Take Advantage of Low Rates While You Can

 

 

 

November 18, 2009 Edition, Volume III

 

Inside Signature Update

 

• The Market – Crisis in Commercial Real Estate?
• The Economy –  Delicate Balance Between Rates & Inflation Pressures
• The Takeaway - Take Advantage of Low Rates While You Can

 

 

 

THE MARKET – Crisis in Commercial Real Estate – it’s not what you may think!

 

Reports have circulated in recent months regarding a possible ‘melt down’ in the commercial real estate market; needlessly raising fears of a second credit crisis, similar to that which we experienced in the fall of 2008.  As recently as mid-October, billionaire investor Wilbur L. Ross Jr., was quoted by [1] Bloomberg as saying the U.S. is in the beginning of a “huge crash in commercial real estate.” 

 

Sounds ominous doesn’t it?  Relax, this is not what some would have us think.  To understand the potential problem, we need to understand the dynamics of the market.

 

According to a December 2008 report from the [2] Federal Reserve Bank of Dallas the value of the entire US commercial real estate market stood at just over $3 trillion in 2007 and represented $1.7 trillion in mortgage debt.  At the same time, the value of the residential market was estimated to be as high as $21 trillion (now less than $17 trillion) with $[3] 14.6 trillion in mortgage debt.  Not only did the commercial market enjoy an average loan-to-value ratio of less than 57%, compared to almost 70% for the housing market, but the difference in the sheer size of the residential market is staggering, with residential real estate being valued at 7 times the commercial market.  Additionally, the underwriting requirements for residential mortgage lending became notoriously weak leading up to 2007, while commercial requirements remained far more stringent.

 

It’s not that there aren’t difficulties in commercial real estate; it’s simply that they pale by comparison.  The Bloomberg report projected U.S. commercial property sales to fall to the lowest in almost two decades as the industry endures its worst slump since the savings and loan crisis of the early 1990s.  In the interview Ross, the 71-year-old chairman and chief executive officer of WL Ross & Co. LLC, said he would use ‘extreme caution’ before putting money into commercial real estate, especially office space, because properties are losing tenants.  ‘I think it’s going to take quite a while to work itself out,’ Ross said.

 

Commercial real estate, like employment, is a lagging indicator of economic activity, and similar to employment is experiencing some of the lowest occupancy rates at any time since the 1980’s.  In such circumstances, property owners with highly leveraged projects may find it difficult to meet mortgage obligations and the risk of default rises. But with commercial mortgages representing less than 12% of those in the residential market, the impact is of significantly less consequence.

 

Likewise, as the economy improves both employment and commercial occupancy levels will rise.  The US stock markets have correctly responded to the risks by modestly adjusting stock values for those banks and insurance companies representing the bulk of the mortgage exposure.  Even still, the equity markets have continued their climb above 10,000 on the DOW, with little in sight to curb current trends.

 

 

THE ECONOMY – Delicate Balance Between Low Rates and Inflation Pressures

 

Wednesday morning’s release of the October [4] CPI figures (consumer price index) reflected an increase of .3% and re-ignited ongoing concerns over just how long the Federal Reserve can keep interest rates at ultra-low levels while waiting for the employment market to recover.   The pressure on the Fed is mounting as the gold and oil markets continue to climb and inflation concerns replace fears of deflation.

 

The Fed’s monetary policy of low rates and open markets is running into increasing opposition from central bankers around the world as the dollar continues to weaken.  Aggressive monetary policy alone can yield an increase in inflation; when coupled with the free spending fiscal plans of the Obama administration and current House and Senate leadership, the inflationary pressures become more than we may be able to bear.  Rates may have to rise sooner than most of us might like and the labor market may face extended pressure as a result.

 

Policy makers have hoped to keep rates low and spending levels high in an attempt to stimulate the job market, but we’re now beginning to see that other factors may soon take the forefront.  The economy has clearly begun to expand in recent months and continued growth is critical to putting America back to work; with low interest rates being one of the more important aspects to recovery efforts.  They’re also starting to jeopardize needed international capital relationships, threaten currency rates and trade balances, and compromise price stability at home and abroad.

 

The Fed has taken great care thus far to limit the potentially negative impact of low interest rates and continues to have a strong grasp on the situation.  It’s unlikely that Bernanke will allow rates to stay at low levels long enough to do more harm than good, but the balancing act becomes increasingly more difficult with each passing month.

 

If unemployment levels stabilize and begin to retreat by the end of the 1^st Quarter 2010, as many are now predicting, the Fed’s job will be much easier.  The Fed can then signal to the international market its intent to increase rates, even if plans to do so are still 2-3 months in the future.  Bernanke and company’s pledge is more valuable than gold in the international markets and bankers around the world will act on the Fed’s intentions as long as there is a time frame they find plausible.

 

As was suggested by [5] Dallas Federal Reserve President Richard Fisher, when US monetary policy shifts to tighten rates it will do so swiftly and aggressively.  Those having bet against the US dollar, or who might have added gold or other commodities to their portfolios, will need to take swift action to protect themselves. 

 

In the mean time, it’s becoming more evident that the US Congress must undergo a budget trimming process similar to what most families have had to endure – otherwise fiscal excess will undo too much of the good the Fed has worked so hard to accomplish.

 

 

THE TAKEAWAY – Take Advantage of Low Rates While You Can

 

• Those able to take advantage of declining lease rates and commercial property values may find the current climate can help trim budgets and increase long-term asset values – fears over a commercial real estate bubble are overblown and don’t even come close to the impact of what we’ve experienced in the housing market.

 

• The US equities market continues to offer the best returns available, and there appears to be little on the near-term horizon to counter the current trend.  Year-end asset sales for tax purposes may have an impact, but most investors will realize gains rather than losses for 2009.

 

• The Fed’s low rate policy is beginning to show signs that a shift will have to take place earlier than we might prefer – the labor market and those who have bet against the dollar (gold, currency hedges, etc.) are likely to get caught in the squeeze.

 

• Health care proposals between the House and Senate are still so far apart that passage seems unlikely.  Though many of the legislation’s sponsors are touting similarities, the reality is that there are simply irreconcilable differences on which neither side appears willing to concede.

 

 

 

 

[6] Signature Update is offered by [7] Richard Haskell, Managing Director of [8] Signature Wealth Management  and CEO of [9] Signature Management, LLC