Volatility And Its Impact

It is not clear how much longer the volatility will continue in the bond markets. Recently it has been high, and has made it very hard for lenders to know exactly how to price the risk. While some lenders have tried to just select a rate vs a spread, this is still risky in that nobody can be sure where index rates will settle out. Likely they will not rise much for quite awhile, but until Europe is resolved well, there is a high risk that volatility could remain high. Maybe this week Merkel and Sarkozy will finally understand that they are playing with a dangerous game of kick the can as they have been for the past two years. There is still a total lack of any leadership in Europe, and things are still just muddle along with no political or monetary structure that is really effective. Having seventeen disparate countries try to agree on anything is a challenge. To have them agree on all of the issues of defaulting Greece, how to stabilize Italy, how to stabilize a very disparate set of banks in all of the affected countries, and how much each country needs to contribute of its taxpayers money to support the entitled, lazy Greeks and the dysfunctional Italians. Is a massively complex problem which is inherent in the unworkable EU rules. The Euro Zone worked when everything was going well and there was no apparent stress on the system of socialist programs which supported not working in Greece, Italy and Spain. Now that reality has struck and there is no longer the ability to continue these massively unproductive programs, there needs to be a genuine reordering of the underlying rules of the Euro.

Whatever they do this week will help, but there needs to be a rethinking of the whole concept of a single currency with no real rules. Greece cheated and lied, yet nothing was done, and now the whole world is paying the consequences. I really doubt we will see Dodd Frank of the Euro as a result. Instead we will see bubble gum and baling wire to get by and sustain the banks, and a defaulting of Greece, but no real restructuring of the Euro Zone. Nobody will admit the whole concept was fallacious from day one and remains unworkable. All they are doing is a big band aid. This is not the end of restructuring in Europe.

The result is the stock market will rally on the belief that the immediate crisis is resolved, bond markets may settle down, but we are far from out of trouble. Europe will remain a weak economic zone for many years. Banks will have to consolidate to survive. The standard of living in Europe will not improve for years, and social unrest and strikes are very likely. Eventually more left wing governments are possibly going to be elected to “right the wrongs” of the banks. None of this is conducive to growing the economies of Europe and none of it is conducive to investing in Europe.

For the US there is good and bad out of this. The good US banks like JP Morgan will become even more predominant in the world. US real estate will look like an even better investment to both offshore and onshore investors. While Obama has completely screwed the US economy, at least the banks are in sound condition, and there is not a high likelihood that the problems in Europe will be severely adverse to US banks or money funds, all of whom have been taking steps to minimize the danger of another Lehman event in the US. There is still that huge pool of liquid assets in the US which is available to invest here when the economy starts to turn as it will if Obama loses. If he wins all bets are off.

With Credit Suisse shutting down its real estate finance group, and others doing the same or at least restraining allocations, it will be quite awhile before the US real estate debt markets are again flourishing. As a result, values will continue to muddle along or possibly even decline slightly. For the assets in secondary markets, it will be a long time before values again rise. There is simply not going to be a lot of debt capital for those assets in the near term, and maybe not for two or three years. As a result, acquiring those assets in good locations in good secondary markets is likely a good strategy over the next year or two if you are a long term owner, 5-7 years. There is less competition for them now, and there will be more distressed opportunities as the debt markets remain shut for them, and as the economy continues to stumble into 2012. The main markets like New York will continue to be too much in demand and prices for those assets will remain too high, with too much capital chasing too few opportunities. Eventually the debt markets will rediscover secondary markets as will equity investors. Then you can sell into that rising demand.

The steps Europe will take this week will get us past the immediate crisis, but it will not solve the real problems in Europe or the US.

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Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.