Commercial Real Estate Blog

The Royal Bank of Scotland’s (RBS) chief credit strategist Bob Janjuah has issued a report to its clients to be prepared for a global credit and equity crash. Bob Janjuah forewarned against last year’s looming credit crisis. According to his report, the next three months will be nasty.

The report includes warnings that the S&P could fall by more than 300 points to 1050 by September. In debt markets, they are forecasting that both the high grade and low grade iTraxx indexes could soar. This index is a European index designed to allow people to trade the “Riskiness” of European debt, with the US having a seperate set of similar indexes as well.

What is key in the report has to do with inflation, the fed pumping money into the market, and what needs to be done about it. All the money being pumped into the market by the Fed is causing headline inflation to increase. Unfortunately we find ourselves in economic conditions which don’t easily allow the raising of interest rates. The economy, both domestic, international, and emerging markets will then be faced with further tightening of credit causing global growth to cool significantly.

The impact on commercial real estate could be significant; you would have the cost and availability conditions of debt to continue to deteriorate, coupled with the fact that risk premiums will have increased in other asset classes. This would suggest a similar jump in expectations for commercial real estate, which translates into higher cap rates and tighter, more conservative underwriting from institutions. Things are trending in that direction, and RBS’s report could suggest that we’re aways away from any reverse.

The Fed’s recent actions to help stabilize economic conditions are not impressing foreigner’s holding US debt instruments. The inflationary actions of the Fed have resulted in foreign buyers of US debt to essentially boycott government auctions for treasuries.

Over the past eight weeks, the share of foreign buyers participating in these auctions was somewhere around 25%. In last week’s auction, they represented only 5.8%.

Additional steps the Fed has taken or will take this week include bailing out Bear Stearns by essentially financing a JPMorgan takeover of Bear Stearns. The emergency overnight rate for bank’s was cut by 25 basis points, and in the Fed’s next meeting, they might cut interest rates by as much as seventy five basis points.

Unfortunately though, the Fed can only control short term rates. What the Fed cannot do is control long term rates and that is what will affect commercial real estate going forward. The current economic conditions, compounded by inflationary pressures and increasing long term rates does not bode well for holders of such real estate. What we see is people continuing to be bullish in certain market sectors, but it is hard to see how they envision that some sectors, such as Silicon Valley, will escape unscathed.

Time will tell who is right, but with a weakening dollar and thereby increasing commodity prices (for those priced in US Dollars), the effect will be felt in Silicon Valley. We are seeing some Venture Capitalists increasingly wary of their ability to raise any more money in this market and have become increasingly conservative in placing investments.

This has already and will continue to have an impact on the Silicon Valley Market.