Feldman Equities

By Larry Feldman
President & CEO
Feldman Equities, Inc.

I returned to my office recently after attending the International Council of Shopping Centers Convention (ICSC) in Las Vegas. The convention was electrifying, with a huge, near-record attendance of about 30,000 real estate professionals (despite recession fears, terrorism, etc.).

Members of the Feldman Equities team at ICSC (partners Scott Jensen, Jim Bourg and Larry Feldman) conducted over 25 meetings with prospective tenants and experienced lots of productive interaction with tenants. Some of these meetings led to advanced discussions and in one case we shook hands on a 10,000 sf lease. Having recently signed and announced a major deal with Loews Theaters at our Foothills Mall in Tucson just before the ICSC gave us a great news bulletin to share with prospective tenants, brokers and lenders.

In addition to good leasing action, Jim Bourg and I met with several prospective lenders for our Tucson property and for an upcoming financing on a new acquisition that we are working on. My observation is that the competition amongst real estate lenders is becoming absolutely fierce. There appears to be an awesome supply of money out there to finance and invest in real estate.

As a result of the enormous amount of money chasing prospective borrowers, the spreads that lenders are charging over their cost of funds are rapidly compressing. We are hearing about lower leverage deals (around 50%) commanding spreads at or below 100 basis points, and higher leverage deals (up to 80% loan-to-value) of below 200 basis points over treasuries, for average quality retail property. All indications are that we will be able to borrow money based upon a fixed rate for five years at a rate close to, or possibly even below, 4.00%. For many real estate developers, including us, this situation could best be described as winning the INTEREST RATE LOTTO.

Also, there were literally hundreds of prospective buyers clamoring to buy more real estate at the ICSC convention, and talk of big price jumps in almost all classes of real estate. One well-known retail REIT was telling prospective sellers that they will buy an unlimited amount of neighborhood and community shopping centers at an 8% cap rate, or possibly lower for higher quality deals. These sharply lower cap rates translate to a nearly overnight jump in retail real estate values of somewhere around 15-20%.

The point of all of this is that I see a much brighter, stronger economy ahead, as this newfound overnight real estate wealth percolates through the economy, together with modestly improving stock gains. Another huge amount of wealth has recently been created in the bond market. Many holders of long term bonds have the option of cashing in on whopping bond market capital gains.

In the past, declining real estate values had a nasty habit of leading the economy down. However, this time around, it is already a fact that the real estate housing boom softened the collapse of stock market prices and, as a result, we’ve suffered a much milder recession than we would have, absent such a boom. Therefore, the evidence is pretty clearly pointed toward a real estate led recovery.

The resumption of oil production from the world's second largest oil reserve (Iraq) is beginning to ramp up. Iraq’s oil is not controlled by OPEC. Therefore, once Iraq reaches full production, which has not occurred in more than a decade, it is likely to have a significant softening effect on world oil prices. The consequential drop in oil prices is likely to have a stimulative economic effect. Almost every recession that we have had in the last 30 years was preceded by a run-up in oil prices, and nearly every recovery was associated with lower oil prices.

The economy is benefiting from dropping oil prices combined with a 44-year low in interest rates. And now, Congress has also lowered the cost of taxes on income, dividends and capital gains. The reduction in the capital gains rate should spur more buying and selling of "locked up" assets that have not been put to productive use for many years because of the large tax disincentive. For example, a landowner sitting on property due to the large capital gains tax, might now sell that parcel, making way for new development. That will spur on new jobs and provide yet another bolstering of the economy.

In my humble opinion, the deflation worry is WAY overblown. This country has seen annual deficits for about 37 out of the last 40 years and the latest projections (post $350 BILLION tax cut) are that these deficits will continue as far as the "economists can see" (and boy ain't that an oxymoronic expression!) And government deficits are becoming a worldwide phenomenon. For example, Japan recently decided to use fiscal policy (i.e., deficits) to reinflate its economy. Previously Japan maintained balanced budgets for the most of the last 50 years. However, Japan is now rapidly reversing course. As a result, Japan’s accumulated debt is huge and growing rapidly.

The point of all of this is a massive printing of money that is occurring almost all over the world, at a much faster pace than the rate of production of goods and services. TRANSLATION = INFLATION, not DEFLATION.

How does this apply to the real estate industry? Lock your rates in now for the long term and you will likely be rewarded with the kind of huge wealth creation that was realized by the lucky developers of the early 70's who had the foresight to lock in their rates and then repay their loans years later with very cheap dollars and super-inflated real estate values. Many of these guys found their way onto the Forbes 400 list of the wealthiest men in America.

If I am wrong (and I certainly can be, as this article is just an educated "Karnac" guess at the future), our worst case scenario at Feldman Equities will be that we will have overpaid on our upcoming fixed rate mortgage by about 2.40%. That "worst case scenario" assumes that the present rate on the 5-year treasury of 2.40% drops all the way to ZERO. My best case, using the Seventies as a benchmark for comparison, is that I might save about 20% (i.e., the difference between treasuries at 2.3% and the peak rates of the late Seventies of well over 20%).

Happy Investing!

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