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Raub Report August 2016

September 13, 2016

Commercial Real Estate investment transactions are slowing markedly from the torrid pace of 2015, however, this matches the trend in 2012, another election year.  Regardless of who wins, a pick up after the election is likely.

Interest rates play a huge role in our economy, and “lower longer” is still going to be the theme.   This severely penalizes savers, retirees, pension funds and insurance companies as they cannot make the 5% per year from their accounts that in times past they thought would be secure.  The FED has gobbled up $4.2-trillion in government bonds and mortgages, ostensively in an effort to stimulate lackluster job creation and wage growth.  That’s not working out, as this is the slowest (worst) recovery since 1949. Perhaps that is the reason it is nearly the longest, too.  And now the other world powers are trying negative interest rates with no success.  This is all a massive experiment with extreme monetary policy, however, this experiment isn’t working out very well so the geniuses at the central banks, like mad scientists, are doubling down on the experiment.  We are in uncharted waters.

The other problem is that nasty little $19-trillion U.S. deficit.  The next 1/4 point interest rate increase adds billions in interest costs for the government and ripples thru the economy.  That has to come from higher taxes or new debt to pay for old interest.  Wow.  I am not an economist, and the impact will be vastly more complex than this equation. I just wanted to frame the problem, which is, we can’t really afford an interest increase because it drives the U.S. further into debt.  Remember the housing crisis of 2008?  Much of that was triggered by sub-prime loans that were adjustable rate, resetting to higher interest rates after the teaser rate wore off. Then, the low income borrowers could no longer afford their payments and went into default.  Now the U.S. is nowhere near default, but you may recall that in 2011 the U.S.A lost its AAA credit rating.  Is that where we are with the whole world economy; that is, have the nations of the world become like sub-prime borrowers, facing grave problems if interest rates spike? “Lower longer” may be the only way the Central banks can keep things on an even keel.

Think of a ship sailing in unchartered waters.  We have no idea where we will end up, but if we turn around, then the ship may likely sink.  That’s our leaders’ dilemma.  Fortunately, U.S. Treasuries are still the world’s monetary safe haven. If (when) the stock market(s) correct (collapse) will everyone run to the safety of treasuries thus keeping interest rates low?  No one knows. Uncharted waters.

And on to other news! Commercial real estate in San Antonio is doing fine.  Tight restrictions on construction loans have prevented overbuilding in most sectors.  However, while the health of the region’s property market is relatively stable, we are still pretty far advanced in this cycle.   Whatever happens with the election, interest rates and global events, we are due for a slowdown.   While on the one hand, the stock and bond markets are very highly priced, on the other hand, commercial real estate, which is tangible and produces income, looks like a pretty good asset.  When you can borrow long term money at around 4% and that borrowed money is 3/4ths of your purchase price, the other 1/4 you put in yourself, (your equity), can earn upwards of 10% and higher.  Part of that net income is tax sheltered by depreciation expense. And your tenants are paying down your mortgage, thereby raising your return on investment by 2 or 3 percent.   That looks pretty good when pension funds are having to lower their achievable investment returns from 8% to 5%.