Yesterday, I bluntly called out the European state of economic affairs as I saw them in "Liar, Liar, European Pants on Fire!" Today, I present the article published by Property EU, one of the leading real estate publications in Europe which illustrates much of my thoughts on the topic of how and why Europe is nowhere near out of its economic malaise, and more importantly how this may pull the value of real estate down. The vast majority of European banks lend against real estate and when the value of said collateral goes down in conjunction with the value of what many are carrying on their books at par as risk free and hold to maturity assets at 30+x leverage... Well, you can use your imagination for the Lehman like results...
This week I will go through several property devaluation scenarios as applied to what looks like very promising cash flow scenarios using real life examples of NYC commercial real estate starting tomorrow, and culminating with a more in depth analysis for subscribers next week. The most interesting part of the analysis will be the application of our real asset protection program to hedge against the risk of property value decline. Stay tuned, it should be exciting, and if you are not a finance nerd like me - at the very least interesting...
Yesterday, I revisited the US employment vs inflation situation, which itself was an extension of my warnings on Employment and Real Estate Recovery. In the second post, I included the story from a BoomBustBlogger who was an investor of a large multi-family properties. As a BoomBustBlogger, he uses math to make decisions and the math simply doesn't pan out. Of course, due to .gov bubble blowing, unintended consequences often occur and this time around it is a bubble within a bubble burst in multi-family housing. The dilemma is, do you pull the trigger m/f investments that have increasing net effective rents even though we are almost certain to have higher interest rates (see Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate), more of a depression in housing (In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse), stagflation (Inflation + Deflation = Stagflation ~ Lower Real Estate Values!) and most importantly... obvious activity that is indicative of rampant speculation that goes against the fundamentals...
I will try to use math to address this conundrum in my next post as I'm running out, but realize that the recessionary (depressionary) pressures of s/f housing is not going anywhere soon. Let's look at the data taken from the February 11. 2011 HUD FHA Portfolio Analysis report:
A reader wrote me complaining about the nonsensical bubble blowing in multi-family properties before the last bubble was even finished bursting. I feel his pain. Let's run through a quick pictorial of how I see the macro climate for real estate as of right now...
Of the major economic powers, China is the only economy that is facing true inflation as I see it and China is primed for a hard landing - at best. The US, EU, and UK face stagflation. After the AP excerpt below is a clip from my recent keynote presentation at the ING Real Estate Valuation seminar in Amsterdam on this very timely topic.
LONDON (AP) — Rising inflation around the world weighed on stock markets Friday as investors wondered how fast central banks will raise borrowing costs to counter the threat of rising prices, while the euro was undermined by ongoing worries that Greece will have to restructure its massive debts.
Figures Friday reinforced market expectations that both the European Central Bank and the People's Bank of China will soon be raising interest rates again to counter rising inflation.
In China, figures showed consumer prices rose 5.4 percent in the year to March, up from February's 4.9 percent. The increase was largely driven by surging food costs and represents a setback for the government, which has boosted interest rates four times since October to cool prices.
Analysts expect the People's Bank to enact further measures in the days to come in response to those figures.
Here is a collection of my archived posts on the topic:
- Economic contractions AND rising prices, dare Reggie utter the “I” word – Enter a global phenomenon
- Reggie Middleton’s Take on Investing for Inflation, pt. 1
- Reggie Middleton’s Take on Investing for Inflation, pt. 2
- Reggie Middleton’s Take on Investing for Inflation, pt. 3
- Reggie Middleton’s Take on Investing for Inflation, pt. 4
- Reggie Middleton’s Take on Investing for Inflation, pt. 5
- More on my stagflation rant
- Deflation, Inflation or Stagflation – You Be the Judge!
- Is My Warning of the Risks of a Stagflationary Environment Coming to Fore?
- China’s Most Expensive Export: Price Inflation
Attention subscribers: related content is available for download: BoomBustBlog Complimentary FX Index model
For anybody who didn't catch the hint, another banking crisis the continuation of the banking crisis is inevitable. I've said it before, Is Another Banking Crisis Inevitable? This is the current landscape, undoubtedly fudged over by optimistic marks.
Banks NPAs to total loans
Source: IMF, Boombust research and analytics
Euro banks remain weak as compared to their US counterparts
Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.
I really do mean substantial!
Here's a quiz for you. An ages old correlation that has pretty much remained rock solid is now upon us. Real estate has been highly correlated to inflation and has acted as an inflation hedge for a very long time. This makes sense, since hard assets that both throw off income and have an actual demand for physical use (in other words, they have have intrinsic value) that hold when fiat currencies assimilate toilet paper in both value and use as input prices skyrocket. The question du jour is, "What happens when you have a glut of unused real estate supply abound in a tight credit environment, a guaranteed increase in rates AND higher input prices?". Of course the smart people out there (in other words nearly everyone with the impetus to read BoomBustBlog) are then forced to challenge the thesis, "So is this time different? After all Reggie, you have been bearish on real estate."
The short answer is, no this time is not different. It rarely ever - if ever - different this time. The key is the terminology. You see, many in the media are throwing around the word "inflation", and understandably so as they see prices (particularly staples, commodity and input prices) and money injected into the system go up appreciably. The problem is that the core real assets are not only in a deflationary cycle, but in a downright depression - reference In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse. How can you have inflationary input prices and deflationary real asset prices amid stagnant employment? The answer is STAGLFATION! I have been calling for stagflation since 2008, and it definitely seems as if I called it correctly. Keep in mind that this will be one of the corner stone topics discussed in the ING Real Estate Valuation seminar in Amsterdam on April 8th, which has now sold out its capacity of 250 seats -see www.seminar.ingref.com. Amsterdam is a very interesting city to have such a discussion, for the pundits there are calling for a 25% office vacancy rate at a time of increasing inflationary pressures. On top of that, they have actually called in the world's leading real estate bear as the keynote speaker! It should be fun. I actually have an implementable solution to this mess. I wouldn't necessarily call it light at the end of the tunnel, but it is a way of pricing, valuing and transacting in these depreciating, illiquid assets correctly. Something that is currently lacking. Let's dig in, shall we...
Summary: I said it! Bill Gross said it (and put his money where his mouth was by selling off all US treasuries)! Common sense says it... Central Bank manipulated interest rates are too low. They will rise. What happens when they rise during a supply glut of real estate, foreclosure issues and a slow economy??? Put it this way... What made the markets crash in 2008: unemployment, slow economy, snow... Or real estate prices getting in touch with reality?
As I sit back and contemplate the content and delivery style that would be best suited for my upcoming keynote speech at the ING Real Estate Valuation Conference in Amsterdam (this is my first presentation to a large group where English is not the primary language), I am bombarded with news bits and bytes that confirm what I've been modeling, warning, fearing and preparing for - for nearly 2 years. That is almost 23 months to the date. What is it, you ask? It is the market's return to the adherence of fundamentals and global macro forces versus following the whims of the concerted efforts of central banks around the world to openly manipulate real asset, equity and bond markets on a global basis.
Really, sit back and think about it. Put some thought into figuring out how difficult it is to successfully manipulate real estate (commercial and residential), stock and bond markets in just one major country. Then give the same thought to how difficult it would be to do the same in nearly all of the developed nations who participated in this crisis. The mere attempt to do so has loaded them up with debt at a time of marginal if not negative GDP and economic upside, a disgruntled populace ripe to ripple from the causes of social unrest rising from the rife economic conditions that the aftermath of incessant bubble blowing has wrought, and last but not least - fundamentally overvalued investment markets.
I made an appearance on CNBC's Fast Money show yesterday. It was a very short clip on real estate, and the fast moving short clips are not conducive to the communication of the thick, fact heavy style of analysis that is common to BoomBustBlog, and yours truly. Nevertheless I am quite thankful for the opportunity to share my contrarian views in the mainstream media.
Now that I have (quite honestly) issued my most sincerest thanks, let's attempt to remedy the shortcoming of the limited amounted of time that I had. You see, after the 3 minute hit ended there was a brief discussion of commercial real estate in which I didn't get to participate, thus I will take the liberty of doing so through this medium.
Yes, commercial real estate has shown some marginal increases in the last quarter, and REITs have been on fire. The issue is, many publicly traded equities have detached from their underlying fundamentals. Let's reference “A Granular Look Into a $6 Billion REIT: Is This the Next GGP?” The following are excerpts from it:
Yes, we are in a balance sheet based, real asset depression. If you take a look at it from an empirical perspective there should be no surprise in this statement, but since most derive their information from the mainstream media media and the sell side of Wall Street (both of whom have a preternatural proclivity for the positive spin) this may come as a bit of a shock to a few. Let's ponder the term "depression" as outlined in Wikipedia with some Reggie edits:
In economics, a depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe downturnrecession, which is seen by economists as part of the modern business cycle. than a
Well, we have had a severe downturn in real estate in much of the EU, the middle east, the UK, Japan, and definitely the US. See "The Inevitable Has Finally Been Admitted In Europe: The Macro Experiment Has Ignited Inflation Without Commensurate Growth & Rates Will Spike" for a series of graphs that compare real estate markets in several of these countries.
Last week I posted a comprehensive piece, The Coming Interest Rate Volatility, Sovereign Contagion, Geo-political Unrest & Double-Dip Recessions: Here’s The Answer To Valuing Global Real Estate Through This Mess. The goal was to outline the literal mess that those who decided to drag us through this “Great Global Macro Experiment”have left us in. Since then, in merely one week's time, we have bore witness to:
- The potentially imminent toppling of another multi-decade, long standing regime, the third in as many months. Gaddafi asserts control amid worldwide dissent - Libyan U.N. mission urges Gaddafi's downfall - Gaddafi son denies civilians bombed - Analysis: Libya could face chaos in post-Gaddafi era. Leading up to the Libyan affair, Tunisia and Egypt fell into the hands of virtually weaponless protesters (at least from a conventional weapons perspective) armed with simply laptops and cellphones (the new age computers and apparently the weapon of choice for those in uprise) to post messages on Twitter and Facebook, amassing solidarity with supporters to converge in certain areas to join the mass protests. Identifying, fearing, and failing to understand the true power of the Internet in toppling a regime, Libya has repeated the faux pas of Egypt in attempting cut the country off from cyberspace - attempting to halt the charge of an African bull elephant with an Acme Walmart (by way of China) fly swatter. It is apparent that Egypt's efforts to isolate its populace from the Internet, although failing to halt the toppling of its regime, did succeed in hiding the futility of such an effort from Quadafi, et. al. This not only forms another basis for contagion, but one that was actually foreseeable nearly a year in advance- see Egypt’s Social Unrest As A Pan-European Economic and Financial Contagion? It Can Happen!!! and First Tunisia, Then Egypt, Now Yemen: Will This Reach The Powder Keg That Is The EU & What Will Happen If It Does? Subscribers should reference Potential Spillover Effects from the Middle East to the EU.