Benjamin Tal speaks at NAIOP on 2012 economic predictions

For those who prefer the executive summary:

I see china slowing down, but I see the government responding in a very quick and appropriate way.  US economy is moving in the right direction.  We will outperform most economies, but still low growth of 2%  Yield like reits will enjoy the benefit of uncertainty in that the BOC will not want to change rates.

 

INTRODUCTION AND PRESENTATION BY BRYDON CRUISE – BROOKFIELD – NOTES:

TOTAL $32B market cap for securitization of real estate in canada.  Brydon suggests there is room to grow this internationally.  In Germany for example, there was an IPO with a 35% discount to NAV for the launch of an offering.  Just not a very mature market yet.  In other words, there is huge room to grow for real estate securitization in the rest of the world and particularly in Europe.

In Canada, while we account for about 2.5% of the World’s GDP we have been very active in foreign markets and have been making 12% of the trades globally.  $5.7B of total capital raised for canadian reits/recos in 2011 – 25% of transaction activity occurred internationally and was deployed outside Canada.  Foreigners have not been buying in canada to the same degree – mostly we presume because they are dealing with issues on their own soil.

CHART: STABILITY OF THE INDEX SPREAD

Spread over the GOC 10-year and the yield of the REIT index was at a minimum in June 2007 (.4%) and a maximum in March 2009 (10.7%).  Currently the spread is at 3.3%

REITS have been growing their cashflow more than their dividends.  REITS have done a good job of holding their dividends stable while cashflows have increased and as a result their payout ratios have been reduced to below 90% (below the dividends), thus eliminating some of the concerns of a few years ago regarding the dividends REITS were issuing in excess of cash flows. A healthy place to be.

CHART: HISTORIC CLASS A TORONTO OFFICE – current cap rate is 5.9%; current debt is approximately 3.8% and the spread is approximately 2.1%

If I have a worry it is interest rates.  Spreads and Margin are pretty vulnerable to changes and have kept our system healthy.  Rates are forecasted to rise, and managers should act accordingly.

 

BENJAMIN TAL – CIBC WORLD MARKETS NOTES 

I spent 2 hrs with BOC yesterday – and they have no clue. Everyone is uncertain.  More uncertain than usual. “The real measure of intelligence is what you do when you don’t know what to do”.

“So what do you do, you don’t take chances”

Monetary policy will be extremely conservative as a result.  With possible reductions in interest rates.

 

EUROPE

In Europe, Greece will default.  They will not call it a default.  But if you bought Greek debt you will call it a default.  Italian financing requirements for italy is $790B euro by 2015.  ECB will start printing money eventually.  But before that you will see more blood.  ECB is not in favour of quantitative easing.

Possible Outcomes:

1. Eurozone collapse.  Germany can not allow.  Germany needs the Euro more than the Euro needs Germany.  60% of exports go to Eurozone.  If Eurozone falls it will kill this exporting machine called Germany.

2. Smaller Eurozone – without portugal, greece – if Greece exits, migration etc… nobody wants this, and it is unlikely.

3.  Eurobond – ECB buying eurobonds to allow some time.  Between now and then, it will be extremely volatile. The euro will go down.  They will start printing money in a different way then they have been, perhaps more like Bernanke.

 

CHINA

China is slowing down.  Because it wants to slow down.  Until now, inflation was 6-7%.  China can shift/stop policy so quickly.  Real estate bubble in China is softening.  BC Lumber exports to China is at a 34 month low.  In 2008 China’s infrastrucutre stimulous was double the size of Obama’s.

Much of the first round of infrastructure investment money was borrowed by Special Investment Vehicles.  A lot of leverage.  From here on in, the government is ensuring that lending is secured on the basis of the project and not on the basis of the government.

We are all SO dependant on China. If china goes to hard lending – we are in a huge global recession. However, the Governent in China can react so quickly and they are already moving towards soft lending. In the next 6 months I would be defensive on commodities due to the Chinese situation.  Thereafter, probably not. With respect to Gold, it will continue to shine during all of this global uncertainty.  But at one point gold will be crushed when it no longer becomes comfort food.  Gold is ok.. for now.

 

USA

I can spend 2 hrs telling you how bad things are in the US.  But I am starting to see some interesting things.  This american consumer is de-leveraging at a phenomenal rate.  They have ALMOST brought household debt to disposable income levels to the historical trendline.  US credit card charge off rates almost back “to normal”.

US Employment – Obama – despite all of the unprecedented stimulous, QE, and investment unemployment actually got so much worse than it was previously.  Unemployment went to 10% and resulted in a very severe economic recession.

Economics 101 will tell us something: If the unemployment rate doubles, lower wages should come in to place and counteract.  HOWEVER this is the first recession ever, that wages DID NOT GO DOWN.  2/3 of the jobs that were lost in the recession were manufacturing and construction.  Can you really re-shift this expertise to other tasks?  You can’t.  Obama can spend as much as he wants but the structural change in unemployment can not be solved that quickly/easily.  All of the jobs created in the recovery WERE ALL MEN – men suffered the most.  Investment rising far faster than employment.

The most important derivative lesson for Economics students from this recession will be The ongoing renaaissance in the US manufacturing sector.  The sector has been expanding for the past 20 months.  For the first time these manufacturers have an emerging market.  The consumers in the emerging markets are big enough to make a huge difference (China.. etc). What these new emerging consumers want is not Junk.  They want quality and a brand name.  Competition is based on QUALITY and not COST.  Penetration in these markets by North American firms is 20%

Previously manufacturing was to produce products that suited needs of a highly-leveraged US consumer.  IT HAS BEEN TURNED THE OTHER WAY.  And it is allowing North American Manufacturing to compete in a big way. FIRST RECESSION EVER WHERE INVESTMENT IS RISING FASTER THAN EMPLOYMENT.  Investment has not created any jobs AND the fastest growing export from US to China is TOYS!!! We thought all of the toys in the world were made in China!

 

CANADA

We have to be a bit careful with economic data.  40% of GDP over the last ten years has been the government.  Can’t last forever.  Must be replaced.  Hasn’t been the consumer.  Has been business investment.  Business investment is the real pioneer of this investment cycle.  Moving away towards leverage into business expansion.

Composition of growth more important than growth itself.  Have to go even deeper: we must talk about debt.  The debt to income ratio in canada is rising and it is rising faster.  Everyone is talking about it.  However, The debt to income ratio is meaningless.  You are comparing the stock of debt to the flow of income – it is not apples to apples.

Consumer Credit is now rising at the slowest rate since 1992.  Mortgages rising at slowest rate since 2001. SO, Debt to Income is rising and credit is decreasing.  So, its not the debt story.  It is the income story and incomes have not been rising.

There are 7 countries with higher Debt to Income ratios than Canada.  Many of them are AAA economies.  So this alone may not be a concern. What might be a concern is that 1/3 of borrows in Canada are heavy borrowers.  This group is increasing.  Older people are taking on more debt as well. We need to pay attention to this group, and thankfully most of our banks are.

The big question: “To what extent is this country sitting on a real estate bubble?”

There is no doubt in my mind that house prices in this country have overshot.  In order to crash, you need a huge increase in interest rates or a subprime situation.

INTEREST RATES:  I’m convinced that this central bank will not increase rates in the foreseeable future – simply because when you don’t know what to do is that you don’t take chances.  This Bank is very strong compared to predecessors and they do not want to take risks.  This central bank is not going to change rates anytime soon.

SUBPRIME: Debt is slowing down.  Prices will be falling.  Prices stagnating a little.  10-15% price softening – but not a crash unless the ratios of highly leverage buyers continues to rise closer to the point where interest rates will be increased.

CASH: There is so much corporate and indiviudal cash.  $35B of extra cash looking for direction.

BANK OF CANADA HAS INDICATED WE ARE AT RECORD HIGH DEBT BUT THAT WE HAVE RECORD HIGH CASH. Can’t we just write a cheque?  Problem is that people with the cash are not the same people with the debt.

Majority of the people with the cash are over 55 yrs and this is the nature of the demand of the REIT market – the search for demand and the search for yield.  This is not a linear recovey.  The first half was BOC, government, second half has been private and business investment.

SUMMARY:

I see china slowing down, but I see the government responding in a very quick and appropriate way.  US economy is moving in the right direction.  We will outperform most economies, but still low growth of 2%  Yield like reits will enjoy the benefit of uncertainty in that the BOC will not want to change rates.