Uncertainty raises its ugly head yet again
 
Uncertainty raises its ugly head yet again
08 JULY 2013 6:17 AM

The mood during the NYU Investment Conference last month was upbeat. Oh, what a difference a few weeks makes.

So soon after you were told all those wonderful optimistic stories at the New York University International Hospitality Investment Conference, the black swans flew over and spoiled the party.

The bond markets are in full panic mode, and the capital markets are volatile and uncertain. Commercial mortgage-backed securities lenders, who were holding hundreds of millions of loans that were slated for CMBS pools, now are faced with possible losses or surely diminished returns. They can only hedge to a degree, and there is no perfect hedge. Over the past two weeks spreads over swaps widened considerably.

The much bigger issue is they need to figure out how to set spreads and other terms going forward because the credit markets are highly likely to remain in flux and to be volatile for possibly months. That makes it nearly impossible with any high degree of certainty to know where to price loans today so they can be sold at a profit later when the pool is assembled.

With the new U.S. Q1 gross domestic product numbers just out and far below expectation at only 1.8%, there are some betting quantitative easing will continue longer than expected. There are also some who think the economy will continue to improve and QE might still begin to taper in September.

With such diversity of forecasts, it is very hard for lenders to really know where to price because they have to hold the loans for weeks or possibly months if the credit markets really remain very volatile and they can’t sell their inventory at acceptable prices.

Costlier loans for you
The result for you is higher cost loans, possibly lower leverage and tighter underwriting for a while until all this sorts out.

Bottom line, it is an expected constraint on values, and, as rates continue to rise over the coming two years, capitalization rates will rise, leverage ratios will decline as debt yield and debt coverage ratios become harder to achieve, and the cost of capital for buyers gets higher.

The optimists at conferences like to ignore these inconvenient factors. Rising rates have begun, and while there will be ups and downs in 10-year treasuries for quite a while, the overall trend is up from here. If rates do materially decline, it will be solely because of the economy going south again, which is even worse news for revenue per available room.

Now we see GDP was just announced to be 1.8%, materially lower in the first quarter than first thought, and lower than all the economists expected. So much for economic forecasters. That is 0.6% lower than the consensus. It is not awful, but it is far from acceptable.

Various Federal Reserve members in the past few days or so have publicly stated that unemployment will remain high into next year, and economic growth will be modest at best. Companies are on the road with salesmen, and reps, and conferences are being held—but not like it would be if the economy were really back on track.

Troubles abroad
Then there is still the rest of the world, which has shown little improvement. Europe only looks OK because a year or so ago we all worried the euro was going to split apart and Greece and Spain were going to default in a massive way. On a relative basis now it looks better.

But the Europeans have not solved any of their banking problems. They have simply subsidized the bad banks or taken them over, but they have not solved the weak balance sheets of the banking system.

China will get through its latest crunch because the Chinese can do things that most other countries can’t on a dictatorial basis, and they do not have a Congress or president who worries about politics instead of solutions.

And then there is the real black swan, which is the Middle East: Syria, Egypt, Iran, Hezbollah, Libya, Tunisia and Iraq. Egypt is in another revolution, and nobody knows how that will play out. It is like watching a tidal wave develop. You know it is coming to wash over the shore, but there is nothing you can do but wait for the destruction to occur.

Far more uncertain
The world is a far more uncertain place today than it was even a year ago. Just look at the circumstances surrounding National Security Agency contractor Edward Snowden, the Administration scandals, which are too numerous to count and will prevent President Obama from really doing anything for the economy. Then there’s “Obamacare.” And to top it off, the war on coal, which will just drive up your energy costs.

All this just as interest rates are rising. There is new uncertainty in the lending market, which nobody at the NYU Investment Conference predicted. What a recipe for all the rose-colored hype at NYU.

RevPAR might be up nicely for the past year or so, but at some point reality sets in, and then it gets very foggy. Stay liquid and be ready for anything over the next year or so.

Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com.

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