It seems that many people in our business have determined to just ignore Washington and much of the rest of the world, and just assume all will be OK and we should just move on. Maybe that will be OK, but more likely not. Others feel politics has nothing to do with us and I should ignore that aspect. I believe Washington and politics and the world at large will determine the future success of our business and the ability to obtain well priced leverage, the level of cap rates, and the ability to get investors to move ahead.
It is pretty likely that interest rates will begin to move up from here. Slowly, but inexorably. It is also almost certain that there will be no good resolution to the fiscal mess the US is in. Neither Obama nor the leading Democrats seem to have any real interest to tackle the deficit or entitlement reform. They say pretty clearly they think it is all about raising taxes even further, and Obama clearly has no intention to sit with the Republicans and negotiate a grand bargain. This does not seem to be a negotiating position, but it appears they really believe there is no need to reform entitlements and that they can just limit deductions on top of raising rates. Boehner has stated he refuses to continue to talk to Obama. Harry Reid proved he is unable to even work with McConnell. That is really disappointing as that is how deals always got done in Congress. The leaders sat down and worked it out. The president got directly involved and acted like a leader. We have none of that now.
So what does all this mean to real estate. A continued slow economy for several more years. Substantial additional monetary stimulus by the Fed which at some future date will create further market rate distortions when they try to unload the trillions off their balance sheet. We have a false rate market no which is being manipulated by the Fed buying under QE3. It is not possible to know today what real free market rates really are. That is not going to change for at least the next couple of years. It makes predicting rates in 4 or 5 years when you may wish to be a seller, almost impossible. That makes predicting cap rates nearly impossible several years out. If we have the sort of fiscal crisis that will happen in February, then the dollar is likely to fall further. Weak currencies are harbingers of future inflation. Throughout history governments have used some level of inflation and essentially devaluation of their currency to deal with being able to try to repay their debts. It appears that is where this administration is headed. At some point, offshore investors could decide that the dollar is no longer as safe as a store of value, and they may decide to put their cash elsewhere. Finance ministers are starting to publicly state that the US is so dysfunctional and in trouble that they no longer are interested to hear what the US has to say about monetary or fiscal policy. That is really serious when they say these things publicly.
Next we have to look at the Mideast and we cannot continue to just assume it will be OK. As I have written many times, Iran has to be dealt with this year. Egypt is no longer a reliable ally or partner, and it is very unclear what that country might do in regard to Israel and terrorists over the next two years. One can go down the list of countries now falling away into major problems due to a total lack of leadership and strong foreign policy by Obama and Hillary. If Kerry and Hagel get confirmed, that will just get a lot worse. We have done nothing about the terror attack in Benghazi other than lie and cover up. The bad guys are watching that and take away is let’s do more. This eventually leads to something really bad happening and US interests here and abroad potentially being attacked again since there are no consequences. An unstable world like this is never good for building a strong economy, so it is never good for real estate value creation.
Unfortunately Obama and his fellow Democrats seem to think they got a mandate in the election to pursue these policies and the reality is they did not. The Republicans kept the House and the polls are very clear that most of the public wants deficit reduction.
I continue to raise the red flags and suggest that while doing deals is fine, just be careful not to go out on the limb and don’t assume the economy will just move ahead and accelerate. Do not assume low rates will continue for three more years. They will not. If they do we are really in trouble. Do not assume cap rates will continue to decline-they will not. We are in for a tough year on the macro level and maybe several tough years. Maybe a big black swan called Iran or Syria will drop one on our heads in the next few months. It is very likely. Just be sure to underwrite carefully, and do not just assume all will be OK, it will not. Be fully prepared for some bad event or events, and stay sufficiently liquid to get through it.