Where’s the Bubble?

[Canesha Edwards]

Hello everyone-

Please keep in mind- that this post is of my opinion only, based on my knowledge of the US economy and real estate markets.

Now, this discussion about a bubble and a crash in the real estate market has been going on for a few years. Let’s say since around 2016 but prices have only continued to rise. However, now we find ourselves in a very unique environment.

First, let me say that the next crisis will not be with the homeowner like ‘07-‘08. Why? Because that crisis was based off terrible lending practices. Anyone with a heart beat could a get a loan and a lot of these loans were variable interest rate loans. Most homeowner loans today are low Interest fixed rate loans. Therefore, even when rates do rise- payments are staying the same. Not a major problem there.

So, where is the problem? I think we are going to see major problems in the commercial arena. I’ve seen too many syndicators and personally talked to a few who are underwriting deals at a 3% cap. This is unheard of and quite frankly bad risk management in my opinion. Why you ask?

All of these deals are based on rents rising and syndicators being able to refinance or sell on a 3-7 year period. The problem is no one is considering the chance of rising rates, but I think this is a real viable option. Jerome Powell has finally admitted that Inflation is not transitory. If inflation gets too out of hand- the FED will have to deal with it. How do you tame inflation? The gov’t could spend their way out of it or they could shrink the money supply. I personally feel the government has been spending way too much and I vote for contraction of the money supply. Meaning the FED would have to raise rates. Well as a syndicator if you have to refinance at a higher rate….well the deal goes from good to suspect real quick.

Cheap credit has its pros and cons but I think this period of low interest rates has served it’s purpose. To me, this era has more in common with the late 1970s than many would like to admit. The question is, will we have a Fed Chairman like Paul Volcker to do what needs to be done?

I’d love to hear others opinion on the matter.

Just my 2 cents.

Happy Investing.

Canesha

[Taylor L.]

Originally posted by @Austin Johnson:

Canesha, do you ever listen to The Peter Schiff show? I've listened a bit in the past (so somethings I say may be dated as I'm not updated)
my understanding was a spike in interest rates would collapse the economy. interest rates are lower than 2008 and have held to that low for WAY longer than needed. I don't see The Fed raising any time soon. 
Description of Schiff's latest episode:
"Fed can’t fight inflation without deflating inflated economic bubble. Data shows biggest drop in productivity in 62 years. Consumer prices are headed much higher. Real wages are headed much lower" 
that basically sums it up for me. It feels like we're in the no mans land here. The Fed will threaten to raise the rates, act like they're 'about ready to maybe start thinking about it in the future' but ultimately I doubt they do. should they? yes. but with the GDP down, people still not working, the "new strain" it gives them endless slack and excuses not to. idk, hopefully I'm wrong and interest rates spike, combating inflation and prices tank, syndications go under, stocks tank, our economy  plummets and they step back in and lower them again. 
sorry for the long winded response! haha.

I like Peter. The problem with listening to him consistently, though, is he always sings exactly the same tune. This ship is doomed very soon and gold is your only way out. He's been saying that for quite literally decades. The only reason he called the Great Recession is because he is always predicting a downturn. When you're always calling for a downturn, eventually you'll be right. That's the business cycle. I know Peter knows about business cycles because I've read his books, but he doesn't really seem to apply that knowledge to his investing strategy.

To address the OP:

We can't predict future movements of the Federal Reserve, but if we take what they say at face value they'll be tapering very soon. However, I believe we should also consider how they've behaved in the recent past. Specifically, the inability to raise rates prior to Covid. They briefly raised, saw that the markets didn't like it, and started to drop rates once again. The same people are still at the helm.

That all being said, responsible underwriting always bakes in cap rate expansion and assumes exit cap rates higher than entry. 

I believe the biggest risks for syndicated deals now are:

• - Poor Underwriting (Less so cap rates and more timeframe, expenses, and potential rent upside)
• - Poor Physical Due Diligence (You need to find where the bodies are buried!)
• - Poor Asset Management (PMs will always underperform if not managed)