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The Headwinds Continue. How The Bond Market Is Wreaking Havoc On Real Estate

Updated: Jan 3


As we continue studying the markets, let's dive into bonds and how they affect commercial real estate. First, let's define "budget deficit" as it pertains to government spending. It's a pretty simple concept. The government determines budgets for the different aspects of its necessary spending. And just a quick word on that... the governments is not a business, they are spenders. They receive tax dollars with the intent to spend every dollar to run the country. They allocate those funds into buckets, or budgets. Budget deficit means that they are spending more than they allocated into those budgets. They are spending more money than they make, racking up debt. Today, the United States' national debt and deficit are both at historic highs. Some data points: the US fiscal year runs from October 1 to September 30th. In the fiscal year that was just closed out, the national deficit rose almost 25% to $1.7T. Increased spending pushed the national debt up over $10T, sitting at well over $33T today. The interest expense on the national debt has risen 67% since March 2020 when the pandemic began, from $544B to $909B. The government pays it's debts back in forms of bonds. That's where things get interesting.

Treasuries and geopolitical influences.

The US economy still appears strong. However, as we have highlighted in previous newsletters, the underlying fundaments suggest anything but. The Fed chose not to increase interest rates, for reasons that we will dive in to in the November newsletter. Treasuries have been called one of the world's safest asset. However, with the country in a recessionary position yet still strong economically, volatility is here to stay for a while. This is partly because the Fed is struggling with it's long term vision for interest rate policy. Things are complicated. Jerome Powell, the Fed Chairman, stated that they plan to hold steady on the interest rates to monitor the economy, and if it is still strong, he will hike it another 0.25%. Other countries are selling off our Treasure securities. Just this month, October, BRICS countries China, India and Brazil sold off $18.5B, yes, Brillion, of US Treasuries. China has been selling treasuries all year, and they re the second-largest foreign holder of US treasuries, with Japan being the single-largest foreign owner of our country's debt. The government sells different treasury notes, bonds, but the 10-year note is the benchmark. Last week, the 10-year yield increased above 5% interest rate. This is the barometer for mortgage rates, auto loans and student debt, for example. Yields (interest rates) rise and fall according to the Fed's interest rate policy and the investors' inflation expectation. That's just the way the economic machine works, as Ray Dalio taught us in his "Principles" series. The rates are increasing because investors are nervous about the US government debt rising. Our collective creditworthiness is at stake. Are we going to be able to continue to pay our debts? Generally, the riskier the loan, the higher the interest rate. Investors demand a higher return if they perceive a greater risk of the government's inability to pay back debt in the future. The rapid rise in Treasury yields may accelerate an already weakening economic picture. What happens when mortgage rates remain high? And when student loans interest rates climb? New car loans increasing? What does it mean for the consumer? Credit cards, small business loans and home equity lines are pegged to this rate. All of these things affect all consumer loans. In the short term, savings rates will climb. But with all the above volatility, will banks become liabilities again like in the 2008 recession? This recession will surely be different, however, the underlying fundamentals will remain the same. Let's continue to monitor this and see how it affects our positions. For now, there is high risk on commercial real estate, especially endangering new development projects. The interest rates for the mortgages are higher than projected when these properties were purchased, which affects values. To be continued....

In closing.

In closing, as investors, it is important for us to remain true to the fundamentals. One simple fundamental is to increase risk during up-cycles and to decrease risk into capital preservation during down-cycles. Commercial real estate is continuing to shake and the headwinds are strong. However, as a mentor of mine always tells me, "there is cash in chaos if you could find the opportunities within the noise." This is where Ten15 Capital is positioning ourselves, to not only weather the storm, but to find asymmetrical opportunities to preserve and grow our wealth in uncertain times.


This is our opportunity!

 

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