Timing Is Everything When Financing CRE

They say that, "Timing is everything."  Right?  Well it certainly holds true when it comes to financing commercial real estate.  There are times during the year when trying to get a loan financed is pure misery and there are times when the financing "gods" are looking down benevolently on you.  But let me tell you a little secret: It's not rocket science to figure out when is the optimal time to get things financed.  It's plain common sense.  Shown below are the worst times and then the best times to get your property financed.

Worst Times to Finance CRE

1. June 10th through Labor Day - If you haven't signed your loan application before summer starts, good luck!  Summer is the time when kids are out of school and family's take long vacations.  Loan officers, underwriters, loan processors, real estate brokers, mortgage brokers, attorneys, appraisers, etc. all lose focus during the summer months and as a result the financing process slows down to a crawl, or so it seems.
2. November 1st through Year End - If your loan is not expected to close before year end, your deal will go to the bottom of the pile.  All the focus during the end of the year is to work on deals that will close before year end so loan officers can make their quotas and for those who have had a good year, to make their bonuses.

Best Times to Finance CRE

1. First Quarter - The best time of the year to start the financing process is during the first quarter.  Bankers are refreshed after the holidays and eager to start working on their annual quotas in order to acheive their year end bonuses.  Most insurance companies will be back in the market ready to lend.  As the year progresses, they become more and more selective on property type and quality of transaction.  
2. Labor Day through October 31st - People are back from vacations, kids are in school, and lenders are again eager to get their last round of deals started for the year so that they close before the holiday season. 
3. November 1st through the 15th - To paraphrase Charles Dickens, "These are the best of times and the worst of times."  No sane loan officer should commit to closing a loan in less than 60 days.  But those loan officers who haven't reached their quota, or have, but want to increase their bonuses even further go into "warp speed" trying to cram in the final deals for the year.  If the "moon and the stars" line up perfectly or they're just plain lucky they succeed.  I just found out late last week that I have a client that must close his commercial real estate purchase before the end of the year or he will experience adverse tax consequences.  There are less than 50 days to the end of the year and the deal is not yet under application.  I haven't closed a loan this year under 75 days, most have been considerably longer. And yet, I have four lenders who have committed to closing on this deal before year end. This just tells me there are a lot of hungry loan officers who want to get deals closed no matter what it takes. 

So when is the best time to finance commercial real estate?  It's plain common sense: Whenever your loan officer is highly motivated to get the deal done.

Source: The Importance of Luck and Timing in Real Estate, by Kevan McCormack, Metropolitan Capital Advisors

The 800 lb Gorilla in the Room

Whether Obama or Romney gets elected tonight, the next administration within the next four years will have two major crises that they will have to confront head on. One has been discussed frequently on the campaign trail – Iran getting a nuclear weapon, the other has been virtually ignored.  It's the 800 lb gorilla in the room.  We would prefer not to acknowledge that it even exists, which is, the inevitable financial collapse of Europe.

What most people don’t realize, or are unwilling to admit, there is no solution to the sovereign debt crisis in Europe. European leaders could assemble the brightest economist minds from all around the world together in one room, give them complete authority to act on the crisis as they see fit and it still would not change the ultimate outcome: Europe is going down. It’s inevitable. They are too far down the path to their own destruction to turn it around.

It’s only a matter of when, not if. True, they’ve done an excellent job “kicking the can down the road” these past three years and can continue to do so for some time to come but at some point the market is going to perceive their feeble attempts at a solution as putting a band aid on a gaping wound. When that occurs, market confidence will collapse taking down the European bond market and many of the European banks.

By now I suspect that many of you consider me a “nut job,” a “doom and gloom” type who thinks the world is coming to an end which I categorically deny. Humor me for a moment and for the sake of argument let’s assume my prediction is true. What then? How will this affect commercial real estate in the Pacific Northwest? To answer that question the following questions need to be answered:

• How will this affect trade with our largest trading partner, the European Union? We will see a substantial decline in our exports to Europe.
• How will this affect the U.S. economy? This will likely throw our economy into another recession.
• How will this affect our stock market? The stock market is affected by emotion. When things are good it soars far beyond any justification. When things are bad it plummets far lower than it should. In this case the stock market will initially plummet similar to what happened in 2008, maybe worse. At best it will be a roller coaster of a ride, soaring to new heights on good news and plummeting back down with any hiccup in economic news. This will not be a good time to be heavily invested in the stock market.
• How will this affect our bond market? It’s likely that Europeans will see our bond market as a safe haven and heavily invest in U.S. treasuries. If true, treasury yields, which are at historic lows, will likely go lower.
• How will this affect our financial institutions? This is where it gets ominous. The vast majority of our lending institutions should be unaffected. Only our five largest banks – Bank of America, JP Morgan Chase, Goldman Sachs, Citigroup and Morgan Stanley are heavily invested in credit default swaps on European sovereign debt. A credit default swap is a fancy term for bond insurance. Our five largest banks have insured a boat load of European sovereign bonds. When these European countries default on their bonds, these U.S. banks will be left holding the bag. Though these banks have confidently stated they have it under control, call me a cynic but I don’t believe them.  Between you and me, I hope they do. I truly hope they do because the alternative is these banks are going down.
• What response will the president (Obama or Romney) make to minimize the fallout on the American economy? This is where it gets interesting. The president has a very difficult decision to make: Does he let these five largest U.S. financial institutions go bankrupt? Or does he bail them out? Is the country in the mood to bail Wall Street out once again? Are these banks too big to fail? If he doesn’t bail them out will it not bring down the rest of the world’s financial system? Good luck Mr. President!
• So back to the original question: How will this affect commercial real estate in the Pacific Northwest? I think this can best be answered by looking back to the 2008 financial debacle. Four years ago some commercial real estate investors survived while others did not. The common denominator for survival was:
• Property type mattered. Apartments fared well. Office, raw land and single family subdivisions did poorly. Everything else was in between.
• Those properties that were modestly leveraged survived. Those that weren’t were taken over by the lender. 
• Those who have subsequently locked in long-term, low interest rate financing were the big winners.

When the Europe bond market collapses commercial real estate will be the investment that has the best chance to weather the economic storm. The stock market, on the other hand, will be a roller coaster basket case, the bond market will have incredibly low yields, and cash in the bank will yield no return. As long as investors invest in the right property type, leverage their properties modestly and lock in low interest rate, long-term fixed rate financing they will come out of this future economic crisis intact. And if inflation is the natural result of this disaster what better hedge against inflation than commercial real estate?

So am I a “nut job?” You decide.

John Mitchell's Economic Forecast - Is It Going to Stop?

I had the opportunity to hear John Mitchell’s economic forecast at the October 19th Commercial Association of Broker's breakfast meeting.  John always does an excellent job making a boring topic interesting.  There were no surprises in his presentation about the current economic situation, the gist of which was, the U.S. economy is growing, albeit at a slower rate than one would hope.

John began with a quick review of where we are:

• In the 4th year of economic expansion (hard to believe that's true but it is)
• 4.5 million jobs below our January 2008 peak
• 4.3 million jobs above our February 2010 trough
• 73 days until the Fiscal Cliff (read my previous post if you want a quick primer on the Fiscal Cliff)
• Globally experiencing economic weakness - Europe, Brazil, China, Russia, India are all either in recession or their economies are slowing down
• In the fourth year with short term interest rates at zero
• The Congressional Budget Office and the International Monetary Fund are both warning of a U.S. recession looming within the next several months

But I didn’t go to hear John Mitchell talk about our current economic situation. I went there to hear what he thinks will happen going forward. Accurately forecasting future economic trends splits the men from the boys, which reminds me of the Yogi Berra quote: “It’s tough to make predictions especially about the future.”

Not surprisingly, John Mitchell didn’t go out on a limb making any bold predictions about our economic future. Economists as a rule are not known for being risk takers. John Mitchell believes that our economy will continue to sputter along in the 2% growth range and that inflation will stay in check at about 2% for the foreseeable future as long as the Fiscal Cliff is handled responsibly.  

What was disconcerting to me was how negative his overall presentation was.  John by nature is an optimist.  He is always looking for a "silver lining." Normally if he says something pessimistic he tries to sugarcoat it with some positive news.  That was not the case this time.  My notes are filled with downbeat statistics.  The big three downers were:

• The economic recovery is growing at an historically slow rate when compared to all other economic expansions since WWII. 
• The Fiscal Cliff.  Congress and the president need to work together to avoid an economic crisis of their own making.  If not handled properly it will throw the U.S. economy into a recession.
• Monetary Policy.  The Federal Reserve is out solutions and nothing has worked.  Interest rates are at historic lows, Operation Twist, and Quantitative Easing have had only modest impact on the economy.  

When he got done, I had to fight the urge to give him a big hug and tell him things will get better. 

Whether that is true or not will depend in large part on who we elect in November.  I hold out no hope if President Obama is re-elected for another four years.  I'm not sure he even acknowledges that we have a serious debt crisis that will take us down the same path that Europe is traveling if we don't do something about it soon.  Mitt Romney talks a good game.  He at least says the right things but I'm skeptical he will have the courage to make the hard choices to get us back on track.  Is he a statesman or just another politican saying whatever is necessary to get himself elected?  I'm sure I've just offended both the Democrats and Republicans that read my blog.  Sorry.  I consider myself an equal opportunity offender.    

Fiscal Cliff Ahead: What it May Mean

Over the past few weeks I've been hearing the term "fiscal cliff" by the TV talking heads.  Some do a better job explaining what they are referring to than others.  So if you're confused or unsure of what they are referring to listen up. 

"Fiscal cliff" is the term used to describe a series of laws that are all expiring at the end of 2012 or are being implemented at the very beginning of 2013 that will have a dramatic adverse impact on the U.S. economy.  Among the laws set to change are:

• The end of last year's temporary 2% payroll tax cut and extended unemployment benefits
• The end of specific tax breaks for businesses
• The end of the Bush era tax cuts
• The start of new taxes related to Obamacare
• The automatic spending cuts resulting from the supercommittee not agreeing to a compromise budget deal 

Without congressional action, up to $600 billion of expiring tax cuts, new taxes and automatic spending cuts are set to take effect.  Some experts predict that if these tax hikes and spending cuts happen all at once the economy would experience a significant slow down throwing the U.S. economy back into a recession.  So the threat to our economy is very real.  

So what is the likelihood that Congress and the president will act responsibly and come up with an acceptable compromise to all parties?  So far Republicans and Democrats in Congress have shown little sign of agreeing on anything except that the other side is to blame for their failure to compromise.  I see four possible scenarios:

Scenario 1: Delay

A likely scenario is that Congress and the president agree to push the issue into 2013 after the presidential inauguration and the new Congress arrives.  If that happens, the tax cuts would continue, the tax increases won't take affect, and the spending cuts will be delayed.  The big problem with this scenario is postponing these difficult decisions continues market uncertainty.  This puts the business community on hold, delaying investments in capital expenditures and the hiring of additional employees.  I think this is more likely if Romney wins in November. 

Scenario 2: Modest Compromise

The lame duck Congress and the president reach compromises on some tax and spending decisions.  I see a scenario where both Republicans and Democrats cave completely on the automatic spending cuts to defense and domestic spending.  I believe this scenario is more likely if Obama wins the election. 

Scenario 3: Over the Cliff

Congress and President Obama fail to reach any compromise whatsoever resulting in the economy going over the cliff into the abyss below.  I would hope that there are reasonable politicians from both parties that could see that this scenario is not in anyone's best interest. 

Scenario 4: The Grand Bargain

In this scenario, Congress and the president reach a comprehensive deal addressing tax, spending and fiscal issues.  The new agreement not only answers the immediate issues facing the country but the agreement also tackles these major issues for the next 5 to 10 years.  Unfortunately I think you have to live in la-la land to believe this scenario. 

So which scenario is most likely?  It's anyone's guess and certainly there could be other scenarios not presented.  I'm personally very discouraged with the lack of leadership in Washington from both sides of the isle.  And yet the alternative of doing nothing is so potentially cataclysmic that I have to believe that even this Congress will do something.  They just have to.  My vote is for Scenario 1.  Any bets?  

Sources: Fiscal cliff ahead: What it may mean, Fidelity Investments, June 28, 2012; Give us a brake, The Economist, October 6, 2012; What is the Fiscal Cliff?, Thomas Kenny, About.com. 






 
  

QE3 - To Infinity and Beyond!

The recent news from The Federal Reserve reminds me of a saying by Buzz Lightyear. You remember ol' Buzz, the toy astronaut, in the movie series Toy Story. Every time he lept from a piece of furniture, he would proclaim with great fanfare, "To infinity and beyond!!"

That's more or less what Ben Bernanke said recently and I might add with about the same enthusaism. The Fed will try a new round of quantitative easing to jump start the economy. And Mr. Bernanke implied there is no cut off to this third round. He'll do it as long as it takes to get the desired results. Hence, to infinity and beyond is a good interpretation of his policy.

My friend Kevin Geraci of Zions Bank wrote a well written article recently on this subject. I don't normally quote verbatim news articles but I thought his was deserving. So here goes:

 

Two weeks ago, the Federal Reserve announced its third round of quantitative easing, more commonly called QE3, whereby the Fed essentially prints money and then buys assets with it in order to add liquidity to the financial system and bring down interest rates.

 

The ultimate goal of this monetary policy tool is to spur economic growth and lower the unemployment rate—the same promise we got in QE1 and QE2.   Further, the Fed also announced that it is also changing its interest rate forecast and now sees the Fed funds rate remaining exceptionally low through mid-2015 (previously it was late 2014).

 

The announcement of QE3 is wearisome for many and for many reasons.  While the stimulative policies are temporary and artificial, the laws of macro-economics typically are not.  Asset prices have been artificially manipulated and do not reflect long-term economic reality. So what?

 

Two weeks ago, commodity prices rose again as investors sought to hedge themselves against a falling U.S. dollar.  Quantitative easing serves to dilute the money supply still more, and naturally the value of the money declines.  This may be good news if you are an exporting business, but the falling dollar will cause commodities to rise even higher, exactly what we do not need in a recovering economy as essential commodities like food and fuel get much more expensive.

 

The FOMC, of which Ben Bernanke is Chairman, now employs a staff of about 450, about half of whom are Ph.D. economists.  Perhaps that is the problem - the lack of common sense in the ‘monetary market place’.  Perhaps Bernanke should employ a few middle-class workers on his staff as a ‘reality barometer’ to see first hand what is working and what isn’t!

 

And now the Fed states that instead of purchasing customary Treasury Bonds, it is going to purchase large quantities of Agency Mortgages (Fannie, Freddie and Ginnie), up to $40 billion per month worth, in hopes of stabilizing the housing market and creating more jobs.  As if the Government debt situation isn’t bad enough, the Government will own huge pools of 30-year fixed rate agency mortgages that over time (certainly before they mature) will be at interest rates less than the Government’s own Fed funds rate.  Now that is a good investment!

 

Little has taken place in the economy here, and elsewhere in the world for that matter, as a result of QE 1, 2 and likely 3.  Meanwhile, our national debt now exceeds our Gross Domestic Product for the first time since WWII.  So when our creditors start feeling confident enough in their own economies to start cashing in their T-Bills for higher yielding investments, where does our Government get that money?  Or, when our Social Security Fund, the only Federal Budget item that is funded via dedicated funding sources, wants to cash in its Treasury Bonds to pay for your retirement or disability, can we pay them?

 

Is it time to ask the wise men at the FOMC what they're doing?!