A Solution For Wall Street – What Happens to Commercial Real Estate and Housing?

Implications: If the subject analysis is realized, the return of Wall Street to advisory services will return real estate debt to the portfolio lenders.  Goodbye to the CMBS market as well as the sub-prime market.  In fact, Wall Street itself will be a unit of major banking institutions.  The major bankers will raise their capital requirements and the returns expected will escalate.

Analysis: Term commercial real estate rates will escalate to provide a return on invested funds plus coverage of the corporate income tax requirement plus an inflationary coverage plus the recovery of administrative costs.  The real question here is what inflationary expectations will be.  Will lenders be real as to the numbers at over 12% or will they follow the government modified numbers which peg the number at 2 to 3 %?  The likelihood is that there will be a median tending toward the government numbers and the government will subsidize the returns through tax preferences or the like.  Rates should be on the average 8 % or higher to make the numbers work.  These rates will destroy the values of commercial real estate whether purchased recently at artificially low returns or a product of an earlier, more rational market.  An increase of 25 % in the interest rate should decrease the value of the property by the same 25% assuming there is a parallel equity yield requirement and there are no further discounts for equity returns expected.  It would appear to me, though, that the equity return requirement will escalate as easy money/liquidity is reduced and risks are perceived to be higher.  
But all bets are off if the government decides we can’t stand the pain.  That’s the conclusion we seem to be coming to in housing as the government obviously will move to protect most of the participants so that we can live another day.  The commercial real estate pain may be so high that there will be no other choice here too.  If so, overall the winners will be those who speculated in housing and the commercial real estate speculators as well as Wall Street.  Stand by to see where reality lands.