lending advice
Tighten Your Belt
by Mark Levine
Back in early November, we discussed the possibility that certain signs might indicate an end to our current financial market woes. The goal back then was to attempt to see beyond the chaos and look ahead to regaining some stability. There is good news and bad news on that front.
First, the good news. There have not been many more major surprises regarding bank or financial sector meltdowns. Yes, certain industries and companies continue to struggle, and many more will close their doors in 2009. But, at least for now, it seems that the velocity of these major surprises has slowed down. When we can start to become comfortable that most of the carnage is behind us and that we won’t wake up to more bad news tomorrow, confidence can once again play a role
in the economy.
The other item we discussed, which was a big hurdle in moving forward, was the presidential election. Clearly, that is now behind us and fortunately there are no lingering recounts or legal challenges this time around. The campaign season is behind us and talk can hopefully turn into accomplishments soon. Regardless of whom you supported in the elections, we should all be satisfied that President Obama is very focused on trying to improve the economy. He understands that real estate is a fundamental aspect that needs to be addressed and supported, so we should all look forward to his work on this issue.
There is bad news too, unfortunately. The first piece of it is that we still don’t see an end to the financial crisis or recession. Yes, we’ve hit some milestones that give us hope, but hope isn’t making our problems go away, so far. In fact, much of the data and much of the anecdotal evidence is still trending in the wrong direction. For instance, retail sales numbers seem to be getting worse by the month. When all of the final and adjusted results of holiday-period sales are disclosed, the picture should be fairly bleak. In fact, prevailing opinions are that many major retailers will close significant numbers, if not all, of their stores in early 2009. This obviously bodes poorly for many aspects of the economy, not the least of which is commercial real estate.
Another troubling sign of a rough road ahead is unemployment. It is my personal opinion that unemployment numbers have been significantly understated for various reasons and that we will see some significant spikes in these numbers in 2009. Unemployment is less of a problem unto itself than it is a result of other issues, but it does have an impact on consumer confidence and it does help us define various cycles of the economy. Furthermore, unemployment also taxes the overall economic system because it means significant spikes in government benefits and assistance. This, in turn, adds to the ballooning deficit at a time when we can least afford it.
The other side of that double-edged sword is that higher unemployment and lower wages mean significantly reduced tax revenues for local, state and national governments. If I had to pick the big story for 2009 at this point, I would guess that it will be about major budget deficits at all levels of government. Of course, at the federal level, we will continue to print money and all signs point to the likelihood that we will continue to spend aggressively. The price is that our currency will continue to be devalued, but it might not be so bad on a relative basis if the rest of the world acts in a similar way.
However, government on the local level does not have such luxuries. Sacrifices will need to be made when tax revenues fall significantly short of expectations. Projects will be put on hold and even some general services will be slimmed down. Schools, which are the last expenditures that should be cut, are already talking about eliminating certain expenses such as after-school sports and field trips. Many municipalities will be looking for funding from state and national sources, but the system will be overwhelmed and it certainly will not be easy to efficiently and responsibly help those who are most needy. It is a grim picture, and hopefully it only occurs on a small scale, but we can be nearly certain that it will occur to some degree.
These are the parts of the recession cycle that are fairly obvious and inevitable, in my opinion. There will be other fallout that is less predictable at this time, as it will result from individual company failures or small industry issues. For instance, I was shocked and disturbed when I read about the LandAmerica title company collapse, and the probable loss of hundreds of millions of dollars of investor money as a result.
For those who are not familiar with this story, LandAmerica filed for Chapter 11 bankruptcy protection in late November. At that time, the company held approximately $400 million of client deposits, specifically those associated with 1031 exchanges. Unbeknownst to most depositors, the company had those deposits in commingled accounts invested in seemingly safe auction-rate securities. Well, the auction-rate securities market crashed, and with it, much of the cash from those real-estate investors in the middle of 1031 exchanges. LandAmerica had guaranteed the deposits, but that guarantee became worthless when the company went bankrupt. Hopefully there are not too many more instances like this where investor money is completely eroded, but I fear that this is not the last.
Another wildcard that we often visit in this column is the future of Fannie Mae and Freddie Mac, particularly the question of what role they will play in the multifamily finance market. Throughout 2008, they were essentially diamonds in the rough. As nearly all other major sources of debt dried up, Fannie and Freddie continued to lend to the apartment investor sector. This helped to maintain some relative stability in the sector as it kept cap rates from exploding and enabled some sales transactions to take place. Will they be there for the same benefits going forward?
In my opinion, they will still be making apartment loans in 2009. But, and this is important, their lending activity will slow down substantially as the government reallocates most of their capital towards home ownership. We are starting to see it already, as Fannie and Freddie have begun to tighten credit requirements and have steadily been increasing pricing spreads during the last months of 2008. They are generally looking for larger loans now and are focusing so much more on the strength and experience of the borrowers. Essentially, they will be much more picky about who receives the limited apartment building loans that are available throughout the year. This is not a great sign for valuations, but hopefully the strong fundamentals that are currently supporting the multifamily business continue to keep the industry relatively strong.
The most common questions these days revolve around when things will start to
get better. Now that we are officially in a recession, we can look ahead to the next two major milestones: the absolute market bottom and then a convincing move towards a recovery. For better or for worse, it is in our nature to look beyond our current problems and try to see what’s around the corner.
Some optimists like to boldly state that things will be “Fine in ‘09.” Other, less audacious individuals are singing the “Good Again in 2010” tune. Then there are the doomsayers, or some might say realists, who are looking forward to “Heaven in 2011.”
One thing that we can be certain about is that we have not seen the last of the financial troubles in this country. There are too many industries (hedge funds) and companies (major retailers) that are not out of the woods yet. Just because we don’t hear them calling for help yet, does not mean that they won’t need it. The government will continue to send rescue parties to help save them, but let’s remember that it will still be a long process.
The opinions expressed in this article are those of the author, and do not necessarily reflect the viewpoint of the SFAA or the SF Apartment Magazine. Mark Levine is an independent consultant with over 12 years of experience in commercial real estate finance and investment banking. He can be contacted at marklevine05@gmail.com. Copyright © 2009 by Black Point Press. All rights reserved.