Thanks to Ilene at Phil’s Stock World for this excellent interview with a commercial real estate insider:
Mr. Solomon (name changed) is a CRE veteran with 40 years of experience developing commercial real estate in 15 states and has kindly agreed to be interviewed about the current conditions in the CRE market.
Ilene: Thanks for doing this interview with me. Like global warming, rumors of continuous heating up in the CRE market, didn’t exactly pan out. What are you seeing in the CRE market now?
Mr. Solomon: CRE is undergoing deleveraging with the rest of the economy, debts are being reduced or going into default. Large numbers of projects are not cash flowing and will have to be liquidated, or ownership will have to be transferred. Concurrently, there’s an oversupply caused by the same ill advised financing that led to the overbuilding.
Ilene: Did you see this happening?
Mr. Solomon: Yes we knew, and so did everyone else. Most people make a decision based on what they can get out of it in the short term. It’s the collective crowd behavior problem. Why do the lemmings jump over the cliff? It seems like a good idea till they get to the cliff – they keep being rewarded, till they’re not. Like the stock market, people invest because it keeps going up, without knowing when to get out, when the market’s going to crash. It’s a justifiable course of action as long as the market goes up and there are no losses. You can argue that the players didn’t really lose because the government bailed out a lot of the participants. Taxpayers lost the most.
Ilene: How far into the decline are we now?
Mr. Solomon: So far about 25%. A lot has been recognized. And it’s no longer a surprise. Some properties have already been foreclosed out. There are a lot of vacancies. I think a further substantial group of commercial properties will get foreclosed. I don’t see it leveling off for another few years because of the problems of contraction, debt, and oversupply. Oversupply in real estate doesn’t get worked off, the buildings have to be used. Less consumption and less business mean less demand. Creative financing, excessive easy money caused the oversupply, caused hyped up prices. Now there’s less demand, less employment, less consumption, and on top of that, the excess debt still has to be paid off – there’s more deleveraging coming. There are probably many years of value declines ahead.
Ilene: Do you think the recession is over?
Mr. Solomon: No, we will be in it for a number of years. Assuming the GDP is up in the short term, it doesn’t matter. It’s due to more debt expansion. The real world debt must eventually decline. It’s a government induced blimp that cannot go on, it’s not sustainable.
Ilene: Are there any areas where you would be building now?
Mr. Solomon: Regions will do better in the lower tax states that are less unionized, with less government regulation, for example Texas.
Ilene: I know many of your projects are in CA, how is that state doing?
Mr. Solomon: The California government is dysfunctional, too little revenue and too much expenditure. Compared to WA, there are more people, more speculation, more bureaucracies, and now more contraction. CA also has extra political risks, the state is bankrupt. The U.S. is also bankrupt. If there were no restrictions due to traveling and language, many people would be going elsewhere. All things being equal, I’d be building where opportunity is greatest, taxes are lower, and there’s less regulation. I’d be more apt to buy something in Texas because the economy is stronger than in CA, there is less regulation, no income taxes and the budget is better balanced.
Ilene: When do you think it would be a good time to buy real estate?
Mr. Solomon: It’s a dangerous time to buy now, but better now than a year ago. It may be better next year.
Ilene: You actively avoid places with any regulations?
Mr. Solomon: The regulation needs to be balanced. Some is needed. But it has to be right and the bureaucratic political system doesn’t help get it right. The system is politicized. For example, Greenspan tried not to have an economic contraction while he was in charge of the Federal Reserve. This paved the way for a longer decline now. The Fed didn’t stick to its mission. It’s complicated because politicians want to be reappointed. This encourages short term decisions. The last thing we want is a short term perspective in the Federal Reserve system.
The basic problem is that they have been and are continuing to print money when there’s nothing backing it. There’s no self-restraint. If you’re creating credit at 25% per year to raise the GDP 2%, something is wrong. Credit induced expansion in the economy. Obama says he’s creating jobs – that’s the kind of nonsense that government parties are selling us.
For example, is it sustainable to give people $4000 to go buy a car – one shot buying of cars to make the GDP go up temporarily? It’s just appearances. On a micro level if you can’t pay your bills, you have to stop spending or get a better job.
Ilene: Does it matter that we’re bankrupt?
Mr. Solomon: We seem to be functioning as though we’re not. There’s no question that only two trillion of revenue can’t service $100 trillion of debt. It’s pretty clear that there’s a major problem.
Ilene: Given the sad shape of the economy, I guess you wouldn’t think the stock market valuations are reflecting reality?
Mr. Solomon: The stock market goes up because it’s an asset class that the government’s moving money into now. It’s a bubble, another Ponzi scheme. Government just moves money from one asset class to another, playing the system. The banks made the taxpayer responsible for all the losses. The government allowed the banks to get into unregulated fields and destroyed regulations. This keeps the problem going. It’s been going on for years but keeps getting worse.
When businesses spend money it tends to be more productive, but not when the government spends it. This is a drain on the economy. Businesses use their money better, people will work harder. If the government taxes enough money away, people will eventually leave for other countries. .
Ilene: In your business, would you be hiring people any time soon?
Mr. Solomon: No hiring. Due to the economy and health care issues, we’re not hiring anyone. Hiring is a liability, might be taking on a life-long obligation. We prefer to be firing now, decreasing the number of employees.
Ilene: What to you think of Obama?
Mr. Solomon: He hasn’t done anything. He doesn’t tell the truth, that’s part of the problem. They can’t for political reasons – we have creditors we can’t tell the truth to, we are in that position with other countries. No one wants open discourse. Our country’s insolvent but the government doesn’t want this to come out as news, so they control how the news is managed.
We owe foreigners $50 trillion. The government wants to sink the dollar so that we’ll owe $25 trillion.. Longer term, it’s better to have a strong currency. But as a debtor nation, we want the dollar weak. In any event we’ll eventually be owned by foreigners. But what does Obama care if he sells out the country? The leaders are international, and they take care of themselves. Once you’re in this vicious cycle, you’re in it. The nature of the information is a problem once you’re so weak.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.