Tuesday, July 31, 2018

Change Is A Coming: How Current Economic Conditions Should Affect Real Estate Investment

Many economist and market pundits are predicting a market downturn, beginning some time in 2019 or 2020. All of the indicators of an overheated boom seem to be present--increasing margin debt, decreasing dividends, stock market price inflation and increased levels of corporate debt. Essentially, low interest rates have made credit more accessible. As a result, businesses are using credit to buy back some of their outstanding stock. In response to the relative decrease in availability of stock, stock market prices are rising, increasing household wealth across the nation. Spurred on in part by technological development, the economy seems to be booming at present, but it is important to note that mechanism that is fueling this increase in wealth is debt.

The Dangers of Debt

Although the use of debt in an economy is not an inherent cause for alarm, the financing of an economic boom through debt can lead to some undesirable outcomes. An increase in corporate debt without an accompanying increase in productivity simply means that companies are borrowing to appear more profitable, merely because money is available at low rates. Cheap money, however, has to be paid back at some point and without an increase in productivity to support the increased leverage, companies that borrow cheaply will have repay their obligations at their current rate of production with future dollars, which have less purchasing power.

Compounding this issue further is that the resulting increase in stock prices leads to an increase in the values of the portfolios of consumers throughout the nation. This increase in household wealth leads to an increase in consumer spending and borrowing. In turn, prices increase in response to the uptick in consumption. In the presence of increased productivity, such economic functionality is normally a mechanism of economic growth. Without increased production, leading to an increase in value created by this cycle of price increasing, inflation results.

Increased productivity is important to sustainable economic growth, unfortunately, it has been outpaced in the present economy by corporate and consumer consumption. The dislocation between interest rate activity and production growth is a clear indication that the monetary policy of the Federal Reserve is the true underlying cause of the economic boom. Unfortunately federal monetary policies alone cannot be the support an economic boom, as these policies will have to change once the economy show signs of overheating. Naturally, a change in the underlying support of an economic boom will cause a market crash.

What Does All of This Have to Do with Real Estate Finance?

As discussed, in a previous post, an economic downturn is the time to acquire real estate exposure, however, it is also a time during which credit is scarce. Accordingly, given the prevailing prediction of a market crash, capital acquisition should be the focus of savvy real estate investors. Therefore, now is the time to forgo acquisition in favor of increased occupancy and monetization. Given the low cost of money, now is also the perfect time to finance repairs that will facilitate higher rates and increased capitalization.

Although the argument could be made that once indicators point to a market downturn, it is already too late to begin preparation, it is better to adjust to eminent market conditions to the extent possible than not at all. The upcoming downturn, although unfortunate, can serve as an opportunity for the liquid, well-prepared real estate investor. A change is certainly on the horizon, be prepared and please feel free to provide your prospective on the matter below.