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  • Leonard Brecken

Realestate: Better Prepared for Downturn?

I recently posed this question to a few executives and my conclusion is maybe. Every down turn is different, although it may share similarities with those in past. The reason I say maybe is that those executives resoundly said the industry wasn't building spec homes lie in past which translated into less leverage and as we all know less supply. However, most executives/business owners tend to only address what "bit them" last go around and never address the broader economic issues this time around. Thus, if the environment is different then so will the fall out of a downturn. Thus, addressing the problems that arose last time around may not address them this time around.

What's different this time around vs 2008 is that the last 2 economic bubbles were specific to technology & credit tied to the mortgage industry. This time around we have the introduction of much lower rates initially, higher leverage (corporate, auto loans, government, student loans) across the economy than anytime in the past and trillions in liquidity (which is now being withdrawn) added to the monetary system by central banks. Further, we have the introduction of tax cuts which in theory should spur economic growth despite the reversal of interest rates. Thus, the environment is different so the fall out should be. The distortions of asset prices (ie them appreciating) is much broader this time around than before which is a key distinction vs past down turns. And the effects of when they reverse will be felt more broadly as well by definition.

The real estate industry has addressed a key risk factor by reducing leverage when times are good, but that doesn't mean they have enough runway cash wise to sustain a broader fall in asset prices. And that is my fear particularly since margins have been under pressure and on the personal side individuals haven't saved enough. The best defense against detrimental effects of a down turn is CASH. And in turn its your best offense when the cycle once again turns higher. So plan accordingly, as the environment risk wise has increased vs even a year ago. For our clients we conduct scenario analysis to assure their operations can sustain a pause in growth and scrutinize new projects to assure they carry higher returns of investment vs the past.

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