Bubbles, Bubbles Everywhere

by Landon M. Scott

It’s been about five years since the great turn of the century real estate bubble burst in 2006. The economy hasn’t even yet fully recovered from the Great Recession of 2008. Yet new bubbles seem to be forming anew. The most bubbly sectors appear to be, in order: commodities, government debt and technologies. That’s right, technologies.

The title to this week’s Economist Magazine (Volume 399, #8733) is “The New Tech Bubble”. While it seems safe to say that the world is older and wiser when it comes to investing in technology equities, the recent purchase of Skype by Microsoft and the IPO price of Linkedin leaves one scratching their head and wondering if we haven’t seen this movie before.

And while commodities appear to have taken a hit from their high of a couple weeks ago, most economists expect hard metals and food stuffs to rally again in the near future. And how the yield on developed world sovereign debt (national debt) is so low despite massive structural budget deficits, warnings from S&P (in America’s case) and the inevitable restructuring of Euro-area debt is nothing less than bizarre.

Are we at crazy levels given the fundamentals in either market? Certainly so, but as Keynes said, “markets can stay irrational longer than investors can stay solvent”.

I wouldn’t go shorting anything quite yet. Why not? And what does all this have to do with real estate? Until we work through the inventory of real estate owned (REO) on the bank’s balance sheets, and commercial real estate in particular, capital will not flow into commercial real estate in search of a safe haven by the world’s investors, public or private.

Until real estate prices aren’t threatened with a flood of supply in the pipeline, bonds, tech stocks, and commodities will be bid up. Of course the smart money paying in cash is already in the real estate market shopping for the best distressed deals in anticipation of the eventual flow of money out of the burst bubbles in other sectors. But until then, those looking at leverage and price appreciation in the short run to make their deal pencil will be sidelined.

The takeaway is this: if you are interested primarily in the maintenance of capital, if you don’t have cash and can’t wait five to eight years to exit your trade, don’t invest too heavily in income producing property for another year or so. Commercial real estate is not the place for the amateur investor right now; one mistake in this environment could be fatal. If you are just looking at first year CAP rates (capitalization rates) or other similar first year metrics (cash-on-cash, GRM, dividend, etc), you are in serious danger of buying a dog or passing up the property that will make your portfolio.

If you belong to this group of amateur investors and really want to get in at the bottom of the market, keep an eye for the other bubbles to deflate, try to pool cash, and look at any prospective real estate deal over at least a five year horizon, with only moderate price appreciation built into your assumptions. That so many other bubbles formed so quickly tells me that there is still an awful lot of money looking for a home. When they pop, real estate will benefit. It’s just a matter of time.

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