Equities, Real Estate, and Deflation

Over the past decade, real estate has become less and less real and has become more and more a piece of paper. MBS, CDS, venture capital, etc. have all helped to take real estate into the heart of Wall Street. By becoming just another asset class, valuations of real estate need to compete more and more closely with equities than anytime during past recessions.

It is therefore important to play close attention to valuations of competing asset classes, and it’s not news that there has been a dramatic decline in the value of equities. The issue at hand, however is how much further will that decline be and whether large-scale deflation takes place. An article in Bloomberg highlights that according to the Q-Index, equities have significantly more to fall. The reasoning behind this is very similar to what has led to trouble in the housing market. Couple falling asset prices with debt which doesn’t and equity gets wiped out.

If the forecasts for the S&P discussed in the article come to fruition, equities will continue to get cheaper and cheaper. In the face of such a decline, it will become very difficult for CRE to retain its current value, and will follow suit.

Banks and appraisers are already taking a very cautious approach in their valuations, which as far as those looking to purchase or refinance are concerned is deflation. Therefore, those who fear deflation and have more than 70% leverage on the books should consider making some sort of contingency plan for that eventuality. Otherwise, their 60-70% LTV today could be 80-90% LTV tomorrow, and making a refinance all but impossible.

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