Paying Attention to the Risk from Deleveraging in Commercial Real Estate

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Lost in the developing cap-and-trade industrial train wreck (with the Rudd government trying to shame the rest of the country into following America’s foolhardy lead), no one is paying attention to the risk posed to asset values by deleveraging in the commercial real estate sector. Be warned!

Standard & Poor’s is preparing to downgrade some $235.2 billion of commercial mortgage-backed securities (CMBS), according to our friend Dan Ferris. When these downgrades occur, the banks and insurance companies that own this paper are going to have a big problem,” Dan says. “Prices are already down around 25% in the past year.”

Hmm. How do you think Australia’s banks and insurance companies would fare if a larger downturn hurt commercial real estate values? Do you think the bad loan cycle Cameron Clyne referred to yesterday might be even more vicious?

We do. Banks want to survive, of course. And they’ll do so by being more prudent about their lending. We’d also expect them to retain more earnings rather than paying them out as dividends. This means if you’re looking for dividend paying stocks, you may have to look harder.

But it’s all a process of repairing the corporate balance sheet to correct the lending excesses of the bubble. It’s happening at the household level too, with savings rates rising. This, by the way, is an ominous sign for economies that are based on consumption, like Australia, the U.K. and America. De-industrialising political policies seem to exacerbate the weakness of these economies (which are structurally vulnerable to begin with, but no one ever said politicians had the people’s best interests at heart. The political class has become a modern-day oligarchy, concerned only about its re-election and wealth preservation (often at the public expense).

Economist and Nobel laureate Edmund Phelps told Bloomberg this weekend that it may take as long as 15 years for households to rebuild what they lost in the recession. In America, that’s the $14 trillion in wealth (via shares and real estate) that’s been wiped off net worth since the bursting of the credit bubble. “The only way we’re going to get a healthy, full recovery is over a long period of time, involving households rebuilding their balance sheets…There’s no silver bullet that’s going to get us into good shape quickly.”

Check out the chart below, courtesy of our old friend Chris Weber. We are often asked how the Aussie dollar price of gold can go up when the Aussie dollar itself is getting stronger relative to the U.S. dollar. Chris shows that all currencies have been declining against real money since 2000. It’s a case of competitive devaluation.

In the case of the Aussie dollar, what’s good for Aussies touring abroad (a stronger currency) is not as good for manufacturers, who desire a weaker currency. “Since about 2001,” Chris writes, “whenever any currency rises too much, the local manufacturers or farmers – or anyone who lives by exporting – start to scream about it. Their local governments respond by doing all they can to lower the value of that currency, having it fall in value and thus making exports cheaper, all this in the hope that the domestic economy will become better.”

“Pick any period so far this young century and you’ll see how this is true. For instance, right now you see it in those countries whose currencies have soared the most in the last few months….As all the countries with unwanted strong currencies move to cheapen them by printing more money, slashing interest rates, or just ‘talking’ it down, the question remains, just what are those high currencies declining against?”

“If you answer, ‘against the currencies of their main trading partners,’ well, yes, this is true. But it is only temporary. If they are successful in this, then the trading partners don’t want their own currencies to go too high, so at some point they try to cheapen them.

“It has become an endless round-robin game, except to call it a ‘game’ is a little perverse. All holders of currencies suffer in the decline of the purchasing power of their money. You go lower, but then your partners go even lower, and then you have to cheapen your money yet more… It’s an endless cycle that really doesn’t help the world economy in the long run.”

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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13 Comments on "Paying Attention to the Risk from Deleveraging in Commercial Real Estate"

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Tim
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I’m getting really sick and tired of the DR/Money Morning etc just bagging anything to do with any program seeking to reduce our reliance on fossil fuels where we don’t need them, or reducing pollution etc etc Waxman Markey was needed. Carbon taxes or ETS’s (or whatever), to cap emissions are needed. You guys are NOT, as far as I can tell, climate scientists, so stick to finance please – you show your utter ignorance apropos the need to act on climate change by your continued snide references to anything climate change related. The free markets and ability to run… Read more »
DH
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Gotta agree with Tim, above. You guys are starting to sound like Denninger on climate change. I’m a fan of sound-money, suspicious about fractional reserve banking, aware of the egregious theft that Fed-bailouts (overtly) and inflation (by stealth) represent, but save me the swaggering red-neck “guns, foon ‘n ammo” climate change denialism, ok? Right-wing republicans deny climate change (despite significant-not complete – but, *SIGNIFICANT*) evidence to the contrary for ONE reason: it affects the fortunes of the incumbents whose interests they most frequently serve. On this issue, DR runs the risk of endorsing positions that are going to look as… Read more »
Tony Hansen
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Tim and DH,
So what about the risk from de-leveraging in commercial real estate?

Biker Pete
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DD: “This, by the way, is an ominous sign for economies that are based on consumption, like Australia, the UK… ” To compare the UK and Australian economies may be a tad simplistic, Dan, doncha think? Our resource base may point to some subtle differences, surely? Your quote: “… it may take as long as 15 years for (US) households to rebuild what they lost in the recession….” is more to the point. Youngest son (24) is currently featured in a reality show set in a Las Vegas mansion with two swimming pools, valued at $7 mil, but currently for… Read more »
Ross
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@Biker Pete, your view is fine within it’s boundaries but it is oft repeated. Concentrating on proving that you’ll be right even as all burns around you eventually wears thin. There are few cashed up enough to hop on your strategy. If your res investments are more toward the top end of the market as you have indicated you may even need to turn your places into boarding houses at some point and the vista of some of your locations may not produce income at all in a deep trough. But you do have horsepower so why not add some… Read more »
Coffee Addict
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Tony Everyone who is in a so called “balanced” super fund allocation is at high risk as the deleveraging continues over the next 2 or three years. Dan is also trying to say that there is significant excess capacity in the sector as the type of world such real estate was built to support no longer exists. Yeah its a bit of a blanket statement but the intention of the article is not to provide specific investment advice. Clearly, some types of commercial property and locations will be in more demand than others. In saying this, Gen Xers and Gen… Read more »
Coffee Addict
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Sorry Tony. I now realise that you were pointing to responses that should be on another thread.

bob
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The central banks of the world have engineered this economic collapse. It will be way worse soon.

Central Banks = Most successful crooks ever!

Biker Pete
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Horsepower, Ross? Or do you mean Whorespower? I should rent out beachside homes to madams, perhaps? Seriously, I take your point about the discomfort at level of risk it would take to do it all again, now; but I think we could. I enjoy working outside, as an unskilled or semi-skilled labourer, adding tens of thousands in value to each new house we build. (My days as CA are over… but I can still enjoy a thermos on my self-appointed breaks.) The future scenario you paint is a little amusing. I’m able to enjoy summers in the NH annually… four… Read more »
Ned S
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Had a chat to a feelance madam about setting up a business when the heat went off the industry a few years ago in Qld Biker – The advice: Staff management issues are a BIG hassle. And the best ones go private anyway. Nah, stick to more conventional investments unless one has found a niche market … Madam Lash and her ideas re members of the judiciary were thought provoking though … And could potentially help keep a smile on a bloke’s face if he ever did have to front a shoulder length horse hair wig wearing representative of the… Read more »
Biker Pete
Guest

Ha, ha… enjoyed that, Ned. I had a free lance, once!

Ned S
Guest

End of conversation I think Biker? We are supposed to be making money – Not having fun??? I’ll just have to take your missus word for the fact you have a point!

Biker Pete
Guest

Enough punishment! Was having so much fun in the Parkside’s garden reticulating, I forgot to eat. Off to find a pizza. I’ll be off to find the missus, Tamara. Feel a little like a fly-in/fly-out mineworker these days, Ned.

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