It Is Almost As Good As It Can Get

If you add back the Toys R Us layoffs, the employment report was pretty much on target, and the prior months adjustments up made it even better than we thought. It is likely that unemployment will hit or better historic lows by October, wages are starting  to rise, oil prices are pretty steady and might decline a little, the dollar is up helping keep inflation down, and it is pretty clear the tariff battle with everyone except China will end by October, if not sooner. The EU is weakening even more, Mexico will make a deal in the next week or two, and Canada will follow. The EU will do a deal on autos along with Mexico and Japan and that will resolve the auto issue which is the big one. The EU now has no choice but to concede as their economy is weakening, Merkel is fading out, and there is political disruptions with the eastern nations going right wing, and Italy siding with them. The refugee issue is going to get much worse in Germany and in places like Netherlands, France and Belgium, and that is leading to more political problems. Those problems make it very hard for the EU to have a cohesive financial and economic strategy.  Add on Brexit, and Trump ramming them, and they will have to work it all out with Trump, and soon. By October there will be a deal and a new NAFTA. Likely there will be steel quotas and that will resolve that issue.

Even if the EU resolves the trade battle and Brexit, they are in real trouble. They just lost their chances for Iranian trade deals, and their budgets are still not under control. Merkel might remain in place for a while, but the old stability is gone, and that leaves Macron fighting for the lead, which he will not likely attain. All in, the EU will remain a weak and unstable place to invest. That means more investment dollars to the US. Latin America is no place to invest either. Asia and emerging markets may offer opportunities, but it is hard for the ordinary investor to go to these places without incurring big risks to their investment due to the corruption and very different way of operating in many places. Africa may be up and coming, but is not, for now, a place to invest for anyone but the people willing to take huge risks. Corruption is rampant and qualified governments is almost non existent there.

China has essentially left for home as to new investments in the US, and so that has alleviated the run up in valuations we had seen from that flood of investment capital. EB-5 is possibly dead, or maybe will be revised in major ways to eliminate large developers in New York and California from using it. The Venezuelan money is already here, and the Russians left years ago. That essentially leaves domestic sources as the prime place for capital.  That will hopefully mean a much more rational and stable market, with values rising sensibly and solidly for good economic reasons. This will mean a longer term stability and prosperity for investors, with much less risk than was posed by rushes of offshore capital from China and Russia creating over valuation. Short term, maybe it is not as good for traders, but long term, it is good for CRE as a whole to be much more stable.

It is unlikely the Fed will raise rates a lot higher over the next two years. So long as inflation remains around 2%, which is likely, then there may be 3 or 4 more increases from here to the end of 2019. Maybe the ten year goes to 3.5% and maybe 4%, but that is not the end of the world by far. Most of us who were around long before the crash, recall a normalized ten year was 5%-6%, and borrowing rates were 8%. If the ten year reaches 4%, and borrowing is at say 6%, then deals should still work well, or you should not do them. The glory days of discounted asset prices and borrowing rates of 3%, or less, are gone forever, so forget it. Somewhat higher rates and exit cap rates will force you to be more careful about due dili and selection of deals. That is all good for the long term continued health of CRE. Now we are in a rational investment situation, where sound underwriting is required and a willingness to walk away and not do a deal is essential. The great economy will continue into 2020, so there is a good run remaining for CRE so long as much more rational rates of return are the target, instead of the 20% and 2x we experienced in the past years. 12%-15% is very good if the risk is fairly low. Don’t get greedy.

It is highly likely Trump will be reelected if the economy holds up, and if the Iran regime is overthrown by its own people, very likely, or destroyed in a war with the US and Israel. Putin will not be able to a lot more major trouble making, and China will have reached some sort of new trade agreement with the world, and the WTO will be reformed by then. N Korea will get resolved with no war. In the end, it is a strong economy, and the world at relative stability with Iran out of the picture, that gets Trump reelected, despite the press and the left. That portends a stable and strong economy at least into 2020, and maybe 20121.  The real issue is the deficit which is out of control and the government employee pension plans which are driving states and cities to bankruptcy. That is the next real financial crisis we face and it will be ugly. The big concern short term is the Democrats get control of the House and Maxine Waters becomes chair of the finance committee and the Dems try to impeach Trump which will disrupt everything. That is the black swan, and why it is critical for the Republicans to hold the House, which I predict they will.

The views expressed here are the author’s own and not that of ALM’s real estate media.