We now are pretty sure rates will begin to rise from the fed in September or soon thereafter. This will be the most anticipated rate increase in history as it has been forecast for months. So there will be no surprises, the markets fully anticipate it and have priced it in. Most real estate investors who are sophisticated are building that into their modes and are building in a cap rate increase of some degree, depending on the projected exit year. So while values are very likely to top out in the next several months, barring an unexpected surge in the economy, wage growth and inflation, there should not be any shocks to the system in terms of rates or cap rate expansion in the next year or two. Should not be is not the same as will not be. There is always the black swan. Greece may collapse any day now, or even if they find an extension, it may collapse later. Either way Greece is no longer a viable state economically and will not be without a massive devaluation which it cannot have without return to the drachma. Then there are all the other geopolitical black swans sailing over head, like Russia pushing further into Ukraine, or into Moldavia or another small country. ISIS will continue to step up its efforts to stage a terror attack in the west and in Europe in particular. A terror attack in the US could come at any time.

So where does this leave us as to upside potential and value creation. The high likelihood is values are reaching their peak soon, whether in 6 months or 18 months is unclear, but we are in the eighth inning for sure. We are closing in on 8 years since the capital markets first began to crumble which was the third week in July of 2007. At first that was not noticed, but the beginning of the end was that week was the start of the disintegration. Most cycles last 6-7 years and we are well into it. Even if you measure from March 2009 as the start of the recovery, it is 6 years. As in most up cycles there are already excesses in pricing of assets driven by the Fed. These excesses are never sustainable for long. Regardless if the economy continues to recover, there are limits to how low cap rate compression can go and we are there. As the ten year begins to rise as it is, then the marginal deal starts to get harder to justify and prices begin to flatten, and as rates move further up the underwriting for loans has to deteriorate further or the deals no longer pencil at those levels. We are about at that level now.

None of this is to suggest there will be a crash or even a severe downturn which I do not expect unless we have another major terror attack which becomes more and more feasible as each day goes on and Obama fails to act to kill the Muslim extremists who want to cause us mayhem. Instead we are possibly going to have small cap rate expansion over the next year or so and potentially a flattening of rent increases as more and more of the opportunistic assets are bought and renovated or shifted to better management hands. There is simply no place for some big upside surprise to come from even if the economy keeps improving.

The real hope is we muddle through until January 2017, and a strong Republican wins the white House and moves quickly to undo the over regulation, and all of the wasted costs associated with the excess regulations, and he begins to step down on the EPA and NLRB and other federal agencies who have helped to slow business growth. Then maybe there will be real tax reform and we might see a real economic recovery which then could possibly give asset values a real boost. If it is Hilary, or someone even further left, then we are all best being in cash and waiting for the next big downturn.

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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.