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Deflation Fears Emerge

September 29, 2009

One of our recent posts discussed housing tax credits and the potential for them to cause deflation. Bill Gross of PIMCO, one of the most well known bond investors is now increasing his position in longer-term government debt, namely 5 and 10 year treasuries, as a hedge against deflation. The loser in his fund are mortgages, which the government is scaling back its purchases of.

Officials at Pimco have forecast a “new normal” in the global economy that will include heightened government regulation, lower consumption and slower growth. The economy will likely expand at a 2 percent to 3 percent rate going forward, Gross said.

Deflation presents a big risk for property investors and banks. The issue is that in a deflationary environment, appraisals based upon comparable sales or income valuing approaches tend to be fickle. The uncertainty which deflation injects into the system leads banks and lenders to keep a tight rein on debt, which will continue to keep the pressure on values. On the investment side, one of the asset classes to get hit hardest during deflationary periods tends to be multifamily/apartments. There is a lot of equity right now chasing multi-family deals, in large part because investors still have the ability to lever up the assets thanks to Fannie Mae and Freddie Mac programs. This can be highlighted by looking at recent offerings by Avalon in the South Bay where more than two dozen offers surfaced. Whether these deals end up making sense in a few years remains to be seen.

[via Bloomberg]

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Categories: Commercial Real Estate Investing | Trends
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Lancelot Lie October 2, 2009

I agree that deflation (or at least the lack of inflation) is the real concern. Inflation simply isn’t evident in bond spreads and 30-year Treasuries are now under 4% and 40-year tax free bonds are at their lowest in 40 years. Real estate is traditionally considered a hedge against inflation by many investors. But I think the competition for multi-family assets you may be seeing is simply the perceived limited supply of housing that the Bay Area suggests. Agency financing has helped prop up values on larger assets for sure. And I tend to agree that some price levels I see for multis (in Chicago) don’t seem to justify the yields I project in the supply-abundant, high-unemployment, consumer-constrained environment that lies ahead.

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