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Uncharted Territory-Rick Chichester Attentus Advisors

ON OCTOBER 10, 2008 the Dow Jones ended its worst week ever, capping a staggering eight-session sell off that resulted in a 2,400-point loss.The world markets soon followed suit. By the following Monday, the market rebounded, posting the largest one-day points gain in its history. No doubt, by the time this issue hits the presses, we’ll have been pitched and tossed through this cycle several more times. So in the ebb and flow that is our current economy, where are we headed?

Clearly we are in uncharted territory and, according to the International Monetary Fund (IMF), “The world economy is entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s.”

At the center of this issue are the liberal mortgage lending practices of the U.S., which have now grown into a world crisis of confidence, revealing both the scale and limitations of globalization. Finance and the financial markets are built on trust and now, suddenly, that trust has evaporated and has been replaced by uncertainty—uncertainty by depositors over the safety of their money. Uncertainty among banks about the risk of lending to each other. And uncertainty among our political leaders, the central banks and regulators, who are wondering if they have the resources and capacity to stabilize the financial markets.

At the core of the global financial decline are the highly leveraged mortgage-backed securities that banks and financial institutions around the world bought and still have on their books. The latest estimates calculate the losses on these financial instruments to be approximately $1.4 trillion and, to date, less than half that amount has been written off.

The instability and uncertainty within the financial markets will soon cascade onto Main Street. The credit issues that we are now experiencing will apply further pressure to an already contracting economy and worried consumers. Banks will reduce their lending to households and businesses, and mortgages and car loans will be harder to obtain. As a result, the spending power of the consumer will be at risk. Consumer spending accounts for three-quarters of the $14-trillion-dollar U.S. economy.

Should consumers reduce their spending, business productivity will be negatively impacted, creating more economic instability. Based on past economic contractions, it takes approximately 18 to 24 months for a financial decline to spread through the balance of the economy.Therefore, the issues within the credit markets will not impact an already contracting economy for approximately two years, which will continue to exacerbate the economic decline. The IMF recently predicted that the U.S. economy will grow at just 0.1 percent in 2009 and has estimated global economic growth to slow to 3 percent. The U.S. economy needs to balance two issues that have come together at the same time: the current credit crisis and a consumer-led economic recession.

However, we haven’t completely lost our way. The markets are changing and, therefore, we need to act with reason, discipline and patience. With regard to the commercial real estate market, this asset class is relatively stable. The vacancy rates in all product types and in most markets are reasonable, and there is limited speculative new product coming onto the market. During the past several years there has been a flight from quality due, in part, to increasing rents and price appreciation, but now there is a flight to quality.

Commercial real estate will return to its fundamentals: quality location, quality product and quality ownership. The focus will be on asset management, operational skill and responsibility, and care for the health and welfare of the tenants and their business. In the near term, expect rental rates to be neutral or decline modestly for core assets and more significantly for non-core assets, and expect greater rigor and discipline in underwriting and property valuations. This is not a time to panic; it is opportunity to create value through a disciplined approach to the fundamentals. And it is a time to be patient—it will take time to work through the current realities of the market.