Expect further slowing in the real estate markets - residential and commercial

Commercial and residential real state markets are buoyed by the ability of bankers to securitize and sell loans. This provides more funds to make still more loans. Bankers ability to securitize is being changed and buyers of the securities demand higher lending standards and greater return.

Over the last several weeks, the market for sub prime residential mortgages as all but disappeared, the market for prime residential mortgages has been characterized with much tighter lending standards, and the market for leverage financing commonly used in buyouts and by real estate investment trusts (REITS) has seen a huge decline in volume as buyers want more loan covenants and higher interest rates.

This is likely to lead to slow down in the commercial real estate market, as interest rates rise and lending standards tighten. This will also likely lead to further declines in residential real estate prices as more potential home buyers are unable to get financed and as more potential home buyers decided that the asset they are considering is not worth it to them.

Still there is little signs of reduced consumer spending. As long as corporate profits are maintained employment is likely to stay high and consumer spending likely to stay healthy.  Thus, these changes are not likely to spread to the general economy and the changes in business conditions will remain limited.  Nonetheless, a slowdown in the volume of deals and the rate of expansion is expected.

Risks has increased in the markets everywhere and the credit markets have reacted to that. This is not surprising or unexpected this late in the business cycle. The stock market is also reacting to the changes in the credit markets and to the increasing perception of risk. While the world is not ending, life may go back to how it was before massive amounts of credit were available, cicera 1999.

Will the turmoil in the funds that have invested in instruments backed by mortgages effect the Southern California residential or commercial real estate markets?

Recently, two hedge funds, High-Grade Structured Credit Strategies Enhanced Leverage Fund and the High-Grade Structured Credit Strategies Fund, that invested in securities backed by mortgage were significantly effected by the losses.  Now United Capital Asset Management is having problems.  Paul Ullman, who runs  the hedge-fund firm, HFH Group LLC, New York, was quoted in the Wall Street Journal (WSJ) saying, "The marketplace for mortgage-related asset-backed securities is characterized by a wide difference between bids and offers, and as a result, trading volume has dropped."

This will likely led to even tighter credit moving forward for every new mortgage borrower.   Further, this will put  pressure on  residential home prices.  Thus, there is still no end in sight to the current market conditions.

On the other hand, with employment high there is no sign of accelerating deterioration on the horizon.  The most likely causes of any accelerating deterioration continues to be consumer spending, as I have written about previously.

Another possible cause is if commercial lending is affected by generally tighter credit.  This would damp companies ability to grow and hire and the lack of hiring would likely effect consumer spending.  However, there is presently no sign that this is occurring.