Interest rate increases appear here to stay as the yield curve points upward at the steepest it has been in three years. With the ten year at 2.88% and headed north over the next few years, it is time to look at your debt position and consider whether it is time to go long or to sell before rate rises cause deterioration in your values. It is unlikely that Bernanke will start to taper before he departs both because the Fed will need more proof that the ;labor market is really strengthening, and because he is now likely to let that decision be made by Yellen. As for Yellen, it is not likely, but possible, that she will commence her tenure with taper the first meeting out of the box. Especially since she is more of a dove on monetary stimulus than Bernanke has been.
On the other hand, debt is back in its old ways. Leverage is now as much as 75% and there is mezz allowed. Five years ago the thought that mezz on top of 75% would be back was questioned. Now it is there. Top quality borrowers like some of the major PE funds can still borrow sub 3%, although probably not much longer. In any event it is like free money. If you can't make positive cash flow and profits at those rate levels, you should get out of the business. Even if you just count on a current return of around 12% to 15% and sell for little gain, you should be able to do that if you buy even decently. However, these deals are going away quickly now. There is not much of real interest left to chase, and rates will be rising from here on.
Unfortunately history is repeating itself despite the catastrophic financial markets collapse of 2008. As I have seen many times in the past of my 50 year career, the young guys think they know how to underwrite better, they are smarter, and they will not make the same mistakes. They will make the same mistakes. They are already headed to doing it. In 1993, when we created the first CMBS underwriting manuals, we had tough rules and tight pricing. Those of us who had been around for the S&L collapse remembered what happens, and we tried to do it right. In time greed takes over, the young guys really think they are smarter and can do it better, and the cycle started all over again. I can see it is happening again,. Just sooner than I expected.
Obama is about to accelerate the problem by appointing Mel Watt again to head HUD. He was rejected once because he is not qualified and because he will carry out the Obama policy of going back to subprime mortgages with 3% and eventually nothing down. HUD is already in serious trouble for all the 3% down loans it has. They are reinstituting the disaster of Barney Frank of claiming it is not right that not everyone can buy a home due to tough underwriting. They are getting ready to force Fannie and Freddie to once again feed the subprime market with buying bad loans. While they are attacking JP Morgan and Jamie Dimon for bailing out Bear and WAMU, and Bank of America for bailing out Countrywide, as a result of taking on these same bad loans, the administration is again doing what they lambast and fine the banks for having done many years ago. Hypocrite is an understatement. Pandering to the left is what it is, and we will once again pay a big price for that, long after Obama is gone from office. Currently we are finally back to 64% home ownership, about the highest in the world. It is about right for the US culture and demographics. Down payments are generally 10%. The home mortgage market is finally getting right and Fannie and Freddie are even attractive takeover candidates. Just watch as Obama and watt destroy that over the next three years.
I have observed over my 50 years in the business that the one thing that never changes is that it never really changes. The faces change, but in the end it all happens again and again. They can claim they changed the rules, fined the banks, or whatever they claim for political reasons, but eventually they are back at it because politics interferes, and greed goes where the opportunity leads, and that is right back to Fannie and Freddie accepting bad loans to meet a badly misdirected political policy bent on putting people in homes no matter what. Enjoy it now, for it will not last forever. That is the one real lesson of the 2008 collapse.
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Joel Ross
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.
