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"...Overcapacity – first of credit, then of real estate
– drove the price of renting sharply lower, bankrupting cautious investors along with big
borrowers..."
A TEXAN
CUSTOMER who came to see me a few months ago told me a story
which illustrates the fine mess we're in.
In the 1980s boom his neighborhood
boasted not one but two commercial real-estate developers, both of whom were
building shopping malls.
The one developer was cautious.
He'd already built two malls successfully, and by re-investing some of his
profits as equity in his new project he'd reduced his leverage and his risk.
Further along the avenue, however, was a more aggressive
developer. He'd borrowed 98% of his construction costs on artificially cheap
credit; money which had been pumped into the banking system by the Fed to
keep the economy steaming along.
Anyway, the experienced developer was earlier into
his construction project and completed it ahead of schedule – and he
got his mall nearly fully occupied. His competitor, as well as being more
highly geared, was slower to build and later to complete, so you can guess
what happened next.
As the early '80s boom in Texan oil projects and
real estate turned into bust, the new mall couldn't get any tenants, which
meant there was no revenue to pay down the debt. The aggressive developer
went bust, and with the local economy sagging, the near worthless debts on his
empty mall were sold by the bank at just 18 cents on the dollar.
That allowed the new owners to slash the asking
rents. They charged 4 cents on the original construction dollar, making a
yield of 4/18 – a healthy 22% yield on their outlay. But that rent
deeply undercut the other, more cautiously
built shopping mall. It was charging 12 cents on its construction-cost dollar,
fully three times as much.
Naturally, as the recession wore on, the cautious developer watched his tenants quit his
mall for those cheaper rents down the freeway. So now the cautious developer failed too.
Why? Because
overcapacity – first of credit, then of malls – had driven the
local price of rented retail space down to third of its reasonable rate of
return. The total rent that could be earned on two malls was significantly
less than what could have been earned on one.
I have always found it difficult to make the logical
step from cheap credit – which sounds so helpful – to financial
collapse, which seems so regularly to follow it. This story shows how the
route passes through overcapacity. Yet even overcapacity was not bad news for
those investors who bought the distressed mall at 18% of its construction
cost.
How were they able to get such a bargain? Simple. They
could raise cash when almost no-one else could. That probably meant they were
debt free at the end of the expansion, and had found a reliable store of
ready value as the credit liquidation played itself out.
I like to think that lots of BullionVault users will one day be the opportunists in stories like this, though I
also believe the credit crunch has a long way to go, which means it will not
be for some considerable time. Gold
certainly doesn't offer a 22% yield, but when other asset classes do, perhaps
sellers of BullionVault gold will contribute the capital which kick-starts our economies from
the bottom of the coming slump.
Until then debtors, politicians, and central bankers
will call us hoarders, and accuse us of destroying the economy. It's not a
label which makes me feel particularly proud, but I think I can live with it.
Paul Sustain
Director and Founder
Bullionvault.com
Paul Tustain is director and founder of BullionVault
- the world's fastest-growing gold ownership service, where you can buy gold today vaulted
in Zurich on
$3 spreads and 0.8% dealing fees.
Please Note: This article is to
inform your thinking, not lead it. Only you can decide the best place for
your money, and any decision you make will put your money at risk.
Information or data included here may have already been overtaken by events
– and must be verified elsewhere – should you choose to act on
it.
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