• JSO Valuation, Ltd.,

How Bad Was it?

Updated: Apr 21, 2019

Analysis by David Huffman - Real Estate Analyst at JSO Valuation Group

January 3, 2013

This bad [1]:

What kicked off the exceptional period of growth from 1944 to present? Innovation and productivity gains were largely responsible, however, they could only be executed due to savings and investment in capital infrastructure: including transportation infrastructure, machinery and equipment, and human capital. This boom (1944 – present) was initialized when corporate, financial, and household debt were at 80-year lows (to present). With that same debt now at approximately 300% of GDP, can we expect the same explosive growth over the next six decades?

Growth has slowed considerably since we have reached the peak of our ability to borrow. The income-generating capacity of the borrower is no longer able to support elevated debt service levels, whether the borrower is the US consumer (student loans, home mortgages, credit cards, etc.), state/local/federal governments, or corporations. Real GDP growth is therefore expected 1% to 2% for the long-term (two to three decades).

The Federal Reserve has done an exceptional job sustaining the status quo, though they have no tools left to fight the next crisis, as interest rates have been at 0% for years and quantitative easing policies are experiencing diminishing returns.

How does this Impact Commercial Real Estate?

  1. In the intermediate term (2013-2018), bonds produce little to no yield due to zero interest rate policy, forcing investors to seek risk assets (i.e. stocks) by design. Prices for both stocks and bonds are therefore very high. This stated policy of market manipulation by the Federal Reserve will make buyers of both stocks and bonds uneasy when making decisions based upon fundamentals. While also influenced by ZIRP [3] in the form of slightly elevated prices (from cheap financing), commercial real estate has substantially lower downside risk given the modest price gains from market lows (March 2009) to present (January 2013). This will be an attractive asset class for investment in the intermediate future.

As evidence, the following table [4] from a 2012 Urban Land Institute report shows the commercial property index for all property types, from 2001 to present.

In the long term (2018-2033), the Federal Reserve will end up keeping interest rates low even in the face of inflation. The Federal Reserve System [5] is dominated by doves [6], with more dovish members expected to be appointed in the second term of President Barak Obama (Bank Presidents serve 14-year terms). The Paul Volcker-style Fed that aggressively raises interest rates to fight inflation is very unlikely, as rising rates would devastate the economy in addition to state, local, and federal government balance sheets (which would be dominated by interest payments on debt, crowding out government services and social spending). These concerns simply trump any distress about inflation with the current and projected future composition of the Federal Reserve Board Members.

While inflation was challenged with conviction in the late 1970’s, current elevated debt levels and lack of political will to fix government balance sheets is going to result in inflation 5-20 years down the road, which will be utilized to alleviate debt burdens. See USA Inc.[7] by Mary Meeker for details on government balance sheet challenges. Following a browsing of this report, contemplate the likelihood that elected officials will generate the political will to meet these USA balance sheet problems with legislation. Inflation is a tool with little accountability and even less difficulty to implement.

Commercial real estate property owners are relatively insulated from these market changes, as commercial real estate is a hard asset that will generate enough revenue for debt service (as opposed to a deflationary environment such as the 1930’s) and operating expenses. Leases are generally negotiated every three- to five-years, and landlords have the tools to account for inflation in leasing arrangements.

Banks that issue loans for commercial real estate will be expected to have relatively low delinquency rates on loans as a result of the ability of property owners to meet debt service obligations. The Commercial Real Estate asset class is therefore expected to be a relatively secure long-term investment.

David Huffman, Real Estate Analyst at JSO Valuation Group.



  1. http://www.crgraphs.com/2011/10/employment-graphs.html

  2. http://visionbancorp.com/vb/finding-certainty-in-a-world-of-economic-instability/

  3. Zero Interest Rate Policy: this is an unofficial term referencing the practice of the Federal Reserve using monetary policy to keep short-term interest rates close to 0%.

  4. Emerging Trends in Real Estate 2012, Urban Land Institute, page 15.

  5. There are 7 Board Governors (including Chairman) that vote at every FOMC meeting, and 12 Federal Reserve Bank Presidents, five of which vote at each meeting (NY Fed President always votes, four additional Bank Presidents vote on a rotating basis).

  6. Doves: unofficial monetary policy term for an individual that prefers low interest rates as a means of encouraging economic growth.

  7. http://images.businessweek.com/mz/11/10/1110_mz_49meekerusainc.pdf