Banks create money out of thin air…
Fractional reserve banking (which means that banks hold only a small fraction of their depositors’ money in reserves and lend out the rest) serves the economy.
Businesses and households borrow to grow their businesses and purchase property.
There is one problem…
Banks have the incentive to create as much credit as possible. That’s how they make money.
More credit means more revenue for them.
Credit growth that finances economic growth isn’t really an issue.
But unlimited credit that supports a finite resource (land or real estate) creates booms and busts.
And since almost every part of the economy has links to land value, as I explained in this issue, falling land prices trigger recessions.
Watch Real Estate Valuations
These booms and busts have happened repeatedly in the past – and at predictable intervals. On average, the real estate cycle took about 18.6 years from start to finish.
Right now, we are in the second half of the cycle.
And today, I’ll tell you what signs to watch out for to predict when the bottom is about to drop out.
(But a reminder… we’re not looking for a crash until 2026… but it’s good to learn to “see” the cycle and its indicators.)
You know something is wrong when the Fed says that it isn’t.
And just recently, Jay Powell, the Fed’s chair, said that he “was aware” that commercial real estate loans are concentrated in banks.
In the United States, banks own about 40% of commercial real estate loans.
This wouldn’t be a problem if the pandemic never happened.
But in the post-pandemic world of remote work and online shopping, commercial real estate is vulnerable.
And banks have a lot of commercial real estate loans on their books.
The problem is… its owners might not be able to make enough money from their office buildings or shopping centers to afford the higher interest rates when they need to refinance those loans.
In the major 10 metro areas, including San Francisco and Chicago, office occupancy is at about 50%. In New York, the world’s #1 business center, occupancy is at 48%.
This is a ticking time bomb for the real estate and banking industries.
When the value of real estate goes down, banks face loan losses.
We have just seen how the collapse of a handful of small banks sent jitters throughout the world’s financial system.
Imagine what could happen if cracks start showing in the banks’ $2.7 trillion commercial real estate portfolio.
(For comparison, the banks’ residential real estate portfolio was $300 billion smaller.)
Higher losses. More stringent lending standards.
Less money created by banks.
Credit creation has sustained the economy, and if banks need to slow down credit growth, we’ll be in for a crunch.
And that’s why I’m watching the value of commercial real estate now. It could be one of the first signs that the end of this cycle is approaching.
But until then… sit tight. We’ve just seen the lows I predicted in March. And we’re looking for the market to head up from here, until the cycle turns.
Regards,
Phil Anderson
Editor, Cycles Trading with Phil Anderson