The Good And The Bad Of QE3

The Fed’s new bond buying program is unlikely to do much, if anything, to help the job market. The issue is not liquidity in the system. US corporations have $3.6 trillion sitting relatively idle. Private equity funds and private investors have plenty of cash to invest. Individual balance sheets, while still a long way from properly balanced, are far better than they were in 2008. The issue is unprecedented uncertainty, fear, Obamacare burdens, and the regulatory threat that once you own an employee you may have a very hard time getting rid of him, and the whole issue of tax reform and increases and the fiscal cliff. Nothing the Fed does can alter that fear. It is a set of policy issues on the fiscal and executive side, and floods of even more cash is only setting us up for the possibility of inflation and crowding out of private capital raising in a few years when the Fed has to sell this portfolio.

While the Fed says it will hold rates at near zero until 2015, that seems a pretty risky projection. Nobody really knows what the next three years will bring. Much depends on who is president and who controls Congress. If Romney is elected with control of Congress, then a lot of things will change. Federal spending will be cut and hopefully there will be a complete reform of the tax code. There is likely to be a view by investors and business that things will be much better and it is likely that the markets will rally and business might start to hire by late 2013 if they see policies implemented that deal with the issues of entitlements and taxes. None of that is certain.

At some point, regardless of who is elected, the economy will improve. That may not be until 2015 as the Fed predicts, but up it will go. Then the Fed will need to sell its then $3 trillion assets into the market. That is one issue. The other is all of this liquidity will cause inflation at some point. It is highly unlikely that the Fed can carefully enough manage the sales of their bond holdings to get it just right. It will in some way disrupt the capital markets. It will surely shift the interest payments from staying internal to the US, to external to foreign buyers of the bonds. Right now the Fed collects the interest and returns it to Treasury. When the bonds are sold then the interest is paid to the new holders who are very likely many foreigners.

The other issue is, they are selling $3 trillion of bonds just as the economy is ramping up and when business and local governments will ramp up capital needs, and be in the market as well. There will be a crowding out to some degree. At best there is the huge overhang of bond sales by the Fed which will have some sort of impact on the bond markets and could possibly drive rates higher for private issuers who have to compete for investor capital.

It is possible that by 2014 or 2015, we could have a scenario of rising inflation and disrupted capital markets with rates rising faster than they otherwise might were is not for QE today. It is impossible to predict in this world what will be the situation. Before that there will for certain be a war with Iran of some sort. If Obama is reelected, then Israel goes alone. If Romney then the US goes with them. If Israel goes alone the US will be in within 24 hours even if it tries not to be as has been reported in the Israeli press. Israel will use high tech weapons and, if they have to go alone, could resort to small nukes if they feel desperate and their survival is at stake. However it goes down, the world will be engulfed in a war and that will change everything. Maybe for the good with the elimination of the Mullahs, or maybe for the bad if oil terminals are destroyed. There is no way to know.

In summary, there is so much we have no way to predict today that the Fed can continue to throw money at the system and it is not going to matter. Who gets elected matters, what Israel does matters, tax reform matters, and the violence against America in the Muslim world matters, European debt matters. The good news for real estate in the US is that there will continue to be a flood of flight capital to the US and it will partially end up in real estate. The bad news is it is showing up already. There is too much money chasing too few good deals and prices are already no longer distressed in many primary markets. My suggestion is forget chasing deeply distressed deals. There are already less and less of them as the flood of Fed liquidity and foreign flight capital results in more and more buyers of real estate in the US. That money is already competing heavily with private funds and pension funds, driving up prices in the top 25 markets. In addition, it appears that the lenders and servicers continue to be accommodative to borrowers who have additional capital to make a pay down or other accommodation. Just find good solid real estate and buy now, and use these historic low rates to get good leverage, then plan to hold until the inflation kicks in and rents rise in 2016 onward. You will do very well. Just make sure you have plenty of liquidity in your bank account in the interim to deal with the possibility of war, oil at $200, disrupted capital markets and maybe another recession. Cash reserves will be essential for the next few years or you will be back where you were in 2009.

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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.