News for the Hospitality Executive |
by Joel Ross, HotelNewsNow
Columnist March 2013 While revenue per available room exceeded what I predicted in 2012, it was primarily because some of what lies ahead is slower to arrive than I had thought. The bubble is growing, and unless Washington—and especially President Obama—act to reduce entitlements and overall spending and accomplishes true tax reform, the result of the bursting bubble someday will be very ugly. The projections of valuation increases going
to the sky,
which come forth from some appraisers, are based either on not
understanding
the macro issues, or simply intentional puffery to make everyone feel
good.
Similar to what they said at New York University’s International
Hospitality
Industry Investment Conference in 2008, when it was predicted that the
worst
was over, RevPAR was still headed higher, and it was time to buy again.
Just in
case you forgot that speech. If you are investing in assets or projecting
the growth or
decline of net operating income, you need to understand what is really
happening. First, by now, you surely understand the federal
government’s
spending is out of control, and it simply cannot continue. Entitlements
are
currently 50% of the federal budget and will soon be up to 67%. That is
not a
typo. There is no possible way that can continue. The number of
retirees grows
everyday by thousands, and the young workforce to pay the bill is at a
far
lesser percentage than it has been. There are 4.5 young people paying
for each
retiree, and it is headed to 2.8. The math does not work. We are about
to add
tens of millions to Medicaid through “Obamacare,” and there is simply
no way to
pay for that other than through higher taxes, which that law mandates,
plus the
$680 billion from the December fiscal cliff deal, and more tax
increases to
come. The sequester reduced the rate of growth of
the deficit; it
did not reduce the deficit. The tax code is absurd and unfair.
Regulations
continue to pour out of Washington raising your cost of doing business.
For
these, and many other reasons, the economy is now in its slowest
post-recession
growth in post-depression history. Because of the refusal of Obama to
agree to
any real deficit reductions, there is little chance this will all
change for
quite awhile—possibly years. So that left the Federal Reserve to try to
bail out the economy
by pouring trillions more liquidity into the economic system through
the first,
second and third quarters, and driving interest rates to
unrealistically and
unsustainably low levels. It is estimated by the Fed, and other
economists,
that rates should be around 65 basis points higher than they are, if
the Fed
was not manipulating the bond market. Right now, the Fed buys 80% of
all new
treasury issues. That is more than two times what is normal. In short,
the bond
market, the lending market and credit markets overall, are being
manipulated by
the Fed to try to save the economy from the inability of Obama and
Congress to
deal with the real problems. It is not a real free market at all. So
values today are
higher than they should be due to rates being 65 basis points lower
than a free
market rate. Capitalization rates are therefore lower, proportionately,
than
they should be. As a result, capital is being driven into buying hard
assets, stock
market equites and real estate markets, and is being financed by
unrealisticly
low rates. In time, the bubble will burst and the price will get paid.
The Fed
cannot keep doing this forever. When they stop, the bond market will
decline,
all lending rates will go up rapidly and the stock market and asset
values will
decline, possibly by a lot. There is no way to know when, but it is
going to
happen. Because the Fed is manipulating the bond market, the market
signals
that one normally hears from trading of debt securities are absent
because
traders have no real say. The Fed has the say. We are, as a result, in
an asset
bubble that will come to shreds one day when QE3 ends and the Fed is no
longer
able to cover for the fiscal mess. That will combine with the
realization that
the U.S. is no longer a sound economy due to a massive deficit that is
swallowing the private capital side through massive new taxes just to
pay the
far higher interest rates required to fund that deficit, which when QE3
ends,
will suddenly make the current deficit seem small. The U.S. has a serious problem because of
the lack of
leadership in Washington. On the surface it might appear the economy is
getting
better, and it is on the surface, but beneath the sunny surface of the
economic
ocean is a tidal wave headed for shore. That is exactly what happened
in 2008.
People stood up at NYU that year giving happy spin and completely
misunderstood
what was really happening, while some of us were busy selling out as
fast as we
could. It is like that recent Florida sinkhole tragedy.
The house
on top looked fine, but underneath the ground was sinking and nobody
noticed
until it was too late to save the man. I am sure many will say, “Here goes Dr. Doom
again, and he
was wrong last year about RevPAR.” I can only tell you that in November
1993,
when we created the first hotel commercial mortgage-backed security
programs,
we predicted it would eventually all crash in a terrible collapse, and
in June
2007, I was all in cash and not reinvesting until March 2009. My
ability to
predict exact timing might be off, sometimes by years, but the
long-term trends
are absolutely clear to many of us who are not trying to snooker the
rest of
you into believing the happy gas is the real world. So you need to stop listening to the puff
and predictions of
great increases in values over the next years and pay close attention
to the
reality of the Fed, the credit markets, interest rates, and where they
are
really headed over time. You might do well for awhile, but at some
point in the
next several years, you will get caught holding illiquid assets if you
are not
paying close attention—just like in 2008. Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com. This article was reprinted with permission by HotelNewsNow. |
Contact:
Joel Ross www.citadelrealty.com |
The
Lodging Conference - Escape From Reality / Joel Ross / September
2011 |
Dr.
Doom: Effects of the Downgrade on the Hotel Industry / Joel Ross /
August 2011 |