Unsound Global Economies Continue to Fuel US CRE

Dotzour: “CEOs are borrowing money to give you your money back—that’s bad news. This is why CRE will still be in strong demand until there is an alternative.”

SAN DIEGO— Foreign financial markets based on false fundamentals are creating more reasons for overseas investors to bet on US commercial real estate , economist Dr. Mark Dotzour told an audience of brokers during SVN ‘s annual conference here last Thursday. In his presentation, “The Economic Outlook for Real Estate Investors and Decision Makers,” Dotzour gave an overview of where he sees CRE and the economy heading in the next few years. Dotzour started off by saying he sees the CRE industry, not surprisingly, as in the seventh inning. A recession may be in our relatively near future, he said, but “Recessions are not something to be afraid of in a capitalist economy.” He pointed out that market, being cyclical, always has its ups and downs, so we look for transitions in determining when a recession might hit. He added that since 1945, the US has been through 11 economic cycles, with the average recession lasting 11.1 months and the average expansion lasting 58 months. We are beyond that now, but each recession can be seen as the economy “taking a breather.” Regarding interest rates , Dotzour believes they will continue to stay low even though the Fed is going to “raise rates.” He explained that the Fed only raises the rate that one large bank can borrow from another for 24 hours and that interest rates are on the 10-year Treasury , which the Fed has no control over. “Rates are not going anywhere this year.” He added that the expected rate of inflation in this country drives the 10-year Treasury, so it doesn’t matter what Janet Yellen, President Obama or anyone else says in terms of raising interest rates. Dotzour spent some time explaining that many international financial markets are “mythical chimeras”—things that exist only in imagination and are not possible in reality. Such is the case with Japan, which has attempted to manipulate its economy with bond and stock purchases. “This doesn’t mean the financial market is doing well there—they’re still buying US commercial real estate.” He said the Bank of Japan owns half of the ETF market in Japan and has promised not to sell this stock until March 2026. “The Japanese stock market is ridiculous.” In addition, Haruhiko Kuroda , the governor of the BOJ, has increased the maximum percentage that the BOJ can own of each Japanese REIT from 5% to 10%, and the BOJ is buying US commercial real estate with it. As a result, “Our prices in US CRE are starting to get distorted by others bidding up prices beyond the criteria of US investors,” Dotzour explained. Based on these false run-ups caused by international markets that are actually suffering, the category that presents the most opportunities for US CRE investors is the tertiary markets here, Dotzour said. International investors aren’t interested in our tertiary markets (e.g., Wichita, Lubbock, etc.), so there is less competition in those markets, properties can be purchased for less and yields will be higher. “Normal investors are getting priced out of the primary markets, moving into the secondary markets and getting priced out of those and then moving to the tertiary markets to get higher yields,” said Dotzour. “Mythical chimeras are driving pricing up in the primary markets, but if these international investors pulled out suddenly,” we could see prices dropping significantly. Dotzour also mentioned the chimeras of negative interest rates on a third of the bonds in Europe and Japan. He also spoke of the fickle nature of the US stock market and why he doesn’t ascribe to it, saying that commercial real estate prices keep rising because people don’t want to buy stocks and bonds in in uncertain economic environment. He added that runaway inflation is not going to happen and that markets like self-storage, apartments and crop-producing land are our best hedges against inflation. Dotzour doesn’t like the stock market partly because companies—even profitable companies like Apple —are buying back stock since they don’t have any profitable investments to make; they’re also using a significant percentage of their money to buy back stock rather than investing this money and growing it. “CEOs are borrowing money to give you your money back—that’s bad news. This is why CRE will still be in strong demand until there is an alternative.” This trend is growing and has for years—the debt margin has been rising since the late 1990s, he said. So, global markets including China, Japan and Europe are barely holding on despite printing money, commodity prices are in a four-year freefall, which is hammering some countries, and the US is the “prettiest pig in the trough,” Dotzour said. “We have room to go for another couple of years because of car sales and single-family home construction and sales. It should be a good year for new-home sales.” He predicted that the Fed will try to raise interest rates so that they can lower them in another two years when we are in a recession, “but the Fed is not out of bullets. It can drop the Fed funds rate below 0%, print money and buy long bonds to drive mortgage rates down to 3% and employ other strategies. Also, the Fed funds rate moves up a lot in election years, so prepare to see this in 2016. Some of Dotzour’s investment themes for 2016 include the following:

• Europe, China and Japan will be printing money with little result
• Emerging markets will experience inflation and recession
• No American inflation until the year after oil prices bottom out
• A couple of meaningless rate hikes by the Fed
• Low GDP—about 2%
• Mortgage rates below 4%—unlikely to go above 4.5% this year
• Home price increases to continue
• Foreign currency values will continue to fall, reducing purchase of US real estate from Russia, Canada and Mexico
• New federal transparency rules on cash purchases (FIRPTA) will reduce foreign buying demands in the US
• The stock market could decline like in October 1987, reducing spending in the US and producing a lack of liquidity in the bond market
• The Black Swan: Putin will get tired of $36-per-barrel oil and blow up oil production in Iraq   and Libya.