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  • RD Geronimo

Global Recession & Prevailing Financial Crisis Equal Massive Fiscal Deficits and Looming Deflation

On August 1, 2006, The Real Estate Journal published an article written by me entitled, “Where are we heading? A negative yield curve = recession, will history repeat itself?”

Here we are in the first quarter of 2009, with an economy sick with symptoms; we know the various causes, how and why it happened, but we do not have the treatment.  Our economy and financial sectors are sick patients, and federal money, $2 trillion worth is struggling to make it better, but will it?  The question then, what is the solution to make the U.S. and global economy healthy again?

To date, the treasury has allocated a $700 billion recovery plan known as TARP, a $250 billion Bank Bailout, and a $100 billion Corporate Bailout.  Now there is the reported “Big Fix” planned by President Obama and Congress for another $1 trillion under the new stimulus package.  Where is the money going and how will the government payoff its debts with a declining GDP at a 2.5 percent annual growth rate?  Reportedly, our national debt is equal to about $6 trillion, or 40% of GDP.  Add the bailout, stimulus and other deficits planned over the next two years, the national debt will approximate 60% of our GDP according to a recent Times article and amount to a total forecast of $11 trillion – who will pay and how long?

On top of our national debt we still have significant liquidity problems, loss of investor confidence, availability of credit, and a housing market which continues to decline commencing as of the last quarter of 2006.  The DOW and equity markets have reportedly added up $28 trillion of capital losses with the DOW shedding $9 trillion since the October 2006 level of 14,100.

Continued bank failures are still imminent, including the big one “Citibank” and those already acquired – Washington Mutual, Countrywide, Wachovia, Sovereign and the looming Fannie Mae/Freddie Mac $100 billion government infusion.  On a more global basis – Bank of Scotland, Barclays, UBS, Fortes and such countries as Iceland - who is next?

Who’s Next in Corporate America Failures

  • Bear/Sterns - $30 billion bailout

  • Merrill Lynch/Countrywide-Bank of America bailout

  • Lehman Bros. – largest Corporate America failure resulting in bankruptcy

  • AGI - $100 billion treasury infusion to keep afloat

  • Morgan Stanley - $9 billion infusion from Mitsubishi UFJ Financial Group (21% stake) – stock declined 50% over the last 3 quarters

  • GM/Ford/Chrysler – junk bonds?!

  • Rising unemployment – national 6.4%; forecasted rate in excess of 9% by year end

  • What Are We Really Buying?

On the consumer side, 5 months of declines; this trend has not occurred since the 1990/91 recession, and reportedly accounts for 70% of the US economy.  The acceleration of job losses will further exacerbate this trend with over 500,000 job losses per month.  Store closures in 2007 totaled 4,603, with 5,770 forecasted for 2008 according to ICSC.  According to PPR retail vacancies will hit levels as experience in the early 1990’s, with one-third of the 54 major markets experiencing economic vacancies reaching an all-time high.

Where is the Where is the bottom?

  • Continued defaults

  • Lack of cash flow/liquidity

  • How much is too much

  • Are we simply printing money without the proper reserves/backstop

How Will This Affect Real Estate?

  • Tightening of credit

  • Lowering of loan to value ratios

  • Increase debt coverage ratios

  • Flight to quality and track record

  • Continued foreclosures and delinquencies (i.e. delinquency rates – sub-prime 2008 1st qtr. 18.79% vs. 1st qtr. 2007 13.77%

  • Increased inventory – all sectors

  • Lack of absorption

  • Affordability issues

  • Lack of financing options – e.g. new construction, end loans, corporate and business loans, etc.

    • Increased state and municipal budget deficits

    • Mortgage/recording & transfer taxes

    • Sales tax reductions

    • Lower rates of return on bonds, CD’s, etc.

      • The above will result in higher real estate taxes

  • Increased operating costs

    • Fuel – 20% to 35%

    • Utilities – 8 to 10%

    • Total operating increases from 4/2007 – 4/2008 NYC RGB 7.8%

      • Results in eroding bottom lines

  • Increase arrears and collectables

  • Continued layoffs – 35,000 financial sector jobs in NYC during 2008

  • Increased interest rate spreads = greater risk and higher cap rates

Positives

  • Conscious effort by all three government agencies

  • Unison with the world’s largest central banks

  • Lowering short term interest rates

  • Oil costs drop to less than $50/barrel

  • Corporations have not built up excess inventories

  • Commodity prices have fallen sharply as have inflation rates

Overall, the economic recovery is not evident through 2009, with some economists projecting a mild economic recovery by year-end 2010.  My forecast is a continued decline in all real estate sectors through 2010, in conjunction with rising interest rates by 2011.

Richard J. DiGeronimo, MAI, CRA, SRPA President/Founder of R. D. Geronimo Ltd. Mineola, NY Email: rjd@rdgeronimo.com

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