Moody’s published a piece the other week that analogized credit quality in the CRE capital markets to the boiling frog – that if you put a frog in cold water and slowly raise the temperature, it never jumps out until it, pardon the pun, croaks. Tad, please tell me you never actually tried that in your youth. I may have done some things as a 12 year old that might have led to questions about whether I was entirely well adjusted, but I never boiled a frog. Do we know that it even works? What a great MythBusters episode. PETA would have a fit.
Let’s assume, for argument’s sake, that said boiling frog does indeed sit still to get stewed. But the analogy for our markets breaks down, doesn’t it? NO ONE LET THE FROG IN ON THE JOKE. You think that maybe if the frog knew that it was about to be al dente, it might have elected to leave the kitchen?
This market has been publically hand wringing over credit quality, credit standards, the deterioration of credit standards, the tensions between risk and the driving need for yield, and the tendency for markets to overshoot almost since the expansion began. For sure, we have been let in on the joke. While a crowd (or a market) is sometimes thought of as something with more than two feet and less than one brain, this industry is more than aware of the risks associated with pushing too hard on the credit envelope. We get it. Oh, there are data suggesting the industry is getting aggressive, to be sure. LTVs are going up, some tough time structures are softening and valuations, having perhaps undershot the target during the bad years, are, to say the least, not doing that now.
We indeed will jump before we croak. Maybe, maybe, because we all have five year memories in a seven year cycle, we have sometimes waited a tad long to get out, but this time the memories of the late lamented fall are both so fresh and so vivid that it remains front of mind. Just a touch of tepid might, this time pretty rapidly cause the froggy tenant to leave the house.
Right now, the cycle is still our friend. Withdrawing capital from real estate markets when its needs are robust is not without costs. Having come out of one of the worst troughs in the real estate market that I have seen in my professional career, we can recognize the fact that the current market is more likely than not to continue to grind up for quite some time without shame. Look, history is not over, the cycle is not dead and it will turn down at some point. When the expansion begins to get elderly, it will be time to get increasingly vigilant. One hopes that the market will remain disciplined as the market grows in maturity and the appetite for yield remains unsatiated, but it’s a little early to light our hair on fire or look out for boiling frogs. The memories of 2007 and 2008 are still raw, and still have a certain immediacy. The water will eventually begin to get hot over the months and years ahead, but this time, there’s a fair chance the frog will be long gone before it boils.