and correlation with a plethora of real world factors.
Then we plugged them into our proprietary cross-exposure model, and then used global cap rate analysis to transform said risks into a spread over the risk free rate of each respective county, and finally plugged said figures into individual discounted NOI style models. I went into the process in a little more depth here: The Coming Interest Rate Volatility, Sovereign Contagion, Geo-political Unrest & Double-Dip Recessions: Here’s The Answer To Valuing Global Real Estate Through This Mess.
We back tested the results with regression analysis, and the accuracy of the results shocked even me - and I'm a pretty confident fellow...
It would appear that we are on to something here... That is, unless... You know, "This time is different!" I will go into this topic depth (and in English) in Amsterdam on April 8th. Anybody interested in attending should contact Jacob at the following link: www.seminar.ingref.com.
For those who have not been following my opinion and analysis regarding real estate and macro conditions surrounding it, here are my latest articles:
- Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate
- Further Proof Of The Worsening Of The Real Estate Depression
- In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse
- The Inevitable Has Finally Been Admitted In Europe: The Macro Experiment Has Ignited Inflation Without Commensurate Growth & Rates Will Spike
- If Japan Lost Two Decades From Its Bubble Popping, How Many Decades Should The US Expect To Lose?
- Why Is NYC The Only Major Condo Market Increasing In Price?
- The Latest Case Shiller Index – Housing Continues Freefall In Aggressive Search For Equilibrium
- I Warned That Banks Will Soon Be Forced To Walk Away From Homes… Guess What!
- FASB Appears to Have Bent Over For The Final Time & Accuracy In Financial Reporting Dies An Ignominious Death!!!
- Davidowitz On Overt Optimism In The Retail Space And Mall REITs, Stuff Which We Have Detailed Often In The Past