Cyprus, the Cost of Doing Business, and Austerity: Why LANDCO Shorts Real Estate

In this Situation Analysis, LANDCO Principal David Rosenbaum examines

the role of austerity in our current economic climate.

1. Austerity

   is counterproductive in a financial crisis. Essentially the EU’s advice to Cyprus was, “Pull in your belt and pay off your debts.” That is a preposterous plan. Cyprus can’t pay off its debts — they’re in a !@#$ financial crisis! They already sold their belt to pay for food. The idea in Cyprus (quickly rejected) that savings should be confiscated from the average citizen is really just a cartoon version of the Ryan plan in this country (still even now advocated by an insistent minority). Both approaches boil down to “tax the poor” — in Cyprus by directly taking cash, under Ryan by slashing the standard of living. But whether you take money out of the economy in one way or the other, austerity reduces output. That’s the purpose of austerity: to help modulate growth, reduce output during highly expansionary periods. Austerity makes no sense whatsoever in times of weak growth or contraction, such as we have now.

2. Everything is related to everything else, and “everything else” costs money. We should learn from Cyprus what we should have learned from Greece and what we first learned in the 1930’s. In the modern world, we are all connected — financially and in most other ways. The Cypriot banking system is tiny in international scale with perhaps $270 MM in total assets. Lehman Brothers were tiny in its way, too, but one little block pulled out of the Jenga pile is enough to dump the whole thing. Complex systems require high maintenance. And high maintenance is expensive. “Market fundamentalism”, the idea that rational self-interest is more efficient (i.e., freer, cheaper) than regulation in governing financial conduct, is bunk.Even Alan Greenspan has suggested as much. The question is, who pays the maintenance cost? Austerity answers, the poor.
3. Bailouts work, or how I learned to stop worrying and love stimulus. When AIG and all the other insolvent financial firms were bailed out, that was good (necessary) for the banking system. At the time, no bankers were calling for austerity toward themselves, though now they demand it of whole nations. “Stimulus” wasn’t a dirty word to them when TARP provided them with large personal bonuses, but now they decry it. Yet stimulus is needed just as much now for the general economy as bailouts were needed back then for troubled companies. If invested in long-term projects in education, research and infrastructure, stimulus will strengthen the economy for generations to come. But of course, stimulus costs money, and corporations are determined to hold onto their cash. We got our stimulus, they say, and now everyone else can have austerity.
4. Austerity and high prices. Simply put, policy-makers are searching for a way to lay off the cost/risk of our economic system onto the general public. The name for that is austerity, a policy that raises the cost of living with the aim of reducing debt. It doesn’t work, it’s unpopular, and it doesn’t only raise prices for the average Joe. Austerity also causes investors to pay high prices for fixed income investments. A slow economy presents limited investment opportunity, so yields fall (prices rise). U.S. bonds, high-grade corporate bonds and single family mortgages are as costly as they’ve ever been in history. Class A real estate is trading at the highest prices we’ve ever seen (i.e., the lowest cap rates). In an economic recovery, whenever that should occur, yields will rise, and a long position in real estate, if not thoughtfully hedged, will surely come under pressure.
5. What do we mean by shorting real estate? In order to avoid the high prices for long-term yields, LANDCO has mapped out a
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   strategy of acquiring impaired mortgages and other distressed real property for short holding periods. In a sluggish economy with lots of idle cash to be invested, there is a premium on income-producing property. However, non-income producing property — property that is burdened by too much debt, too little occupancy, unmarketable physical deficiencies

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   management — has no such premium. This is what we refer to as real estate being sold short. In an otherwise high-priced investment market, this is the type of asset that can be profitable today without exposure to rising yields tomorrow.In the U.S., the odds are that our economic policies will move toward stimulus in the coming years. Advocating for austerity in the last election served Romney/Ryan poorly and probably won’t be any more popular in 2016. If, as a result, Congress should show greater interest in economic stimulus, then LANDCO would probably interpret that as a buy-signal for real estate. At the moment, however, our politics haven’t quite escaped the gravitational pull of austerity, and the short strategy makes more sense.