Overleveraged — Corporations vs Commercial Real Estate

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Many corporations continue to binge on cheap debt to inflate their stock prices — enriching their current executives and shareholders at the expense of future growth and earnings.  However, when interest rates inevitably rise and/or earnings fall, stock prices will plummet and workers (i.e. consumers) will be fired so those companies can continue paying the interest to avoid default on their debt. This explains why the Fed keeps dropping the rates despite full employment and a seemingly robust economy.  This time around commercial real estate has not become overleveraged. Nor has excessive inventory development occurred in most product types in the majority of U.S. metro areas. Any increases in property valuations are now primarily reflective of increasing property income through rising, but not excessive, rent increases. Property value increases resulting from CAP rate compression have ceased in most areas of the country. Since 2005, commercial loan-to-value ratios have dropped from about 71% to about 62% on average, while average debt-service coverage ratios have increased from approximately 1.53% to 1.73% — meaning lenders are requiring borrowers to have more cash flow relative to the underlying debt payments.

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