Before I jump into the history lesson for the day, let me set the context by explaining the elementary moral of the laws of economics. As they say, “economics is the painful elaboration of the obvious.”  And while this old joke is true, the laws of economics do not bend or bypass stature. This is why we call them laws. There is no immunity to a government or an individual who accumulates too much debt. You either have to spend less and balance or face insolvency.  The same law of economics applies to the United States Federal Government.

Our first option is to implement austerity measures. Australia, among other countries, should be looked to for inspiration.  Australia went through a downgrade experience. In 1986, both Moody’s and Standard and Poor’s downgraded Australia’s foreign currency rating. Australia was downgraded a second time in 1989, after little action was taken to make the necessary changes. The shockwaves of the second downgrade sent Australia into a deep recession. The treasurer, Paul Keating, cautioned that Australia was in jeopardy of becoming a “banana republic.” Instead of running budget deficits and playing the blame game, he altered the direction and, after two years, delivered the first surplus. “But that did not get our credit rating back,” Keating said. “We did not recover our AAA rating until 2003.” It took a little over 17 years after that first downgrade for to Australia completely recover.

Canada also endured a manifold stage downgrade over a period of several years. In October of 1992, S&P dropped Canada’s foreign debt rating by one notch from AAA to AA+. Interestingly, there was little impact on Canadian markets. Moody’s followed S&P and downgraded the foreign debt rating by one notch. The 10-year note increased 0.45% over the subsequent months and stocks plunged 6%. In April 1995, Moody’s downgraded Canada again. In reaction to the downgrades and severe negative economic news, Canada enacted strict budget reforms. Prime Minister Jean Chrétien slashed federal spending by a monstrous 20%.  He fired 23% of public sector workers, raised taxes, cut defense expenditures by 15%, lacerated certain subsidies by 40% to 60% and eradicated some ministries completely. Canada did not regain the prestigious AAA rating until 2002.
There are two things to be cognizant of in the next few years. Both Australia and Canada reported minor hiccups in economic growth after the 1st downgrade. It was only after the second downgrade did both countries experience a chain reaction to brutal economic consequences. They also reacted with swift and bold changes only after the second downgrade. If history is any guide, not much will change with the 1st downgrade. As it sits now, S&P has the United States on a negative outlook. It only seems reasonable to assume we will be downgraded again. A second downgrade seems especially eminent because Congress has such a wide ideological rift in remedy for the debt problems. The second thing to be aware of is the status of other AAA rated countries. Besides Australia and Canada there are 12 other countries with a AAA credit rating. The other countries are Austria, Denmark, Finland, France, Germany, Hong Kong, the Netherlands, Norway, Singapore, Sweden, Switzerland and England. In the near future, I can see most, if not all, of the European nations challenged with a downgrade. France and England seem especially vulnerable in these volatile times.

Option number two is to inflate our way to “prosperity”. Quantitative easing is a fancy way of saying the Fed is going to print (or as they say “digitize”) money to ease our debt and stimulate the economy. Hoping that this will pave a way for a brighter economic climate is just as wishful as magically finding the other side of the rainbow. It does not work. The by product is always inflation or hyperinflation. Inflation is a law of economics. History is my witness.

Think Weimar Republic, Germany, post World War I. The German Mark ratio to the U.S. dollar was 4 to 1 near the end of the war. It was 8 to 1 in 1919, 250 to 1 in 1921, and 2000 to 1 in 1923. Hyper-inflation hit so hard that newspapers sold for $100 billion marks! It was reported that most people were paid by the hour so individuals could purchase goods during their lunch break before the mark slipped further into the value of nothing.

In 1989, after years of massive budget deficits that were financed with borrowing from abroad, the Argentinean government resorted to the printing press. Hyperinflation soon kicked in. It was reported that grocery stores did not price any inventory. A man with a microphone would broadcast the prices of numerous items, frequently increasing the price every few hours by 30% or more. Workers would get their pay in cash and dash to the store to buy anything. By the end of the week their pay would be worthless.
Zimbabwe has been plagued for years with colossal deficits. In 2008, Zimbabwe’s annual inflation rate reached 516 quintillion per cent, that is 516 followed by 18 zeros. For the common Zimbabwean, the end result is atrocious. They must spend money as soon as they get it before it loses its value. The dysfunctional economy means that goods are in dreadfully short supply and they must spend hours searching for things to buy.

Of course, these are extreme examples however it goes to show, inflation is not a theoretical issue; it is reality. There are many other examples such as Hungary (1946), Japan (2001), and the United States (1933).The history and consequences of hyperinflation is required material in most Latin American schools. The United States is not exempt to these fundamental laws. Expect QE3 to be on the horizon despite many assertions to the contrary.

We are at the crossroads of a very important historical decision. Quantitative easing is the hail marry of economics. It is the last resort. For the sake of the future of this country, I hope we can find a way to reduce federal spending and find a way to balance. It really is the only way of out of this hole.
Brandon Saylor
-Associate

I know it has been a while but I truly want to get back into the swing of things and keep this blog going.  Once recognized as one of the top ten commercial real estate investing blogs in the country….now….just another blog…maybe worse.  I hope to fix that in the next coming months.  So….I would like to kick things off …..again….

I would like to introduce you to my buddy and colleague, Brandon Saylor….he’s a writer and a good one at that…..check out his latest below.  Brandon is sometimes controversial but….I agree with most of what he says…if not all.  With Brandon’s permission….I will be posting Brandon’s writings on this blog.

Brandon Saylor

Anatomy of an Economic Bubble

This recession has taught me a lifetime worth of knowledge. Observing the catastrophic meltdown that occurred in 2008 seared lessons within me. One of these fundamental lessons is the understanding of economic cycles and the red flags of danger. In short, the economic meltdown of 2008 began with the bubble bursting of credit markets affecting everything from real estate to the stock market. It is paramount to understand the anatomy of a bubble and the natural economic cycles that ebb and flow through time. Below are the main stages of a bubble.

There are no time limits between each stage. The “stealth phase” is the 1st phase in which the asset is adhering to its core fundamentals. Subsequently, the “awareness phase” is when the value of the asset begins to rise above its fundamental value. In the third phase, the asset value explodes as the media begins to remark about its escalating value. A swelling number of investors eulogize the merits of the asset as they merge with the cause.

In the final phase, the value of the asset begins to dissipate. Many naive investors still believe it will continue to increase in value. The daunting reality sets in that the asset is overpriced and everyone tries to get out. Unfortunately, many are left behind as the value of the asset plummets to its long term fundamental value.

Conceivably, the most legendary and oldest, well-documented instance of a speculative bubble is the “tulipmania” that hit 17th century Holland like a bomb. The tulip became an instant hit upon its introduction to Western Europe in the mid 16th century. Dutch collectors developed a hierarchy of tulip varieties based upon their species and coloring. Because it was impossible to determine which variation would bloom from a particular bulb, the tulip grew into an asset of speculation. Before the 1630s, the bulbs were popular among the extreme wealthy and were flaunted to exhibit class. By the mid 1630s, the obsession caught on with the middle class and lower socioeconomic classes. The increased demand caused the price of the bulbs toescalate dramatically.

The market reached its pinnacle in late 1636 and early 1637, after the bulbs had been seeded to blossom the following spring. People mortgaged their homes and traded in their savings in order to buy rare and exotic bulbs to resale at higher prices.

In February 1637, as winter turned to spring the bulbs were close to flowering, consumer confidence evaporated and the market suddenly crashed. As the price collapsed, nobody would buy the bulbs, even though they offered them at one quarter of the sums they had paid for them. The tulip bubble burst is alluded to in the recent sequel of Wall Street 2.

Economic bubbles are a reality of any capitalistic monetary system. The point of this email is to recognize the red flags before it is too late. The first red flag is to recognize the larger macroeconomic forces that dictate the market. It is now understood the catalyst for any bubble begins with easy money. The Austrian School of Economics believes “asset bubbles occur when there is an extended period of low interest rates coupled with an expansion of credit. The availability of cheap money encourages speculation in one or more asset classes causing the price to escalate rapidly exceeding their underlying fundamental value.” The availability of cheap money promotes an over abundance of growth. Consequently, a bubble ensues. Bubbles can be an excellent way to make money if you get in at some stage in the “awareness phase” and get out before you reach the inevitable landslide. The key to success is to not be trapped when the eruption begins.

What is the next bubble? In the past decade, we have had the escalation and crash of the dotcoms, the oil bubble and the monstrous credit bubble following the oil crash. Is the stock market the next big bubble? The Dow Jones industrial average is now trading at 86% of its all time high of 14,164.53. Is it gold? Gold is constantly breaking record prices for the value of a troy ounce of gold. Could it be the bond market? Another energy bubble? At this point, it is hard to determine which market/asset is going to be the next bubble. However, armed with the knowledge of warning signs it will be easier to decipher the craze when an asset is going gangbusters.

Ultimately, there are two things about economic bubbles I want to leave with you today. Greed intensifies the problem and it is the definitive drive to astronomical prices. As they say, “Avarice has ruined more souls than extravagance.” And ask yourself does this type of speculative behavior make sense?  Does gold trading at $1,455/oz make sense? Is the stock market value reflective of the health of the economy? Does $107/ barrel of oil make sense? If common sense does not fit the reality of the time then maybe it is a good time to get out before it is too late.

Have a great weekend my friends!

-Brandon Saylor

Good stuff huh?

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Until next time….rob

I am still trying to get back on top of things.  This summer has been extremely busy….but great too!

I have received a number of emails regarding my blog.  Honestly….I was surprised.  Thank you!  I need encouragement all the time and your emails and your request for me to write more has given me the inspiration to start again….so….here we go.

A jump start in the real estate market?  Well….yes and no.

I do most of my investing in the Southwest.  El Paso, TX is going nuts.  Did you know El Paso is experiencing a housing shortage?  A huge deal indeed.  Last year my partners and I purchased a down-and-out apartment complex and today it is running 100% occupancy…..that is after rent increases.  Yes….more rent increases on the way.  This apartment complex blew our conservative analysis out of the water.  Now….investors are heading to El Paso, TX from all over the country.  2500 units online to be built in 2011.  Experts are saying that is 5000 units short of what is needed.  Unreal!

Well…what about Albuquerque?  As an associate broker with Grubb & Ellis | New Mexico, I am seeing a hint of recovery.  We are seeing an increase demand for retail space and a little more activity in other real estate sectors.  Although we are no where close to what the demand was two years ago.  Albuquerque commercial real estate is doing much better than 2009.

Overall, I strongly feel this is a great time to invest especially in markets that have hit bottom and are now starting to see a hint of recovery.  In the Southwest, El Paso, TX is well on its way. Albuquerque, NM is starting to crawl out.  Keep an eye on Arizona and Nevada….I am predicting that it will take a little longer for them to hit bottom.  Hard to believe it could get worse for those states huh?  Maybe I am wrong.  Either way….the time to buy is here.

Until next time……rob

‘A whole lot and a whole not’ sums up the last few weeks here on the blog.

How long has it been?  Well, it has been one heck of a ride for the last few months.  I have been attending a few luncheons, a couple seminars, and a handful of meetings and they are all saying the same thing:

‘Cash-rich investors are sitting on their money waiting for commercial real estate to hit bottom.’

Once it does, the assumption is the investors will jump in with both feet.  This is what is called vulture investing.  You can read more about it HERE.

The belief is that there will be a dramatic tipping point sometime late this year or early next.  The assumption is that this ‘tipping point’ will start with the banks doing a mass liquidation of assets that are on their books.  This huge sell off will be a mountain of discounted assets in order to move the assets quickly.  This will led a domino effect that will dramatically pull values down even more.  I guess the real question for me is what is taking so long?   We are seeing a little bit of liquidation here and there but not what everyone was expecting.

Although there is some positive press that things are turning around.  Most experts don’t buy it.  What do you think?

When a question like this comes up, I start following the money.  The problem is the money is not going anywhere….hence…there is my answer.

Until next time…..rob

In simple terms, this process, executed with the help of a mediator, allows you to avoid paying capital gains tax (for now) when you sell a commercial property.  The catch?  You have to put your profits into the purchase of another (bigger) property within a certain period of time.

Want more details?  Read on!

How Can A 1031 Tax Deferred Exchange Work For You?

A tax deferred exchange is a simple method that a property owner employs in a property trade without having to pay the federal tax on the transaction. Generally in an ordinary sale transaction, the property owner is taxed on any gain he or she realizes by the sale of the property. But in exchange, this tax is deferred until some future time when the acquired property is sold. Authorized by the Section 1031 of the Internal Revenue Code, these tax rules are sometimes referred to as 1031 exchange rules. The transaction however must carefully meet the section 1031 rule set and must be structured in such a way that the transaction is in fact an exchange of one property for another and it is not a taxable property sale.

When you look at it, the tax deferred exchange is actually an investment strategy that people are often not aware of. One of the misconceptions on the 1031 exchange rules is that an exchange requires 2 parties who want each other’s properties. However, in reality though, such two-party swaps rarely occur. Today, this exchange can be accomplished by involving four principal parties that include the exchanger, the seller of the replacement property, the buyer of the relinquished property and an intermediary. These parties often do not even know each other and may be located in different states. Furthermore, the exchange properties do not have to close at the same time. As long as the 180-day deadline has not been met, the exchange is considered legal and thus tax-free.

You Need To Know And Understand The 1031 Tax Deferred Exchange Rules Before You Sell Your First Property

It is clear that 1031 exchange rules have the advantage of shielding the exchanger from incurring immediate tax liability. Upon the death of the taxpayer, the deferred tax is forgiven and the taxpayer’s estate never has to repay the ‘loan’. A tax deferred exchange nevertheless carries the disadvantage of additional fees for entering into the agreement. These costs could be attorney’s fees, accounting fees, intermediary and accommodation titleholder’s fees. The taxpayer is also not allowed to use the net proceeds from the property disposition other than in real property re-investment.

1031 exchange rules offer a taxpayer the benefits of tax deferment. However, this should not be the only reason to enter into a deferred exchange. Business decisions like the need to consolidate investments, increase cash flow, relocate a business investment, obtain greater real property appreciation and eliminate management problems should play the dominant role. When all of the above factors are considered, one may be in a better position to engage or disengage from a tax deferred exchange.

For More Information

If you need more information on 1031 Tax Exchangers, drop us a line and we will let you know who we recommend.  We can also help put you in touch with an agent if you are looking to sell or buy a property.

Just let us know how we can help – and best of luck with your first 1031 exchange!