This Time Is Different

This Time Is DifferentHaving lived through several major downturns, including the eighties interest rates of over 20%, it is instructive to compare and contrast. This time is very different. While the S&L industry imploded in 1989, the rest of the world was not so affected, nor did the US financial system collapse. The S&L’s were a small sector in terms of dollar impact. This time we have the entire world financial system nearly ceasing to function and suffering enormous long term damage. Foreclosures will not be mitigated by the modification plans and it is entirely possible that the problem will be with us for a considerable time. Home equity lines are mainly a thing of the past. Unemployment will take 4-5 years  to recover to more normal levels of 5.5%, and real estate loans will not permit high leverage on inflated projected values.All of this indicates that the over inflated values of 2007 will not possibly be recaptured for probably at least a decade on an inflation adjusted basis. There will not be the ability of consumers to over leverage to buy things they can’t afford including homes, take trips they can’t pay for, and speculators will not get the absurd funding to take what amounted to options on assets they intended to flip.Just because the 1990 and 2001 recessions happened does not mean they are relevant to this time. Almost all the metrics are different. The politics are very different, the regulations will be different, and the risk officers and auditors will be under enormous pressure to restrain the free wheeling over leverage of investment banks and others. Real estate has returned to fundamentals finally, and it will not be the trading vehicle it had become over the past 15 years.What does this mean. You need to be a lot more careful on the buy this time. Values are not going to take off. Net effective rents will remain constrained for many years. Leverage will remain constrained. In about two years inflation will begin to drive up operating costs but leases signed in 2009-2011 will be at lower rates than had been the case in 2007-8. Interest rates will go up. Most importantly, property taxes will have to rise to cover the massive deficits at the local and state levels where the budgets of these levels of government are simply unable to pay the bills. The federal budget will continue to rise unrestrained to dangerous levels. It is clear Pelosi cares nothing about fiscal responsibility and neither does Obama. They will do anything to pass healthcare and all of their agenda no matter the damage it is doing. That has to mean higher taxes for all of us who actually still pay taxes-which is just a little over 50% of the population. Those of us who are able to earn high incomes will be paying far more.The bottom line is you need to take all of these issues into consideration when pricing an asset for acquisition. Discount rates and terminal values need to be adjusted to take these metrics into consideration. Your risk adjustment when making assumptions about discount rates and cap rates need to be cognizant of these future restraints on value over the next 5 years. It is all in the buy. Don’t let a few recent deals where too much money was bidding on just a couple of properties let you get lulled into making a mistake that cap rates are low again. They are not indicative. When a lot of assets are finally put to market, so supply of deals is again normal, cap rates are likely to rise a little at that time. Don’t buy at any price just to spend those available funds- you could regret it later. Stick to old time fundamentals.