Happy New Year or should it be said Be Wary of the New Year...By Bob Canter Performance Realty Solutions

Implications: Recent headlines from the most recent to eight weeks ago certainly tell the tale of what is happening in the economy. Yet there are those that are in total denial because its not in their best interest to admit trouble is brewing and it is now ready to boil over.  How could so many been so wrong when all the warning signs have been there? Why didn't anyone stop for a moment to think about what was going on? Well some of us in the vast minority did, but not enough to make a difference. 

Analysis: Happy New Year; that sentiment lasted one whole day...The stock market had its worst first day trading session of a new year ever in its history. Why are the investors acting surprised, as today’s downturn was blamed on The Institute for Supply Management's report that its manufacturing index fell to 47.7 percent for December from 50.8 percent in November raised concerns that the economy could be slowing at a quicker pace than some investors had estimated.

This writer has been saying for over a year that you can not kill the housing market, or that a declining housing market can bode well for any part of the economy. The ripple effect is too great. Not that the housing market crashed, but those who have degrees in economics, Wall St. gurus, so called experts that had to know that when the housing market went into retreat, the sub-prime loans would soon follow and so on.


I had commercial mortgage experts tell me a year ago when the Federal Reserve asked for new guidance on commercial real estate loans, that we are in a New World Order when it comes to commercial finance. It will be the banks that the Feds will clamp down on, not Wall St. I retorted but...when ice water is thrown on any part of the credit markets, it sends a chill throughout the system.


When buyers of CMBS and Sub-Prime paper mistakenly believed they were actually buying Triple A rated bonds which only a handful of public companies or the U.S. Government can attain such ratings, then you have to know that the system is broken. Thanks in part to the culpability of the largest rating agencies it should be noted. But who fooled who?


The investors should have known despite such ratings, after all the pension fund advisors, mutual fund money managers, insurance and banking advisors all had to know right from wrong. The problem is no one wanted the party to end. Let’s make a ridiculous profit and let the next investor worry about the problem was the order of the day. Just look at Blackstone's buy of EOP in which they had buyers lined up at the closing table of the EOP deal for their cast-off properties.
We’re not talking about making reasonable profits or returns which are to be expected.

However when property values skyrocketed the way they did, one has to take pause and ask why? The why, was the easy access to credit nothing more nothing less. Its called asset inflation, as the rents for commercial buildings were not accelerating anywhere near the speed in which sale prices increased. Which is why lenders began permitting “Pro-Forma” income statements to be used. That methodology I would have said died in the late 1980’s and would never be resurrected again.


How could have Harry Macklowe borrowed $6.8 Billion in short term loans, with only $50 million in equity? Does anyone see the problem? Why did such a seemingly sophisticated investor such as Harry Macklowe make such a bad decision? We all know timing is everything in business, and that is part of the problem. If you stick with basic business fundamentals you can ride out business decisions whose timing may be questionable. But not in the case of the Harry Macklowe’s of the investment world. What is even more shocking are the lenders themselves thinking this type of debt leverage was OK.


Now that lenders have been shown to have no conscience or credibility in the real estate sectors the entire credit market is subject to question and votes of no confidence. This will create a self fulfilling downward spiral affecting everyone and everywhere. Every aspect of the credit marketplace has been called into question.


It matter’s not that the vast majority of all loans (debt) are performing and are in good shape. Investors, banks, borrowers, everyone has herd mentality which is why the economy is faltering. No one wants to be that last person holding the hot potato.

When the United States and the World’s economies are based upon a strong, confidence based credit system everything works well. When it breaks, just a little bit, it sends shockwaves throughout the credit system. Just look back at 1998 with the debacle over the Russian Currency bet made by Hedge Funds. The Hedge Funds bet wrong and the result was credit got extremely tight.

Now, if you want to believe Professor Shiller, who had predicted this mess in the housing sector for over two years , the shockwave to hit is in the multiple trillions of dollars.

It matters not that the Federal Reserve is cutting rates, as was previously written about, because it wasn’t just the rates that drove real estate lending to the extremes, it was the parameters by which loans were made. You have to love it when experts say there is plenty of liquidity in the system...but at what cost and to whom? It takes a long time for the pendulum to swing back...


Investors know they can not buy commercial real estate with the stricter lending standards at the same low cap rates...or should I say the sellers have been spoiled. The fact there is still such a disconnect between buyers and sellers is an indictment against real estate investment brokers. They should have been telling their sellers the new reality of the credit markets and how that negatively impacts pricing. But that advice may have the seller withdraw their property! Again self interest at work as there must be some buyer out in the market that has been living in a closet for the last 6 months that can get a loan on a property being offered at a 5%-6% cap rate?


To advise clients correctly means to have courage, but brokers for the most part have never shown their willingness for telling folks what they need to hear. Just look at the flag bearer NAR and you’ll get the picture.


Perhaps having been in commercial real estate for over 34 years has given me wisdom and insight as to what was to come. I just find it incredible that more investors, practitioners, lenders, et al didn’t see or worse, chose not to see what their actions were creating for short term profits and gains. I have seen private real estate investors, no not the institutional variety, but the smaller players who have made their fortunes on gut instinct and being intuitive to the market and current events get totally swept up in the frenzy. Now the bigger players wait for the foreclosures, which in case anyone hasn’t noticed, there are some large funds being put together to buy the bad debt packages, what does that tell you? But that is for another analysis.


Yes there are loans still being made, and properties being sold, the business world is not coming to complete standstill. However, it will seem that way when the recession hits, (if it hasn’t already). Add to the current woes of the stock market having declined by over 10% that too will affect spending habits and create job losses.


It will take longer to cure this mess, because as you will read the Global ripple effect has started, the British Commercial Real Estate Market is headed into the dumper. British Banks have all but shut their loan windows as this contagion is now spreading worldwide.


The experts have been saying how resilient the United States economy has been due to the Globalization of Commerce. That is true, however when the best customer in the world stops or substantially reduces its buying spree, the Global Marketplace will eventually suffer. Yes the World’s economy is centered on the U.S.


The emerging markets of China & India and elsewhere can not sustain themselves without the United States. Their own people can not afford to buy the products they make due to their low wages. As the United States economy goes so goes the European markets, deflated US currency aside.


No Country is an Island in the Global Economy and that is why this economic downturn is just beginning. Add to all the above the United States Presidential Election, and you have the proper mixture for the perfect economic storm that is about to hit. Seek the High Ground.


Recent Headlines:
1/2/08 The Institute for Supply Management's report that its manufacturing index fell to 47.7 percent for December from 50.8 percent in November raised concerns that the economy could be slowing at a quicker pace than some investors had estimated. The reading below 50 signals economic contraction, whereas readings over 50 indicate expansion. -MSNBC

12/29/08 Banks halt commercial property loans-Telegraph Co UK Some of the City's biggest investment banks have stopped lending to commercial property buyers, stifling deals in an already depressed market. According to research by William Newsom, head of commercial valuation at Savills, eight of the 97 lenders in the UK commercial real estate market have shut their doors to borrowers, while 11 more remain reluctant to take on risk. Almost 30 will lend but only on a qualified basis - such as to long-standing clients buying robust assets. Lending term have also tightened with rates for secondary properties increasing by up to 1.5 percentage points Newsom declined to comment on which banks have stopped lending. However, they are believed to include Credit Suisse, Lehman Brothers, Bear Stearns, Deutsche Bank and Barclays Capital, the investment banking arm of Barclays Bank.

12/26/07 U.S. home prices declined 6.7% in October from a year earlier, a record drop for the 10-city S&P/Case-Shiller index, and the state of the housing market remains "grim.” - WSJ

12/26/07 U.S. shoppers spent furiously in the days just before Christmas, spurred by discounts, but holiday sales appeared to still fall short of expectations. -WSJ 12/26/07 The fallout from the credit crunch is driving down commercial real-estate prices and forcing some owners to seek cash. -WSJ

12/26/07 Outlook Darkens for Big Banks For major banks, the next few years will be a return to a simpler and possibly less-profitable time. -WSJ

12/23/07 Amount of unpaid credit card bills is rising Experts link increase that could threaten economy to housing crisis- MSNBC Americans are falling behind on their credit card payments at an alarming rate, sending Delinquencies and defaults surging by double-digit percentages in the last year and prompting warnings of worse to come. An Associated Press analysis of financial data from the country’s largest card issuers also found that the greatest rise was among accounts more than 90 days in arrears. Experts say these signs of the deterioration of finances of many households are partly a byproduct of the Subprime mortgage crisis and could spell more trouble ahead for an already sputtering economy. “Debt eventually leaks into other areas, whether it starts with the mortgage and goes to the credit card or vice Versa,” said Cliff Tan, a visiting scholar at StanfordUniversity and an expert on credit risk. “We’re starting to see Leaks now.”

12/21/07 Sales Activity Continues Descent as Cap Rates Inch Higher. - CommercialRealEstatedirect.com “The credit crunch shows no signs of loosening its stranglehold on commercial real estate investment-sales activity.”

12/20/07 Rating Subprime Investment Grade Made `Joke' of Credit Experts-Bloomberg.com

12/15/07 Commercial sales outlook turns darker As it has gotten harder to obtain loans in the global credit crunch, deals for prime office buildings have faded-Chicago Tribune

11/29/07 Beige Book Blues...Dow Jones Santa's load could be slightly lighter this year, thanks to a "depressed" housing sector, according to the Fed's latest take on regional economies. The so-called beige book, which compiles reports from the 12 Federal Reserve districts, suggested that the housing slump may be affecting consumer spending. "Reports on retail spending were downbeat in general," the Fed said, and, with some exceptions, "the reports were slightly pessimistic about prospects for the holiday retail season." Policy makers have been fretting about what effect the subprime mortgage meltdown might have on the broader economy and in particular consumer spending, which makes up two-thirds of economic activity.

11/1/2007 Office-Space Market Show Signs of Slowing...Sublease space on the increase- WSJ