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The Continuation of Asset Value Deflation?

By Jeff Wilder Group
for H&MM October 5, 1998 Issue

A number of months ago I wrote a column about hotel asset value deflation that was sparked by a newspaper column I'd read called "When Optimism Meets Overcapacity." The thrust of the article was that low interest rates and the abundance of capital were leading commercial optimists to create more product (of all types) than was really necessary to satisfy consumer demand. The result being lower prices for goods and considerable excess capacity of producers worldwide. This imbalance between supply and demand eventually gets corrected by market forces that include the closing down, paring back, or sale, of plants and the diminution of their owners' equity, or net worth. These owners may be consumer goods manufacturers, oil producers, hotel developers, and the like. In other words asset inflation, such as in stocks and real estate, is eventually reversed by overcapacity that reduces everyones fair share of demand and, and of course, their profits.

Little in the intervening period has caused me to change my outlook. Rather, the question that begs an answer is whether a 15 - 20% stock market correction, when twinned with declining interest rates, reflects a sufficient piercing of the inflated asset value bubble caused by abundant liquidity meeting excessive optimism. Or, must yet another shoe drop before we reach equilibrium for asset prices?

Anyone that owns a hotel in one of America's thousands of localized hotel markets will affirm that the new rooms capacity being added almost everywhere surely reduces the value of each individual hotelier's properties. The rush to merge, sell (privately or publicly), or upgrade, existing facilities all are prescient indicators of a hotel market seeking safety against the real potential of further adverse market risks to hotel values. Everywhere, hoteliers are evolving strategies to hold, or expand, their customer base; this with a fervor born of concern that is well-founded. So, it was against this background of apprehension (even as the goods times roll) that I recently read a N.Y. Times article on the predictive capacity of the Dow Theory to point us in the economy's future direction.
(Here let it be said that I own not a single share of stock; rather my money is in real estate, cash and mortgage receivables.) The theory is a trend following system that focuses on the direction of Dow industrial and transportation stock market averages. According to the article, a recent study of the Dow Theory by professors at Yale and NYU shows it to be "astoundingly" accurate in predicting the future course of the economy. (The study covered a 70 year period from 1929 to today).

Might the recent stock market correction be offset by even lower interest rates that buttress asset values, as in the case of real estate, simply by lowering debt service costs? Or, could we be facing more difficult sledding ahead? Will global overcapacity in everything from oil to cell phones to automobiles to hotels presage growing equity erosion and loan defaults that undermine the confidence of debt providers, reducing liquidity and money lending? In perhaps the darkest scenario by Dow Theory proponents, one observer hotel noted that "every primary bear market in history has wiped out at least half of the preceding bull market's gains." If that happened it would be a damaging blow to our economic confidence. This would certainly cause real estate lenders to increase their loan underwriting standards, thereby reducing liquidity and, for a time, asset values. In the case of hotel real estate, that would mean fewer deals penciling out for development. Of course that'd be a good thing for owners of exiting hotels. Maybe, a healthy breather in new development is just what the doctor ordered. Or, perhaps the new hotel development party is simply fated to continue until hotel developer optimism meets room supply overcapacity with a loud, and predictable, crash!