March 3, 2008
Re: Monthly Letter
Dear Clients:
A superior sailor uses his superior knowledge so as not to have to use his superior skills!
I recently attended a seminar to overcome a mental disorder many of us are being troubled by. The seminar was entiltled; Overcoming Recession Obsession Anxiety. Having been in “the business” almost 25 years now, I find that experience is a marvelous thing. It enables us to recognize a mistake whenever you make it again! Well the risk with our Recession Obsession Anxiety is that eventually consumer and business sentiment succumb to the anxiety and you do in fact become sick. These days on Wall Street an optimist is hard to find!
As we have pointed out in this years Gold Report ( www.cdccommercial.com/goldreport2008 ), the US economy is in a position to be ravaged by the two headed monster of inflation and stagnant growth, otherwise called stagflation. Unfortunately, the Fed and our Congress have embarked on the quick fix methods and are preparing to feed the boom to bust cycle that has been our economy for the last ten years. Unfortunately, if the Fed’s policy of massive interest rate cuts succeeds in reviving the economy by years end, won’t we also see a spurt in inflation? The argument to date has been that with a slowing economy comes slower growth and less upward pressure on prices. However, a one year 17% increase in energy costs and 5% increase in food costs are not likely to recede, because the pressure is caused from outside of our borders (Global demand). I think we are likely to see more rate cuts. Bill Gross at PIMCO says the Fed will have to go to 2.5% or less to save the housing market. Doesn’t all of that – higher economic growth, a flood of cash into the economy, slashes in interest rates – create a massive inflationary push.
Mainstream advice during a recession is to buy bonds and wait for the rate cuts. However, bonds may not be the haven this time. If the cost of living rises unabated, that will depress bond prices. A traditional refuge in inflationary times is gold and we have certainly seen its price rise. Unfortunately, gold is highly volatile and it doesn’t pay out any income. So how do you buffer yourself from the ravages of inflation and a possible stagnant economy? You need to find an investment that combines income and price and rises with inflation expectations. Better yet, it should be a real commodity (not a paper asset or loan) and if you can borrow to buy it you can pay back the debt with cheaper dollars in the future. What is this magic investment you ask? Well it sits beneath your nose, it is off course commercial real estate.
Net operating Income (NOI) often continues to improve through a mild recession due to the lease terms that average three to five years. Even if a landlord had to lower the asking rent, tenants renewing a lease will still end up paying more over the lease term given the annual increases. Falling interest rates will give investors a better spread until the economy gets better and then rents will rise again. Plus cap rates may rise with fewer investors in the market and some sellers believing the “sky is falling” causing a buying opportunity.
The fundamental metrics of the commercial real estate market – vacancy rates, net operating income and capital available for investment – remain strong. But the erosion of the credit market and consumer confidence are starting to hurt properties. If nothing else we as agents are facing tenants and buyers who have adjusted their expectations. Despite low vacancy factors and still high TI costs, tenants believe they should get a bargain basement deal. The gap between “asking rent” and “offered rent” is growing. Although we are in “sales” an inordinate amount of our time is spent educating our prospects as to the real (instead of perceived) conditions of the market. We are hoping this is translating into more deals done while most of our competitors are on the sidelines bemoaning a slow market. If you don’t already know the CDC story and my approach to life and “the business” you might enjoy a recent profile that the Dan Diego Transcript ran (www.cdccommercial.com/theCDCCommercialStory ).
Business Week recently reported that the signs that we have turned the corner are likely to be;
1. Fading stagflation fears
2. Stable credit and housing markets
3. Especially low interest rates
4. Improved corporate earnings
5. “Blood Curling Screams” – which they report as Wall Street investors throwing in the towel.
Recent affirmative votes for school construction and casino expansion will couple with the fire storm rebuilding efforts to lift the construction industry by Summer and into the Fall.
My favorite tag lines of the New Year – 2008 is going to be Great! Surviving to Thriving! Get ready to inflate in 2008! So many of you enjoyed my link last year to Sam Zell’s (the legendary real estate investor) annual Year End Gift (YEG) that I have attached a link to this years creation. This years is entitled “Confusion” and once again hits the nail on the head.
http://yegsz.com/Confusion/index.html
ENJOY!
Regards,
Don
Don Zech
CDC Commercial
Real Estate Services
