Tapping the brakes: Always be wary of those tail lights - by Bill Pastuszek

March 09, 2018 - Appraisal & Consulting
Bill Pastuszek
Shepherd Associates

Boston traffic is tough, getting tougher. This long expansion has had long legs, big strides made. Those brake lights we see every morning, noon, and night: are they telling us anything?

The expansion is going on nearly a decade without a recession, the longest stretch in U.S. history. What could happen to end it? Fed action and tax changes are at least to macro events that could end the hot streak and “incite” a recession. Is it just tapping on brakes or will it require a fuller application of force? Some thoughts:

Warren Buffet Letter. Always anticipated, always worth waiting for. The latest letter contains a couple of salient points. However wrapped, ultimately, a stock investor buys a piece of a company, just as a real investor buys a piece of real estate. It is investment (for the long haul), not speculation! 

The example of the Great Recession is instructive. Those that went “long,” found several years later a healthier economy and a stock market has recovered all of its losses and then some. In comparison, consider Japan, which has experienced two deflationary decades with economic stagnation and equity market contraction. 

The letter asks, in the long run, when did it ever pay off, to bet against the U.S. economy? The letter notes per capita income growth and that this free market system remains simply the best engine growth and prosperity, and continues to make America’s economy the most innovative on the planet. 

Rates. Many observers, both in residential and CRE markets, note that rising rates will be “bad news” for originations and for floating rate loans. The 30-year fixed mortgage rate rose to an average of 4.4% in the week ended Feb. 22, the highest level since April 2014. Concerns about NOI quality and coverage will have portfolio managers assessing downside scenarios. Future rate hikes, based on the Fed’s commitment to keep the economy in check, have to be timed just right. 

Housing. The Globe reports that the median price of a single-family home in Massachusetts climbed 4% to $369,000 in January from a year earlier, while single-family home sales fell below 10,000, a nadir for the month. Meantime, the number of single-family homes for sale in January fell by 32% over the same time last year. The Mass Association of Realtors provides a positive report. Anecdotal evidence indicates that the buyers are out there and still isn’t much inventory. 

While it always pays to be wary of drawing conclusions from short term trends, sales of new U.S. single-family homes fell for a second straight month in January, weighed down by steep declines in the Northeast and South. Nationally, the Commerce Department indicated that new home sales, which account for nearly 10% of the housing market, dropped in January to the lowest level since August 2017. Sales “tumbled” 33.3% in the Northeast and plunged 14.2% in the South, which accounts for the bulk of new home sales.

Capital Markets/ CRE. A brokerage notes, that , regarding capital markets, the next “three years will likely see cap rates flat at best or rising, which we expect will outstrip property income growth. The economy’s performance over the period will determine whether commercial real estate values continue to rise mildly, remain relatively flat or decline mildly or moderately. “A note of caution here.” 

One well-known investor survey notes “all that is going on in the geopolitical, monetary and fiscal policy environment, and the shockwaves moving through the financial markets, CRE remains a tangible asset with low volatility, reliable income and solid risk-adjusted returns.” The survey notes that “capital appreciation will further decline in 2018, but that income will remain stable,” and it is that stability that continues to attract investors to this asset class. 

Lending Quality. In the January 2018 Federal Reserve’s Opinion Survey of Senior Lenders, responses indicated that, on balance, banks eased their standards and terms on commercial and industrial (C&I) loans with demand for such loans was basically unchanged. Meanwhile, banks’ standards on most categories of commercial real estate (CRE) loans tightened, while demand for CRE loans reportedly weakened. The survey also noted “more aggressive competition from other banks or non-bank lenders was by far the most emphasized reason for easing.” 

Further, there are plenty of banks out there willing to “roll the dice” in this upbeat environment.

Markets have a way of outwitting the smartest of seers. Markets defy prediction. Real estate markets always have seemed particularly slippery in that regard. Major downturns have been missed over and over: maybe denied is a better way to put it. At the very least it is hoped that the right amount of prudence is built into forecasts. Worry about the long term; the short-term will get worked out. 

Warren Buffett once said, “Price is what you pay; value is what you get.” Tap the brakes; always be wary of those tail lights. Let’s see how that works out. 

Bill Pastuszek, MAI, ASA, MRA, heads Shepherd Associates, Newton, Mass.

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