How are we looking with present trends in the market?

In all the chaos that has been our real estate markets from the economic dunking we took that officially started  in December 2007 according to the National Bureau of Economic Research (NBER), there now seems to be increasing optimism, especially regarding commercial real estate trends in the market, that we are getting back to some semblance of normalcy.  Why even my home state of South Carolina, which has boasted some of the highest unemployment rates in the nation, seems to be looking forward to better times in the near future as the unemployment rate here in The Palmetto State has finally gone below double-digit territory to 9.9% for the first time in over two years.

So do trends in the market indicate that we are back to boom times and a healthy economy again?

Not even close, in my opinion.  As mentioned in a previous blog post, I still think our economy is headed for a “double dip” given how our federal, state, and local governments are putting the squeeze on capitalism by introducing more and more legislation to beat down our entrepreneurial spirits, as well as how poorly our federal government manages our money.  For example, I have a newsfeed to the blog of an attorney named Jeff Watson, who is a cutting-edge real estate attorney and proponent of ethical real estate investing, and saw that 17 mortgage lenders were ordered to reimburse homeowners who the federal government says “were incorrectly foreclosed upon”.  I can only imagine that government intervention of this magnitude will only serve to make it even more difficult to borrow money because of the associated risks to the lenders who make these loans.  It’s hard enough to collect money from people who probably don’t have it and rulings that punish lenders for making mortgage loans will only serve to close the lending gates rather than open them.  I could name a whole slew of other anti-investor/anti-capitalist legislation that was passed as a result of this recession but you get the idea.  Macroeconomics, e.g., governmental policies, have a huge effect on trends in the market.

In addition to ever-increasing government regulations and negative credit outlook, we still have that tiny little loan to pay down called the National Debt, estimated to be $14.26 trillion as of March 25, 2011, that continues to grow because of foolish spending by our elected policy wonks in Washington DC.  Yes, that’s $14.26 TRILLION.  My calculator doesn’t even go that high and I’ll bet it even puts a burden on Bill Gates’s mind to think that Microsoft had to design a spreadsheet that allows for that many zeros.

There is an empirical principle called Hauser’s Law which states that tax revenues, as a percentage of Gross Domestic Product (GDP), average about 19.5% regardless of the top marginal personal income tax rate.  This Law was discovered by William Kurt Hauser, an investment economist who is chairman emeritus of the Hoover Institution at Stanford University and chairman of Wentworth, Hauser & Violich, a San Francisco investment management firm. He is also the author of “Taxation and Economic Performance” (Hoover Press, 1996).  Given his credentials, Mr. Hauser is probably pretty well qualified to give intelligent commentary on where our economy is headed.  In February of 2010, the Obama Administration was on track to spend an estimated 24.13% of the GDP.  It doesn’t take a Ph.D. in mathematics to see that, by President Obama spending a higher percentage of the GDP than what is taken in by taxes, our country is in a negative-cash-flow situation.  Basically, the United States is flat out broke and must keep borrowing money to function.  Trends in the market will not show this immediately since there is always a lag between when an event happens and when people start to realize what happened.

The above being said (or written), I’m not saying to crawl under a rock and go into hibernation until the economy becomes more stable.  If you did that, you might be under there for a really long time, maybe even longer than when Rip Van Winkle took that brief nap against a tree in the Catskill Mountains.  There will always be good deals in real estate no matter what the economy is doing, especially in commercial real estate, as long as we are just careful with what we are buying.

The news media may tell us that commercial mortgage loans are at all-time highs in delinquencies, but let’s break that down a bit and take a closer look.

When we take apart what the pundits and “gurus” are telling us about how badly the defaults are on commercial real estate mortgage loans, we can see that the highest percentage of delinquencies were the commercial mortgage-backed securities (CMBS) at around 9% in 2010.  In contrast, Fannie Mae and Freddie Mac loan delinquency rates were less than 1% in 2010.

Since multifamily properties (apartment complexes) are the only commercial real estate (CRE) asset class that qualifies for funding involving Fannie and Freddie, this tells me that all the hype by “gurus” who sell courses and boot camps on how to buy distressed multifamily properties is just that.  HYPE.  True, there are multifamily assets in default, and there always will be, but the number of delinquent loans for this asset class pales in comparison to the other commercial classes such as retail centers, hotels/motels, and office buildings.  Apartment complexes are often hyped because they happen to be the easiest to get financed and are probably the easiest to understand since it involves people living in them, just like in single-family homes.  There are great apartment deals that are financially distressed, but if the only assets that you want to buy are distressed ones, you might find it easier to get those deals by fishing for different kinds of fish rather than just fixating on bringing home only one kind.

Or, if you’re really hung up on buying multifamily assets, you may want to go where there are fewer people fishing by going after apartment buildings that the big guns with LOTS of cash, such as real estate investment trusts (REIT’s), don’t want like the smaller multifamily complexes.  If you decide to go after these smaller multifamilies, though, just be sure to have your exit strategies VERY well planned since it is a lot more difficult to get conventional mortgage loans for less than about $2 million than it is to get them for $2 million and more.

If you want to bait your hook with something that will catch different fish, a few distressed non-multifamily deals that popped up on my radar include:

And the list goes on and on and on…

If I were to put my entire list of distressed and underperforming commercial properties here, this would easily keep you reading this blog post for another month or so if you didn’t tire of looking at all of this distress first.  This should give you an idea of how abundant potentially good commercial real estate deals are out there, even if commercial real estate markets seem to be outperforming the dismal expectations predicted by many market forecasters.  But, as I mentioned before, be VERY careful with your numbers and due diligence in this sluggish economy, especially with hotels and retail properties since they are much more sensitive to consumer sentiment than are multifamily rental properties.  A deal that looks good now can easily turn into something that you wouldn’t wish upon your worst enemy if my guess is correct about this Titanic of an economy spiraling right back down.

Don’t be fooled by temporarily benevolent trends in the market.

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