"Insanity Reigns in Commercial Real Estate"

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A colorfully written and informative post by Toro at Seeking Alpha on the overheated state of the commercial real estate market. We’ve commented before that it has somehow gone unnoticed that lending standards in the commercial real estate sector have become as permissive (one might say non-existent) as in the residential sector before the subprime implosion. Lax lending leads to overheated buying as night follows day (apologies to the Bard).

From Toro:

[I]nsanity reigns in commercial real estate these days. Prices of commercial real estate are as ridiculous as residential real estate was a year or so ago, and as silly as big cap growth stocks were during The Bubble. It is no different, and the end will also be no different.

But, because of the reckless monetary policies of Easy Al as well as his successor Helicopter Ben – who may differ in style and approach towards inflation targeting but does not differ in attitude towards the asset-driven economy – an ocean of liquidity which has flooded the world has to go somewhere. With the copy-cat pension and endowment funds looking wistfully at the funds which had the foresight to invest in alternative assets such as private equity and real estate a decade ago, money is pouring out of stocks and into alternative asset classes. A decade from now, those piling into alternatives will discover that they were duped. And they will wonder what happened to the asset economy of Easy Al and Helicopter Ben, both of whom should be long gone before the proverbial you-know-what, hits the fan.

Indeed, much of private equity is merely leveraged equity that is not marked to market. Pensions and endowments could get the same effect investing in index funds by either borrowing 5x the amount of equity and investing in an index then turning off its TVs for five years, or investing in futures at 5x the rate to synthetically create an index return, and again turning off the TV for five years. It would then hire a private valuation to firm to tell it what the market should be valued at, all the while not paying the 2 & 20 gravy-train that has the all the ambitious Ivy League MBAs scrambling to jump on to. But we will leave private equity for another time.

Commercial real estate’s cousin, residential real estate is dead. Home prices will, at best, move sideways for a decade or, at worst, fall 20-30%. But the Greenspan Bernanke Put is alive and well, as vividly demonstrated by Helicopter Ben when he was madly pumping liquidity into the financial system as the over-leveraged subprime market (a market which we are now assured by the best and brightest was but an afterthought in the mortgage market), was collapsing. Thus, housing prices will not be allowed to fall by those controlling the printing presses of this once mighty currency. But homebuilders stocks have, and will.

Alas, commercial real estate is dead as well, and the REITs will face a similar fate as the homebuilder stocks. It’s just that the patient is not yet aware that he is dead.

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