Jamie Dimon: The “Crisis” Forming in the Real Estate Market

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You’re going to want to hear what Jamie Dimon has to say about the future of the real estate market and the economy. Dimon is the CEO of JP Morgan Chase. With 3.7 trillion dollars of assets, JP Morgan is one of the largest and most powerful financial institutions in the world. Dimon’s position as CEO gives him an inside perspective of what’s happening in the economy that is unmatched by anyone else on the planet. That is why he got my attention when in a recent interview Jamie Dimon discussed the quote unquote crisis that is forming in the US real estate market.

For generations real estate has been considered an incredibly safe investment in the United States. It was almost as if investors couldn’t lose money with real estate, even if they bought in some lets just say… less desirable neighborhoods. The reason why real estate has been such a great investment over the better part of the last 50 years has to do in large part with interest rates. This chart here is the Fed Funds Effective rate. Think of this as a proxy for interest rates in the economy. As this chart shows, interest rates peaked in the 80s. Since then, interest rates have been on a consistent, steady decline. You can literally add an arrow to this chart that follows the path interest rates took over a 30 year period.

Decades of declining interest rates acted like jet fuel for real estate, pushing values to the stratosphere. You see, commercial real estate is valued using what is known as a capitalization rate, or cap rate, for short.. A cap rate is just a fancy name for the rate of return an investor anticipates for a property based on the income that property is expected to generate. The cap rate formula is super simple. Just take the income the property is expected to generate, and divide it by the value of the property. So let’s say we have a property that is going to generate 80,000 dollars in income this year. Let’s also say that property is worth 1 million dollars. By dividing the annual income by the property’s value, we get the cap rate. So in this case, 8%. The higher the income relative to the property’s value, the higher the cap rate. The opposite is also true. The lower the income relative to the property’s value, the lower the cap rate.

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