Riding Out the Recession in Commercial Real Estate: Time to Hold?

Our property with a Walmart store has arguably declined 25% in value in the last six months. But cash-flow hasn’t changed.

By John E. McNellis, Principal at real estate developer McNellis Partners, for WOLF STREET:

Years ago—beset by the Great Recession—one of Tennessee’s finest developers shook his head at his financial statement and drawled, “My net worth’s gone down by half, but my cash flow’s the same.” He wasn’t alone. Commercial real estate nationwide lost around forty percent of its value during those trying times.

His rueful comment acknowledged two things: his portfolio’s plunge in value, but more importantly, the fact that it really didn’t matter. While worth half as much, his properties were still occupied by rent-paying tenants.

Because this savvy investor had lived through several recessions—they’re like high school reunions, they sneak up on you—he’d been downright abstemious with the mortgages he’d placed on his real estate. With little existing debt, he wasn’t forced to fire-sale his properties when their loans came due; he could refinance instead. Thus, his only losses were on paper—the shrunken numbers on his financial statement—and he still collected his rent. And when the market rebounded in a couple years, his financial statement recovered.

Fast forward to today.

Real estate values may not have dropped much yet, but they’re staring down the bunny slope. We looked at our retail holdings in January, thinking we’d do a little pruning. We considered selling a Walmart supermarket in the Central Valley, and asked one of our favorite brokers what it would fetch.

Because its Walmart lease is short-term, he said the property would sell at a 6 percent capitalization rate; that is, a buyer would want to earn 6 percent a year on her purchase price. Hence, if the rent were $200,000 a year (it isn’t), the purchase price would have been $3.33 million ($200,000/.06 = $3.33 million).

We weren’t ready to sell in January, but we were last week. We checked back with our broker. Somewhat sheepishly, he explained that the nightmares of the last six months—the bear market, the soaring inflation and interest rates—would have buyers insisting upon an 8 percent return today. This means that our Walmart would now sell for $2.5 million ($200,000/.08 = $2.5 million).

In other words, this property has arguably declined 25 percent in value in the last six months. Like that canny Tennessean, we decided we’d rather keep our losses on paper and elected not to sell.

This example demonstrates the close resemblance single-tenant retail properties bear to the bond market: The price of both declines when their returns rise and, conversely, increases when their returns fall. And, to oversimplify things a bit, the value swings of each are irrelevant if you don’t sell: If you buy a $1000 Treasury bond paying 5 percent interest and keep it to maturity, you’ll get your 5 percent every year and all of your principal back. But sell when interest rates climb to 10 percent, and you’ll only receive a much lower price. On the other hand, sell when interest rates fizzle to 2.5 percent and you’ll get a much higher amount.

The same math works for single-tenant retail: if you don’t sell, your “cash flow’s the same.” If you do, you ride the market like a mechanical bull.

My example also implies a different point: Even if we concede a breathtaking fall in commercial real estate values—it’s possible—we’re unlikely to see the emergence of a vibrant buyer’s market.  Instead, sellers with the financial wherewithal will put their wares back on the shelves and await a sunnier day before selling.

Rather than a buyer’s market, we’re likely to see buyers and sellers dug in a mile apart, entrenched in their own expectations, while we watch the market’s velocity evaporate like spit on a griddle.

The sellers forced out of their redoubts by death, divorce, dissolution, disaster, or simply over-leverage may indeed be slaughtered, but there’s so much money chasing real estate these days that even they may live to fight another day.

Back to that shrewd Tennessean. He understood that net worth is for bragging, cash flow is for eating. So might you. By John E. McNellis, author of Making it in Real Estate: Starting Out as a Developer.

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  198 comments for “Riding Out the Recession in Commercial Real Estate: Time to Hold?

  1. Brandon Gray says:

    “Rather than a buyer’s market, we’re likely to see buyers and sellers dug in a mile apart, entrenched in their own expectations, while we watch the market’s velocity evaporate like spit on a griddle.”

    I’ve been shopping for a home in rural New England and this description of the commercial RE market perfectly describes what I’m seeing in the residential RE market. More homes are on the market but high prices are keeping them on the market for far longer than even 4 months ago.

    • SocalJohn says:

      Way too soon. Takes time, then the prices will drop.

      • joedidee says:

        in commercial the banks will soon need nice appraisers
        to keep the values up they will throw out all cash sales
        cash sales will be 30-50% lower
        but I’m seeing LOTS OF EMPTY COMMERCIAL
        and cannot come up with WHAT/WHO will use it

        so the real decline is JUST STARTING

        • Dale says:

          Near me is a strip mall that was brand new in 2004, but completely closed down by 2009. Surrounded by million dollar homes, it stood vacant until last year when redevelopment started.

          How many other zombie CRE properties are there? The owners of this property didn’t feel a need to redevelop for 12 years. How long can zombie properties continue?

    • NBay says:

      I just needed a place to maybe further confirm Wolf’s analysis on that Walgreens SF “shut downs due to crime” MSM BS that he went through a while back.
      The one I go to in SR, 50 mi north, is failing, I think. It seems maybe their “7-11 drugstore” model for mostly wealthy people to pick up Rx (pay a bit more) and/or maybe get some over priced sundries after work or on quick shopping trips isn’t working anymore.

      It’s in a pretty wealthy neighborhood and on main hwy to many more, but the shelves are getting bare, more junk, staffing one Pharmacist and 2-3-4 max underpaid (big turnover) pill counters/counter service people. Other than phone menu, (which will nicely tell you ready at 11am tomorrow, and you will come in at 2pm, wait in line, then be told it’s not ready, and wait 30-45 min or more), you can seldom speak to a person in the pharmacy any more. Last time phone was obviously shut off…never rang for an hour.

      Had long discussions waiting with other people who, like me, never had a problem there for years. Happened pretty quickly….3-4 mo? We even told a well dressed lady who was wasting hard working clerks time yelling about her cat medicine to shut up and wait like the rest of us. She left.

      Not sure if it’s temporary screw up and they will correct things or just close. I just plan for an hour wait now, and kinda suspect the latter.

      To me it’s just more austerity….it’s everywhere, get used to it. I am very fortunate I am retired only have one monthly Rx, eat simple, and have free time.

      Noticing understaffing at grocery store, also, along with close to expired milk, easily day old bread (which I don’t mind, it’s all I used to get before they closed the day old stores years ago) and even had to move a grade up from the store brand milk because it was freezing on me…thinned out with water, I guess.

      But I have shelter and food which makes me lucky…many don’t.

      • Alex says:

        No need to wait an hour or drive anywhere at all… discover Amazon Rx.

        • El Katz says:

          Mark Cuban’s Cost Plus Drug might have Amazon beat. The one drug I take is $96 via CVS mail (with insurance). $17.10 on Cost Plus.

      • NBay says:

        Thanks but no thanks. I have the time to buy local and will continue to. Not supporting Bezo’s or Cuban’s empires. Rx only $2-3 bucks anyway, 60’s drug, out of India last I saw. Or any stocks. Still don’t have 36K on 2012 Frontier…including Tucson round trip and 140 mi trips to work on off grid container house where I finally killed well worn back…hence the pills……don’t need much.

        Main point was just possibly confirming Wolf’s “NOT shut down due to theft”, but rather stupid business decisions, anyway, plus a run of the mill inflation complaint.

    • gametv says:

      I dont know about the specifics of this real estate, but it looks like we have a massive shift in the debt markets and that will mean a re-pricing of everything that is financed by debt. To think that the real estate value will bounce back is a huge mistake. This is the first phase, the denial stage.

      If this is a short term lease, then the Walmart will negotiate a lower lease rate when it comes up, citing the current real estate market.

      In a long term downtrend, the people that sell out first are the ones that win.

  2. Crush the Peasants! says:

    Valuations are hypothetical, but money received is not.

    • Cas127 says:

      Agreed, the valuation compression isn’t that different from the fall in absurd PE ratios for stocks…and both are attributable to the rise in Treasury rates (after 20 yrs, more or less, of Fed repression).

      Interest rates have a profound effect upon net present values (NPV) – because they are a key variable in the discounted cash flow formula.

      No RE holders were complaining when the Fed slashed interest rates in half 20 yrs ago (doubling their valuations).

      How many tears were shed for savers who had their yields slashed in half for over 7000 days (2 decades)?

    • Wisdom Seeker says:

      Today’s rent isn’t hypothetical but next month’s is!

    • georgist says:

      Agreed. This guy lost real money by holding the bag.

    • Joe says:

      When some arbitrary bureaucrats control the currency, ‘value’ in paper debt is also arbitrary.

    • Sams says:

      Money is just an abstraction of wealth. ;)

  3. VintageVNvet says:

    Some really cute ”alliterations” IMHO and thanks for your continuing efforts to educate and inform WE, in this case WE the PEONs who just might go ahead and invest in CRE in spite of the clear challenges.
    But, IIRC, that’s exactly what our old pal JP did and did SO well his name lives in perpetuity,,, SO FAR…
    Know I’m repeating, but JP Morgan said ”buy on the way down but only if you know you can hold through the bottom…
    Apparently worked pretty well, at least for him.

  4. cb says:

    Well written article. Beneath it all lies the manipulations of the money creators that favor one group over another and picks winners and losers based on proximity and access to the money and credit.

    Existing owners have been given a free ride through cheap refinancing if needed, increased cash flows and higher valuations via lower cap rates resultant from cheap money. Speculators and financial engineers have also been rewarded.

    The deck should have been reshuffled after 2008, actually before that starting with Greenspan. Instead the FED saved favored parties at the expense of others.

    • Digger Dave says:

      Commercial Owners also get a nearly free-ride through tifs, subsidized roads and infrastructure to unsustainable levels. They will also let their properties sit vacant for years versus lowering the rent because commercial notes are to tied to a value and cap rate that would sink the value if they rented it lower. So these landlords tend to be so flush with cash that they can wait out recessions to re-rent.

      It’s a good thing that I’m not in charge. This commercial crap-value-construction that litters the exurbs of every city in this country would have to carry its own weight and would bring this sector back to reality.

      • Sams says:

        The future price of personal transport, cars in the USA is the big question there. If driving become to costly the exurbs may get problems.

        • Apple says:

          That question has been asked since 1972. No one likes the answer.

        • NBay says:

          50 mph speed limit was simple solution. Increased mileage and greatly reduced accidents and deaths. Asking for smaller/lighter personal transport is totally unacceptable to car manufacturers in US, ok many other places. Modern version of my old Honda 600 WOULD sell to 70% or more, I betcha. Throw in a roll cage and 5 point harness option if you are chicken.

      • Landlord says:

        This is the dumbest comment I’ve seen today. Landlords pay property tax. Landlords pay income tax. Also having your property said vacant if they come up with mortgage payments taxes and other expenses. Not very cheap

        • Digger Dave says:

          It must be nice to be ignorantly bliss. Keep chompin’ on that blue pill.

          Big box retail usually pays little to no property taxes up front, a la TIFs. When those TIFs expire this single-use throwaway construction gets abandoned (often with onerous deed restrictions preventing competitors taking possession) or the landlords go to work fighting for unjustified abatements, which communities often grant on dubious grounds to avoid legal costs (read up on the dark store theory).

          They may be responsible for “last mile” infrastructure, but often public roads are widened and overbuilt to satisfy the shiny new retailer promising jobs and investment. Many times the entrance road that appears to be private is actually public, with no long-term obligations to maintain for the landlord.

          And because this development requires acres of infrastructure far from public utilities, they often have to be built there at exorbitant expense. This expense, without exception never pays for itself out of the property taxes generated. I have yet to see a case study that shows it does.

          I don’t have to make this stuff up because it’s so egregious and happens right in public view. Local politicians and voters are so friggin’ clueless. It’s much better to argue about whatever dumb cultural issue matters the most today while your pockets get picked, because, well, development math is hard.

          Small landlords pay taxes and their fair share. Big ones game the system. And big ones know that it’s far cheaper to build things to fall apart, negotiate great deals and just move on to the next gullible community when the pipe needs to get paid.

        • NBay says:

          Thanks for good info Dave.
          Tilt-ups and especially damned engineered beams and trusses can be real crapp. Had to beef sister’s condo….put plywood gussets, screws, and glue over nailless “nail plates” to try to stop bending and cracking. Plus perpendicular angle bracing. Adobe heaving….so also had to concrete small “yards” for good drainage and mess with gutters and use 4″ flex drains at down spouts.
          Think her’s all came off the reject pile and site boss said, “gotta do one more, use ’em”.

      • David says:

        Developers put in the infrastructure. They never get a free ride

        • VintageVNvet says:

          not true D,
          While it IS true that these days there are ”impact fees” that do cover a portion of the cost of infrastructure IN MOST PLACES…
          Those fees to my certain knowledge never cover the entire cost of any new development.
          Taxing authorities just HOPE that the ”property taxes” on new construction will eventually cover the cost of all the now extensive pipes and roads and wires and so on for eva needed.
          ( for reference, been involved in RE and construction over 60 years now. )

    • gponym says:

      Feels that way to me, too: Fed action creates classes of the favored and non-favored. Seems like most any consequential policy decisions will do the same – the Fed’s being no exception – but I’m no economic policy expert.

      I suppose I must be biased since I’m not one of either the deep-pocketed or favored. But it sure feels like we’ve been for years now encouraging financial engineering, speculation and concentration as opposed to emphasis on savings and leveling the economic playing field.

      Not sure how small entrepreneurs feel about the Fed since Greenspan but that seems an important criterion.

      • cb says:

        no good Capitalist wants a level economic playing field …..

        • NBay says:

          Or boundaries…..a very strange game…….

        • phleep says:

          In orthodox, neoclassical economics, free and open markets with low barriers to entry, and thus robust competition, drives profits to ZERO.

          And an efficient market means one cannot make excess profits from speculation.

          Try fitting all that with the observed reality.

        • phleep says:

          An era of deregulation AND a tilted playing field gave us the runaway inequality we are seeing.

        • phleep says:

          Oh, plus regressive tax cuts to give a jolt of juice to those juiced-in.

        • Jdog says:

          BS You do not know the difference between a Capitalist and a Corporatism. Capitalism is free trade, Corporatism is socialism.

        • cb says:

          @ Jdog who said: “Capitalism is free trade”
          ———————————————–

          Keep drinking that kool-aid.

        • cb says:

          @ Jdog who said: “Corporatism is socialism.”
          ———————————

          Another laugher. Corporations are a favorite tool of Capitalists.

        • Sit23 says:

          You are thinking of Crony Capitalists. They are the ones running poor old Joe, and pulling the Fed’s strings as best they can. But Wolf thinks Mr Powell hs been finally dragged, kicking and screaming, up to the levers to do the right thing, in spite of his mates demanding he do the right thing for their gravy train. I hope Wolf is right, but suspect he may not be. I don’t underestimate the power and control of these people.

    • cb says:

      The FED and those who control them are larcenous bastards.

  5. perpetual perp says:

    The aggregates matter. If there’s leverage then there’s a wipe out when the tenant leaves. In the S&L wipe out (1980s and early 1990s), there was leverage and the economy went into recession. Wipe out.

  6. Nunya says:

    Reminds me of a previous saying told by a CEO. I worked for a company who was on their 4th CEO in 4 years. The new CEO was introduced by the board and they had a presentation for the masses. The first slide read “Profit is an illusion, Cash is King.” We hadn’t turned a profit in 4 years, but had lots of assets. He was going to sell the assets and pick it all apart.

    4 weeks later, the board removed the CEO. Funny how perspective really matters.

    • Cas127 says:

      Actually that “Illusion/cash” quote is mostly true.

      “Profits” are a function of GAAP accounting standards, which in the near to intermediate term can be heavily manipulated.

      And, when a recession hits, sales collapse, and loans come due…cash matters a helluva lot more than promises (asset “valuations”, promised receivables, contractual “obligations”)

      What happened to that company and that board?

      After 4 yrs without profits, did firing the tough talking CEO within 30 days turn things around?

      • Nunya says:

        Not at all. COO was made interim for 6 months. They hired another CEO from a different part of the country who ran a different type of business, although in the same construction industry. COO walked out since the board snubbed him for the CEO position. New CEO removed certain people, plugged in his people. That was 2018.

        Fast forward to 2020, the company was bought by a serial M&A holding company. Still no profits. Fast forward to 2022, the holding company will go public via a SPAC.

        You can’t make this sh*t up, even if you tried.

  7. One and a Penalty says:

    John, great article as usual. One observation I would add is that if/when the economy slows/collapses, you will have requests for rent reductions or worse dark stores. This includes anchor tenants which, if they go dark, raises co-tenancy issues which could make the whole house of cards collapse. Even if you have a recapture right, that takes time. This will certainly affect your cash flow. This is especially true for “B and “C” centers or your central valley center. This business is not for the faint of heart……

    • Wisdom Seeker says:

      This was a good point. John’s article is great but does assume that cash flows won’t change much. For great properties in great locations that is likely solid, especially with inflation still raging. But if the Fed overshoots, or if other government policies impair the economy, we could see a deep and lasting recession resulting in occupancy and rent decreases.

      But one could take John’s point about survival a little deeper: most asset prices AND rents eventually recover, so if the portfolio can survive a temporary decline in cash-flows without forcing distressed sales, one can make it through to the Promised Land on the other side of the market bottom. And maybe pick up some bargains along the way?

      The same is true for homeowners with employment income, or really anyone sitting on declining illiquid assets who feels it’s a bad time to sell now.

      There’s a good argument to be made from this about the importance of having a reasonable liquidity cushion (i.e., savings) as well as cash flows, to protect those illiquid assets against distressed sale.

      • Lena Lori says:

        We are now guaranteed a recession in H1 2022. Will the Fed keep tightening into a recession? Inflation is guaranteed to be raging for at least another year due to money printing in 2020 that has only been about 50% incinerated. Money velocity is at record lows, which indicates that the financial system is oversaturated with $$ debt notes.
        What is going to give? The govt is guaranteed to make the right decision, but only after they try all the wrong options. It’s either stagflation or hyperinflation for another year at least.

  8. sunny129 says:

    Wolf

    Bond analogy is so apt to describe the situation

    There is a saying ‘ real estate RICH but cash poor’

    Now it seems (for commercial RE) – real estate POOR but cash RICH!

  9. Publius says:

    But what happens when the market fundamentals change? I wouldn’t hold onto mall property through a recession, waiting for the ecomony to recover, because the mall business model is outdated. And will office real estate ever fully recover in a (even limited) hybrid/remote work environment? Once the cash flow takes a big hit, is it too late to sell and avoid huge losses?

  10. Phil says:

    The gaping hole in the story here is what happens if commercial rentals are way down (they are.) Suddenly you’re paying a mortgage on something that’s not earning any money. Now what?

  11. Michael Engel says:

    Compounding $1,800,000 at 6% in 10 years, means buying today at slightly
    below $1,100,000, before other expenses.

  12. Petunia says:

    John,

    You were right to keep the Walmart property because the aspirational shopper is downgrading rapidly. If you are getting a piece of their revenue, as well as rent, expect it to go up for the rest of the year. All the fashionistas I follow are spending less and discount shopping a lot more. Everybody’s new favorite is Walmart, Target, TJMaxx, etc.

    The downgrading also extends to the services. I see more women just getting either a manicure or pedicure but not both.

  13. Doordenker says:

    The drop in value of fiat money is likely (to become) much worse.
    Real estate is ‘real’, fiat money is not.

    • phleep says:

      There absolutely are times when “fiat money” (liquidity) is the only lifesaver in sight. And in such times, real estate can carry a negative cash flow, thus (if held with leverage) an anchor that can drag that owner underwater.

      It’s not like the prospect of inflation repealed half of economics. It’s not a binary, where it will be permanently one thing or the other. People spit out the words “fiat money” as if it was a curse. tell you what: it buys me food, housing, transport, all goods and services, last time I checked. What else does all that inside one day? Not gold or land, in the world of reality. I hold land AND fiat.

      • VintageVNvet says:

        WAY too ”simplistic” ph:
        try to get your thinking around the entirely WHOLE ”thingy”
        Will very clearly indicate many other results/concepts,, as many on here continue to say.
        Nothing,,, repeat NOTHING,,, is going to be the same,,, after ”going to heck” in less that a straight line once again,,, as always…
        Time and again, IMHO, the real challenge for ”investors” as opposed to gamblers, is to determine where the very extensive propaganda ”stops” and the ”real data” starts…
        Very clearly NOT easy, as clearly since JP Morgan, those in control of the communications have prevailed.
        IN all markets.

  14. JD says:

    While my gut tells me that CRE will never recover after WFH and more employees insisting on never setting foot inside a work facility again, I can’t help but wonder if a recession might have the opposite effect. Right now at my Fortune 500 employer, the employees have the power. Resignations are up 30-40% over last year. The bosses have made it very clear they are don’t with the WFH experiment and are ready to RTW, but the last time they said this publicly, we saw a new wave of high value and very public departures. Since then, the corporate overlords have kept quiet. But I can’t help but wonder when the job market isn’t so hot, layoffs are happening and there’s blood in the street and suddenly employees aren’t in charge anymore. I know many of these old school execs who have hated to see their employees with all the power and no cubicle farm fiefdoms to walk through every day will use this as an opportunity to get butts back in seats. Probably under the guise of “needing to have our most creative minds working together” to survive the recession. My two cents.

    • Sams says:

      On the other side, those WFH may have gone to companies that are ok with that and still make money. Now, the big question is, what companies get the best results?

      Only time will show. Those old school execs may not get the most productive emploees and manage to get the most of them.

      • Apple says:

        Regardless, the old school execs will still have corner offices. And that’s what important. It’s something they have worked their entire lives for.

      • Happy1 says:

        Agree. I am in a small health care business, we have a support staff of IT and clerical people of about 11 people, all were in house prior to COVID so we leased about 7,000 Sq feet for office space, now all of them work from except for quarterly in person meetings, we are looking at a much smaller leased space just for some IT equipment and training space, 2,000 Sq feet, and our employees are much happier. Multiply this by 100,000 and it is clear that work will be much more from home, employees will mostly be much happier, and the need for office space is about to be cut in half.

  15. SoCalBeachDude says:

    When BOTH cash flow and asset value drop, you know the game is over and that should have been the obvious outcome quite a while ago.

  16. Michael Engel says:

    Rome was gone when her enemies dissected her viaducts.
    In 2022 Russia dissected Europe viaducts.
    How about 15% – 20% compounding.

    • Xavier Caveat says:

      The sparrow lives to fly another day in the dark moonglow.

    • Sams says:

      Rome is still there;)

      • Michael Engel says:

        Sam, so are the viaducts. The Roman Empire engineers were the best
        in the world, bringing water from the mountains, descending
        like a bunny slope.
        The 19 EU countries will not be dissect if NATO 32 will.

        • Sams says:

          Totally on the side, I do think part of the problems with the viaducts was lack of maintenance. Money for maintenance was siphoned of and the viaducts fell into disrepair.

          Or maybe not that different from today.

        • kielbasa says:

          I hate to be a scold, but I in this case I can’t help myself. You mean aqueducts.

        • Xavier Caveat says:

          That’s too bad you had no idea what an aqueduct was, I could almost understand your missive for once.

        • Sams says:

          Yes, was not paying attention to the answer and mixed the aqueducts and viaducts. :)

          Anyway, it was the aqueducts that was no longer maintained. Some of them still stand, the maintenance issue may have been that the waterways was not cleared for debris and silt.

  17. CreditGB says:

    Have to wonder though. At some point malls were still cash cows while their values started to decline. Maybe too simplistic, but maybe some in depth analysis of the devaluation should be undertaken. And who is doing the valuation?
    Guess I’ve become highly skeptical of everything.

  18. Margaret Fagan says:

    ” .. staring down the bunny slope.”

    Wolf – get this man back to write some more – he’s almost as good as you.

  19. Degobah Smith says:

    One thing I rarely hear or read about anymore is the velocity of money. Maybe it’s a quaint thing now, I don’t know. One thing that I do know (or believe, anyway) is that an economy can be likened to a flowing river. A nicely flowing river is clean, carries food to organisms, waste products away to be cleansed by the aerating mechanism of the flow, and is a nicely balanced ecosystem with something for everybody.

    A non- or restricted-flowing river has eddies and whole portions where the water becomes stagnant, waste accumulates, oxygen levels plummet and life becomes difficult or impossible. It is no longer a beautiful, life-giving thing for all.

    One of the problems with the FED doling out free money, especially to those who don’t need it (except to bail out risky bets gone bad – Wall Street 2008) is that some people end up with gobs of extra money and can afford to sit on all kinds of assets and “wait it out,” thus restricting the velocity or flow of the economic river. We see this all over our land from vacant properties to zombie companies to multi-million-dollar paintings. It’s the classic “pushing on a string” thing, and it is sucking the life out of us.

    The velocity of money (M1) has been something south of 1.2 since the pandemic, orders of magnitude below where it historically resides. No wonder the powers that be ignore this little tidbit of economic info. It doesn’t bode well for life as we know it. Economic stagnation, indeed, with no end in sight. Happy 4th.

    • SoCalBeachDude says:

      The Federal Reserve never ‘doled out free money’ in any sense of those words and simply used funds to purchase existing US Treasuries and MBS instruments at prevailing market rates and is now not repurchasing those as its inventory of them matures. What does that have to do in any stretch of the imagination with the velocity of money?

      • cb says:

        ha ha ha

        “simply used funds” – you mean trillions of newly created dollars?

        “prevailing market rates” – you mean the rates they have manipulated?

      • Wisdom Seeker says:

        1) The “prevailing market rates” respond to Fed “forward guidance” and reprice in advance of the actual Fed transactions. On top of that, the decline in rates arising from the Fed’s purchases drives up the prices of all other assets. In short, Wall Street both front-runs the Fed’s policy and profits indirectly from the “free money”, leaving the financiers with massive mountains of idle cash.

        2) The cronies of the current Federal Government leadership are the other beneficiary of the “free money”, being able to borrow-and-spend more at lower rates. To mix 4 metaphors – there’s a lot of squid tentacles in the DC swamp, leeching away at that trough of Fed-funded pork spending.

        Finally, when money flows to those who need it least, it ends up sitting idle in bank accounts and that is the definition of a slowing in monetary velocity.

        • Degobah Smith says:

          Thank you, Wisdom Seeker. I could not have responded better myself.

      • otishertz says:

        The Fed created funds to buy new and existing Treasuries and MBS, then the government doled out Trillions of free money. The money multiplier being 1.2 is very interesting because it shows that money is not trading hands like before.

    • Seneca’s Cliff says:

      I like your river analogy but I will add something. If the economy is like a river than the Fed is like the cannery that drops a huge slug load of corn processing waste in to the river. This waste is filled with nutrients that cause a massive growth in the the organisms that eat it and use up all the available oxygen causing death and destruction downstream. This is much like the death and destruction the Fed causes when it dumps easy money in the the economic river.

      • unamused says:

        The Great Material Continuum is a Ferengi belief which speaks of a binding force that connects the universe together. In this universe, there exists worlds which possess some material in excess while others it lacks. The Great Material Continuum serves as a connecting force that allows the movement of material from one point to another among the worlds of the universe. Its been described as a “Great River” with the Ferengi ensuring that those things that are provided are replaced with adequate means or by payment.

        It was believed by the Ferengi people that should the “Great River” ever return to its source then the end of all existence would happen.

        This concludes your Exo-Mythology lesson for today. Test on Tuesday.

    • Nice analogy Deborah,

      Thing about zombie companies though, is that while not very profitable, they do employ people and they do provide services.

      I would call that a net plus for the citizens and the economy.

      • Wisdom Seeker says:

        In an economy with excess labor that might be true, but when labor is scarce we need the zombies to die. Zombies’ services aren’t the ones that people really need (otherwise they would be profitable), and workers in subsidized-but-profitless firms mean insufficient workers for the companies, that could do more with (and likely for!) those people.

        • phleep says:

          Like flammable materials, stave off enough zombie die-offs, and you get a huge pile of kindling just waiting for a spark. I.e., Fed policies, explicitly aiming for above 2 percent inflation, even as the bloated economy was well into overheating. The former zombies may have a lot of quick adjusting to do, in a very un-ideal circumstance. Guess who will be clamoring to effect a “rescue?” The familiar friendly neighborhood monetary drug dealer.

    • Jdog says:

      The direction M1 is more of a symptom than a disease. Over the past 70 years we have fundamentally changed our entire business environment.
      Our business environment 70 yrs ago was primarily small locally owned business.
      Every town had multiple retailers and service providers who all had a stake in, and involvement in the community. They actually had an interest in the prosperity of their local area.
      We have replaced those small businesses now nearly entirely with corporate owned big box and chains who have little or no community ties or involvement. Some are international in nature and do not even have our countries best interests in mind. Their only concern is profit.
      This has resulted in money flow and wealth concentration going to fewer people at the top of the pyramid, while the majority of people struggle for a working wage. Many communities fall in to disrepair and develop social problems due to the money being exported to corporate headquarters elsewhere.
      The few dollars you save on new corporate retail strategy is sending the majority of your local money away, and resulting in an overall lower standard of living along with the homelessness, crime, drug abuse and other social problems that occur when the community loses self ownership.

  20. polistra says:

    Theoretical “value” is worse than theoretical, because a bigger theory means more property tax with no increase in usability or comfort or rent.

    • Cas127 says:

      It is interesting how few people (especially home owners) recognize that property taxes are actually more dubious than even wealth taxes (taxed, re-taxed).

      Residential property taxes are levied upon theoretical, volatile, unrealized valuations, driven by the money printing attitudes of the Fed.

      And prop taxes *also* don’t net out the huge debt necessary to acquire the property in the first place.

      Vanity…all is vanity.

      • Jdog says:

        Both income and property taxes are involuntary and therefore immoral taxes that are equally evil.
        Income taxes are the governments claim to ownership of the workers, in that legally you cannot claim ownership to the fruits of someones labor without also claiming ownership of the person themselves.
        Property taxes, are the governments claim of ownership of your personal property. True property ownership is known as allodial title and is not taxable.
        The only forms of taxation that are moral, are voluntary taxes such as sales taxes, tariffs, and excise taxes in which the taxpayer has a choice to pay the tax by making a purchase or not.
        The concept of involuntary taxation is incompatible with freedom or the self ownership of the individual.

        • VintageVNvet says:

          I LIKE it jpup!!
          It will go right along with bountiful free energy from ”gravity mirror” and completely free food from farms totally operated by robots with the free energy…
          Wish I could hang around to experience this obvious utopia on the way,,,
          Or, could you just refer me to anyplace where anything even close exists, for me to retire to?

        • Jdog says:

          There is no utopia on the way, only dystopia. When people are too stupid to understand simple concepts like the foundations of self ownership, and moral vs immoral taxation, then we are doomed to the kind of feudalism you see growing every day.

  21. unamused says:

    Losing money on the valuations of your real estate holdings?
    The obvious solution is to jack up the rent.

    If your tenant(s) move out, find an investment group that has some money to waste on a new development, tear out the old building, bribe a few officials to get the land rezoned, and Bob’s your uncle.

    Common business procedure. Happens all the time.

    In other news, Ernst and Young has been fined $100 million for cheating by its audit professionals on ethics exams. Let that sink in for a moment: cheating on ETHICS exams.

    EY evidently uses these exams to screen out ethical auditors, because ethics is for losers. Modern management practice is to jack up share practices at any cost, so long as those costs can be externalized and you have lawyers who are unethical with everybody except you.

    • HowNow says:

      $100M is a small price to pay for the publicity. New clients will beat a path to their door.

      • Anthony A. says:

        And probably some displaced auditors who were fired by other audit firms for unethical auditing.

    • phleep says:

      Matt Levine in his Bloomberg column pointed out (at least in the recent high-flying era) what a great resume-stuffer it was in high finance, to have lost not merely a large, but a vast amount of money. It means the blow-up artist had lots of someone’s trust, creativity, and nerve. And I guess all that might be marketed to the next bunch of punters. John Meriwether of Long Term Capital management had such a reprise.

      Then too, he pointed out what an attractive labyrinth of confusion the new SEC rules on sustainability (ESG) reporting would be, to a modern techno-legal expert. As a legal guy, I can see that. It is like a bureaucratic thicket that any skillful Brer Rabbit could happily romp in, and “arbitrage,” as we say it.

      Now, I guess, we will see various “personalities” from crypto selling pencils on street corners. Accountants, however, are always with us.

  22. Got a great deal on Walmart Plus and I love it. What that means for walk up shopping, maybe not so great. What happens if you lose your tenant? I see CRE sit idle for years. They demo’ed a taco bell not far from here, looks like they are taking it down to the bare ground. Not sure what is next but it will take some time I am sure. my neighbor had his house rented, took if off the market, proceeded with a very expensive remodel. Now about two years later, no work going on, no money coming in. Someday someone will explain it to me.

    • Cas127 says:

      There is a Walmart-sized lot in Las Vegas, at the corner of Sahara and Boulder Highway.

      It used to be a Gemco.

      37 years ago.

      It has *never* been redeveloped, despite multiple historic booms in LV.

      I assume cursed Indian burial ground or some such, but I also have a couple of 700k sf empty malls in Columbia, SC that you can get cheap.

      A *lot* of things can go wrong in CRE…

      • Xavier Caveat says:

        Didn’t Gemco have a rather exclusive $1.00 lifetime membership?

      • Colonialman says:

        Interesting on the holding of lot in the trend of movement in Vegas. My uncle was a CRE Broker there in the 80’s. I am sure the concentric ring analysis and SWOT was involved in that somehow. With Lake Mead almost to dead pool that lot will just keep eating taxes.
        Some CRE developers are not using refinance and banks but utilizing Promissory Notes to get investors/tenants to share skin in the game. Wait until gas hits $10 a gallon.

        • phleep says:

          > Promissory Notes to get investors/tenants to share skin in the game

          … were used by my bro-in-law selling timeshares in Tahoe. They were the first, he said, among those debtors’ liabilities to go in the wood chipper when tough times hit.

      • Mendocino Coast says:

        Boulder Highway is a dead zone in Las Vegas

        • phleep says:

          That lot and Gemco membership will still be there when the sun goes supernova.

        • phleep says:

          The desert will reclaim its own. Hate to say it, from here in SoCal (its whole scope and scale engineered on rainfall expectations that turned out anecdotal), but the cheerleaders here are building like there is no tomorrow. Zombies to house zombies, hopefully all of whom who do not need water,or there accursed little dogs either.

        • Cas127 says:

          Boulder Highway ain’t fancy, but I bet a traffic count would put in the Top 20 roads in LV.

          One of the very few diagonal roads in LV with half the usual # of stoplights – it sees a ton of commuter traffic.

          (I want a bird dog fee if that Gemco lot gets sold now…)

  23. bq says:

    Curiously missing from Mr. McNellis’s article are what happens to that cash flow if the tenant vacates. And how quickly will a new tenant be found in this economic environment. All the while, taxes and maintenance costs continue to be incurred.

    Yes… “Net worth is for bragging, cash flow is for eating”… and losing a tenant is vomiting.

    • Cas127 says:

      See the cursed Gemco story above.

    • Happy1 says:

      Yes. There is a redeveloped mall in south Denver near my home that has vacant locations that were formerly Macy’s and other national chains that failed during COVID. Walmart feels like a recession proof tenant but also a tenant that could demand and probably receive rent reduction.

  24. Ghassan says:

    Thanks for the Article

    If Fed actually goes ahead with QT everything would worth less, starting with your commercial property, it’s deflationary. But if they pivot then your property’s value goes back to what it was few months ago, the same price that you, like every other real estate holder, have difficulty to let go of because you thought you had that much money even though it was just paper value.

    If Fed does QT long enough, eventually many owners will accept the new reality & start selling therefore you end up with a reduced property value even if you don’t sell.

  25. Harvey Mushman says:

    “The same math works for single-tenant retail: if you don’t sell, your cash flow’s the same.”

    John, at some point won’t your cash flow drop? For example if you have to lower the rent?

    • Gomp says:

      Base rent plus percent of sales. common in retail.

      • Cas127 says:

        Well, I don’t know if “common”…

        But if so…the average Walmart generates $100 mil per yr in revenue, so if there *is* a Rev share, I don’t think the landlord has really done too poorly…

  26. Harvey Mushman says:

    Great article by the way!

    • SpencerG says:

      His articles always are… but this one was a cut above. I am really grateful to Wolf for letting his guest writers post such high quality articles on his website. I learn an awful lot from them.

  27. Brady Boyd says:

    When the US housing market went bust in 2008, it took several years for the Sellers to finally accept they won’t get the previous high prices. Where I live, it took 3 full years (4Q 2011 – 1Q 2012 for that to occur.

    • SpencerG says:

      It always does in a bust. For one thing LOTS of sellers have the finances to ride out the storm (or they think they do). Three years later they find themselves broke and STILL needing to sell.

      As my Dad likes to say… usually your first offer is your best offer… and you should take it.

      • Apple says:

        It’s much different now. People financed at rates below 3%.

        Back in 2008, it was ARM and interest only loans.

    • turlock says:

      That happened here (tidewater Va.) I kept watching for “absolute auction” signs. Never happened. Seems like most of the rancid paper was owned by Freddie and Fannie and profits/losses don”t matter to daddy gov. After 3 years or so, private agency signs began to sprout and I was able to pick up several properties 10-20 cents on the dollar. My bids were ridiculous and accepted.What a boondoggle.

  28. gorbachev says:

    I love blogs written in real time.Thanks a bunch.

  29. BestLaidPlans says:

    The Walmart in Vallejo, California closed in 2007 and remained closed for over ten years. It is now a “neighborhood” Walmart.

    The county had assessed the value of the property at $14MM while the owner argued that it was worth $7MM. They reached an agreement and the value was pegged at $11MM. I won’t bother to do the math to figure out how much money was lost paying property taxes on $11MM worth of vacant, commercial property for ten plus years.

  30. David W. Young says:

    Walmart’s adjusted to existing stores’ sales (comparable sales) in First Quarter, 2022 rose a nominal 3.0% from First Quarter, 2021. So let’s say that a Fed Reserve economist or BLS statistician figures overall Walmart sales were impacted by inflation of only 5% year to year, not even close to reality, but this is our Government at work.

    So Walmart already experienced declining Unit Sales more than likely in the First Quarter, and our current Recession, yes, the naughty “R” word whether it is declared from on High or not, was just getting started. More to follow, and talk to any Walmart store manager as I have, and shoppers are buying less at today’s Putin’s War Prices (PWP).

    So the statement that New Worth has declined, but I am still getting the same cash flows as last year is a bit of a stretch since most Commercial R.E. leases of retail space include a percentage paid based on gross revenues of the tenant for the rental period. And a landlord, no matter how prudent he or she has been regarding the Debt Monkey and other Fixed Costs, still has operating expenses to cover that have done nothing but balloon over the last year due to Putin’s War. Wait until hurting counties and municipalities starting adjusting millage rates to compensate for declining real estate values. So the appropriate measuring stick off the Balance Sheet view and onto the P&L is Net Operating Cashflows, not the Gross.

    For Walmart and Target and other humungous Box Store Retailers to have already have hit ir pockets this early in 2022, one can only envision unit sales and even gross sales declining for the Second Quarter and Beyond. To fill the family mega-SUV with $60 worth of petrol and then walk into Walmart, does not exactly put one in a very big spending mood. Only so much credit card debt that the average American can take on anew before the Consumer Spending Machine hits a brick wall based on monthly household expenses.

    There is a signpost up ahead and it says: “Welcome to the Land of Overspending and Once Free Money”.

    • VintageVNvet says:

      Agree DWY; how some ever:
      1. Almost no newbie biz owner/operator that I have ever discussed this with even KNOW the difference between gross and net, and most end up in the dust bin because of that.
      2. $60?? Try $150.00 to fill up many of the newer SUV and Pickups.
      Paid well over $100 in NV 3 years ago, and our pu was not even totally empty.
      OTOH, having a couple vehicles with 30+ gallon fuel tanks provides a good storage option, and with a little planning ahead to reduce and combine trips, that can last for months.

  31. Michael Engel says:

    John, ignore the 4% and the 6% compounding. WMT was down from 120 to 117 within a month. WMT is paying the price for higher wages, transportation and energy.
    When it’s time to sign a new LT lease, they will squeeze u the little guy. You will pay the price for their demise. Your options : vacancies or roll back. When SPX pop, u can reduce risk, if u wish… Have a nice 4th.

    • Wisdom Seeker says:

      @ME: You meant WMT dropped from 160 to 117 within a month…

      But – Cost of moving a store isn’t trivial. Good established locations remain good for a long time, shoppers get used to them. Other locations maybe not so much. New locations take time to become profitable.

      Be interesting to see how the commercial REITs get through this too…

      • Michael Engel says:

        Wisdom, no edit on Wolfstreet !
        Game theory : WMT will squeeze John. John knows what will be the cost of WMT moving to another location. If John wants to reduce his risk he cannot pretend to be a big shot with them. John have to cry a little, complain, roll back a little, give WMT fu..king lawyers a candy in order to reach a fast agreement. No real harm is done. Once the new lease is deep in John pocket it’s a new ball game.

        • David W. Young says:

          Yeah, Wolfmeister, we need an edit function so some of us finger tangled seniors don’t get so embarrassed with so many typos! Hopefully, that will be the only issue we get embarrassed about on this uber stellar site!

        • phleep says:

          Typos are fine, take it in stride, it’s part of the aesthetic. I can’t speak for Wolf, but if he had to endlessly reread to moderate, the burden would be absurd, potentially infinite, and out of proportion to any benefit.

          We all make typos: so what? Is our aging vanity worth making such frictions for Wolf?

  32. JC says:

    This is a very wise real estate investor.

  33. David Hall says:

    Thanks for your explanation of cap rate and the value of cash flow.

    I remember a 1970’s drive-in movie property in Hybla Valley near the location of George Washington’s home at Mt. Vernon, VA. The drive-in fronted Route 1. The drive in theater was demolished and a Walmart was built there. Later a Costco was built next door to the Walmart. Mt. Vernon is an affluent suburb of Washington, D.C.

  34. John in San Diego says:

    John, I think ‘value’ changes infrequently, only when long-lasting fundamentals change. Conversely, I think ‘price’ changes frequently, as it is subject to emotional response. That is the gist of one thing I read in Graham and Buffet some 25 years ago. Buffet said, words to the effect, that, on some days, price was set by Dr. Jekyl and, on other days, it was set by Mr. Hyde.

    Me, I see a big unwind coming in home prices, stock prices, bond prices, and, yes, commercial real estate prices. I see prices for my wife’s family’s five commercial properties here in San Diego taking hits (and, I think ‘values’ will take a hit, too: apartment rents in San Diego appear to be coming down, now). But, given that my 89 year old father in law has been utterly conservative, only keeping modest mortgages in place to keep banking relationships open in case of need, I think we are in a good position to weather — and if we choose, to take advantage of — the coming epic storm.

  35. ru82 says:

    Housing inventory is dropping again in my midwest city. I don’t understand. Inventory hit a low of 2400 in March. Started rising to 3500 in May. Now it is back down to 2600 as of July 1.

    A year ago it was around 3600.

    Even though inventory is dropping what I have noticed is days on market is increasing though. Up about 30%. Prices are not going up and there have been a few price reductions. Maybe people were trying to sell at peak prices but are giving up and pulling the houses off the market.

    • SocalJohn says:

      Some really smart guy once said, “nothing goes to heck in a straight line.”

  36. MarcL says:

    What the Authors misses to call out ( intentionally or not) is what multiples were used to buy this property and when. The 6% multiplier the author used in his article was a direct correlation of the FED lowering the short term rates to almost zero pushing up the value of his property by allowing him to assume a 6% multiplier.
    My cousin owns many residential multi family properties and they all went up in value as the interest went down to zero. But as the interest rates start going up, the value of his properties is going lower.
    It seems that the author is making the assumption that the interest rates will fall back to near zero and thus he is holding on to his property until then . I am doubtful but time will tell

    • phleep says:

      > interest rates will fall back to near zero

      The next thing after that might be a fire sale to Xi’s cousins.

  37. Pilot Doc says:

    There once was a wealthy Duke, Earl, Prince, Baron, or King…

    His “tenant farmers” addressed him as “Lord”.

    One day he decided, I
    “I’m going to sell all my family’s generational lands to the serfs because the value has gone down.”

    So he sold off plots for development and 50 years later, his heirs were broke and living amongst the wretched in low income housing.

    One of those heirs worked hard and began buying up properties and renting them back to the previous owners.

    They no longer worked in agriculture to sustain themselves and their kingdom, so they were now simply called “tenants” and they once again referred to the one providing them shelter as (Land) Lord.

    The end.

    Never sell the land

    • Pilot Doc says:

      Unless of course, you are going to buy more.

    • Michael Engel says:

      Pilot, each farmer had few siblings using the same plot. Each one of them
      siblings further dividing their grandpa plot. That led to starvation.
      One of those heirs, along with the banks, start buying up properties,
      renting them to those who could afford rent. The rest…

      • Pilot Doc says:

        Whether through hard work or corruption, wealth aggregates into the hands of the few.

        It’s rare that the “few” are benevolent. If they obtained it through corruption, well they had no morality in the first place.

        If through hard work, they don’t have pity on the stupid or lazy.

        It’s a cycle, just like the changing of the seasons.

        If I build it for the good of my future generations, what are the odds they don’t squander it?

        If I build it solely for my own enjoyment, sooner or later, the masses will covet, revolt, tear it down and the cycle starts again.

        The greater part of humanity looks to someone else for everything. Dangerous game deciding to be the decision maker.

      • NBay says:

        English Nobles in Medieval times had a system. The eldest son got ALL the land. The girls were married off and became someone else’s problem. Younger sons had two choices, join the military or the clergy.

        • phleep says:

          Many of those dispossessed serfs’ forebears had been small land freeholders, such as Roman legionnaires, paid off with their gains in conquest. Into debt and peonage they went, when there was a big downturn. Many had to have no kids and crowd into communal (monastic) living. Makes sense. I’m waiting for our version of it.

    • Jon says:

      Can this be said about the stocks ?

    • cb says:

      Under all is the land

      All the gold to you, all the land to me
      and a renter ye shall be

  38. SpencerG says:

    “The sellers forced out of their redoubts by death, divorce, dissolution, disaster, or simply over-leverage may indeed be slaughtered…”

    Every house I have ever bought fit this profile. It is a lot easier to make money in Real Estate if you buy at a discount on the front end.

    • Shiloh1 says:

      Channeling 1980 book Nothing Down by Robert Allen. Find a “don’t wanter seller”.

  39. EcuadorExpat says:

    At $6 plus for gas, many cannot afford commuting and must WFH.

    Will not the same hold true for retail because of online shopping? If people are not out of the house for employment will they leave for retail?

    I read a reader comment somewhere who said if he had to start commuting today, it would cost him $20k per year. Average cost is $5-8k.

    • Kracow says:

      Would love to know what he’s driving. Would make daily driving my 360 a bargain compared to that 20k a year in whatever they are using.

    • Xavier Caveat says:

      Lots of people in LA & SF live out in BFE because of cheap digs and have to drive a long way to work, and many of them must be hardly making it.

      • phleep says:

        My neighbor was doing so well, year after year, driving all over SoCal daily, doing contract troubleshooting construction work. He and his perch seemed to disappear in a day. He had lots of shiny nice vehicles. Maybe the and the wife moved in with relatives in Vegas. Yikes!

        One might awaken and find oneself on a somewhat unexpected space on the roulette wheel, when the goddess Fortuna’s whims (and wheel) have turned. I see how that fatalistic mythology came into being.

    • MiTurn says:

      “At $6 plus for gas, many cannot afford commuting and must WFH.”

      Not quite that simple.

  40. QQQBall says:

    John didnt mention if the lease rate was below market and if WMT multiple options remaining, which can impact the cap rate. No info on the footprint/functionality of the building and if it is still highly adaptable to other retailers. Where I live, we have had mass exodus of drug stores moving out of grocery-drugstore anchored centers and building free-standing stores. Near me, in place of Sav-ons we got an indoor swap meet. In another center a national grocery store was 50% replaced after a couple of years by a store (i forget but they sold packaged veggies and stuff); the second 1/2 was EVENTUALLY filled with a dollar store. the downgrading of the anchor space in the first center KILLED the in-line retail which has seen an ongoing decline in tenant quality and high vacancy and ongoing turnover.

    If there are competing sites, someone is likely to offer WMT an attractive build-to-suit.

    • Happy1 says:

      I’m seeing this also, even in fast growing Denver suburbs, box store now vacant except for a seasonal Halloween store, former grocery store empty, old office supplies store empty, I can’t imagine what it would be like in a part of the country that is losing population.

    • Petunia says:

      I forgot to add this to my previous comment to John. There is a move away from the chain drugstores to Walmart and supermarket pharmacies. We now only use the supermarket pharmacy for almost everything. The chain drugstores are just unaffordable. The big box stores are using their pharmacies as a draw and it’s working.

      There is a limit to what the average family can afford and that includes rent too. We are seriously considering living out of the country when we retire.

      • SoCalBeachDude says:

        The biggest moves are to Amazon.

      • Jdog says:

        Retirement offers lots of different opportunities. There are still places in this country where they will pay you to move to.
        It is an area where lots of homework can pay huge dividends.

  41. Ian says:

    What happens when the tenant can no longer maintain the rent because his input costs for his widgets are through the roof and the public cannot afford the widgets as their real income is destroyed by inflation. Maybe you look back at the selling price of that asset today and wish you had taken it and bought missile manufacturer stocks.

  42. Jpollard says:

    What happens when cash flows as a whole also start going down .
    Just like when the Japanese stock and real estate market topped out in 1990 , the US stock and real estate markets are destined for the same

  43. SocalJohn says:

    It seems like most people assume that we have NOT recently gone through a long term cyclical low in interest rates. Most people have never known anything other than a downward trend in rates. Is this the basis for expecting a return to normal (whatever that is) after each rough patch? That isn’t necessarily going to happen. We have had really long cycles in rates in recent history. Multi decade long. With the tsunamis of liquidity generated by CB’s, would anyone be surprised by lasting inflation? I wouldn’t. Nor would I be surprised by a long trend of increasing interest rates. If so, there might be a looooong wait until asset prices recover, at least in an inflation adjusted sense, and maybe even nominally. I realize this is unconventional thinking. The underlying hypothesis is that we have now reversed the long term trend for interest rate variation. Just a guess, but it seems plausible.

    • Old school says:

      I have heard arguments that interest rates are destined to go lower and arguments that they are destined to go higher. There are good arguments on both sides.

      Sluggish economic growth the next decade is probably going to mean t-bills and money markets are going to average paying negative real returns as far as the eye can see.

      • SoCalBeachDude says:

        There are no good or reasonable arguments that interest rates will fall when risk is now rising so substantially. Moreover, the BIS has clearly stated that interest rates will rise globally and they obviously are as government bonds around the world reprice risk to proper and more appropriate levels.

      • SocalJohn says:

        Yes, I think you’re right about negative real returns. Heard someone the other day declare the end of financial repression. Nonsense. We used to have it with 0% rates and 2% inflation, now we have it with 1% rates and 7% inflation (or whatever number is preferred… they’re all high). The repression is worse now. In any event, it’s hard to imagine nominal rates not rising, which likely means falling asset prices. Big question is how long does this trend last.

        • Jdog says:

          The analogy of the public being a heard of sheep is fairly accurate. There are times when the owner of the heard feeds and cares for the sheep, a time to sheer them to make some money, and a time to kill and butcher them.

  44. Anon1970 says:

    The CVS store near one of San Francisco’s largest medical-dental buildings (450 Sutter St.) has been closed and empty for months. Unless CVS is still paying rent, the building’s owner is suffering a real hit to cash flow and building market value. There are lots of empty stores in SF these days. Some of the stores in my suburb have been sitting empty since Covid hit and in some cases well before that.

    • MiTurn says:

      A new acronym: SFH — shop from home.

      It’s the latest and greatest….ask any brick-and-mortar store manager. /s

  45. Michael Engel says:

    1) China Shimao RE developer defaulted on $1B bond.
    2) BlackRock stand tall like the Rocks of Gibraltar.
    3) A new HQ, the largest landlord, $10T AUM.
    4) Mr Fink is the most connected and flexible ceo in US, more than Ilan and Jeff.
    5) He was invited to the WH to play the music after 62% retracement
    from Mar 2020 low to the weekly ma200.
    6) SPX might rise in Nov 2022 and 2023, before removing a cesspool
    of debt later on.
    7) In 1776 the British Empire lost her 13 colonies for the Rocks of Gibraltar.

    • Anthony says:

      They didn’t really lose their thirteen colonies as the Zurich/London banks never left. They own more of the US now than they ever did way back….

  46. Nissanfan says:

    Yet in Chicago suburbs, developers buy out neighborhoods of residential properties at 100% premium only to level it and build new warehouse buildings.

    • unamused says:

      And when the new warehouse buildings become unprofitable they level them and put in residential properties.

      It’s funny how that works. Why aren’t you laughing?

  47. Nate says:

    It’s early days. Of course everyone has diamond hands and will ride out volatility. RE can go slow relative to other assets.

    Also, not sure correlation between residential and commercial re this go around. If anything, WFH has completely opposite impacts in most markets.

  48. Diogenes says:

    “Today’s rent isn’t hypothetical, but tomorrow’s is.”
    Very nice, Wisdom Seeker.

    Today’s 8% cap isn’t hypothetical, neither was 1980’s 16% cap.
    Watch out. 2042’s cap rate may not be a hypothetical 8%, either.

    CRE is the corporate welfare queen of America.
    Depreciate an asset every time it sells, again and again.
    1031 exchange.
    Deduct interest for an 80% leverage.
    40 years of interest rate decline from 16% UST bonds in 1980 to 1.5% a few months ago.
    CRE guys are spoiled.
    But hold on, wait it out until the dollar losses reserve currency status,
    as is happening with the BRICS as we speak and Iran, UAE and Venezuela with its oil wanting into BRICS.
    Then see where cap rates are.
    Hold on, John, you just might get what you are seeking and deserve.

    • phleep says:

      That bell tolls for residential subsidies too. Fire sale to Xi’s cousins? or Vlad’s? Or Chapo’s?

  49. Max Power says:

    I have seen an almost brand new Wal-Mart Marketplace grocery store in what looked like a pretty decent location close because they were making enough profit at that location. It was almost kind of shocking given that it was Wal-Mart, how new that store was and the fact that it wasn’t located in the ghetto or anything like that. I’ve never seen a supermarket close that quickly. It’s now a few years since and that location is still closed and hasn’t been taken over by another tenant. So… I would only hope for the property owner that Wal-Mart is making their numbers in that location or otherwise passing on selling that location might turn out to be a mistake.

    As for there still being gobs of money trying to make its way to the real estate market… that does appear to still be the case. I still get many unsolicited offers to purchase residential RE properties I own every week.

    • Max Power says:

      Correction… Wal-Mart closed the store because they were not making enough profit.

      Hopefully Mr. McNellis’ property isn’t in this same boat.

      • unamused says:

        All you need to stay in business is to break even. You don’t want to close shop and start up somewhere else because that’s expensive and introduces additional risk.

        “Not enough profit”? You don’t throw away a ten dollar bill because it’s not a twenty.

        You don’t close because you’re not making ‘enough’ money unless you can sell and use the proceeds to buy something better, which isn’t at all likely because somebody else is sure to have already bought it.

        Businesses typically close in relatively affluent areas because their leases were short-term and the landlord raised the rent, figuring they could extract more from a rental property in an affluent area. See my earlier comment. It’s why you see a lot of cre FOR LEASE signs in affluent areas, even without a recession.

        It’s mostly an American thing and far less common anywhere else. Various authors have commented about how weirdly obsessive Americans are about money for 300 years.

        ‘Monopoly’ is a game invented by a socialist to demonstrate the evils of capitalism. Capitalists love it, even though most players must lose. In the end there can be only one, and the winner always has the luckiest dice. There are no win-win scenarios in Monopoly.

        • phleep says:

          In a clean and frictionless market, competition takes profit to zero. Only inefficiency exploited, provides profit.

        • Wisdom Seeker says:

          @Phleep – not all the way to zero. There’s always a minimum profitability required for the capitalists to stay engaged.

    • Old School says:

      I think Walmart builds some new concept stores to see if they are a viable concept. Maybe they leaned what they needed to learn and moved on.

      I was surprised to learn Walmarts net profit was only around 3% where a lot of the dollar type stores was 8%. That was about 10 years ago anyway. Walmart’s model is definitely high volume,low margin. Put a lot of retailers out of business.

      • Max Power says:

        Most of Wal-Mart’s revenues come from grocery sales (even tough general merchandise occupies more of their actual sales floorspace). Grocery is well known for being a very low margin business, which is why it’s not surprising dollar type stores command a higher profit margin.

      • MiTurn says:

        About 20 years ago a brand-new Walmart was built across the street from an older K-Mart. The prices at the Walmart were cut-throat and, among other factors, the K-Mart soon closed and the Walmart remained. And then retail prices inched up at the Walmart.

        Not my anecdotal evidence, but documented otherwise.

        Shrewd.

        • unamused says:

          Walmart was built on anti-competitive practices.
          Technically those practices are illegal. Technically.

        • rick m says:

          Every Walmart I ever worked on several decades ago was originally located just outside the city limits of wherever it was. Every one was eventually absorbed into the local tax base by municipal fiat. Deals had to be cut to get the jobs. Later reneged on to get the taxes. Their business model was initially realistic and figured on this happening. Costs must hurt now at 3% margin. Those blue cart employees that shop for the transactionally immobile now drove me away, between them and the stockers it’s grocery gridlock.
          25% overnight price increases on some in-store bakery stuff seems gratuitous. It’s not like it’s really all that good.
          Unrelated: I’ve enjoyed fresh local shrimp, blue crab claws, white trout, and flounder in the past week. Looking for triple tail and small black drum. Not looking at Walmart. Ours probably stops at Mrs Paul’s and imported tasteless shrimp. Never leave home without an cooler full of ice in a fishing place.

      • unamused says:

        “Put a lot of retailers out of business.”

        Anti-trust enforcement isn’t what it used to be.
        If anything.
        Almost nothing, in fact.

        • phleep says:

          A lot of the New Deal and postwar economic order was built on government price controls (including, limiting supplies), and toleration (plus protection) of (highly regulated) monopolies, as in telecom. Recall Bell Telephone? Airlines? Banks? But that was done with a conscious policy of full employment, and labor-friendliness, and arm-twisting those businesses accordingly.

          This was the period of the most widespread USA household prosperity, hitting a tipping point finally in 1968 (and further inflections downward, as in 1973). When the thrust turned to price stability (as Reagan and deregulation arrived), the meaning of favored monopolies changed: straight to private profit to the top dogs,a and damn everything else. (Yes, we in the middle class could tag along with stocks.)

          This does not mean some delusion of “turning a clock back” would reinstate some “golden age” that wasn’t what people think it was. Witness the Supremes now trying to reinstate some pre-20th century America, and what a tragicomic crock that is, in so many ways.

          But monopolies can be many different things.

  50. Johnny5 says:

    RE Investor Psychology 101

    When valuations go up: “My wealth has increased!”

    When valuations go down: “Those are just paper loses, it’s all about cashflows!”

    When valuations go down and property sits vacant: “Sh*t!”

    • heyjagoff says:

      Funny you mention that. My brother went full on Airbnb guru last couple years and leveraged out (at top dollar) several SFR’s in various areas (Joshua Tree, Cape Coral, Smoky Mountains) which he manages remotely. When asked about concerns about losing his equity/down payments, his response was:

      “It doesn’t matter because they cash flow and he’s holding them forever”

      Perhaps a handful of YouTubers have him convinced that Americans are stupid, and they’ll sell their kidneys to spend on vacations. Personally I’m very skeptical.

      What are you thoughts on his discretionary spending assessments?

      • Jon says:

        Unless people become very rich
        Discretionary spending like vacations would be the first to go.
        I am cutting down on my expenses and vacation is the first thing to go.

        Time to tighten up expenses.

        One more anecdotal observation: most of my well to do friends are Tightening up their expenses but not so well to do have no clues about tightening their belts.

        • heyjagoff says:

          Yes sir. Common sense would dictate that.

          Guess it comes down to the old famous quote “Ignorance is Bliss”, or as my late father frankly put it “Stupid people always suffer”

      • Johnny5 says:

        Live by the sword, die by the sword.

  51. Michael Engel says:

    1) ) Chinese RE co are caving from within, expanding overseas.
    Happy 3rd China. China third and most modern aircraft carrier was launched on June 17. They liked it so much, they asked for more. More aircraft carriers, more deep sea ports and more long runways airports.
    2) China build deep sea ports and long runway airports in the Solomon Is and in Papua New Guinea surrounding Australia, a launch pad against Japan.
    4) Chinese teaser construction loans trap poor oil nations, or strategically important islands to dominate the world, to replace US.
    5) Higher inflation rates destroy small nations, they accept China friendly hands. Higher interest rates will make it difficult to pay debt. The deep sea ports will become Chinese naval bases and the airports Chinese air force bases.
    China execute it’s long term plan…

    • MiTurn says:

      Same old story, just different actors. History books are full of ’em.

    • phleep says:

      Kind of a brilliant financing twist, I have to admit. UK’s and our old trick of simply extracting resources and labor (or shipping in opium, as to China) seems so old fashioned!

      Of course, at some point, we got affluent enough as to want to shed those old nasty stories. I think this is becoming codified law for schools in Florida and Texas. Which sounds kind of Xi-like.

      • David W. Young says:

        Comparing elected governments in Florida and Texas to communist dictatorship in China under Xi, kind of a very big stretch, phleep. Most school boards in America are way out of control, taking behavioral and moral teaching away from the rightful instructors, parents, and putting these basic family issues into the hands of teachers, many still wet behind the ears?

        We pay their salaries, we contribute to school construction and land acquisition, we as parents should have a very active say in what they try to indoctrinate our kids with day in and day out.

    • sunny129 says:

      ME

      Same things are done by IMF and World Fund when they supposed to help developing nations. They dictate ‘austerity’ open the sectors, beneficial US/Eu multi-nationals, there by capture and dominating the mkt. They dictate that those nations reduce the subsidy to agriculture, so that Western Companies can thrive!
      Bottom line:
      Exploitation of the developing countries by super powers. All the members of the security council are the largest weapon manufacturers and exporters. There is a war(s) some where, all and or any time in the world!

  52. russell1200 says:

    I have often wondered how this works in Solar PV. I did ask someone in the business, and he said the PURPA (Repurchase) agreement with the Utility will match the expected lifespan of the Solar Farm.

    But I know that there was push back from utilities, and some were utilities were (at least trying to) limit the agreement to 10 years. So I don’t know how that part of it stands.

    But so long as the PURPA matches the investment time frame, you pretty much have the same thing as what is being talked about in Commercial Real Estate.

  53. CCCB says:

    Something else to consider…. Single tenant landlord is very different from a mall/shopping center with multiple tenants. Most good leases by non anchor, smaller tenants have rent reduction or complete cancellation clauses in the event the main traffic drawing tenant leaves or even has a substantial reduction in sales volume. The same goes for nearby properties. One Walmart/Walgreen’s/Publix/Kohls closure can have a huge domino effect commercial property values in the entire area.

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