Last week what started out as a $100B problem ended on Friday with the Feds agreeing to solve a $700B problem. But does that solve the problem? Can the Feds solve the problem? What else is out there? And what does that do for me, my job, and our company?
The times are very reminiscent of the early 90s when real estate brought down the economy. It seems that real estate never gets credit for the good times (essentially the past 5 years of economic growth were driven by peoples ability to borrow against increasing home values) but does get the blame for the bad times ( housing declines cause economy to fall). One thing about the real estate market and housing in particular is that leverage substantially changes the upside and downside swings. With the ability to borrow up to 95% of a homes value comes the inverse problem of; if the house value declines by 10% your investment is not only wiped out but you owe substantial money on top of that. Now multiply that problem by the millions of home owners that received cheap, easy credit in the last few years.
Over the years investment bankers became the lender of choice for home owners (mortgage backed securities). They bought the loans by the Billions. But when the music stopped and the real values of these loans started to become apparent they wanted out of them as quickly as possible and some sold them cheap (Merrill Lynch started it with 22 cents on the dollar sale of loans.). Once that started everyone had to start adjusting the pricing of these loans so what they could have on their books was $1B that now became worth $220M almost overnight. Problem was that bankers are even better at leverage than home owners so they had to cover the loans they took out against these diminishing assets. It created a ripple effect that has pretty much eliminated all investment banks, many commercial banks, and insurance companies (they liked the high returns of these loans in good times).
The problem in the real estate industry as we are seeing in the finance markets with a decrees in value of these loans we are going to begin seeing in the real estate market. Fortunately or unfortunately depending on how you look at it the real estate market is not priced on a daily basis. So the drop will take a little longer to take effect but it will come. We have already seen drops of 10% in most markets over the past 12 months and now that the ability to borrow has substantially dried up we are going to see even steeper drops.
So what do we do as a company?
First off we have to make sure that what we have stays profitable and cash flows. In the good times of easy credit we always pushed to get to the next refinance to solve our cash issues. Well now there isn't going to be a refinance out for a few years. So we need to double our focus on profitable operations.
Next we need to make sure that the projects we have that are being stabilized continue as quickly and efficiently to stabilization so that we don't have to worry about continuing to fund them. We still do have a few funding sources to refinance these projects through but they need to be truly stabilized projects.
On the acquisition front we need to really pay attention to our fundamentals (Proforma). We need to make sure that we are not making projections based on what the economy has been doing (the real estate values can only go up syndrome). Times like these will provide lots of opportunity and the key is not to deploy limited capital into projects that will not allow immediate and substantial returns. If we follow that acquisitions model the rewards when prices start accelerating upwards will be tremendous. I speak from experience of seeing values stay very steady for years (best time to buy) and then spiking substantially in the early 2000s (best time to sell or refi).
We played the market perfectly in the mid-90s early 00s. And now it’s our chance to play it again with a much better management team, and better capital sources.
Let's Make It Happen
Nick
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