John Mitchell’s Interest Rate Forecast

John Mitchell, a well respected economist, gave his economic update at the annual HFO Investor Roundtable event January 8^th.  It was another excellent presentation by Mr. Mitchell who has the uncanny ability of making economic forecasting interesting. 

To summarize Mr. Mitchell’s economic forecast, he believes we will continue to see an improving economy, albeit at a slow growth rate of about 2.0% annually.  Certainly this is nothing to be excited about but it’s far better than falling into recession.  

What I would like to focus my attention on today are Mr. Mitchell’s comments about where interest rates are heading over the foreseeable future.  So let’s first discuss what The Federal Reserve has been doing recently and then discuss what policies they intend to adopt going forward.     

·        From the standpoint of monetary policy, The Federal Reserve cannot push interest rates down any further.  Short term rates are near zero and they can’t go any lower than that.

·        The end of last month, The Fed’s Operation Twist was terminated.  This program manipulated the market by selling short term treasuries and purchasing long term treasuries which has resulted in driving down long term interest rates.

·        The Fed recently announced QE4.  Recall that quantitative easing is an unconventional monetary policy of buying financial assets from banks and private institutions thus injecting a quantity of money back into the economy for the purpose of stimulating economic activity.

Now let’s see what The Federal Reserve plans to do going forward.  QE4, as it is being implemented this time around, has two components: 1) the purchase of $45 billion of U.S. Treasuries a month with maturities in the 4 to 30 year range; and 2) the purchase of $40 billion a month of mortgage back securities.  Both types of purchases will keep long term interest rates artificially low. 

The Federal Reserve announced in December that they plan to keep interest rates exceptionally low as long as unemployment remains above 6.5% and inflation is no more than 2.5%.  Currently, the U.S. unemployment rate is 7.7%.  The buying of securities by The Fed is open ended until these two benchmarks are achieved.    

So the big question is: Do you think that the unemployment rate will decline significantly in 2013 or that there will be a jump in inflation this year in order for QE4 to be discontinued?  Not very likely is it?  As much as I would like to see unemployment fall below 6.5%, at the present pace of the economy we are likely two to four years away from that happening. 

Mr. Mitchell then posed a very troubling question to the audience: How will The Federal Reserve unwind QE4?  The Fed currently owns about $3 trillion in securities.  By the end of the year that number will be about $4 trillion.  Discontinuing QE4 will result in a significant “pop” in interest rates and selling the $4 trillion they currently own will further cause interest rates to rise.  Long term this looks like a gigantic problem with no easy solution.   

But back to the original question: Where can we anticipate interest rates to go this year?  It all depends on our economy.  There are two likely scenarios.

1.   If the economy continues at the current pace, then interest rates should stay where they are. 

2.   If the world economy begins to slow down at the end of this year due to the current recession in Europe and the economic slowdowns of other countries such as China, Japan and Brazil, then our economy will begin to slow down too.  If the U.S. economy were to show signs of a recession I believe The Federal Reserve will double down on its efforts to keep the economy going.  If true they would buy more securities which means interest rates would go down even lower than they are today.       

I believe there is no chance that rates will go up this year as long as QE4 is being implemented.  In fact I will go out on a limb and say I believe the second scenario is the more likely.  If true, then interest rates a year from now will be lower than they are today.   

Either scenario bodes well for commercial real estate.  Keeping interest rates low will continue the current trend of rising real estate values in the Pacific Northwest. 

Three Business Principles Steve Jobs Lived By

I had the opportunity over the Christmas holiday to read the excellent biography of Steve Jobs by Walter Isaacson.  Mr. Isaacson does not sugarcoat Mr. Jobs’s personality.  Steve Jobs would have been an awful person to work for as he could either profusely praise his employees or call them a piece of sh**, sometimes on the very same day.  To say the least, Jobs was a very difficult person to be around.      

That said, 100 years from now I believe he will be remembered as one of the great men of our era, held in the same high esteem as Henry Ford, Alexander Graham Bell and Thomas Edison. 

So what can we learn from Steve Jobs?  What made him unique?  What made him highly successful? There were many traits that made him successful, far too many to list in a short blog post, but I would like to mention three:

1.   He had an absolute passion for his work.  It was never about getting rich; it was all about making something he believed in.  He passionately believed in the Macintosh computer, the iPod, the iPhone, and the iPad to name just a few of the products Apple developed.  A recent survey indicated that 80% of Americans are not passionate about ANYTHING!  What are you passionate about?  Are you passionate about your work?  Do you find excuses to work late or come in over the weekend because what you do excites you?  Or do you even know what passion feels like? 

2.   He had an obsessive attention to detail.  There was a book written a few years back titled, “Don’t Sweat the Small Stuff… and It’s All Small Stuff.”  Jobs would have vomited his scorn on the author of that book.  Jobs was all about the small stuff.  “Good enough” was never good enough for Jobs.  Jobs was all about hiring the most gifted people he could find and then working them to their extreme limit.  Conversely he would also not hesitate to ridicule and quickly fire those who did not meet his high standards. He pushed and prodded his talented minions to perform at higher levels than they thought possible resulting in many technological breakthroughs that Apple is now known for.  He was absolutely ruthless on his employees but afterward they grudgingly loved and worshiped him for it.  How often do you settle for results that are less than your very, absolute best?     

3.   He was a “value creator.” He didn’t invent many things outright, but he was a master at putting together ideas, art and technology in ways that superseded what had come before.  Jobs once said, “Picasso had a saying, “Good artists copy, great artists steal” and we have always been shameless about stealing great ideas.”  Regardless of what we do for a living, our job boils down to adding value in the form of a product or service, for either our boss, if we have one, or our clients who are our ultimate bosses.  When we stop adding value, watch out, we’re expendable!  What can you do today to add additional value to your work so that your boss or client without hesitation realizes your importance in making them more successful?

I have heard people say, “Well I’m not Steve Jobs.”  Or they might insert another celebrity entrepreneur in that statement, like Richard Branson or Donald Trump.  Deep down what they are saying is that they don’t have the courage to try to be exceptional.  And I ask, “Why not?”  Being average is certainly not the road to success.  Yes, it is highly unlikely that we will ever be remotely as successful as Steve Jobs but should that stop us from living by the business principles that led to his great success?  I think not.     

My Crystal Ball Forecast for 2013

Forecasting reminds me of the quote attributed to one of our most famous philosophers of the 21^st century, Yogi Berra.  He said, “It’s tough to make predictions, especially about the future.”  But it’s that time of year when we all want to know what the new year is going to bring.  Specifically those of us in commercial real estate want to know, “How is commercial real estate going to do in the Pacific Northwest in 2013?” 

Well you’ve come to the right place because I’m bullish about the immediate future of commercial real estate.  Interest rates should remain low throughout 2013.  Commercial real estate should continue its upward trend out of our plunge into the abyss caused by the Great Recession of 2008.  Four years ago we were in a free fall, similar to a skydiver who waits as long as possible before he pulls the ripcord that opens his parachute.  It looked bleak.  Let me correct myself.  It was bleak.  But in 2010 we bottomed out and 2011 showed a modest improvement.  Last year was even better and there is no reason to believe this trend won’t continue into 2013.  

However there are three caveats to this prediction.  As James Carville once said, “It’s the economy stupid.”  And sure enough how well we do in 2013 assumes that the economy continues to grow at the modest pace that it has grown for the past few years.  If not, then all bets are off.  There are three things that could derail our economy. 

1.  The Slow Down of the World Economy 

Even though 70% of our economy is derived from domestic spending, the United States is not immune to what happens in the rest of the world.   And what is happening in the rest of the world?  Europe is in recession and the economies of other countries are slowing down.   This means that there will be less demand for our exports, which means our economy will begin to feel the affect.  However, I don’t believe that during 2013 we will feel the brunt of this slowdown to any real degree.   If the slowdown continues into 2014 and beyond then it is likely that it will slow our economy, maybe throwing us into recession as well but not this coming year.  

2.  Europe Muddles Through 

As I’ve discussed on several occasions, Europe’s sovereign debt crisis is not going to end well.  There is no satisfactory solution to their problem.  The only question is when, not if, it will implode.  The Europeans have been doing an excellent job kicking the can down the road these past few years and I’m guessing they will be able to further kick the can down the road through 2013.  If they can there will be little negative consequence this coming year to their sovereign debt crisis on the American economy. 

3.  Fiscal Cliff Outcome 

As of the time of my writing this blog post the Senate has just passed a bill to avoid the fiscal cliff but it has yet to be voted on by the House.  It’s hard to tell if this version will be acceptable to House Republicans.   At some point there will be an agreement, either this bill or one modified slightly to accommodate the House Republicans.  But let me let you in on a little secret, actually a big secret: It makes no difference which side wins the budget negotiation.  What both sides are proposing is equivalent to arranging the deck chairs on the Titanic.  They are haggling over nuance differences over how to raise tax revenues with almost no proposed spending cuts.  The proposed bill will raise about $1 trillion over 10 years.  That’s equal to $100 billion annually, which is an insignificant amount when compared to what is needed to right our fiscal ship.  So instead of having annual deficits of $1.2 trillion, we will have going forward $1.1 trillion in annual deficits.  So in ten years the total U.S. debt will go from $16 trillion to $27 trillion.  Sadly, no one in Washington has the courage to put our fiscal house in order.  Not the president, not the Republicans.  

Now the real question for 2013 is whether or not the stock market and the credit agencies perceive this miserable attempt at political theatrics as the sham that it is.  If not, then it will have no adverse impact on our economy.   If they do, the stock market will start to decline, possibly precipitously, and the credit agencies, such as Standard & Poors, may be forced to further downgrade the credit rating of our country.  That’s the potential fallout from the Fiscal Cliff.   Stay tuned.

If we can avoid these three pitfalls from happening in 2013, then our economy should continue to grow.  And with a growing economy commercial real estate in the Pacific Northwest should do quite well this coming year.   But the bigger issue is finding people on both sides of the aisle who have the political courage to get us out of our fiscal mess.

Lessons from My Father

Even though my father passed away several years ago I’m surprised how often I think about him.  Something happens during the normal course of my day, and it triggers a flashback of him.  It wasn’t a conscious decision to think about him, but rather some random thing happens and instantaneously I’m transported back in time forty years hearing my dad say or do something.  It happens all the time.  Does that happen to you?

My father in many ways was a good role model.  He also had his faults but as time passes the good memories of him are winning out and the not so pleasant memories are fading.  I hope that’s what happens with my two adult children when I’m dead and gone. 

As I said my dad was a good role model, but he was a lousy teacher.  I don’t ever recall him ever trying to teach me an important life lesson.  He just lived what he believed.  At the time, I didn’t understand the importance or appreciate what I was witnessing.  It was just my dad saying or doing what he always said or did.  It was nothing special, or so it seemed.  It was just vintage Dad.  But the older I get the more I appreciate the values that he lived.   

So what life lessons did I learn from my father?

LIVE WELL WITHIN YOUR MEANS

Growing up my family lived in a very middle class neighborhood.  The neighbor on our left was a grocer and the neighbor on our right owned a gas station.  Although my mom drove new cars, I can’t ever recall Dad driving anything but used pickups.  A vacation to us was visiting our relatives, certainly not going to a destination resort.  We lived quite modestly.  It wasn’t until I was in college that it dawned on me that my parents were financially well off.  Over the years there had been hints of my parent’s wealth but I hadn’t been able to put the pieces together.  That changed when Dad, who owned his own CPA practice, sold his business and retired at the age of 50.  He lived quite comfortably for the next 30+ years off the income generated from his investments.

TREAT EVERYONE EQUALLY

After retiring, my dad spent most of his days working on his tree farms.  Having grown up in the rolling farmland of Iowa he was in awe of the beauty of the forests in the Pacific Northwest.  About ten years before he retired he bought a parcel of logged over timberland and spent his weekends nursing the land back to health.  He was very comfortable working alongside loggers, foresters, and other blue collar workers associated with the forest products industry.  And they were equally accepting of him as one of their own.   

I’m not sure why (it’s a question I wish I had asked him) but he was politically well connected in Oregon state politics.  I remember back in the sixties he was a pallbearer at a funeral where a fellow pallbearer was Mark Hatfield, the then governor of Oregon.  Dad never showed preferential treatment to his wealthy friends.  Those in a lower socio economic class were treated no differently than the rich and powerful. He treated everyone with the same friendly Jimmy Stewart like manner. 

PUT TOGETHER WIN/WIN AGREEMENTS

Dad didn’t believe in win at all costs.  He proposed agreements that were fair for both parties, not just for him.  He had no problem leaving a little bit on the table if it meant getting the deal done sooner rather than later and with both parties satisfied. Sometimes the person he was negotiating with would attempt to take advantage of his desire to strike a fair deal and would respond back with some unrealistic and unjustified counter offer.  You see, not everyone plays by the same set of rules.  But for the most part, people intuitively understood that he was proposing an agreement that was fair to both sides and they respected him for doing so. 

Sometimes life’s most important lessons are better absorbed not through formal instruction but by the consistent actions of a role model over a lifetime. 

May God richly bless you and your family during the holiday season.  Merry Christmas!

Four Common Mistakes That Make Financing Your CRE Difficult, If Not Impossible

I’m surprised how often I am asked to find financing for a property that for one reason or another is obviously not financeable.  It’s as if the borrower wants the lender to forgo the use of common sense.  I’m going to let you in on a little secret: IT ISN’T GOING TO HAPPEN!!!  Anyone who is at all knowledgeable about commercial real estate lending realizes that lenders are risk averse.  They are not in business to take on any more risk than is absolutely necessary. 

So if you want to either refinance your property or to sell your property there things you must do a year or two before financing is needed to get the property to the point where I call it, “lender friendly.”  Not doing so will likely make it much more difficult, if not impossible, in getting a lender interested.  Here are four common mistakes:

1.   The property is in poor physical condition.  It’s a big turn off to lenders to see a property poorly maintained.  Why would a lender refinance a property for a borrower that is not willing to maintain his property?  If you want to refinance a property that has a lot of deferred maintenance you better have an excellent explanation as to why it’s in poor condition.  Better yet would be to get the big ticket items fixed prior to refinancing your property. 

2.   The occupancy rate for the property is below market calling into question the seller’s property management company’s ability to professionally manage the property.  If the property is self-managed you’re in deep trouble.  If the property is for sale some sellers or listing brokers think that providing a rent guarantee on the unoccupied space will satisfy a lender’s concern.  WRONG!!  It does just the opposite.  It’s a great big red flag that something is wrong with the property.  A better solution is to offer as much free rent as needed to get the vacant space occupied.  Offer the free rent at the beginning of the lease.  Once the free rent has burned off, then refinance or put the property up for sale.  You still need to disclose the free rent to the lender but it is much better to have your property at stabilized occupancy with free rent than to have a property with a high vacancy rate. 

3.   Operating expenses are well above normal for a property of that age and condition.  You need to investigate if there is a reason for this.  Is it an anomaly?  Are some ongoing maintenance expenses actually capital expenditures?  Can you explain why?  If you can determine that the additional expenses are costly one-time expenses then capitalize what you can identify and operate the property for a year to show what your operating expenses should be for a normal year.  If you rush to refinance the property with higher than normal operating expenses it will likely lower the loan amount because of the lender’s minimum debt coverage requirement.  And if you’re trying to sell the property, the value of the property will be adversely impacted because the NOI for the property will be lower than it should be.  Worst case scenario, the lower NOI could reduce the loan amount and thereby increase the equity required by the buyer beyond what he is willing to invest in the property killing your sale.      

4.   Most tenants are on a month-to-month basis (not a concern for apartment renters) or have only 1 or 2 years remaining on the term of their lease.  Most lenders will not accept rollover risk.  Again, proposing a rent guarantee on those tenants whose leases have expired or will expire shortly is a big turn off to lenders.  One way to mitigate risk is to identify when each tenant originally moved in.  If they have been a tenant at the property for 10 or more years then it is much less likely they plan to move once the lease expires.  But the best thing to do before you sell or refinance your property is to get as many tenants re-leased for as long as possible.  Once you’ve minimized the rollover risk then seek financing. 

Remember, it’s all about getting the lender as comfortable as possible with financing the property.  You’re asking the lender to lend you or your buyer lots of money.  Make sure to take some common sense steps prior to requesting a loan that makes it easy for the lender to say yes.