It is becoming more apparent that 2015 was the big year for CRE prices to rise, and now there is a topping out beginning. Not a crash, but a leveling off. Prices of all types of buildings in secondary markets are at levels that are now uneconomic in many cases, and a growing number of bids are not closing or are taking much longer to close. We are now near the eight year of the cycle if you start with the start of 2008 as the time the financing markets were already in collapse. Cycles only generally last 7-8 years, and in some cases the longest being 10 years. In many markets multi is beginning to be over built and rents are reaching maximum levels that they are close to unaffordable for a growing number. Wages are simply not growing to the degree that would be needed to afford the projected rents on many new projects. Retail and office rents in some markets are now coming close to that same level where the numbers are simply not economic for the tenants. That is already happening in Manhattan. Construction costs are much higher now, so my going in cost today on development is far higher than two years ago. To all of this we add that interest rates are about to start rising, even if very slowly. It will make underwriting more cautious when one looks ahead over a 5 year hold. What will rates and cap rates be in five years when I want to exit. Maybe the ten year by then will be back at 5.5% , and cap rates could be back up to more normal levels. So what is my exit value if the then buyer is looking at debt yields calculated on a loan rate of say 7.5% or 8%., and cap rates 150 basis points higher than today. My terminal value will be a lot less than if a sale was taking place today so I can't afford to pay as much today and hold for five years, as I was willing to pay two years ago when things looked less problematic long term, and if I figured to exit in 3 years.
Now add to all of this the terror threats and the high probability that the US and Europe will be in a real war next year and for maybe a few years. Europe had real structural issues within its financial system, and continues to do so. They still have not taken the steps needed which US banks took, to fully clean up the mess, and to clear their balance sheets. We see thousands being terminated at several major banks which simply shows the depth and the enduring nature of the problem. Draghi is going to do another major round of QE in a few weeks which is further evidence that Europe remains weal and needs to be saved for deflation. It is now likely that the Euro will sink to par early in 2016, and will still be struggling through next year, and maybe longer. There is a demographic issue now in Europe where they need younger people, which is the real reason why Merkel wants the refugees. Germany needs to young workers to keep the export business going.
For quite awhile I have been warning that Europe was highly risky due to the structural problems above, a weakening Euro devaluing the investment, and the high probability of a black swan event which has now happened. Who among you would have thought the entire city of Brussels, the heart of the EU and NATO, would be locked down for days at a time. Who would have thought France would be under emergency orders and an armed camp. Who predicted the refugee wave which is bringing new dangers of terror attacks to Europe. Did you think that heavily armed soldiers would be patrolling the Jewish quarter of Antwerp on a now permanent basis to protect the people from Muslim attacks. Major corporate events booked for Paris are now being moved to Spain. None of this bodes well for investing in Europe for several years. The ECB can flood the market with all the stimulus it wants, but unless the Muslim assimilation and refugee issues are dealt with quickly, and in a major way, and the structural issues in the banking system resolved properly, the long term future of Europe is a polluted fog.
The world is at war, it will get even uglier, and Europe has major issues with its Muslim population and its inability to really come to grips with the heavy debts of the sovereigns, and the banking system. We are in for a rough several years, and that will make investors more cautious, and lenders more reticent. The US seems to best place to be, but we are reaching the top of the cycle. It is going to be a period ahead for great care in investing, and hard analysis of markets to not be caught in a downdraft.
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