Commercial Real Estate: The Next Shoe to Drop

The residential real estate sector is in shambles and, some economists say, will not recover until the end of 2010, at the earliest. Now it looks like commercial real estate may be the next block to fall in our “Jenga economy.” Casey Research’s Olivier Garret explains…

On November 19, bonds and stocks backed by commercial real estate loans plummeted on investors’ fears the struggling U.S. economy might lead to a wave of defaults.

Big real estate companies suffered big losses: shares of Simon Property Group, the top U.S. mall operator, declined 13%; Boston Properties Inc., owner of skyscrapers and office buildings in key U.S. markets, fell 12.1%.

General Growth Properties Inc., which owns more than 200 mall properties throughout the United States, is teetering on the brink of annihilation. If the flailing company can’t come up with the $958 million of its debt that is now due, and the $3.07 billion due next year, it will have to file for bankruptcy protection.

“Ghost malls” may become a common sight around the country, with major mall developers and big-name retail chains like Linens ‘n Things and Circuit City going broke and others, such as Starbucks, closing hundreds of stores nationwide. Small businesses are even worse off as shoppers tighten their belts.

A recent Newsweek article quipped that it would “take some kind of sorcery to keep the current mix of store closings, skeletal inventories, hard-to-find sales staff and anxious consumers from turning the yuletide shopping season of 2008 into a seriously cranky Christmas. Even Santas have been getting pink-slipped.”

None of what’s happening surprises Andy Miller, a consummate real estate entrepreneur and friend of Doug Casey’s, who presented his outlook on the commercial real estate market in the September edition of The Casey Report. Here’s what he had to say on a few topics:

Miller on retail shopping centers:

“Retail are the most exposed product type. For example, we have a grocery-anchored shopping center in Phoenix that’s about 94% occupied. We’ve been trying to sell it for the last nine months. We’ve had it under contract probably four times. Each time, it’s fallen through because the buyers were unable to find a lender. The lack of liquidity is particularly acute in the commercial markets.

“Most commercial mortgages that were written over the last 10 years for most product types, except apartments, were done by conduits, and they were done by asset-backed finance securitizations, CDOs, etc. The overwhelming number of those conduits are now either out of the market or shut down. There’s going to be a tremendous upheaval in the commercial market relative to the fact that there’s almost no conduit money available anymore.”

On office space:

“The office market, of course, is eroding. While I expect the central business districts around the 20 top cities in the country to probably be relatively stable in terms of office occupancy, I think the suburban markets are going to get creamed.”

On warehouses:

“Warehouses are bad. They’re very flat. Users are consolidating; they’re not expanding.”

On hotels:

“I’d also be wary of hotels. The hotel business is proliferating right now, in a way that I’ve never seen. There are so many new hotels being built right now nationally that there’s no way, even in good times, that I think they could sustain occupancy. A lot of these hotels now have created new flags and they’re putting them in multiple locations in most big cities. So there’s been a tremendous proliferation of hotels and, with high air fares and high gas costs, there’s no question that that’s going to be a bad place to be.”

On the real estate bubble:

“There is no historical comparison to the situation today. Not even the Great Depression was like this. I believe we’ve just lived through the greatest expansion of capital in the history of planet Earth, in the history of mankind.

“And this happened really all over about 12 or 13 years, this gigantic, dynamic expansion of money. There is no precedent for this. One truth about cycles is that the downward part of the cycle is usually quicker and more painful than the upward swing. We didn’t get into this thing overnight. It took many years, and we are not going to get out of it overnight. It’s going to take many years to unwind.”

Waiting for the other shoe to drop is an uncomfortable position to be in. Thankfully, there are a number of lifelines we as investors can grab on to, to avoid getting sucked into the whirlpool of declining asset values and a declining dollar…and we should take every chance we get to use them.

Regards,

Olivier Garret
for The Daily Reckoning
December 02, 2008

P.S. How well you do in the unfolding crisis will depend on how well informed you are. “Making the trend your friend” is now more critical than ever to financially survive the onslaught of tidal waves rocking the U.S. economy. The Casey Report diligently analyzes major economic trends and provides actionable advice on how to profit from the “market riptides” – with the goal of preserving and multiplying your assets while others capsize in the stormy seas.

“Shopping has become a patriotic duty in America,” writes Tom Leonard in the Telegraph.

Remind us how that works again…

Let’s see, the Wall Street insiders made billions in bonuses and fees during the Bubble Epoque – and they were smart enough to take the money off the table. Then, when the bubble popped, they were a little short of money down at the shop. And since they didn’t have any money, they couldn’t lend any. And since they couldn’t lend, well, Americans couldn’t borrow…and since they couldn’t borrow…they couldn’t shop…and since they couldn’t shop…the whole kit and caboodle of the U.S. economy came to a halt.

Worse, it started going into reverse. According to the official numbers, it went backwards 0.5% in the 3rd quarter.

And because businesses are selling anything, profits are falling…and investors are pulling out their money.

Last week, it looked like the much-anticipated Obama Bounce had finally gotten off the ground. But Monday, it was back into the mud. The Dow lost 679 points yesterday. Oil fell $5. Gold dropped 8 bucks to $770.

And get this: the yield on a 10-year T-note has fallen to 2.719%. We believe that is the lowest level ever recorded.

Bloomberg says the recession actually began in 2007. That means it is already the longest recession in nearly 20 years.

And it’s not just in the United States. Shipping has sunk. Manufacturing in Britain has had it biggest drop since the early ’90s. And house prices in the United Kingdom are back to where they were three years ago. India reports the first decline it in its exports in seven years. And in Iceland, people are holding rallies to “protest the economic meltdown.”

If you lived in Iceland, you’d think you’d be pleased to have a meltdown of any sort. The Icelanders are clearly wasting their time. Meltdowns are inevitable. They’re just part of the process of capitalism – wiping out mistakes so it can get on with things. They might just as well protest death…

But all over the world, people are getting edgy…depressed…worried…

O! Bama! Where is thy bounce?

Of course, everybody thinks we have a big problem on our hands. And they’re pretty sure what caused it – too much borrowing and too much spending in the bubble years.

The funny thing is that most people also are pretty sure that if we don’t start shopping more, things will get even worse.

And that’s where we come up short. But you’ll have to excuse us because we’re just a country lawyer… Or, we would be a country lawyer…if we lived in the country…and if we were a lawyer.

Well, what we’re really trying to say is that we’re a little slow, here at The Daily Reckoning. Sometimes we just can’t keep up with these smart fellas from the big city…

Let’s try again.

The U.S. government borrows money from taxpayers…gives it to Wall Street so they can lend it back to the taxpayers at a profit. Wall Street borrows ‘our money’ from the Fed at, say, 1%…then they lend it back to us at, say, 6% or 7%. That way, Wall Street makes money and we can still borrow what we need.

Nice system huh?

And take that Hank Paulson…please! Now, there’s a big city guy we admire. He made a fortune running Goldman, right up until he was tapped to run the U.S. Treasury. He knows all about those CDOs, SIVs, MBDs, – heck, he probably knows every letter in the entire alphabet. And he’s used them too – putting together those fancy sub-prime investments and such.

Well, that’s why he was the perfect guy to be the honcho at the Treasury Department. He knows all about that toxic investments that are causing so much trouble – after all, his firm created them.

Of course, if you ask him, he’ll deny it. He’ll say it was just some rogue investment engineers down in the basement who did all the bad stuff. He was attending important meetings and saving nature; how was he supposed to know what they were up to? Yes…he was the CEO. But c’mon…no chief exec can keep up with all that alphabet stuff, can they?

But that’s the kind of guy you want running the economy, right? Keeps his eye on the big picture…not distracted by the details…

And then there’s his replacement, Tim Geithner. We know he’s the man for the job. Why? Because he’s got experience. He’s been on the case for years. As head of the Fed in New York, he was right there while all those investment scientists were conducting their experiments…he was practically right in the room – keeping a watchful eye open – when they ran those fancy linear regression models…mixed in some subprime mortgage debt…and then tossed in a whole ton of fizzy derivatives. Nobody really knew what happened next. The windows blew out and a cloud of smoke rose so high in the air you could see it from New Jersey. But heck, it wasn’t his fault the stuff blew up!

And since these guys know so much about how we got ourselves into this crisis, they are clearly the ones to help us get out… Makes sense, right?

Sure, they’re going to give money to their old friends back on Wall Street…and do everything in their power to prevent the cost of living from going down…

…and of course they’ll be encouraging people to borrow and spend… then people can spend more money they don’t have on more things they don’t need. And then they’ll be deeper in debt than ever before.

…But that must be just the way this money thing works. We shouldn’t be so thick about it…

*** Wonder why government economists favor inflation over deflation? We’ll give you a hint. Everybody always wants to get something for nothing. In that regard, paper money is one of the greatest inventions of all time. You can get an almost unlimited amount of something for about as little nothing as you can get. Want more something? Just add more zeros. Here’s another explanation from Jorg Guido Hulsman at the Mises Institute…

“Fiat money [the kind of money you get from trees]… allows the owners of the printing press and their political and economic allies to enrich themselves far quicker and at much lower cost than any other producer in any other field. This explains why governments have for centuries sought to establish a paper currency. And it explains why, after they had achieved this goal in the 20th century, governments and their business allies set off on an exponential growth path. The welfare state has exploded in the 20th century, and Wall Street and the banking sector grew quicker than almost any other sector of the economy.

“The deflation-phobia of our elites is therefore the rational reaction of those who profit from the privileges that our present inflationist regime bestows on them, and who stand to lose more than any other group if this regime is ever reversed in a deflationary coup. Perennial inflation is based on monopoly. Deflation brings in the fresh winds of the free market. True elites would welcome deflation for precisely this reason, because they owe their leadership positions exclusively to the voluntary support of other members of society. They have nothing to fear from deflation – a shrinking money supply – because their leadership is grounded on the useful entrepreneurial services they provide to their fellow citizens – services that would subsist through any changes in the money supply or in the price level.

“But large parts of our present-day elites are ‘false elites’ or ‘political entrepreneurs.’ These men and women owe a more or less great amount of their income and decision-making power to legal privileges that protect them from competition and which enrich them at the expense of all other people. The fortunes of many political entrepreneurs are directly or indirectly attributable to the money monopoly of the Federal Reserve System. It is only because of this monopoly that the Fed could create a near boundless expansion of the money supply. Political entrepreneurs are thus right to fear deflation. For deflation takes away the source of their illegitimate income and puts them finally back on equal footing with all other members of society, whose incomes are based on efforts and services provided in a competitive environment.”

*** We’re down at the bottom of Africa. We’ll have a report on what’s going on here tomorrow…

Until then,

Bill Bonner
The Daily Reckoning