LOOKING BACK AND LOOKING AHEAD IN 2010

I am a firm believer in enthusiasm, both in business and in life; I think it is equally important to stay sharp and to deal with realities. I stress this now because we are approaching the New Year, which is always a time to reflect. Added to this, we also happen to be entering into the recovery stage of what has been a gruesome recession. In fact, it was the deepest recession since the Great Depression of the 1930’s. Fantastic news, right? Not so fast. Although it is comforting for all of us to hear the word “recovery,” I do not think that we are out of the woods, yet.

THE FACT AND FIGURES– LOOKING BACK & FORWARD

As the rate of growth or contraction in Gross Domestic Product (GDP) is the primary technical measurement of whether our economy is in or out of a recession, the 2.8% growth between July and September, by official accounts, marks the end of what has been a very rough two years. Most economists will assert that recessions are much more dynamic than a shrinking GDP. The good news is that recent estimates from the Federal Reserve project that in 2010 the economy will continue to grow in the neighborhood of 2.5% to 3.5%. That is pretty good.

In addition to good GDP news, the Fed also announced that it was maintaining short-term interest rates at the 0% to 0.25% in order to ensure that credit continues to flow properly again. Hopefully, banks will get the message! Once rates start to go up, it is the signal that inflation is right around the corner.

Consumer confidence and spending are up. Holiday sales were up, but that did not necessarily mean profits due to heavy discounting. If you have not already heard, the economy is counting on you to buy a 50-inch LCD television… no, make that 60”. But just know that it is all for the greater good.

Is it a big surprise that the housing market remains a mixed bag? With mortgage rates set at record lows, sales have been up, which has led prices to follow suit. While this chain of events seems to suggest that the housing market has finally stabilized, current data indicates more trouble on the horizon. The latest Standard & Poor/Case-Shiller Report revealed that prices only rose a marginal 0.3% during September. This weak figure has prompted concerns that prices could again backtrack as much as 10% in 2010. Added to this, foreclosures are likely to climb in the first half of the next year. This is in part due to the deep reluctance of banks to provide refinancing. I anticipate a showdown or two (or three) in the near future between the Obama Administration and lenders over this issue. We saw the President muscle the big bank CEO’s during a White House meeting with them. The other major culprit that could potentially push-up foreclosures is unemployment. In fact, unemployment will continue to be a major economic hurdle that will impact not just the housing sector, but all other aspects of the recovery.

Speaking of jobs, the national unemployment rate in November was 10%, down from 10.2% in October. As a bit of historical background, the jobless rate has only been above 10% twice since World War II, the other instance being in 1982, when it reached 10.8%. The good news for November was that only 11,000 jobs were lost, compared to October when the figure was 111,000. I am sure that the White House was all smiles the day of the press release. However, the economy shed a larger-than-expected 85,000 jobs in December, which left the unemployment rate at 10%. But reassuringly, the unemployment estimates for 2010 have been reset to range from 9.3% to 9.7%, down from 9.5% to 9.8%. Looking forward into 2011, the jobless rate projection currently stands anywhere from 7.2% to 8.7%.

In short, we are headed for a very slow job recovery. Some like to call it a “jobless recovery.” At the Fed, the word around the water cooler is that it will take five to six years before we see the employment situation return to healthy levels. Unless you are a Socialist, an acceptable level of unemployment (what economists call “full employment”) is 5% to 6%. When do we turn the corner on jobs? According to the experts, including Lawrence Summers (Obama’s top advisor on the matter), the turn around should happen sometime around the spring. But even then, we are just shifting from awful to bad. Hey, at least it’s a start! Job growth is the engine of economic growth, period.

To further compound the issue, the unemployment figures that are most often quoted in the news really only paint just part of the jobless picture. Surprise! There is more than one unemployment rate. The “U-6” rate offers a more comprehensive account by tracking the following: a) the unemployed who are looking for work b) the underemployed (i.e. those who are working for less than they want) c) the unemployed who have given up on trying to find work. All these groups combined raise the unemployment rate to 17.5%. A very scary figure, indeed.

Speaking of scary figures, let’s look at California. As we all know, the Golden State has been hit disproportionately hard by the recession. Much of the economic growth during the first part of the decade came from rapid growth in the housing sector. More recently, major declines in tourism and international trade have combined to create a triple-whammy of hurt within our state. This, combined with some probable not-so-great politics, has forced California into yet another staggering $21 billion projected deficit.

In August, unemployment reached a 70-year high of 12.2%. According to the latest UCLA Anderson Forecast, this staggering figure peaked in December at 12.7%. While seemingly positive, the report, however, does not foresee joblessness dipping below 10% until 2012. This is even after the state economy begins to grow in 2011. In short, we have a lot of unemployment to contend with for a long time to come.

As for housing, though prices have been climbing for the last few months, the foreclosure rate, as I mentioned above, is expected to increase into 2010. Evidence of this can already be seen in the second half of 2009, as foreclosures jumped to 14.41% in the Third Quarter, up from 13.16% in period before. Put another way, 1 in 7 homes are in some form distress.

REAL ESTATE– BIG PICTURE

In order for the real estate market to stabilize we need job growth. Until the economy adds a substantial level of jobs, we can continue to expect continued downward pressure on rents, high vacancies, and diminished values.

Out of this scenario comes another predicament, which is sure to make the headlines more in the coming year. I am referring to the maturation of commercial real estate loans. The topic has several facets and many opinions as to what will actually play out. But the most immediate concern is that the significant drop in rents, which affect the property’s total income, could ultimately lead to borrowers defaulting on their mortgages. Hundreds of millions of dollars of loans are coming due in the near future. The situation is very similar in size, scope, and cause as to the housing crisis. On a very large and devastating scale, owners may not be able to get refinancing on their mortgages because property values have plummeted far below the original purchase price. When the value is less than the loan, it is called being “underwater.”

To give you a glimpse of what is in the works, opportunity investors (also called “value-added,” “bottom-fisher,” and “grave dancer” investors) have spent the last few years raising hundreds of billions of dollars in order to swoop-up what could be a major surge of these distressed properties. More on this in the first quarter….

REAL ESTATE– CLOSE TO HOME

After all the excitement of easy credit and fast-moving deals that were priced to operating perfection during the first half of the decade, real estate has returned to its rightful place of being an industry of realities and fundamentals.

Where do you stand with your property? In many situations, I have calculated a 1% to 2% return on the current equity of an owner’s property when the owner thought it was closer to 7% to 10%. The key word is current. People tend to remember what they paid and put down on a property, and then use that as a benchmark. The truth is, with years of appreciation and loan pay-down, the equity grows. If rents have decreased even a little, then the return on current equity is going to be lower than you think. Let’s get together and analyze your situation and figure out if you’re making less than 5%. You could be making 8% to 9% returns by exchanging into a new property.

I understand that it is difficult to take the first step towards positive action. But what is the alternative, a deeper bottom? There is no rule stating that you have to sit back and watch your investment deteriorate. In fact, smart investors refuse to let this happen. Smart investors do not wait and hope for the best. Whatever your situation, there are a number of alternatives. We can tailor make an investment recommendation to fit your needs. If you are not getting appreciation, at least you’ll be getting cash-flow. The longer you hold onto what is not working, the harder it is for me to help. It happens all the time in the stock market. Your broker calls you and says that you have had a nice run up (or bad run down) in Microsoft, so let’s move the money to Apple. Bing, bang, boom, it is done.

In many situations switching your investment into a single-tenant, “Triple Net” (NNN) commercial property offers the best solution. These are well-known, financially stable entities that are leased on a long term basis. The NNN leases are when the tenant pays for all the expenses (real estate taxes, property insurance, and building maintenance). You do not have to manage the property; just simply collect the check every month. Sweet! Your income will grow substantially, and there is a deferred tax liability on a capital gain for conducting a 1031 exchange from your current property to the new asset.

Unfortunately, values and rents will continue to be in jeopardy in 2010. In response, astute buyers will turn their equities into cash-flow properties as discussed above. Why own a property experiencing rent reductions, vacancies and negative appreciation when you can get a cash-on-cash return of 7% to 8.5%?

Due to my knowledge of the marketplace, and the extensive research my team does to keep updated on the local Santa Monica/Westside apartment markets, I can accurately pinpoint the value of any Santa Monica/Westside property. If you want to know the value of your property in today’s current market, I am always available to give you an evaluation.

I would like to wish everyone a great 2010. I look forward to working with you to improve your current investment holdings and to maximize your returns.