Commercial real estate (CRE) investors and experts now live in a brave new world where government default is no longer infeasible and partisan politics threatens to unravel many of the pillars against which the CRE market relies for its relative stability. Analysts believe that default would undoubtedly cause a spike in interest rates, which would greatly impact the ability to acquire capital for CRE investment. And, that does not account for the damage that obstructionism has already caused in the form of sequestration that has hampered economic growth, particularly within the office market. For more on this continue reading the following article from National Real Estate Investor.
The inability of the two parties to work together in Washington, D.C., brought the United States dangerously close to a default in October. A last-minute deal was struck to continue funding the government for three months and raise the debt ceiling. The resolution ended the 16-day shutdown. But it set the stage for a renewed round of political wrangling after the New Year.
The showdown was over enactment of Obamacare. But such conflicts have become increasingly frequent and more reckless in recent years. What was once unthinkable—the U.S. government welshing on its debts—can no longer be considered out of the realm of possibility.
The cascading effects of a default would be catastrophic for the economy at large and for the commercial real estate industry in particular. But that doesn’t seem to be changing the strategies of either political party. There’s no attempt to find middle ground. And even when they have set supposedly damaging consequences—such as the automatic blunt spending cuts of the sequester—they have failed to reach a deal.
The result is a broad public distrust of Washington, with approval ratings for President Obama down near 40 percent and approval ratings for Congress in the single digits.
What does this mean for commercial real estate? For one thing, many decisions about what happens in real estate are tied to interest rates. The spread between various benchmark rates—such as the federal funds rate or yields on 10-year Treasuries—determine the cost of capital for commercial real estate. Spreads between the Treasury yield and prevailing cap rates are another important metric.
A default will result in an immediate and painful spike in interest rates. The repricing that would need to take place in the commercial real estate sector as a result would cause pandemonium.
And there are other effects that the crises inside the Beltway are having on the sector. At the macroeconomic level, Washington’s tactics, including sequestration and the shutdown, have slowed economic growth and the pace of hiring. Since commercial real estate generally tails the broader economy, the slow recovery in the broader markets also means a slow recovery for our industry.
Uncertainty translates into delaying big financial decisions at all levels. So consumers put off big purchases, which affects retail real estate. They put off vacations, which hurts the hotel sector. And corporations put off investing and hiring, reducing potential demand for office and industrial space. In general, uncertainty means delayed decisions about new leases and renewals, which translates into a slowdown in leasing activity.
There are also key pieces of legislation of importance to the industry. With the economic climate the way it is, it’s difficult to know how likely it is that these measures will get through Congress. Most pressing is the federal backstop for terrorism insurance. The backstop has been in place since 2002 and Congress renewed it on two occasions. The last renewal happened in 2007 and is set to expire at the end of 2014. There are bills in both houses of Congress that would extend the backstop. But given extreme attitudes of some members of Congress it’s no sure bet that such a backstop will be extended.
On the far left, the backstop is seen as a corporate handout to the insurance industry. On the far right, some have asked why the government involvement is necessary and if a purely market-based solution isn’t possible. A coalition of trade groups representing the insured and insurers is attempting to educate legislators on why the backstop is necessary. They are hopeful, but given the overall dysfunction, there is no guarantee that it will be extended.
This article was republished with permission from National Real Estate Investor.