As we end 2011 and head into a new year, I’d like to write a few thoughts about where I think we’re headed with our economy and give a brief real estate market forecast for 2012.

Given the gridlock that we have in our government about what to do and after observing almost a full year of fiscal mismanagement, I think it’s safe to say that our economy ain’t getting healthy any time real soon and that any real estate market forecast I make will be equally gloomy.  Our federal government has almost shut down at least twice this year for lack of money, city governments are being forced to drastically cut their budgets to the point of shutting down vital services such as public safety, and even our once-invulnerable Postal Service is on the verge of having to declare bankruptcy.  “Neither snow nor rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed rounds” but lack of funding can apparently accomplish what Mother Nature can’t by shutting down our post offices.  I tell ya, it’s enough to make a guy go postal.  As for our true unemployment rates, not the ones put out by our federal government via the media…well…

Even though I originally meant for this post to give a commercial real estate market forecast, I may end up slipping in a thing or two about the residential side of things to give a similar but much briefer real estate market forecast regarding this as well.  Commercial and residential real estate are hopelessly tied together so to comment on one without the other would be like trying to ride a bicycle with only one wheel.  It can be done but not without a lot of stumbling and fumbling.

In my previous blog post, I mentioned how our media praised the decrease in unemployment and said how this is an indication that our economy is improving.  I call bullsh%$.  In this previous post, I also mentioned that the bottom lines are the net revenues that a government can take in, not how low that unemployment rates can be driven.  Of course, revenues and employment rates are tied together but how can a person making the federal minimum wage of $7.25 help as much, financially, as a person who is making $1000 an hour?  To make any realistic real estate market forecast, both metrics really  should be considered but somehow weighted to reflect the differences in pay.  For example, even though our unemployment rate supposedly decreased to its lowest level in more than two years, according to our  media, the net worth of American households drastically decreased by $2.4 trillion this past quarter.  This tells me that maybe people are finally finding employment, but they are getting paid a lot less for those jobs than prior to the most recent recession.  As a result, there is a decrease in net revenues to them and to our governments.  This, surely, affects any real estate market forecast since this adversely affects not only the abilities of people to pay for things to keep money in circulation but, perhaps more importantly, this adversely affects the confidence in their own abilities to pay for things so they understandably hoard money instead of let it circulate as is done in healthy economies.

But even though a newspaper as venerable as The New York Times ran a story proclaiming that the unemployment rate decreased to 8.6%, I disagree with its assertion that it appears that the American economy is improving.  I think that this economy will continue to stagnate for at least another five years so my real estate market forecast will closely parallel this belief.  For example, even though employers supposedly added 120,000 net jobs to their rosters in November, this falls well below the monthly average of 132,000 net jobs for November.  Again I’ll mention that even if jobs were added, they are likely to be lower-paying jobs than in previous years resulting in lower net revenues and, accordingly, lower disposable incomes.

Perhaps the most difficult things to account for in a real estate market forecast are consumer confidence and investor confidence, both very important factors in determining the status of the economy.  For example, let’s take an extreme example and assume that the unemployment rate is 0% and that each person gets paid $1000 an hour but nobody spends any money to buy goods or services because of lack of confidence in the economy.  It makes very little difference if people can’t pay for anything or if they just won’t pay for anything, the money remains tied up rather than flowing so the economy stagnates.  Let’s add on top of this the gridlock in our federal government caused by disagreements in where to raise taxes and cut budgets, and now investor confidence decreases which ties up investor money as well as consumer money.  Anyone still think that any real estate market forecast is going to be anything but gloomy?

So how is investor confidence looking these days?  I think that cap rate is a pretty good indicator.  If investor confidence and expectations never change then I believe that, theoretically, the cap rate shouldn’t change either since purchase price would be adjusted to account for change in net operating income and we would all live happily ever after.  But in reality, most investors will want higher returns for what they perceive to be higher risks and will settle for lower returns when they think that risks are lower.  Let’s take a look at what’s happening now and use it to make a realistic real estate market forecast.

Cap rates have generally decreased from their peaks around the beginning of 2010.  This tells me that investor confidence is on the rise.  That doesn’t mean that our economy is getting any healthier.  It just means that investors are willing to pay more for the same asset class performances than they were two years ago and that they perceive the risks of investing in those assets classes to be lower than they were two years ago.  But do investors know best what’s happening in our economy?  Not necessarily.  Anyone can be an “investor” if they have something that is perceived as being an asset to someone else, especially if it’s money.  Let’s take a look at what I see and apply it to my real estate market forecast.

As can be seen above, commercial mortgage-backed securities (CMBS) have the highest default rate of any commercial mortgage loan type.  A real estate market forecast will factor this in and point us in the direction of CMBS mortgage loans as possibly being good deals to pick up and I’m not the only one who thinks that CMBS defaults are soon going to rise drastically.  Trepp and Morningstar, both of whom specialize in CMBS defaults, think that the CMBS markets are in for some serious financial pain as well.

I have a hypothesis for that high CMBS default rate.  CMBS mortgages are often securitized and sold on the secondary markets to investors who have faith in their investment advisors selling them on these with an often overly-optimistic real estate market forecast.  I’m not saying that all investment advisors are scumbags but think “Bernie Madoff” and the amount of trust that people put into him.  Investment advisors are essentially salespeople who are educated about securities laws and definitions.  As with all salespeople, the more they sell, the more they make.  Not to say that all of them purposely sold lemons to their clients for investment vehicles by putting them into CMBS mortgages but let’s face it, the compensation structures of how these licensed salespeople make their money are such that they get paid while their clients are the ones who take all the risks.  Now I know some very competent and honest investment advisors but in the end, nobody will care more about your money than YOU.

So now that that we’ve identified CMBS defaults as possibly good hunting for finding deals, what else is there?  How about matured and maturing mortgage loans?  Could these be good game animals to take home to our dinner tables?  In a previous blog post, I gave references to sources that indicated that record numbers of commercial mortgage loans are set to mature within the next four or five years.  How will the lender handle these maturing loans, especially now that many commercial properties are worth less than what are owed on them?  What, pray tell, will a real estate market forecast tell us here?  Well, let’s see what a recent survey of commercial real estate lenders tells us.

Note that while most of the surveyed lenders, almost 54% of them, would rather modify and extend these matured/maturing mortgage loans, this only tells us what they want to do, not what they can do because of lack of equity caused by declines in property values.  Hey, when I was a kid, I wanted a pony but never got one.  I’d put into any real estate market forecast that more lenders than what is indicated by this survey will end up having to sell off their loans in order to satisfy regulatory requirements and remain solvent.

So, as is tradition with my blog posts, I’d like to put out a few possible deals that show up on my radar for the note-buying vultures who might want to hunt down matured and maturing commercial mortgage loans.  But just beware that my real estate market forecast includes an economy that will continue to deteriorate in the face of our federal government’s budget problems and inability to properly balance a checkbook.  I suggest that you factor at least an additional 5% increase in vacancy rates, on average, into your offer prices.

As with any real estate market forecast, mine is just an opinion so take my real estate market forecast and any others with a grain of salt and use some common sense.

Stumble! for WP