Uncertainty is the New Normal
The ongoing real estate drama is not coming to an end anytime soon. Even though the crisis is two years old, we are just approaching the end of the first act. The final outcome is much in doubt and there are certainly scary plot twists ahead; worse yet, no one is allowed to leave the theatre.
Economic cycles come and go and ordinarily there is a comforting predictability about the course of hard times. What worries me this time around is not what I don't know but what I cannot conceive of, what Donald Rumsfeld called the "unknown unknowns". This uncertainty is like being a medieval merchant transporting rolls of cloth from one village to another through a murky forest, fending off bandits, road warriors, tax collectors, trolls, highwaymen, and all other sorts of evil creatures along the way. When this plucky traveller emerges from the dank woods, he finds no welcoming villagers but a treeless plain with no familiar landmarks; only a vastness which needs to be traversed without reliable knowledge of what lies ahead or even what path to follow.
Kicking the can down this untraveled road is probably the best we can manage. Our political and financial leaders are out of fresh ideas. The always reliable remedy of low interest rates has not proved to be as effective this time around, although without them the situation would be far more dire. (In this I would include the $8,000 first-time homeowner and $6,500 move-up tax credits.) Although the Feds have spent a bundle keeping the residential sector on life-support, our betters have discovered this correction is different from other post-war downturns. The fundamental restructuring of the American job market means housing will linger in the ICU. The patient will fully recover when homes and mortgages are re-priced; then the new wage structure will match home prices and rents. Only then will meaningful appreciation start anew.
But that is not the worst of our problems as commercial real estate is headed for a rocky two years. Loan underwriting policies and lack of consumer demand are at the heart of the looming crisis, both of which are driven by core changes in employment and wage levels. Businesses and individuals are consuming and borrowing at diminished rates. This threatens the debt and equity structure of a substantial amount of investment real estate in this country. As bad as the ongoing residential market is, the upcoming commercial reckoning could be worse.
Commercial loan defaults will reach a crisis point next year and that poses a threat to the viability of local and regional banks. The Fed seems content that banks are sitting on big reserves of cash and Treasuries. This is false comfort and encourages lenders to remain risk averse. Credit is the mother's milk of job creation and somehow the team of financial titans shepherding the nation's financial institutions have lost sight of that fact or chosen to ignore it. Given the realistic valuation of their commercial portfolios, perhaps there are no other good options. Our best hope is that financial self-interest will trump timidity.
For most people this potential and ongoing carnage means little. If you are financially upright enough to service your family debt you can survive a huge paper loss on your home. Still everyone has an vital interest in the outcome of the next act in this tragedy. The sorry state of these investments is only partially due to overbuilding and over-leveraging. There are many projects, well conceived and managed, that are failing because our economic world has been turned upside down. Landlords everywhere are short of customers.
The financial industry has mostly survived the home mortgage crisis only because of massive federal bailouts of the mega-banks. The question is: can we afford a second bailout for a host of regional, national and community banks? As commercial defaults ramp up next year, which is surely to occur absent some other meaningful shifts of fortune, this Administration will end up creating, at taxpayer expense, several huge banking monopolies. There is supreme irony in that this particular administration could end up midwifing a new Gilded Age of banking monopolies.
Perhaps we are in the midst of an era of great social change, sparked by reduced credit and spending power. Many have noted recently that rampant consumerism may not be in our cultural DNA. If so, investment real estate will be the biggest casualty of the Great Awakening II. Or maybe we are witnessing the results from the global reshuffling of the economic pecking order. In either instance, we will adapt and prosper and learn to live with far more economic and social uncertainty in our economic lives. There have never been more real estate opportunities than today; forget worrying about the future and push ahead and embrace the new uncertain world.