The Collapse of the U.S. Economy

Commercial Real Estate Surpassed Residential Real Estate as Worst Performing Property Class in 2009

January 15, 2010

mybudget360 - Some of you are probably not aware that the commercial real estate market has crossed a dreaded line in the sand. Commercial real estate (CRE) that includes apartments, industrial, office, and retail space is now performing worse than residential real estate. Not just by a little but by a good amount.

While the CRE bust took about a year longer than the residential housing bust, once problems started hitting in this market prices have been steadily collapsing. At the peak, it was estimated that CRE values hit $6.5 trillion in the country. With $3.5 trillion in CRE debt outstanding, this seemed to provide a nice equity buffer. That buffer is now erased ...

Putting together all CRE values we find that the market has fallen by a significant 42 percent. Now assuming this figure, that $6.5 trillion is now “worth” approximately $3.7 trillion giving us an equity cushion of $200 billion for all CRE properties in the U.S. I doubt this figure is even that high.

It is safe to say that commercial real estate is now in a negative equity position. The U.S. Treasury has discussed plans on bailing out this industry but not much has been done on this front since all the bailout funds have been concentrated on residential real estate and protecting the too big to fail banks. Many CRE loans are held in the smaller regional banks that are actually small enough to fail.

... If we look at residential real estate, prices are down 32 percent from their peak. Keep in mind it is likely to fall further because many items like the Fed buying up $1.25 trillion in mortgage backed securities and keeping rates artificially low cannot go on forever. Also, is the government going to give our a tax credit forever? This is highly unlikely and when each program is phased out, we can expect minor shocks back into the market. Plus, we have to remember that many homes have been in a state of purgatory because of moratoriums and other patchwork programs. These only delay foreclosure and once they hit the market prices will continue moving lower.

Yet commercial real estate is falling with no support. And what would be the support given that our economy is contracting so viciously? Why would we need any more retail space near sub-divisions where people didn’t even move in? With housing there is a price point where people will move in.

Take for example the college student graduate that is only making $10 an hour because of the poor employment situation. He may need to move back home even though this isn’t what they want. If apartment rents are $1,000 a month, then renting on their own won’t make any sense. But if apartment rents are $400 in this area he may consider moving out.

This is the new calculus of the market. And apartment pricing is seeing pressure to the downside because of massive vacancies ...

And it gets even worse when we look at rental vacancies and this is where apartments fall under ...

This is the highest rate on record and tells us that we have over built and the market is still unable to sop up the excess properties. So what will happen is competition for cheap housing by lowering rents. This is the only way to drive demand in a market where average Americans are becoming more price conscious every day.

The problem with many of the CRE projects is that they were expecting peak value rents and will have no ability to service their debt with new market rental rates. That is, they are insolvent. And many bankruptcies will happen because of this. Or if you are a too big to fail bank you can simply walk away from your commitments . ..

And companies are not building any more properties as you might expect. This in turn means millions that derived their income from the building and housing industry will have years to wait before any recovery begins to take place. The CRE bust is now in full force even surpassing the disaster in residential housing. What we can get from this massive bubble burst is our near religion with all things real estate has led us to the economic abyss.

Home Building is Going Nowhere

January 17, 2010

MarketWatch - After plunging by about 75% from the lofty levels during the housing bubble, new home construction has finally stopped falling.

But, despite massive healing efforts by the government and the industry, home building hasn't shown any real improvement since bottoming early last year.

Through November, housing starts were essentially flat for the past year at an average annual pace of about 550,000, bouncing higher in one month and drifting lower in the next.

Economists expect little change when the government reports on December's starts activity on Wednesday of the coming week. The housing number will be the major economic release of the week.

The consensus forecast of economists surveyed by MarketWatch calls for a 3% decline in starts to a seasonally adjusted rate of 555,000 from 574,000 in November.

"Activity in the residential construction sector is still essentially unchanged relative to where it bottomed out in early 2009," wrote Meny Grauman, an economist for CIBC World Markets.

It is quite possible that housing starts will see the first year-over-year increase since early 2006; starts hit a pace of 556,000 in December 2008.

Weather could play a factor in this December's figures, economists for IHS Global Insight said. The numbers are seasonally adjusted, but unusual weather can extend the building season, or shorten it. In November, starts increased nearly 9%, in part because it was the one of the warmest and driest Novembers on record.

"As a result, some homes that would have been started in December were instead started in November," said Brian Bethune and Nigel Gault of Global Insight. December's weather was the opposite: cold and wet.

Home building is really two markets: single-family and multifamily. Building of single-family homes has actually improved, rising by about 30% from the lows of last year. In the meantime, starts of multifamily dwellings have collapsed, dropping over 50% from November 2008 to November 2009.

The industry has slashed production of new homes to work off a massive inventory of unsold homes. As of November, the number of new homes on the market had fallen about 60% to just 235,000, the fewest since 1971. And many of those homes are simply not salable. If it wasn't sold before, it's taking nearly 14 months on average to sell a home once it's completed.

The government, at the bidding of the builders, Realtors and bankers, subsidized buyers. But most of the first-time home buyers went for more-affordable existing homes, not new ones. However, repeat buyers are now eligible for the taxpayer-funded subsidy.

"The expansion of the program to include buyers who have previously owned homes could benefit the new market," wrote Peter D'Antonio, an economist for Citigroup Global Markets.

The new-home market is still at a disadvantage because of the number of foreclosures and short-sales.

In this environment, builders aren't eager to expand production, particularly because they don't know how the housing market will fare once the extraordinary support from the federal government wanes after the first half of the year, when the tax credit goes away and the Fed stops propping up the secondary market for mortgages.

"Residential construction should not be a significant driver of economic output in 2010, or even 2011 for that matter," Grauman predicted.

Another reason to believe that the economy won't boom.

Companies Flashing Financial Danger Signs

January 22, 2010

Forbes - ... Last year saw 207 bankruptcies of publicly traded companies. If there's a double-dip recession, this year's count could easily be as high. Leverage is still a big feature of American business.

We asked Audit Integrity, a research boutique in Los Angeles, to rank 2,700 companies for financial risk. The group consists of all public nonfinancial companies with market values of at least $100 million and $150 million in assets. Focusing on the 100 firms at the top in risk, it calculates an average 8% probability of going bust over the next 12 months.

ArvinMeritor is among the high-risk companies. More likely than not, it will sail through 2010 without any financial trouble. But the risk is higher here than at 99% of public companies, in AI's opinion.

AI's risk model incorporates the usual factors that go into credit ratings, like balance sheet strength and earnings. But it also figures in a measure of "accounting and governance" quality. The idea is that historical data can uncover push-the-envelope accounting and help predict which firms are likely to undergo financial restatements, regulatory troubles, class actions or severe financial distress.

James A. Kaplan, chairman of AI, set up the firm eight years ago after building and selling two other financial data crunchers: Capital Management Sciences, a bond analysis outfit, and the online financial portal MarketWatch. His inspiration for the latest venture came in 2002 as Enron was falling apart. Was there something that might have flagged this firm as a likely target of a Securities & Exchange Commission enforcement action? While studying SEC cases he deciphered common patterns involving such things as doing lots of acquisitions, divestitures, restructurings and share repurchases, or relying heavily on stock price gains in determining the boss' pay. From that he created his firm's Accounting & Governance Rankings.

AGRs are now used by big investors, director and officer liability insurers and others to gauge the chances that a public company will restate financials, face SEC action or get hit with shareholder litigation. Forbes.com publishes AGRs on its company tear sheets.

"Companies rated 'Very Aggressive' or 'Aggressive' have proved much more likely to face class action litigation and financial restatements and to suffer severe equity loss," Kaplan says.

Recently Audit Integrity began assessing bankruptcy risk as well, using not only accounting indicators like liquidity and leverage but also the AGR metrics and market measures like stock volatility.

"We find governance and transparency correlate with bankruptcy," says Kaplan.

Under AI's model 81% of the public companies that went bankrupt last year would have been classified among the riskiest 10%.

Not surprisingly, many of the companies now dubbed risky find fault with AI's methodology. One criticism is that the model doesn't capture some recent balance sheet or earnings improvements. Another is that the calculations don't give companies enough credit for making debt nonrecourse or for extending maturities. ArvinMeritor notes that its bonds are trading above par and its stock has soared.

All valid arguments. Yet at a time when markets are giddy and the riskiest assets the hottest, investors would do well to recall that bad things can happen--even to companies with credible arguments about why the naysayers are wrong.