Why the Recovery Will Take So Long
In a recent excellent blog article entitled The Death of Real Estate Investing, Susan Lassiter-Lyons pointed out that mortgage financing for investors and real estate speculators is drying up.
Investors are being forced to pay all cash to buy up foreclosures, which greatly curtails the number of investors bidding on these properties. The fewer the number of investors competing to buy these REO (Real Estate Owned; i.e., bank foreclosures), the lower the price these REO's will fetch.
I then wrote a blog article with the same title that expanded on Susan's insightful theme. A reader asks:
Where can I get a copy of your (my) book?
My blog article raised the spectre of crushing deflation and referred to my new book, The Reverse Multiplier Effect - When Crushing Deflation Destroys America. You can order a copy here.
Why will the current depression last so long?
Japan's deflationary depression has already lasted 18 years, and the Japanese people entered their depression with large amounts of savings. The magnitude of any depression is proportional to the size of the credit creation binge preceeding it. Our debt creation bubble was a whopper. It may takes decades to liquidate all of this debt.
What is the outlook for the commercial real estate finance industry?
As short as one year ago, the conduits were making more than 50% of all new commercial real estate loans. Now this industry is just a shell of its former self.
The money center banks were all involved in the securitization game, so when the secondary market for CMBS loans died overnight, they were left holding far more commercial real estate loans than they wished. For the time being, most of the big banks will be originating just a few very clean deals.
The small banks - the ones not hurt when the CMBS market dried up - are still lending. But they only have so much money.
Lehman Brothers, which has a portfolio of $200 billion of subprime commercial loans, stopped originating new deals this month. Bayview Financial, another huge institutional originator of subprime commercial loans, has cut its lending volume by at least 70%.
Subprime and even prime commercial loans are now flowing to the hard money lenders. Unfortunately many hard money commercial lenders are stuck with huge portfolios of non-performing construction and land loans.
Fortunately my own hard money shop, Blackburne & Brown, never made any construction loans, and we made very few land loans. We are still actively arranging loans.
But the bottom line is that the entire commercial real estate finance industry is severely depressed. And if commercial lenders aren't lending, this will depress the value of commercial real estate. I expanded on this in my other blog today.
The commercial loans securing most commercial mortgage-backed securities are performing quite well. The delinquency rate is less than 1.5%. Why is the CMBS market getting so badly slammed when the main problem is in the subprime residential loan sector?
The issue is one of confidence in the rating agencies. The rating agencies issued some wildly over-optimistic ratings on residential mortgage-backed securities. Investors in these residential bonds are now getting slaughtered. Commercial mortgage-backed securities are guilty by association.
But there is another issue. The collapse of residential real estate has triggered a recession that will probably lead to a deflationary depression. All real estate could get clobbered in this depression, even if commercial real estate fares far better than residential real estate.
Some final comments:
There is one asset class about which I am very bullish - farm land. But I am very bearish on all other classes of real estate.
I debated selling my little mortgage company office building here in Indiana in anticipation of the real estate bear market; but I decided that there is always a chance that the Fed could drop trillions from helicopters. My advice to you is to only buy real estate that you're going to use. As explained in my book, the deflationary forces on all real estate are far more prodigous than most investors would imagine.