Skyrocketing Consumer Debt & Falling Rates
With home mortgages, the primary collateral for the loan balance is the home itself. In the event of a future default, the lender can file a foreclosure notice and take the property back several months later. With automobile loans, the car dealership or current lender servicing the loan can repossess the car.

Homeowners often refinance their non-deductible consumer debt that generally have shorter terms, much higher interest rates, and no tax benefits most often into newer cash-out refinance mortgage loans that reduce their monthly debt obligations. While this can be wise for many property owners, it may be a bit risky for other property owners if they leverage their homes too much.

With credit cards, lenders don’t have any real collateral to protect their financial interests, which is why the interest rates can easily be double-digits about 10%, 20%, or 30% in annual rates and fees, regardless of any national usury laws that were meant to protect borrowers from being charged “unnecessarily and unfairly high rates and fees” as usury laws were originally designed to do when first drafted.

Zero Hedge has reported that 50% of Americans don’t have access to even $400 cash for an emergency situation. Some tenants pay upwards of 50% to 60% of their income on rent. A past 2017 study by Northwestern Mutual noted the following details in regard to the lack of cash and high credit card balances for upwards of 50% of young and older Americans today:

* 50% of Baby Boomers have basically no retirement savings.

* 50% of Americans (excluding mortgage balances) have outstanding debt balances (credit cards, etc.) of more than $25,000. 

* The average American with debt has credit card balances of $37,000, and an annual income of just $30,000. 

* Over 45% of consumers spend up to 50% of their monthly income on debt repayments that are typically near minimum monthly payments.


Rising Global Debt 


According to a report released by IIF (Institute of International Finance) Global Debt Monitor, debt rose to a whopping $246 trillion in the 1st quarter of 2019. In just the first three months of 2019, global debt increased by a staggering $3 trillion dollar amount. The rate of global debt far outpaced the rate of economic growth in the same first quarter of 2019 as the total debt/GDP (Gross Domestic Product) ratio rose to 320%.

The same IIF Global Debt Monitor report for Q1 2019 noted that the debt by sector as a percentage of GDP as follows:

Households: 59.8%

* Non-financial corporates: 91.4%

* Government: 87.2%

* Financial corporates: 80.8%


Rate Cuts and Negative Yields

As of 2019, there’s reportedly an estimated $13.64 trillion dollars worldwide that generates negative yields or returns for the investors who hold government or corporate bonds. This same $13.64 trillion dollar number represents approximately 25% of all sovereign or corporate bond debt worldwide. 


On July 31, 2019, the Federal Reserve announced that they cut short-term rates 0.25% (a quarter point). Their new target range for its overnight lending rate is now somewhere within the 2% to 2.25% rate range. This is 25 basis points lower than their last Fed meeting decision reached on June 19th. This was the first rate cut since the start of the financial recession (or depression) in almost 11 years ago dating back to December 2008.

It’s fairly likely that the Fed will cut rates one or more times in future 2020 meeting dates. If so, short and long-term borrowing costs may move downward and become more affordable for consumers and homeowners. If this happens, then it may be a boost to the housing and financial markets for so long as the economy stabilizes in other sectors as well such as international trade, consumer spending and the retail sector, government deficit spending levels, and other economic factors or trends.

We shall see what happens in the near future in 2020 and beyond.

* The blog article above is a partial excerpt from my previous article entitled Interest Rate and Home Price Swings in the Realty 411 Magazine linked below (pages 87 - 91):
May 14, 2017

Why Commercial Real Estate Values are Improving


Since the Credit Crisis began back in the Summer of 2007, both commercial and residential property values have fallen significantly throughout the USA. As I have written before, property owners are more likely to walk away from their “upside down” homes, office buildings, retail shopping centers, or other types of properties if their existing mortgage debt exceeds their current market value.

Thankfully, home prices have begun to stabilize or increase in price ranges of between 5% and 20% + in various regions of the country over just the past year partly related to near record low mortgage interest rates. The faster and the lower that interest rates drop, then the higher the mortgage loan amount the prospective mortgage borrower will qualify for which drives home sales prices even higher.

Sadly, incomes for the vast majority of Americans have stagnated or declined since the start of the 2007 Credit Crisis. To best try to stabilize real estate values, the borrower either needs higher personal or business income levels, or access to cheaper money by way of incredibly low interest rates and more flexible qualification guidelines.

Lenders have more “skin in the game” than borrowers

In many regions of the USA, residential and commercial property buildings (i.e., retail, office, industrial, etc.) experienced price or appraised value declines of 50% or more since the last market peaks near 2006 – 2008, depending upon their region of the country. Increasing vacancy rates in small to larger retail shopping centers, office buildings, or other property types also made it more challenging for property owners to refinance or sell their properties at prices anywhere near the peak values in recent years.
When purchasing commercial properties just like residential homes, it is typically the lender who provides most of their own capital in the purchase deal as opposed to the borrower. Whether it be a 5%, 10%, 20%, or a 35% down payment invested by the property buyer, it is the lender who has more “skin in the game” or money invested in the deal. As such, the lender tends to not be as optimistic as the prospective borrower about the property since they have more of their own money at risk.

Commercial Underwriting Guidelines: It’s all about the numbers

When underwriting, analyzing, or investing in commercial properties, it is all about the numbers. How is the gross income? How high are the expenses or expense ratios? What is the true NOI (Net Operating Income)? What is the typical Cap (Capitalization) Rate used for the subject property’s building and location? How is the Cash Flow? What is the potential Cash on Cash return? What are the typical vacancy rates for the building type and region?

Commercial properties can be much more subjective deals for both potential buyers and lenders. Regardless of the building’s unique design style, prime oceanfront or downtown location, sales comparables in the region, or the quality of the tenants, lenders tend to look first at the numbers.

Many commercial loans are taken on by business entities such as LLC’s (Limited Liability Companies), Partnerships, or Corporations as opposed to individual borrowers. Some commercial loans are “Nonrecourse” in that the lender or creditor may only seized the subject property in the event of a default, and not pursue any of the individual members, stockholders, or partners for any additional remaining losses or deficiencies.
Cap Rates: How lenders and buyers analyze values
In years past, lenders typically used cap (“capitalization”) rates of between 6% and 10%+, depending upon property types and location. The capitalization rate is a measure of a property’s potential performance without factoring in or considering the mortgage financing. It is effectively the NOI (Net Operating Income) divided by the sales price.

The Cap Rate is also used to convert the expected future Net Operating Income (NOI) over time into a prevent value number today. Many borrowers today are willing to pay higher prices for all types of real estate partly since their borrowing costs are so low due to almost near record low interest rates. Cheap money and rising prices are akin to a “see saw” with one another.
The lower the cap rate used, then the HIGHER the potential sale price. Between the fourth quarter of 2002 and the first quarter of 2008, average national cap rates plunged from 9.3% to 6.75%. If investors and lenders can’t increase rental income numbers in the short term, then why not ease lending underwriting analysis calculations so that property values stabilize or actually increase?

As a result of the declining cap rates considered by both lenders and investors, commercial property values increased for prime buildings such as apartments or multi family, office, retail shopping centers, and industrial / storage facilities. As the Credit Crisis continued onward between 2008 and 2012, then more lenders began to consider lower cap rates for properties partly due to the rapidly decreasing interest rates as well.

Cap Rates = Interest Rates

Amazingly, some prime properties located in prime big cities like Los Angeles, Seattle, New York City, Baltimore, Washington D.C., San Diego, San Francisco, Atlanta, and Boston now may sell at cap rate prices as low as the 3% and 4% range for some multi family apartment deals which also parallels many of the best fixed rate options for mortgage loans today, surprisingly.
These rapidly declining cap rates are helping to increase commercial property values significantly in many regions of the USA today in spite of the ongoing sluggish economy, regardless of whether or not the subject property’s net operating income actually increased in recent times.

For example as it relates to trying to partly determine a commercial property’s potential value or sales price using much lower Cap Rates today:

* Net Operating Income = $100,000 per year
* Cap Rate using 7% equals an approximate value of $1,429,000.

* Cap Rate using 4% equals a $2,500,000 value.

** Please note that lenders use a few other types of property underwriting analysis formulas as well to better determine property values and loan amount limits.

Inflation is the key to prosperity when owning real estate

When incomes are stagnant or continue to decline, then one of the best ways to improve property values (commercial and residential) is to drop interest rates as low as possible and ease up the underwriting guidelines such as decreasing the allowable Cap Rates, considering higher vacancy rates, and being more flexible with the borrower’s credit and financial histories.

In spite of our questionable U.S. economy, residential and commercial property values have improved in many parts of the country. Cheap money and easier underwriting lending guidelines are two of the main reasons why property values have appreciated right along with our increasing rates of inflation.

Once again, real estate continues to be one of the best asset class hedges for inflation so more flexible underwriting guidelines can help property values continue to increase right along with the higher rates of inflation.


Hide Comments (1)       Add a new comment
Terry McGovern on August 24, 2013 3:30 PM
 Sir, I have enjoyed reading the article and, your companies outlook, very informative. Yet, do you not agree that investors are buying the residential distressed and/or re-habbed properties and the family buying unit is not involved due to the uncertainty of the continuous poor economy, the actual unemployment rate(14.3%) and the loss in value of the dollar.
I believe we are in A Mexican Stand-off in more ways than one, by the way, and with the Current Admin and Congress policies, rules, regulations , etc., we are going back to the DODD_FRANKS debalced legislation which got this country into this mess.
I know Real Estate, historically, trends up /down but to revert to these known failures are just ludicrous and irresponsible. Of course given this Current Admin I'm not surprised. Finally, are you saying the Cap Rates are being manipulated to increase the value of Commercial Properties?   THANK YOU 
Terry McGovern
Unified Investment Group, LLC 

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