Commercial Real Estate Investment

Upcoming Speaking Appearances

2009-11-06T12:12:00.000-08:00

Upcoming Speaking Appearances:

November 19, UW Madison Graaskamp Center for Real Estate

December 4, Distressed Real Estate Summit, Minneapolis MN

December 11, Distressed Real Estate Summit, Milwaukee WI

New Initiative

2009-10-06T08:13:00.000-07:00

I am working on a new white paper "A Case for Real Estate in 2010". Looking for contributions - specifically fact related trends, charts, and indicators. Email me for more info.

Todd

Comments from Dealmakers: Opportunities

2009-09-27T19:16:00.001-07:00

This is the final of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section describes some of the opportunities that will likely get traction over the coming quarters.

OPPORTUNITY IN CRISIS

Consensus is that this might be the best opportunity for buying real estate in our lifetimes. However, the early mover advantage this time is fraught with peril.

The economic downturn may have been caused by a credit crisis, but the collapse of credit created real problems for the economy and in turn for real estate. Not only are most deals gasping for capital like a fish out of water, now we are dealing with deteriorating fundamentals. In some cases it is a sharp decline. Therefore, it probably goes without saying, but current deals need to have a distress component to attract any capital at all.

As evidenced by the enormous amount of capital flowing into the public REIT space, however, capital will not sit on the sidelines forever and deal making should begin once investors feel values are at the bottom.

POTENTIALLY HOT SECTORS

Given that there is a consensus that there is a once in a lifetime buying opportunity forming, it makes sense to gear up, but there is no consensus on where opportunity will strike first. Given that multifamily has held up well, most people are viewing those buys as core. Given that retail was likely overbuilt in most markets, that sector is likely the most opportunistic. The other classes are likely somewhere in the middle and heavily dependent on where the economy starts to rebound first.

Sector – What to Watch

Retail – Consumer Spending

Office – Jobs

Multifamily – Housing

Industrial – Consumers and Inventories

It will not be uncommon to hear entrepreneurial investors state that their goal is to control as much real estate as possible through 2015; especially when coupling the idea of a buying opportunity with almost certain inflation on the horizon. Therefore, real estate professionals should stay positive – the future is likely bright.

The most confounding part of the next few years will be how difficult each and every deal will likely be. Buyers will likely be negotiating with several parties including the seller and the seller’s bank, but also lien holders, tenants, and other people with interests in the property. Deals are going to be messy – and those who are good at dealing with messes should get the lion’s share of the opportunities.

Because of this messiness, mezzanine and/or senior equity may be the best opportunity over the next 12 months. Given that there is a capital vacuum in most deals right now, a group could control a lot of real estate for a low investment.

WHAT TO DO NOW

It is time to get ready, time get your house in order and build relationships. There may not be a tidal wave of deals over the next few years, but there is strong consensus that volume will pick up from where we are at now. Your old relationships are not the ones you need in this new environment.

The best advice is to choose your opportunities and create a three to five year plan. One person at the conference commented: “If you are not at the table, then you are on the menu”

New Commercial Real Estate Website!!!

2009-09-27T15:13:00.001-07:00

Real Estate Professionals - Look!

The newest commercial real estate website:

Real Invest 2.0

www.realinvest20.com

The site is still in Beta mode, please let me know your thoughts and comments. I am working with the creators to make it an extension of my linkedin group, Commercial Real Estate Professionals, which is now closing in on 10,000 members worldwide.

Todd

Comments from Dealmakers: Equity Outlook

2009-09-27T06:50:00.001-07:00

This is the fifth of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of commercial real estate equity.

INSTITUTIONAL EQUITY

Earlier in the year, Institutions’ investment allocations were out-of-whack. A quickly falling stock market made real estate appear over-allocated. Real estate values have subsequently dropped and equities have recovered. It appears as though allocations have been repaired and may now be in line for institutions to start investing in real estate again. Given that even the least savvy investors can infer that bond values will drop in the near to mid future (hard for treasuries to go below zero), then there would seem to be a case for allocating even more to real estate.

There is evidence of this happening – small pockets of pensions are announcing increased real estate initiatives. Nearly everyone, however, is targeting at least second quarter of 2010 (if not later) for getting serious about putting capital to work.

New equity funds will likely be smaller, with fewer investors for two reasons: Limited Partner issues (read: too many cooks in the kitchen) and scarcity of debt for really large deals. Although in my opinion, there is a play in buying all cash today and leveraging up with non-recourse financing when debt markets recover. Complex waterfalls are likely gone in favor of more simple (and investor-friendly) models.

Real estate historically produces strong, positive cash flow which will continue to make it attractive when compared to other investments, especially when combined with a potential for appreciation.

Institutional equity owns roughly $450 billion in real estate (give or take depending on whom you talk to). Of this, there is another estimated $45 billion of committed capital sitting on the sidelines as a leftover from the previous buying cycle.

Institutional trading capital (short term) is somewhat active, but long-term investor capital is still on the sidelines. There simply is no perception in the institutional community that tomorrow will be better than today. Until that changes, expect most of this equity to stay on the sidelines.

ENTREPRENEURIAL EQUITY

Although there were very few entrepreneurs at the conference the general perception was that this group would be first to act and will likely profit the most from this buying cycle.

In my experience, this is a uniquely challenging market for entrepreneurial real estate investors. Many of them are dependent on the debt market for at least a portion of their capital.

Compounding problems for the entrepreneurial crowd was their previous appetite for recourse loans during the previous cycle. Most of these buyers are dealing with workouts in their existing portfolio and are, at the very least, having to de-leverage properties with debt maturities. Deleveraging requires a great deal of capital which is difficult, if not impossible, to raise (can’t sell properties, can’t refi, and can’t attract outside investors).

I think that we’ll see only a handful of these investors active until the debt markets recover.

PUBLIC REITS

Public REITs have been the lone bright spot for real estate in 2009. Public REITs have had their best year of raising capital on follow-on offerings since REITs were first conceived. Through the second quarter, REITs have raised nearly $16 billion. It is generally understood that most of this capital will be used to repair balance sheets versus invest in new deals. However, once there is consensus that a REIT’s balance sheet is healthy, they will be given the green light by investors to start acquiring distressed deals.

What remains to be seen is whether this frothy equity market will carry over to IPOs. It certainly did in Starwood’s case, but their new REIT is a mortgage REIT. Other mortgage REITs are rumored to be in the works, but no one has been brave enough to launch a fresh property REIT.

PRIVATE REITS

Private REITs enjoyed a big run earlier in the decade. It remains to be seen when this will rebound. It would make sense that once public REIT IPOs start to come online, that there would be a spike in demand for private REITs.

The second quarter for private REITs were a stark contrast to public REITs. Private REITs (and LPs/LLC s) had one of their worst quarters on record. There are two major drivers for this, (1) the private REITs on the market had spent a year or more ‘on the shelf’ and thus they have real estate acquisitions from the last cycle (aka legacy assets) and (2) due diligence officers have spent the better part of 2009 clearing old unsold REITs off the shelf rather than adding new offerings. Those REITs from the 2007 / 2008 vintage that are still open have been heavily discounted, but that isn’t helping them sell.

Once the public REIT market looks sustainably healthy and B-D’s have cleared their bench, I think we will see this market spike similar to the public REIT market in the second quarter.

Comments from Dealmakers: Debt Outlook

2009-09-25T15:24:00.000-07:00

This is the fourth of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of commercial real estate lending.

COMPETITION

Supply and demand factors have a very large affect on the debt markets. During the last cycle, there was an enormous supply of debt capital and competition was fierce fueled in large part by the growth and abundance in the CMBS market. Today, not only has CMBS dried up, but the other more traditional sources of capital have problems of their own / and or have abundant opportunities outside of commercial real estate. Therefore, it should not be a surprise to anyone that supply of debt capital has all but disappeared.

In order for debt markets to return, competition on the capital side of the equation must first return.

SECURITIZATION

After listening to a number of experts, I think the question is when securitization gets resurrected versus if there is ever securitization again.

There are many positive arguments for loan securitization. Many in the public have a current perception that leverage is bad, however, we know leverage is not bad. It is simply a bifurcation of the risk and allows the most efficient use of capital. One presenter at the conference astutely pointed out that “the goal of any functioning financial system is to bring to bear the most efficient capital to the user.” Not only does debt itself do that, but to have a healthy securitization market, complete with tranching, further accomplishes that. So, while it is hard to say if tranching is gone, but there is a valid reason to have it.

Too much leverage comes as a result of out-of-whack perceptions of risk. For example, a first mortgage of 85% priced as though there is little to no risk, is clearly out of touch with the reality of economic and fundamental cycles. But if the 85% was tranched to different parties with an appropriate risk-reward distribution, then the same loan may make sense.

This brings up the notion that loan originators need to have skin in the game, that is, the should be required to keep the most risky first loss position. This would align the interests of the syndicating group with the investors. As a result, securitization may be very profitable, attracting more players back into the market.

There was also a great deal of speculation that securitization may be further solved by a regulatory ‘standardized blue-print’ for inter-creditor agreements and securitization agreement. Right now, owners of these pools have found themselves in a confusing environment with little or no documentation and lawsuits to unfold the mess will likely take the better part of a decade to work through.

At the end of the day, the argument can be made that securitization is good because it took an illiquid business (traditional lending model) and created a liquid market. The problem was that the industry, just like all fledgling industries had not run a full cycle yet. One commentator compared it to running a marathon. Where an individual who typically runs short distances who tries to run marathon, typically finds their weakness (bad knee, toe, etc.) over the long haul. Now that securitization has run a full cycle, many believe it can be fixed and come out stronger and better than before.

BANK LENDERS

The consensus is that banks need to earn their way out of their balance sheet stress. How long that will take varies greatly bank by bank. Many banks are in denial or simply haven’t devoted resources to deal with CRE yet, most are still focused on their residential real estate problems.

Again, the experts say, while banks appear to be better capitalized now than before, don’t look for them to be aggressively quoting loans until (a) they have cleaned up their own mess, (b) there is competition among lenders and (c) the fundamentals of commercial real estate rebound.

Comments from Dealmakers: Deal Flow

2009-09-23T08:54:00.000-07:00

This is the third of six installments of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of ‘deal flow’ for commercial real estate.

DEAL FLOW

It is no secret that deal flow is off more than any real estate professional would like. Many in the real estate industry are highly dependent on deal flow for their livelihood. We should not be shunned for this, in a functioning system we need dealmakers, we are the fabric of the system. I don’t know if most professionals have come to grips with just how much deal flow is off, however. Many experts at the conference calculated that deal flow is off 90% or more; some are saying 95%. Ouch.

The general perception is that real estate still hasn’t been squeezed enough. The ‘kick the can down the road’ mentality is prevalent right now. Therefore, most experts aren’t predicting the tsunami of deals in 2010 like some had hoped.

WHAT KIND OF DEALS ARE GETTING DONE?

The deals that are getting done have one of two components: either they are “orphaned assets” (missed CMBS pool) or they have a “capital vacuum” (deals that can’t be fully refinanced and where there is not enough equity). A common theme of the conference was that “distress sells best.” Which leads me to conclude that every viable deal probably has a distress component to it.

Because of the distress, more deals will be done with structure. That is, it likely won’t be just the seller and buyer at the closing table; rather you’ll see the existing lender, a mezzanine lender, senior equity and possibly subordinated equity to boot.

Also important to note, is that industry players are going to have a strong desire to keep their ‘lumps’ out of the public so most deals will be off-market.

This tells me that dealmakers need to: (1) make new relationships, the old ones aren’t going to be enough, (2) learn as much about structure as possible, and (3) figure out how to get off-market deal flow going.

EARLY INDICATORS

Banks are still in workout mode on commercial real estate as compared to foreclosure mode. Add to that the fact that some foreclosures can take up to two years at it may be a while. Most of the deal flow is residential right now. The FDIC is still dealing with $15 to $20 billion of distressed residential deals and there is likely more to come (CA arms to blow up in 2010). As a result, commercial deals appear to be on the backburner at banks and the FDIC right now.

Banks will, on the other hand, sell management intensive and high-risk properties, e.g. hospitality (management, liquor licenses, etc.). Syndicated bank loans will also be sold early because of a lack of consensus from various stakeholders. Most experts agree that the 4^th quarter will start to show more commercial real estate deals and it should start with syndicated loans and hospitality. But this won’t go away anytime soon, deal flow from lenders will continue for four to five years.

Consensus among the institutional investors is that entrepreneurial ultra-high-net-worth (UHNW) investors will be first actors and will likely make the most money.

A leading indicator to watch for is institutional investors buying core. They will start with core because it is cheap from a price per foot perspective and will only buy vacancy after the core opportunity dries up. Although logic would dictate that it should make sense to dollar-average into this market (i.e. no one is really capable of timing the bottom), we probably won’t see that materialize.

Therefore, if you are watching for early signs of a return to deal flow, watch the UHNW investors, the banks for selling hospitality and institutions starting to buy core assets.

Comments from Dealmakers: State of Real Estate and Outlook

2009-09-21T09:56:00.000-07:00

This is the second installment of my notes and comments from Institutional Real Estate, Inc.’s Dealmakers Summit (Sept. 14 – 16, 2009). This section regards the state of commercial real estate and the outlook for commercial real estate.

STATE OF REAL ESTATE and OUTLOOK

Most people are well aware that real estate is currently wearing the ‘dunce cap’ in public sentiment. Given how well real estate held up in the last recession (2001-2002), however, real estate has had quite a run (17+ years). The housing market unfortunately, is reinforcing negative sentiment; most of the populous just doesn’t discern a difference.

The downturn is certainly showing up in transaction volume, which, according to several sources, is off somewhere around 90% this year.

It now seems everyone is also aware that commercial real estate fundamentals are on the decline. Most landlords reported making ‘blend and extend’ deals with tenants that have the effect of eroding net operating income. Most landlords are also predicting that fundamentals will continue to erode for at least 24 months, although most report that decision makers are postponing decisions as long as they can, leading many to believe that things could get worse before they get better. This continuing downslide will be caused mostly by job losses and reduced consumer spending (although jobs seem to be the main factor).

The consensus among real estate veterans is that the economy must recover before rent growth resumes. One analyst purported that fundamentals will return six to ten months after GDP growth resumes.

A major topic of discussion at the conference was the fact that there is no market-clearing mechanism (e.g. creation of the RTC after the S&L crisis) as a tool to quickly ‘clear the bench’ and get back to normalized deals. Consensus is that we have to clear the market ourselves and that it will take some time (up to five years) to return to normalization. At the end of the day, the market needs to clear bank inventory of bad debt. It is affecting both the capital markets and leasing markets (given market views that there are large blocks of excess space on the market).

The capital markets will likely recover prior to a rebound in fundamentals. Most investors, however, believe values will drop another 10% before industry can call a bottom. Little to no capital will flow into the market until investors can comfortably call the bottom, even if the bottom turns out to be in the past. A full recovery will be marked by equity players starting to buy vacancy again.

However, even in the absence of a fundamental or capital recovery, inflation may drive capital into real estate quickly. This could subrogate the negative sentiment of fundamental declines. On the other hand, if debt yields go up because of ‘bad credit’ – governments over borrowing and reduced credit profile, then even though this may look and feel like inflation, capital will not go into real estate.

One commenter stated that land would be the first asset class to recover, but yet there is absolutely no market for land right now. That particular speaker works at a large bank in the REO department and further explained that his bank is holding on to land while waiting for recovery. Therefore, you might be able to infer that land may be a leading indicator.

In summary, I’d expected capital markets to rebound in 12 months (give or take) and fundamentals to begin to improve after 24 months. Until then, we remain in a period of deteriorating fundamentals.

Comments from Dealmakers

2009-09-20T12:56:00.000-07:00

Last week I spent three days in La Jolla, CA at Institutional Real Estate, Inc.’s Dealmakers Summit. I was impressed by the number of very high-level speakers and I think everyone can benefit from what they said. Believing such, I am going to attempt to regurgitate some of what I heard along with my own comments and opinions.

I will post my comments in the following segments: (1) General Economic Outlook, (2) State of Real Estate and Outlook, (3) Deal Flow, (4) Debt Outlook, (5) Equity Outlook, and (6) Recommendations on What To Do Next.

Economic Outlook

The overarching message of the conference was that “we are still in a period of macro uncertainty; we are deep in uncharted territory.” Recovery really can’t take place until that clears up. There is sentiment that this is not a sustainable recovery, but rather more of a fragile recovery. Although we are beyond the ‘scary period’, as many called it, there is no market-clearing mechanism as there was in previous recoveries. It seems likely that we will have to work our way out of this one.

Interestingly, there was almost no ‘safe harbor’ in this crash (exception: treasuries earned +/- 15% over the last year). All asset classes seem to be correlated right now. However, markets will decouple and some will recover faster than others. Real estate is not predicted to be a leading indicator.

Going into ‘defense mode’ may have been a large factor in causing the problems, but optimism alone will likely not get us out. Reality is, the credit pullback caused very real problems that can’t be fixed with capital or optimism alone.

A key discussion point for speakers and among participations was the shape of recovery. Will it be a V, Square Root, W, or broken-W (where the second part of the W is a long, slow recovery)?

There was a significant consensus that a sharp recovery is overly optimistic, but this was a crowd of real estate people who are facing declining market fundamentals for the next several quarters. Reading economists outside the industry paints an even muddier picture. As a result, I still have no idea although I tend to fall into the broken-W camp, given that a large percentage of my inner circle are still ‘kicking the can down the road’ and the worst is yet to come. In my opinion, calling it a recovery now is overly optimistic.

Interestingly, one economist calculated the statistical probably of the type of breakdown we recently experienced: 1 in every 20,000 years. So the bright spot is we don’t expect it to happen again any time soon.

One of the speakers pontificated that a big part of the bubble was caused by “too many people managing other people’s money that don’t care.” I tend to agree. The syndicated loan market for commercial real estate loans as well as the lack of fiduciary duty at Fanny / Freddie flushed the markets with irresponsible capital. Of major concern, is that rather than cleaning up FNMA and FHLMC, the government has blessed them and given them mounds of fresh capital. This may lead to prolonging of the recession or a return to financial crisis.

Notwithstanding this recession, the US economy is and has been in a long period of erosion. Other countries will gain ground, both because of their growth and because of our erosion. This isn’t necessarily horrible news, but to the extent we continue to live beyond our means, as individual households and as a country, we will suffer increasingly harsh consequences.

Of particular concern to me was learning that some very savvy and highly respected participants were bearish on financial institutions, to the point of shorting financial stocks. If they are correct, economic recovery will likely resemble the ‘broken W’ model.

Banking System

One speaker reported that the banking systems’ stress is gone, as evidenced by LIBOR rates. The three-month LIBOR that spiked last fall in an unprecedented run up, is now back down around 0.3% (wow, that’s low). Also, the 30-year fixed mortgage rate spread over treasuries has tightened which further indicates reduced systemic stress. Short rates will go higher soon; there is no consensus, however, as to when.

Banks need to ‘earn’ their way out of balance sheet problems. It appears there is a large discrepancy among banks’ ability to earn out of stress. Some may be able to do it in 12-24 months, many will take longer. Those banks that take longer may see the current environment for ‘easy’ earnings dry up, exacerbating their problems.

Consensus among bankers attending the conference was that banks are dealing with their residential inventory, but they are still in workout mode on their commercial portfolios. This may indicate that some banks have not yet come to grips with the state of their commercial loans. Some participants I talked to were of the opinion that the decision to loosen FAS 157 (mark-to-market) has only prolonged the problem.

Recovery

“Capitalism without failure is like Christianity without hell.” – I can’t remember who said it, but it is worth repeating.

Again, the key questions on recovery are when will it happen and what will it look like? Economists at the conference were divided between the broken-W and the square root-symbol models. There was hopefulness that we may have a recovery based on optimism alone, however, it is most likely that this recovery will take real, hard work.

There was consensus, however, that a financial crisis is the hardest to recover from.

A considerable bright spot is the fact that there is still a significant amount of capital on the sidelines. Which, if you buy Dr. Mark Dotzour’s * ‘spotlight’ theory of capital, we know at least one or two sectors will get ‘burned up’ by the spotlight soon. We will probably look back and say treasuries are the benefactors of that right now. I am not convinced that the return of capital will signal true recovery, but in many sectors it will definitely help.

According to one presenter, in the coming decade, the stock market is projected to have a real return of +/- 8%, which is not necessarily compelling. Add to that the fact that Bond values will likely drop as rates rise, and that stocks are being heavily scrutinized then real estate may be seen as an attractive asset class.

Here are some key components to consider: inflation on the horizon plus deteriorating fundamentals, equals low prosperity for a long period of time. Be prepared for 4-plus years of little to no job growth, and thus low demand for commercial real estate over that time.

Summary

The worst appears to be over, but the future is unclear at best. It will undoubtedly be several quarters before we see fundamental growth in commercial real estate.

* Dr. Mark Dotzour, Chief Economist, Texas A&M. HE was not at the conference, but because of his dual understanding of real estate and economics, he is worth following closely.

Raising Equity Capital in Today’s Market

2009-09-10T15:12:00.000-07:00

I see at least ten quality deals a week from people in need of equity, up several fold from last year. It seems there are limitless opportunities in the market right now, return projections are as high as I have ever seen them and people are coming up with brilliant and creative solutions. Unfortunately, on the other hand, capital is as scarce as I have ever seen it. So I thought I’d write a quick article to give you, the brilliant real estate entrepreneur, the best shot at capturing what little is out there.

Item #1 – the game has changed. Not all that long ago, it was commonplace to see things like master-leases, proforma net operating income with expense reduction plans and next years’ rents. Those days are long gone – perhaps forever. Especially gone are the days of collecting large acquisition and securitization fees upfront. The good news is that fundamentals never go out of style. Stick to the fundamentals, and be honest. This will at least keep you from getting doors slammed in your face.

Item #2 – be cognizant of securities laws. If what you are doing is selling a security, then do it right. Create a private placement memorandum and adhere to the general solicitation rules. Savvy investors will ignore your project unless the I’s are dotted and T’s are crossed. It will also help a great deal to use a reputable law firm for your ppm. Investors want to see that someone super-smart has looked at your structure and disclosures.

Item #3 – spell out your track record. Good or bad, get it out there right away. Nothing will anger an investor as much as finding skeletons in your closet. If you lay it out upfront everyone understands that mistakes happen to the best of us, the important thing is what you learned from them and how you acted when trouble started. On the other hand, if you don’t have a track record, then get one. Partner with someone that has one. In today’s environment no track record = no funding.

Item #4 – contribute a significant amount of your own money. Investors want to see the deal guy putting skin in the deal, lots of it. If you don’t have it, then partner with someone who does. Again, no skin = no funding.

Item #5 – create high quality marketing materials. Investors want to know you are legit and nothing spells legit like quality. There are large numbers of talented marketing designers out there scouring for work. It is likely the most opportune time to get this work done on a budget.

Item #6 – network (but be conscious of general solicitation rules). I have noticed more people are willing to listen these days, which is a big change from a few months ago. Take advantage of this, but don’t be pushy - investors are still reeling. Work your network to find people who might be interested in seeing your deal now or in the future.

Item #7 – get your name out / build your profile. Ten years ago, having a website bought you credibility. It is not that simple today – you need to have a complete online presence. Think “viral”; build an online network. Put your entire resume on LinkedIn and use it, send it to people. Build connections and show people who use the internet to ‘check you out’ that you are legitimate. Be careful, however, the opposite can happen if do it half-assed. A short resume, small network (or the wrong network) can do more damage than good. Also avoid overselling yourself. There are numerous scammers in the social networking world. Try hard not to look like one.

Item #8 – hire someone to raise capital for you. With capital as scarce as it is, you’re likely going to need to go to an expert. Make sure the broker you are working with is registered and in good standing with FINRA, www.finra.org.

Hope that helps. Feel free to contact me with questions.

Todd

TALF Update

2009-09-08T07:35:00.000-07:00

SNL Reporting several lenders aggressively quoting loans for creation of TALF-backed pools.

This is what we have been waiting for!

http://www.snl.com/Interactivex/article.aspx?CdId=A-10011755-14387

REIT Run-up

2009-08-05T09:55:00.000-07:00

REITs are on the climb: the popular REIT index IYR (iShares) was up 4.8% yesterday (Aug 4) and is up further today (Aug 5). REITs were also up more than 10% in July. They are also up more than 60% since March 6. A good sign for the industry.

Todd

Vornado Realty attempts to breathe life into CMBS

2009-07-30T05:44:00.000-07:00

Another large REIT is tapping into government money and at the same time, trying to restart the CMBS engine that drove the commercial real estate industry through the last cycle.

Keep your fingers crossed.

Read the whole article here: http://online.wsj.com/article/SB124880426449487319.html

Forbes: Making a Case for Real Estate (Sort of)

2009-07-22T15:18:00.000-07:00

Just got done reading the latest issue of Forbes - and I was excited to see a whole section on real estate investing. Unfortunately, I was disappointed once again by the mass-medias complete misunderstanding (maybe thats too harsh) of Commercial Real Estate. We'll correct some of the errors here, then its good reading.

Art. #1: Why REITS Make Sense:

http://www.forbes.com/forbes/2009/0803/real-estate-commerical-property-why-reits-make-sense.html

This isn't a bad article, only it fails to bifurcate real estate into its two components: residential v. commercial. They are not the same, not even close. So when the author states "[he] chuckles at how poorly he fared in his only direct property investments. He recently lowered the asking price on his four-bedroom Tudor house, which he built on 1.5 acres in 1983. If he manages to get the $385,000 he's now listing it at, the house will have returned 1.5% a year, not even keeping up with inflation. REITs generated average annual total returns of 9% over the same period" it's misleading. You can't compare the two, they operate on totally different fundamentals. Commercial real estate will outperform residential over every time period, simply because it is built to. People buy homes to live in them, not as an investment. The Author makes this mistake again in saying "Buy a $100,000 property and closing costs can easily run $3,000. Assuming you put down $20,000, that represents a one-way drag of 15%. Sell and your Realtor is likely to skim off a 6% commission. REIT operators absorb some of these same costs, but at least you can get in and out of their shares at their prevailing market value. The Simon REIT runs up overhead of 0.8% of assets annually; this is on top of operating costs (like janitors' salaries) of the sort that any property owner incurs." Again, this isn't apples to apples. I would think it would be more compelling to compare net lease investments (single tenant stores, etc.) to REIT investments if you want to compare direct investment to REIT investing.

The author also misses out on another key component of REITs versus direct real estate investing: REITs are invested in pools of properties. This diversification is a HUGE advantge. It means the investor is less exposed to a particular region, sub-market, tenant, or a number of other factors that can be road hazards to investors building their own portfolios.

I like the remainder of the article, it is compelling. Worth printing out and saving.

Art. #2: Rent Out Your Home. Cut Your Taxes:

http://www.forbes.com/forbes/2009/0803/real-estate-rent-residential-home-sweet-tax-break.html

This is a good article for people (like me) who decide not to sell a home they used to live in and instead rent it out. It cites the tax reasons for doing so, and albeit there are a couple of minor errors, it is a good representation. What I think readers need to keep in mind is that the changes to the tax code in 1986 were specifically geared toward thwarting the abuse of real estate tax benefits. Congress left many of the tax benefits for real estate professionals (like me), but put significant restrictions on passive investors. So, reader beware: Unless you make LESS THAN $100,000 per year, joint with your spouse, OR you are a real estate professional, your tax benefits will be significantly limited, most likely to zero. In my prior life as a CPA, I can't count the number of people I had to break this news to. I repeat, reader beware. Renting your house better make sense when comparing your rental income to your mortgage, or it's not worth it.

Art. #3 (my favorite) How Much Real Estate Should You Own

http://www.forbes.com/forbes/2009/0803/real-estate-reit-housing-dividend-property-poor.html

This article hits the nail on the head when it comes to the 'my house is a real estate investment' argument. It's not. End of Argument. The author also makes a case for allocating 20% or more of an investment portfolio to commercial real estate. I agree. In studies I will address here later, you will see that adding real estate (especially private, low-leveraged real estate) reduces volatility and increases returns over nearly every time period since the industry began tracking those yields.

Here is the trick to interpreting the authors suggestion that you increase your exposure to real estate: you HAVE to do it right. If the vehicle (REIT) you are investing in has legacy assets (those it purchased between 2001 and 2007) you need to verify that those are priced to market, or reasonably close to it. In addition, not every REIT or syndicator will have the capital to take advantage of the current buying market, nor do all of them have the expertise. Yes, fortunes will be made by buying today, but only by those with the capital AND the experience to play the market right. A very wise person told me early in my career: 'Real Estate is a street game, either you can play it or you can't; you're either in, or your out'. I have spent the entirety of my career since then staying close to people that are 'in'.

Todd

REIT Equity Offerings Strong in 2009

2009-07-22T07:39:00.001-07:00

Found a REIT.com link that shows capital raised by public REITs since 2001. The numbers are interesting. IPO's are down in 2009, but the year is on pace to have the largest capital raised through secondary (follow-on) offerings in the past 8 years. Seems the REIT space is a good place to be.

http://www.reit.com/portals/0/files/nareit/htdocs/library/industry/HistOff0906.pdf

Developers Diversified to Sell TALF-Backed Bonds

2009-07-22T07:27:00.000-07:00

By LINGLING WEI - wsj.com

Shopping center giant Developers Diversified Realty Corp. is working on raising $600 million through two bond sales that promise to be a litmus test for one of the government's key economic rescue programs.

Those deals are on track to be the first major offerings of commercial-mortgage-backed securities that will take advantage of the Term Asset-Backed Securities Loan Facility, or TALF, program. TALF is designed to jump-start lending by increasing investor demand for securities tied to all kinds of assets, including consumer and commercial loans. As long as banks can move loans off their books by repackaging and selling them as bonds, they will be able to make more loans.

S&P Changes mind on CMBS Rating?

2009-07-21T16:22:00.000-07:00

What in the world is going on here:

By Sarah Mulholland - from Bloomberg.com

July 21 (Bloomberg) -- Standard & Poor’s backtracked on ratings cuts issued last week and raised the ranking on commercial mortgage-backed debt from three bonds sold in 2007.

The securities, restored to top-ranked status, had been downgraded as recently as last week, making them ineligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility to jumpstart lending.

S&P lowered the ratings on a class of a commercial mortgage-backed bond offering from AAA to BBB-, the lowest investment-grade ranking, on July 14. The New York-based rating company reversed the cut today, S&P said in a statement. In a related report, S&P said it adjusted assumptions on the timing of projected losses on the mortgages.

“It is a stunning reversal and certainly raises questions concerning the robustness of their revised model,” said Christopher Sullivan, chief investment officer at United Nations Federal Credit Union in New York. “It may engender further uncertainty with respect to ratings outlooks.”

Debt rated below AAA isn’t eligible for the Federal Reserve’s TALF. Investors sought $668.9 million in loans from the Fed to purchase so-called legacy commercial mortgage-backed bonds on July 16, the first monthly deadline to finance the purchase of the securities.

- Again, stay tuned, not sure what is going to happen next...

TALF

2009-07-18T07:31:00.000-07:00

Paul Bunby gave us a TALF update on GlobeSt.com.

See the article here: http://www.globest.com/news/1454_1454/newyork/179891-1.html

From this and a bunch of reporting I saw on Bloomberg tv over the week, it looks as though the market for existing CMBS issuances has stabilized. According to Bunby, it has not affected new issues to date, but it appears as though we may see a break in that iceberg soon.

"Earlier this week, CMBS experts told GlobeSt.com that the TALF program stood a chance of succeeding if the pieces fall into place. 'The reason no one applied for the first round is that there simply was no new product in the marketplace,' Spencer Levy, senior managing director with CB Richard Ellis, told GlobeSt.com on Tuesday. 'The view I’ve gotten from the marketplace has been a bit warmer than what some suggest, particularly from some of the originators,' because 'they see some purchasers of their CMBS securities are going to be able leverage it up using TALF capital.'"

Stay tuned, this could change everything.

Todd

Commercial Real Estate Investment Handbook

2009-07-17T15:13:00.001-07:00

I am writing a book on commercial real estate investment for the benefit of passive real estate investors to better understand commercial real estate fundamentals, metrics and trends.

I plan to post sections here for comment. Thanks for your help!

CHAPTER 1

Why Invest in Real Estate?

Real estate is a gripping investment. Many individuals, families, and institutions have created and sustained generations of wealth from real estate. Real estate has created icon’s like Donald Trump, it has been featured in numerous Hollywood hits like Glengarry Glen Ross. Real estate has been given credit in many clichés “Buy land son, they aint makin’ any more of it.” But in today’s fast paced environment, we have to elaborate beyond that. There must be something compelling about real estate; something that drives its value up. Over my career, I have narrowed it down to four main factors: (1) attractive yields, (2) relatively stabile value, (3) non-correlation to other assets classes, and (4) income tax benefits.

Yield

Yield is probably the main driver for most investors. Real estate is rented to third parties through leases, creating a stream of rental income. Real estate also tends to increase in value over time, tied for the most part to inflation. That is, rents tend to increase over time and thus the value of the property increases generally as the rental income increases. When underwriting properties, it is a mistake to include growth in value from increasing rents and add to it an additional growth factor for inflation, however, they are tied together through rents.

Real estate also provides yield from the repayment of debt. Most mortgages require debt be repaid (amortized) over a set time period. When an investor sells a property, the amount due on the loan is often lower than the amount borrowed. It is somewhat like a forced savings account.

Yields over time have fluctuated, but annual real estate yields tend to be higher than both public stock dividends and most investment-grade bond rates. Total yield on the realizations of gains tends to be 1.5 times to 2 times the annual yield on the property. For example, a typical investment in 2005 was projected to yield an annual cash return of 8% and yield upon sale of 12% to 16%. This is higher than expected return on stocks and significantly higher than historical bond returns.

Several groups have set out to track values of commercial real estate and have created tracking mechanisms and valuation models. One of those groups, the National Council for Real Estate Investment Fiduciaries, “NCREIF”, has created the NCREIF index. A ten-year example is illustrated in table 1.1 Table 1.2 on the other hand, shows the S&P 500, an index of the 500 largest companies in the US over the same time period.

As an investor, these numbers can be verified and are widely available on the internet. A researcher can play around with them and come up with different results over different time periods, or use averages, moving averages, returns on $100 over time, or any number of other techniques, but most of the time investors will find real estate yields are attractive when compared to other asset classes.

Stabile Value

Commercial real estate values tend to remain relatively stable over time. Another quick look at the NCREIF (table 1.1) quickly verifies this. There are several reasons for this but two really stand out as the cornerstones. First, most buildings have long-term tenants and rollover is infrequent. Second, investors tend to buy and sell commercial real estate much less frequently than investors buy and sell stocks.

Rents, in essence, represent a historical moving average. That is, they are historical because the leases were signed in the past and represent the market leasing rates at that time and they are a moving average because tenant rollover happens at intervals. The result is similar to dollar-cost-averaging when investing in stocks or mutual funds. Landlords keep a snapshot of their leases in a file commonly called the ‘rent roll’ (see example). A good rent-roll is one that is staggered with leases expiring in different years, so the investments is exposed to multiple points in the cycle.

Investors also tend to hold on to real estate given high transaction costs and the lead times it takes to sell a building. Costs of sale can be disposition fees, selling broker fees, title costs, shoring up deferred maintenance, etc. Selling fees can often be five percent (5%) of the value of the building or higher. Acquisition costs can include acquisition fees, buyer broker fees, legal costs, title examination, survey, structural reports, appraisal, loan origination fees, etc. and can likewise be as much as three to four percent of higher. All considered the cost to both parties can be as high as ten percent, which is a significant deterrent to frequently buying and selling real estate.

---

Non-Correlation to Other Investments

This book will describe real estate cycles in more detail in later chapters, but for the purposes of correlation, commercial real estate has a relatively low correlation to other traditional investment asset classes such as stocks and bonds. Readily tradable instruments tend to fluxuate, sometime wildly, in value. This leads to low correlation in some respects. Add to that, however, that real estate cycles are often not in direct correlation with general business cycles. Real estate cycles are driven by the rental income an individual property can generate. Rental rates in turn are driven by the supply and demand of tenants and leasable space in the immediate sub-market.

When it comes to correlation to general economic cycles, things get a little muddier. In normal times, I would still say being in the right submarket at the right time with a good location will trump economic cycles, however, this latest economic disaster has proven otherwise. Many well-located, well-leased buildings are going to suffer in a deep enough economic recessions. The perhaps over-simplified reason is jobs. Jobs affect tenant demand for leasable space. When jobs fluxuate in the overall economy by 1-2%, sub-market demographics play a far greater role in determining rents, but a wild fluxuation in unemployment will inevitably affect all rents.

Income Tax Benefits

Most tax experts will tell you real estate is one of the last bastions of tax shelters. Depreciation is the key. The US tax code allows taxpayers to take an allowance for the depreciation of an asset whether or not the value actually went down. This allows taxpayers to essentially write-off the cost of the investment against the income received. If the asset is later sold for greater than the cost less any depreciation, then the depreciation taken earlier is simply recaptured. This book will go into further detail on the tax benefits, how to take advantage of them and how to avoid potential pitfall in a later chapter. For now, suffice to say that many investors are attracted to real estate by the potential for partially (or totally) tax-free cash distributions. This puts real estate in a small class of investments that allows individuals living on the cash flow from their investments to live with relatively low income taxes, thus maximizing their lifestyle.

Join My Group on LinkedIn

2009-07-17T13:06:00.000-07:00

My group on LinkedIn, Commercial Real Estate Investment Professionals has more than 7,900 members who are linked to the commercial real estate investment industry. Members are from all over the world. Make use of news feeds, discussions, and postings. I am planning to add new features to the group in coming months that will benefit you as a professional.

Go to LinkedIn.com and start networking with me. Lets create our futures together!

Todd

Look for this logo:

The Eggheads Were Right After All - maybe...

2009-07-17T12:18:00.000-07:00

Jon Fosheim, formerly of Greenstreet, argues that REITs should not have taken on any debt and that debt to a REIT is nuetral to their value.

Read the article at: http://www.realestateportfolio-digital.com/reportfolio/20090708/?pg=46&pm=2&u1=friend

Fosheim's conclusion may well prove correct, but his argument is flawed. Hindsight is easy in economics and he argues that he and his former cohorts at Green Street got it right. We shouldn't be so quick to pat him on the back. He makes the point that as REITs add debt, their equity multiples (similar to cap rates for the real estate folks) adjust to meet the new risk. What this article fails to explore, however, is a very important point. Adding debt to a REITs balance sheet, whether at the property level or at the entity level, is simply a bifurcation of risk. That is, a lender takes on the least risk, but in return gives up yield and control. The equity holder increases its risk, but retains control and increases its yield potential (it also gets ALL the tax benefits for less capital in the case of privately held RE).

This is an important distinction, because it doesn't mean that REIT CEO instincts were wrong, it simply means they took on more risk for their equity stakeholders. Unfortunately, I don't think anyone saw this type of a recession coming. In many property types, fundamentals were still improving. Real estate equity holders simply got caught in a horrible market decline. Real estate debt holders, who were transferred the least risky part in the bifucation, will ultimately not be hurt as badly. In essence, the market worked as it should have.

Don't belive me? Try this example: An extremely conservative invstor buys all debt, no equity. He got hurt in 2008, but didn't lose everything. An agressive investor bought all equity, no debt. He got hurt, badly, maybe lost everything. On the other hand, assuming most properties were leveraged at 75%, a market neutral investor would have bought 75% debt and 25% equity. His returns would be market neutral.

So please don't discount debt, Mr. Fosheim. Without it, we would all be market-neutral and none of us would have anything to talk about.