Economists and professionals in the corporate and real estate restructuring sectors have been expecting a struggling economy for the past 18 months. So far they have been wrong.
The public is just confused. Many people today trust their politicians, their news sources, and surprisingly not even their healthcare providers and professionals. This lack of trust, coupled with the pandemic mandated way many employees are working remotely, has caused many people to reevaluate their lives and where they are willing to deliver their services from.
Many mid-level and senior employees will choose to work remotely permanently and never return to the office. This shift in how people will work in the future will have a profound impact on many aspects of our economy, including the ability of landlords to keep commercial space leased.
Factors affecting the current economy
COVID-19, the Delta, Omicron variants and now the highly contagious BA.2 variant have left millions of workers unavailable for work, either remotely or otherwise. This has caused a serious disruption in the supply and distribution chain. This problem is partly caused by manufacturers being unable to supply component products due to work stoppages in factories. Add to this supply shortage the fact that staffing disruptions in the transportation and delivery of products are being caused by COVID (i.e. the shortage of truck drivers) and we can clearly see the bigger picture of the disruption in the supply chain.
The threat of a significant new round of tariffs, embargoes and other economic sanctions due to the political climate creates further risks that the US will become a troubled economy. There is also a risk of high inflation. On the positive side, the stock market and the overall economy have generally been moving at a solid and positive pace until recently. The stock market doesn’t always accurately represent what’s really going on in the economy, but recent market volatility may be a harbinger of troubled times ahead.
Will the accumulation of these factors ultimately lead to the projected economic distress? No one knows for sure, but when analyzing the situation, it can be instructive to look at the issues that prevented the expected downturn.
banks and banking
Since the pandemic began, regulators have not pressured banks to take action on defaulted loans. Historically, banks have been willing to “throw the can” on defaulted loans if they could do so without significantly impacting the carrying value of the loans in terms of banks’ capital requirements. The current stance of regulators has enabled banks to do just that.
While the laissez-faire attitude of regulators has clearly had a positive impact on the economy in the short term, regulators will eventually know that the impact of their actions will result in banks preparing misleading balance sheets.
Regulatory behavior ahead of the midterm elections is unlikely to change later this year. At some point, however, they must stop allowing banks to circumvent credit classification. Otherwise, they risk that the banking system will continue to misstate the value of its credit claims, with all the risks of such a situation affecting the creditworthiness and stability of the banking system.
If bank regulators change their position on how they treat defaulted loans, I think we’re in for an expected tsunami of real estate foreclosures and bankruptcies.
Additional Factors to Consider
Interest rates have historically had a significant impact on the economy, particularly the real estate sector.
The Feds have kept interest rates close to zero to support the economy. Now, however, the specter of high inflation will almost certainly put an end to near-zero interest rates. Annual inflation in 2022 is expected to be close to 7%. The Fed has already announced that it intends to combat inflation by raising interest rates as early as March. The question is not whether interest rates will rise. Rather, it depends on how much and when.
Rising interest rates harm individuals in many ways:
- The most obvious is that they make housing less affordable. When interest rates rise, fewer and fewer people are eligible to buy a home. Existing homeowners with adjustable rate mortgages are also negatively impacted by interest rate increases.
- Rising interest rates also have a negative impact on corporate profits. This affects the stock market and therefore the value of stocks in individual IRAs and 401(k)s.
- Big changes in how people work will result in winners and losers. Time will tell how this will play out, but it certainly looks like the economy is about to be disrupted.
The pressure on companies is increasing
The reemergence of COVID in the form of current variants has all but destroyed the timeline for society to return to normal. There is no reliable way to predict the impact this reappearance will have on the country’s psyche. However, it is foreseeable that this resurgence will have a negative impact on the economy and further delay the return to normality.
In fact, it is likely that pre-pandemic normalcy will never fully return. Trends such as consumers shifting towards online shopping will negatively impact brick-and-mortar retail. The demand for retail space is likely to fall even more sharply than before. This problem has been accelerated by the pandemic.
Shopping center and commercial property owners are gearing up for the vacancy wave that is sure to be on the horizon. Individuals are well advised to assume that inflation and higher interest rates are imminent in the near future, and should act in whatever way possible to mitigate the damage they are inflicted by the looming dual threats. It is uncertain how the federal, state and local governments will react to the situation.
Uncertainty is the enemy of business and it is clear that we face uncertain, unpredictable times. The general public perception of all this remains to be seen. There is much distrust among the people of our nation. These factors combine to create the perfect storm for businesses and real estate investors to weather increasingly difficult financial times.
Steps to consider
The best advice we can offer is for companies to deal with their distressed assets early on.
- for homeowners, Interest rates will almost certainly rise in the near future. If a homeowner can refinance their mortgage to take advantage of the current low interest rates, this course of action should be considered.
- for consumers, It makes sense to speed up the timing of major purchases as the threat of inflation will make the dollar less and less valuable and the actual cost of an item will increase over time.
- individuals should are also considering exiting the stock market as soon as possible or minimizing their stock portfolios. Converting stocks into cash is not a good strategy at a time when the value of the dollar is set to steadily decline. Conventional wisdom dictates that investing in precious metals like gold and silver is a safe haven investment. Therefore, it makes sense to sell stocks and buy gold and silver.
- entrepreneur should analyze their deals based on the assumption that the near future will bring high inflation, high interest rates and continued supply chain disruption. It is prudent to take steps to restructure the business to mitigate the damage if these future assumptions materialize.
The public at large will watch inflation and rising interest rates and react accordingly. The sooner people and businesses accept and respond to these changes and respond appropriately, the more likely it is that Chapter 11 bankruptcies can be avoided. Not only does this increase the chances that companies will be able to resolve their financial problems without resorting to bankruptcy, it also often reduces the need for layoffs.
Founder and President of Distressed Capital Resources LLP
William N. Lobel is the Founder and President of Distressed Capital Resources LLC, a company that has brought together virtually every resource available to assist borrowers with financially distressed properties or businesses with the goal of successfully maximizing a borrower’s leverage and options in the solve the borrower’s financial problems.