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"Buffett's Warning: The Looming Storm in the US Real Estate Market"

9/22/2023

Billionaire investor Warren Buffett has raised concerns about a potential storm brewing in the US real estate market, and he believes that the real impact of this issue is just around the corner. This looming crisis is closely tied to the massive $1.4 trillion debt that has been fueling the real estate market, and it has already begun to make its presence felt.

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"The Federal Reserve will cut interest rates 6 times in 2024 as the economy shows clear signs of cooling down," ING says

"An economy that is showing clear signs of decelerating means the Federal Reserve will cut interest rates at least six times in 2024, according to a Thursday note from ING Economics. Moderating inflation, a cooling jobs market, and a deteriorating outlook for consumer spending mean the Fed may need to cut interest rates more than the market expects."

12/04/2023

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To understand the root of the problem, we need to take a step back and look at the last 15 years. During this period, the US real estate market has experienced a sustained surge, primarily driven by the availability of cheap debt. Buffett points to a critical indicator - the US federal funds effective rate, which serves as a proxy for overall interest rates in the economy.

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If you examine the chart below, you'll notice that interest rates remained exceptionally low for the better part of the last 15 years, often hovering near 0%.

These historically low interest rates have created a significant incentive for investors and buyers to leverage substantial amounts of debt to fund their real estate ventures. As a result, property values have skyrocketed to unprecedented levels. Let me break down how this process typically unfolds.

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Imagine someone wants to purchase an office building in your city, and let's set the cost of this building at a neat $1 million. Now, it's highly unlikely that the buyer has a spare $1 million in cash just lying around to purchase the building outright. Instead, they turn to a bank to secure a loan to cover most of the purchase price. In this scenario, our buyer contributes $350,000 as "equity," which is essentially the down payment, a concept similar to when someone buys a house. The remaining $650,000 is obtained through a loan from a local bank.

The profitability of this purchase hinges on several factors, but one of the most critical factors is the interest rate attached to the loan. When interest rates are low, as they have been for a significant portion of the last 15 years, the cost of borrowing becomes more affordable, making real estate investments more attractive and potentially more profitable. This trend has led to a surge in real estate prices, which many experts fear may be unsustainable.

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Warren Buffett's warning about a "debt-fueled tsunami" hitting the US real estate market is rooted in the concern that these artificially low interest rates have inflated property values to unsustainable levels. As these rates begin to rise, which they inevitably will, it could trigger a chain reaction of consequences, potentially leading to a significant correction in the real estate market. In essence, he believes that the impact of this real estate bubble is just starting to reveal itself, and we may see its full consequences in the coming months. Investors, homeowners, and the broader economy should pay close attention to these developments and prepare for potential turbulence in the real estate sector.

How can CCRE help?

While Warren Buffett's concerns are indeed valid, they also highlight the importance of having a dedicated and knowledgeable partner by your side. With Cortinas Commerical Real Estate, you can move forward with confidence, knowing that we are committed to helping you make informed real estate decisions in any market condition.

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