2012 Remains Uncertain

By Joel Ross

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I think virtually everyone is agreed that 2012 is the year of massive uncertainty. Now with Newt winning S Carolina, it is even more uncertain. Thanks to a nieve foreign policy from Obama the world is a much more dangerous place in the year ahead. Europe will continue to stumble form one deadline to another and the IMF and governments will have to continue to prop up the major banks.

Barring a black swan event, which is a big bet right now, GDP is likely to grow at 2%-2.5% in the US, and real unemployment will likely stay at something above 15%. The real issue is not the headline unemployment number, but the employed number which is continuing to decline to very low levels. If fewer people have no paycheck, then they can’t spend on retail, can’t go to hotels, and they don’t take up office space. They do rent a place to live, but they don’t buy a house or a condo.

With the continuing attack on banks and Wall St by Obama and Cordray, there is little hope that the capital markets will see any material improvement this year. Combine that with the European banking crisis, and it is hard to see how CMBS rises above $40 billion, if that. Major originators are not going to commit large allocations of their balance sheets to CMBS with so much uncertainty, and the risk that some event will again shut the market during the year and stick them with inventory they may suffer losses on. There are also less originators now and that is unlikely to change for the better during the year. It is no wonder that it has been projected that as much as 60% of all maturities may not find 100% refinancing of the maturing balances. Extend and pretend has to return for the servicers so that they can continue their fee income. That servicing income stream will drive more decisions to kick the can than any sound underwriting analysis. While there should be a flood of distressed paper this year, it is starting to appear that the banks and servicers may punt so as not to take the hits and not to disrupt one of the few steady income sources they still have. Rescue capital should be a very good place to be this year since there will be a lot of opportunities to cut a deal with owners and servicers to do a pay down and extension once again. Unfortunately this does not allow the market to work as it did back in 92-94 when we cleared things out at distressed pricing, allowing the free market to do its job and drive a long recovery. Financial services is not where you want ot be if you are a sharp new MBA seeking his fortune. That party is over. New York will see the consequences of this administration assault as more bankers and support services of lawyers and others are further forced to cut back.

There is little doubt that the top end of taxes are going to rise in one way or another next year. Either tax reform will cut deductions or rates will just rise. There will be more attacks on carried interest treatment but it is not likely to get changed, although you should not count on that. Nobody in Washington, or out past the Hudson, likes us, so it is as good as it is going to be right now. If you have a big capital gain built in, you should think about your strategy of when to sell. Do you bet on values going up or taxes going up or both.

The ECB balance sheet is now larger than the FED balance sheet and that is likely to get even more expanded. The European banks are on life support, and there is nothing on the horizon to change that over the next year. Even if a deal is cut on Greek default, that is just cosmetic and solves nothing. With massive fiscal cuts throughout Europe, and the need for them to reduce labor costs materially vs the US, there is little chance of a growing economy in the Eurozone in the near term. That means a lot more flight capital coming our of Europe and little new investment or banking business. More defaults have to come for businesses that will simply not be able to hang on. The French and Italian and Spanish banks cannot earn their way out of this in the near term.

The good news is the US remains the best place for the moment to invest. If for no other reason than it is unlikely we will have social unrest, massive corruption or political instability, regardless of being an election year.  We will have a normal election process. Obama might get reelected which would be terrible for business, but it will be done without violence or political upheaval as in many other countries. Consumers are in far better shape despite the loss of home values. Their debt coverage ratios are close to a record. Loan delinquencies are way down. Auto loans and other similar loans are rising. The Fed is not raising rates in 2012. It is not clear they will raise them in 2013. Assume in 2014 there will be rate increases and they could be sizable depending on what else is happening in the world and with inflation. By 2014 the ten year might rise to 4% or more. The massive monetary stimulus has got to cause inflation at some point. There is no way to know, but the chances are good it is more likely than not, so make that assumption in your underwriting. . The low rate environment is likely to last  awhile which will allow many real estate deals to survive a little longer if the owners can find the rescue capital to get past maturity default.

If you can buy well today and not lever up, and if you believe inflation is coming in 2015 or 2016, and if you have a long term strategy, you should do very well. 2012 is a good year to be a cash buyer. Just be very disciplined and underwrite to account for the black swan events that are sure to come.

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