Rent Dilemma
We are remodeling and went today to look at a condo to rent. The condo is new and similar units are selling for approximately $500K to $520K. The association fee is $200 a month. I figure - using 20% down and a 7% return on equity - the condo would have to rent for $3,300 a month. This would cover debt (interest-only in my assumption), property taxes, the association fee and provide the 7% return. The asking rent is $1,800. I figure the owner is carrying at least a $900 negative every month. This is nuts. Real estate is an income play. I don't get the logic of buying a property that will not provide at least a 7% rate of return. But as a short-term renter, I like it.

This should be a measure of the over priced real estate market. Rents are going to have to increase significantly or prices are going to have to drop to narrow this disparity. A quick calculation shows that the condo should be worth about half its current price - $260,000 not $520,000 - to justify its $1,800 rent. This covers debt, taxes, association fee and provides a 7% return on equity to an investor. If I owned this property with a $520K basis, I'd be scared. I bet the owner did not run any numbers and thinks future appreciation will erase all his negatives. Good luck.

Private Equity Opportunity
Private equity firms have been buying REITs at a dramatic pace. I don't think the private equity guys are buying the firms as a bullish statement on the real estate market. They like REITS because REITs are moderately leveraged, typically 50%. The public equity markets start discounting REIT shares when the debt gets too high. This acts to keep REIT debt moderate. Private equity investors have no such constraints. Moderately leveraged REITs offer private equity firms a chance to leverage the real estate assets to much higher levels. The debt can be used to repay the private equity firms. I think the private equity guys will sell assets as they either repay debt or unload properties that don't fit in a portfolio. This should be an opportunity for small real estate firms, like tenant in common sponsors or other nimble real estate investors. If the private equity investors get over extended there will be many bargains.

Wild West
Interesting article about the Phoenix housing market and the speculation that drove up prices. People are walking away from their deposits on new homes and "For Sale" sings are prevalent. It is interesting to hear "experts" who expect that the downturn will only last a matter of months. I think it will be years not months. The wild card that will determine the length and severity of the downturn will be finance. People who bought on speculation to "flip" houses, or could not afford the house to begin with, and used exotic mortgages to finance their acquisitions are the ones that will decide the future. If they walk away from their mortgages when they reset, the downturn will be ugly, (and watch for the herd mentality if people start defaulting). If the loans are refinanced the downturn will be modest. Phoenix will not be alone.

Real Interesting Article
The mutual fund story, to me, is a yawn. (Not so, I am sure, to the idiot bank executives who are calculating how many attorney hours ten basis points buys.) The article about Glaxo making up a condition - restless leg syndrome - to sell an unnecessary drug to skeptical doctors is the real crime. Drug companies have carte blanch and doctors fall for their sales pitches. But making up restless leg syndrome to sell drugs is over the top. If your legs hurt after a hard day, drink a beer and watch TV or read a book. Glaxo has sold a staggering $550 million of this drug, Requip, this past year. It made up restless leg syndrome when Requip did not work for Parkinson's Disease. The FDA is worthless. Doctors need to start looking out for their patients (because they know restless leg syndrome is nonsense) and stop looking for freebies from drug companies and falling for sales pitches from pretty young saleswomen.

Rational Realist Comments
The Rational Realist was asked to comment on Elliot Spitzer's crackdown on twenty-seven mutual fund companies improper sharing of service fees with third party record keepers. The complaint says that mutual funds paid a fee to outside firm, Bisys, who paid up to 75% of that fee back to the fund company. In other words, the fund companies overcharged investors for outside services and then received most of that charge in the form of a kickback. My comment is that this does not surprise me and it shows the stupidity and greed of fund companies and their executives. Is it worth ruining one's career for ten to fifteen basis points? These kickbacks happened at bank-owned mutual funds for crying-out-loud. Bank-owned funds are already overpriced! The extra fee could have been tacked on to the management fee and no one would have been any wiser. Memo to fund executives: if your going to ruin your career do it in a big way, not for ten basis points. If you are dumb enough to only steal ten basis points you deserve career death.

Tenant In Common Association Meeting
I went to the Tenant In Common Association (TICA) meeting in Las Vegas on Monday. It started on Sunday and went through Wednesday morning. One day was enough for me, plus the hotel rooms in Vegas were $300 to $400 a night. TICA has these meeting twice a year and it's the same agenda every time, but one has to show up just to network and affirm existing relationships. From that standpoint the conference was a success, and possibly a huge success.

The opening speaker, a Wharton economist, was really good. The economy is strong, housing will drop 10% to 12% and condos will offer a buying opportunity in two to three years. He said that the government will leave the economy along for the next two years as it will be preoccupied with Iraq, but look for a recession in 2009 when a new president tries to institute new initiatives. He ended on immigration and had real good comments, in that the US should encourage immigrants and that they are positive for the economy.

The lunch speaker was torture. He was from the real estate industry's lobbying group and it felt like he handicapped every House and Senate race in the country. It was information anyone could get in ten seconds on realpolitcs.com or polling.com. His final conclusion is that the real estate industry will likely benefit from a Democratic House and Senate, just as its benefited from a Republican Congress.

More Farmer Welfare
It appears farmers have no risk. They get paid twice for every disaster that befalls them - too much rain, not enough rain - you name the calamity they get paid twice for it. These guys are unbelievable. There hands are out so fast they are the ones that should be picking pears, not the illegals. The poignant pictures of farmers plowing under E-Coli tainted spinach take on new meaning. Tears of sorrow are tears of joy for the soon-to-be-received double Federal payments. According to the article referenced above, farm relief programs have cost taxpayers $24 billion since 2000. Farmers have to vote liberal, because this sounds like Lyndon Johnson's Great Society on steroids. With all this welfare, why are tomatoes are still $3.99 a pound?

Disappearing Burrito
Wendy's is selling Baja Fresh for $31 million. Wendy's bought Baja Fresh for $275 million in 2002. Chipolte, which had a successful IPO in January, has beat Baja Fresh in the market. Good for Chipolte, but if I had to choose between the two for lunch, Baja Fresh wins.

Not Surprising
A real estate firm returns are not available in any investment - yes, you can get lucky with a good stock pick but no one is capable of generating 25% returns in stocks every six weeks - and investors that look for and invest in deal that promise that offered investors 25% returns in as little as forty-five days has missed interest and principal payments, is closing shop and is being investigated by the SEC. The firm allegedly used investor proceeds to buy and "flip" foreclosed properties. (I think someone watched too many late night infomercials.) I don't feel sorry for the company, because they likely stole a good portion of the money or paid it out to investors - how does one spell Ponzi? I don't feel sorry for investors because investors looking for this kind of return need to know better. Outsizedunbelievable returns deserve to lose their money. In the article, one dumb sap took out a second mortgage on his house to invest in this scam. His penalty will be having his wife scream at him for the rest of his life.

Oil and Gas Investing
This article shows the problem (for investors) with the oil and gas industry. Money flows in when prices are high, like the fall of 2005, and investors still can't make money. This is due to high fees, mutiple revenue sharing partners and the general risk of the business. The risk is why all the sponsors ask for other people's money in the first place. Investors in oil and gas deals bear all the financial risk, because the sponsors put little to no money of their own into their deals.

A successful deal in the oil and gas world is one that returns investor money (oh, and forget that crap about adding tax write-offs to the return). Investors dream of hitting the oil and gas lotto, but it never happens. They receive decent income in the first few years, but this falls quickly, and investors are lucky to receive small amounts in later years (twenty-year time horizons are not uncommon). Sponsors limit their risk becuase they receive a percentage of revenue, 30% is not uncommon, for their role in the offerings, plus fixed fees for other services. Their cash flow is assured because the fixed fees are paid to them no matter the price of oil or gas or what the wells are generating. To put it bluntly, oil and gas deals stink for investors but are good for the promotors. Buyer beware!

Its All Politics
Buried on the front page of today's (10/3/2006) Wall Street Journal is a blurb that the Energy Department is delaying its purchases of oil to replace the strategic reserve that was tapped after Hurricane Katrina. The reason is help reduce prices. Deferring the purchase will not lower prices - but it will not increase prices either. The national average price for a gallon of regular unleaded gas has dropped $.70 a gallon since the start of August. The strategic reserve will be replaced after November's election when there is no immediate political cost to a price increase. It would be prudent to replace the reserve now when oil is more than 20% off its high, but this administration has proved over and over that politics trumps prudence.

It's Not 1999 Anymore
I completed an overview of a TIC offering for a client. The deal was raising around $10 million and was part of an established offering - each TIC deal is a separate part of the larger offering. The TIC deal had a non-accountable Organization and Offering fee of 4%. This means that the sponsor receives a fixed $400,000 for the legal and printing costs of the TIC deal no matter what the acutal cost. As the deal is part of a larger offering many legal costs have already been paid. The supplement discribing the deal was less than fifteen pages long. A stand-along TIC deal should pay approximately $150,000 for all its legal and printing costs, so this TIC deal's actual cost has to be much lower. This fee is egregious. It was not my only issue with this deal, but I don't want to waste computer ink on it.

Wells Timber REIT
I just received Wells Real Estate's newest offering in the mail- Wells Timber REIT. This may be interesting. (There has to be a joke somewhere - what will happen first, a tree dying of old age or a Wells deal going full cycle? I am betting on the tree.) The offering is effective, but it has no timber executive to run the company. That is an important omission. The cover letter states that Wells understands if broker/dealers wait until a timber executive is hired. I'd wait until Wells hires the executive, the offering raises $100 million or more, and buys and manages some timber land.

Wells Timber REIT
I just received Wells Real Estate's newest offering in the mail- Wells Timber REIT. This may be interesting. (There has to be a joke somewhere - what will happen first, a tree dying of old age or a Wells deal going full cycle? I am betting on the tree.) The offering is effective, but it has no timber executive to run the company. That is an important omission. The cover letter states that Wells understands if broker/dealers wait until a timber executive is hired. I'd wait until Wells hires the executive, the offering raises $100 million or more, and buys and manages some timber land.

Coffee Wars
I was in Hartford, CT, two weeks ago and saw the Dunkin' Donuts / Starbucks battle firsthand. The two were about 200 yards apart duking it out at 7:00 in the morning. The Dunkin' Donuts was packed, the drive-thorugh line must have been ten to fifteen cars deep. The Starbucks was crowded but nowhere near the level of Dunkin' Donuts. I went to the Starbucks out of habit but am curious to try Dunkin' Donuts' coffee.

Robert Shiller States My Case
In today's Wall Street Journal, economists Robert Shiller and Karl Case have an opinion piece that talks about the housing market. Buyer psychology is very important. It led to the big rise in housing prices and will determine the length and severity of the slowdown. I liked this paragraph from the article:

While our surveys indicate that relatively few expect prices to actually fall, buyers do not want to pay prices that are significantly higher than a year ago. Buyers are waiting and low-balling. Sellers want to get a price increase of the kind they've observed in the recent past. The result is that fewer agreements are reached, and sales fall. If the housing market were like the bond market and all houses for sale were auctioned every day, prices would indeed fall precipitously. But they are not. The aggregate indexes based on repeat sales have decelerated markedly but are not yet falling.

Wow
This is a big real estate transaction.

Light Blogging
The blogging has been light for the past week. I have been traveling to see a property in Hartford and have been busy since my return. The blogging should increase later in the week.

Lease Risk Dichotomy
Properties with lease risk are common in TIC offerings. In a TIC offering with a single office property, lease turnover of 100% is not uncommon over a ten-year term. The offering's cash flow could be impacted if the space is not leased for an extended period or if unanticipated tenant improvement costs are required to retain existing tenants or to attract new tenants. Sponsors estimate leasing costs and either borrow these costs initially or reserve cash from operations. But future leasing costs are best-estimates, as a leasing market in five years, for example, is unknown.

The large non-traded REITs avoid properties with significant lease turnover. Sponsors view lease turnover and the potential impact on cash flow as too risky. Long-term leases that generate predictable cash flow are preferred.

The dichotomy, in my opinion, is strange. The TIC offerings need the steady income and do not have the means to pay for unanticipated leasing costs or the reserves to withstand an extended vacancy. Unanticipated leasing costs and extended vacancies in a TIC offering will result in a distribution cut and may impact the long-term outlook for the offering. The non-traded REITs, with their diversified portfolios, can take leasing risk because of their cash reserves and access to capital. A non-traded REIT's all-important distribution should be unaffected by one property's leasing problem.

In the TIC market, leasing risk will result in out performance and under performance, as some offerings will benefit from a strong leasing market while others will suffer in poor leasing markets. Analysis should be centered on a property's lease terms, and the assumptions a sponsor has made. The non-traded REITs will muddle along. They may not have much leasing risk, but they certainly have cap rate risk, but that is a discussion for another post.

(Another issue for a future post is that TIC offerings' cost structures (front-end load) make properties with long-term leases unattractive, as these properties are expensive and a TIC's load structure makes the properties more expensive. Many TIC offerings with single tenants are uneconomical and do not sell despite the long-term lease.)

Shocking!
Housing sales are off, unbelievable. The breathless articles act like this is some kind of a shock. The minimal reaction of the stock market indicates that the market is not surprised. The debate is whether the housing market will have a hard landing or a soft landing. As a home owner I hope for a soft landing, but as a potential upgrade buyer I want a hard landing. Homes are not moving (at least in my neighborhood) and sellers are not acknowledging the new environment. When houses are priced to move, and when recent buyers with exotic mortgages can not refinance and have to sell, that will tell whether we are going to have a hard or soft landing.

Related Capital
Today's (8/22/2006) Wall Street Journal has a profile of Stephen Ross and his Related Companies. Related was, and still is, a big player in the low income housing tax credit business. (My former company, largely on my recommendation, approved one of Related's public tax credit programs in the late 1990s.) I won't go into the economics of the tax credit programs from an investor standpoint, but basically an investor put up a certain dollar amount and received tax credits over a number of years. An investor would receive approximately $1.30 to $1.70 in tax credits per dollar invested over a ten to twelve year period, with an overall hold period that will likely be twenty years. It is very rare for investors to receive any cash return other than the tax credits during the hold period and I imagine that cash from property liquidations will be minimal. According to the article, the tax credit properties are a cash machine to Related, and have served as the financing source for Related's push into conventional real estate. It is not surprising that the sponsor of the tax credit deals can generate so much recurring cash while the tax credit investors are left with only the tax credits.

Why Should We Care
Glenborough Realty Trust agreed to be acquired by Morgan Stanley for about $2 billion today. The Glenborough transaction is just another in a string of real estate investment trust acquisitions. There are a couple of interesting points about Glenborough. First, it is the resting place for many of the August limited partnerships, which were widely sold in the 1980s. One of the principals of August was Luke McCarthy, who with his firm Evergreen, is a major player in the Tenant In Common syndication business.

Speaking at Conferences
I have been invited to speak on a panel at a non-traded Real Estate Investment Trust (REIT) conference at the end of October. This may be interesting, but I am not sure if I'm wanted for my expertise or my registration fee. The conference I'd like to speak at is the TICA meeting in Vegas in mid-October. I just bought a real estate finance book, recommended by Josh Kahr, who gave a great presentation at the TICA meeting last March in San Diego. I hope to refine my cost of capital calculations and develop a few other benchmark calculations to help in the analysis of TIC transactions, which would be interesting to present. My guess is that traditional financial analysis may not fit the TIC model, as the high fees keep expected returns lower than the required returns. Presenting that information would go over real well.

Housing and the TIC Market Place
I believe that the housing market and the TIC market are highly correlated. I have not seen any figures to verify this, but I imagine much of the money flowing into TIC transactions is from the sale of residential rental properties, such as small apartment complexes, duplexes and houses. The slowing housing market will affect the sale of the rental residential properties and limit the flow of money into TIC offerings. The dramatic growth of the TIC market was fueled, in part, by the strong housing market. As the housing market goes, so goes the TIC market.

Collateralized Senior Notes
I received Triple Net's collateralized senior notes' memorandum in the mail. I will probably have more later on this deal later when I get some free time to review the memorandum. My gut reaction is to avoid not only this deal, but all debt deals put out by firms that raise equity.

More on Intrawest
Was the Intrawest deal a verification CNL's strategy of investing in "baby boomer" leisure lifestyle investments? Maybe, and I imagine that is how CNL will spin the transaction. The company that bought Intrawest, Fortress Investment Group, paid a 29% premium over Thursday's (8/10/2006) closing stock price. The Wall Street Journal's article on the transaction said that Intrawest's largest stockholder, a hedge fund, had been pushing the company to create value with its real estate assets. I hope CNL Income Properties is talking to Fortress, too.

Another Non-Topic Post
I heard Come on Eileen by Dexy's Midnight Runners today. This has to be one of the worst songs ever recorded. Life will be good if I never hear this song again.

Talk to Private Equity Investors
Any sponsor of a non-traded Real Estate Investment Trust (REIT) that is not talking to private equity firms is not looking out for investors. Private equity investors have shown a willingness to pay a premium to market value, and a deal with a non-traded REIT would provide an excellent exit for investors. Private equity firms flush with cash and blind to value will not last forever and the non-traded REIT sponsors need to put investors' interest first and make a deal.

Not Getting a Warm and Fuzzy
I was catching up on my reading and saw this article on Countrywide Financial in Tuesday's Wall Street Journal. I did not find the article that informative until I saw these two gems at the end of the article (my emphasis added):

One reason for concern: Countrywide has heavily promoted pay-option adjustable-rate mortgages, known as option ARMs, a type of loan singled out by regulators for closer scrutiny. These loans give borrowers several payment options every month, including one that is less than the interest due. If borrowers choose that option, the balances of their loans grow. Eventually, that can lead to a big leap in monthly payments due. Option ARMs account for 45% of loans held as investments by Countrywide's banking division.

Countrywide says it has been careful to give these loans only to borrowers with relatively strong finances. Still, the test of these loans will come when borrowers face "resets" to higher monthly payments, Mr. Mozilo said during the conference call. "I'm not sure exactly what will happen then," he added.

Countrywide has a large exposure to exotic mortgages and its CEO is unsure of what's going to happen when they start to reset.

CNL Income Fund Tenant Agrees to Buyout
Intrawest, a large tenant in CNL Income Properties, has agreed to be bought buy a private equity firm. Intrawest manages and is a tenant at the ski resort properties in Income Properties.

Active V. Passive
I received the following this morning in DFA's monthly blast email:

Passive wins again. Standard and Poor’s recently published its SPIVA results. The conclusion? Surprise, surprise…active managers underperformed indexes on average in a wide variety of asset classes*.

S&P Asset Class	% of Active Funds Beat By the Index (5 yrs ended 6/30/06)
Large Cap	67%
Mid Cap	84%
Small Cap	79%
Global	65%
International	80%
International Small	78%
Emerging Markets	88%

* Source: Standard and Poor’s

One often hears the claim from so-called “core-satellite” investors that indexing only works in the efficient liquid areas of the market, like US large caps. They espouse that insightful managers can add value in less efficient areas of the market like small caps, international, and emerging markets. The data is simply another example that such positions stand on shaky ground.

Pretty interesting, especially in the non-large cap asset classes. I always viewed emerging markets, international and small cap as a place where active management could add some value.

Another View of Operating Fees
I listed a comparison of non-traded Real Estate Investment Trust fees last month. Here is another view of the operating fees. The table below shows the operating fees as a percentage of the distributions:

REIT	Ratio
CPA 16	28.25%
CNL Inc Prop	32.01%
Wells II	35.83%
Inland America	46.33%
Hines REIT	53.83%
Div Cap TRT	56.73%

The operating fees are the expected fees - assuming the anticipated leverage based on the prospectus and operating revenue based on property type, and the distribution is the current distribution. The calculation reflects the expense to distribution ratio when the programs are fully operational. An increase in distribution will lower the ratio. On a positive note, it is good that the two net lease programs have the lowest ratio. Hines' high ratio may be why it has no stated exit strategy.

I don't suspect that the sponsors of these REITs tell investors that their annual fees will be one-third to more than half of what is paid out in distributions. And the above fees do not reflect any incentive fees (except Inland, which has too low a hurdle not to include), which would make the ratio jump. The REITs are all advised by affiliates (the outside advisors), and most of the fees paid to the outside advisors go away if a REIT is listed on an exchange. The public market does not put up with this self-dealing and neither should broker/dealers.

And Now for Something Completely Useless
Economic news on the strength of the housing market here and here from the National Association of Realtors. What could be more reliable than a housing forecast from a realtor?

Interesting Quote
From yahoo.finance, Robert Toll, of homebuilder Toll Brothers trying to explain the companies third quarter sales:

Robert Toll, chairman and chief executive, expressed some surprise at the weakening.

"It appears that the current housing slowdown ... is somewhat unique: It is the first downturn in the 40 years since we entered the business that was not precipitated by high interest rates, a weak economy, job losses or other macroeconomic factors," he said in a statement.

The Madness of Crowds is now working in reverse. The prices of homes went too high on nothing fundamental. People bought because others were buying, which led to a frenzy that drove up prices. Low interest rates helped and exotic mortgages enabled people to buy homes they could not afford. The buying has slowed and will slow further as the frenzy works in reverse. Interest rates are still low and exotic mortgages are still available, plus the economy and employment are strong, so there are no fundamental reasons why the frenzy has stopped. It is time to save cash to take advantage of future buying opportunities.

Housing Slow Down
Here is an article from yesterday's Wall Street Journal talking about the possibility of the housing slowdown being worse than anticipated. The article has no pricing evidence, just extrapolated estimates from monthly home sale data. The worry is what the housing slow down will do to the overall economy, and the article guesses that it may take .75% to 2.0% off GDP, which is significant, especially when GDP was 2.5% in the second quarter.

Inquiring Minds Want to Know
I received Omni's TICTalk newsletter today. I only read the introduction. It said that at the end of the second quarter there were sixty-three current TIC sponosrs, and during the quarter eight TIC sponsors left the business permanently and five suspended their TIC offerings. Twenty new sponsors have indicated interest in entering the TIC industry. I want to know the eight sponsors.

Update: One sponsor is Beheringer Harvard (sp?) and another is Mammoth - sponsors of uninspiring deals, to say the least. Both had heavy affiliate involvement either through purchasing from affiliates or investing with affiliates. It's not sad to see these sponsors exit the TIC market.

Pension Trouble
This does not sound good.

Non-Topic Post
This post is related to the whole Arab/Muslim/Iran/Iraq/Israel situation (like I have the knowledge to say anything). I tend to view the world in terms of economics - the better the economics the better the overall outlook. I have thought for some time that many problems in the Middle East could be solved if the economies could be improved. If people had a decent job and income they would be less susceptible to the influence of the Islamists, like Hezbollah and Hamas. These organizations provide social aid, along with their military wings, which builds a strong foundation among the poor. Someone with a full-time job and supporting a family may hate the US and Israel, but is a less likely terrorist recruit than the unemployed person who has no hope. I have not seen much reporting to support this premise, but today, as part of a longer blog, I did see improving economics mentioned as part of a long-term solution. Until people's economic outlook is improved, I do not see much hope.

PhD in the Obvious
I have seen a number of recent articles about condo conversions being reverted back to rentals. Here is one from yahoo.finance. The speculative demand for condos led to more condos being built than markets could absorb. The excess condos are now being rented. Here are two quotes from the article:

"There was a huge craze," said Larry Leitzman, a Tampa-based research and marketing coordinator at Grubb & Ellis, a national real estate agency. "Everybody was taking apartment buildings and converting them to condos. A lot of them are reeling them back in and taking the apartments that didn't sell and converting them back to rentals."

Other markets that have seen reversions include Miami, Fort Lauderdale and Orlando in Florida, as well as Las Vegas, San Diego and Phoenix, according to Hessam Nadji, managing director of research services at Marcus & Millichap, a national real estate investment brokerage company. Between 25 percent to 40 percent of the condos being developed or converted in those markets are likely to be offered as rentals instead, he said.

This trend is not surprising. The article I want to read is the one about the speculators that used wild financing and are now stuck with mortgages where the rent does not cover the cost of holding the condo. My guess is that many of these are small, unsophisticated investors who invested without much forethought with the assumption that they could make a sizeable profit in a short period. The opportunity will be when these investors have to start selling.

I Hope They Ate Their Own Cooking
The genius private equity guys did quite a job on Burger King. The firms, Texas Pacific Group, Bain Capital and the private equity arm of Goldman Sachs, bought Burger King in 2002 and then paid themselves substantial fees, including a dividend of $367 million, which was paid with borrowed funds. The fees and dividend approximately totaled the amount the three firms invested to take Burger King private. Burger King went public in May at $17 a share, which valued the remaining stake of the three private equity firms at $1.8 billion. Today Burger King announced its first earnings report since it went public and the results were not good, but predictable. Earnings were hurt by a $30 million management termination fee that went to the three firms. The market lopped 13% off the stock price. The stock is off 22% since it went public. If the three firms still own their shares, their value is off $400 million since it went public. Private equity investors pay themselves huge fees and add questionable value. Investors should stay away when private equity firms take their companies public.

Slacker Nation
What the hell is wrong with these guys? As I read this story, I wondered the politics of these men. I bet many of these guys are "value" voters who do not see the contradiction of their politics and their current positions. Stop immigration! Intelligent design! Prayer in school! Don't stop my disability! SUCK IT UP AND GET TO WORK!

Mammoth Ad
Mammoth Equities had a full-page ad in yesterday's Wall Street Journal. Wow! No mention of its TIC operations. I wonder if any TIC money went to pay for this unnecessary extravagance.

Delaying the Inevitable
This article in the New York Times confirms what I have been saying for sometime, that people cannot pay their exotic mortgages and need to refinance when the teaser period is over. According to the article the new mentality is that no one lives in a house for thirty years, so why paydown the mortgage, just get the lowest possible payment. This may work for a small number of people, but my guess is that the refinancings are based on an inability to pay the higher rate not a nomadic view of housing. The dollar value of loans subject to adjustment in 2007 will be two and a half times this year's value. The article does not mention the refinance cost - $3,000 to $5,000 per refinance - and how borrowers do not see these fees. Nor does it mention that a house is a great source of wealth accumulation. I would bet that the largest asset of the parents of these over extended borrowers is their house. This is a safety net their kids will not have.

Correction
The tables below need to be updated as I found a few errors. I will do this later today. CPA 16's Front-End Load needs to be lowered slightly and Inland's Operating Load needs to be raised.

Update: The correction and adjusted rankings are shown below. I caught the errors, not a sponsor. The CPA 16 change was an adjustment not an error, as the leverage was lowered to the amount used for the other REITs (compared to the figures shown in the prospectus which were in the original table). This lowered the fee, but as half this fee is deferred and accrues interest at a rate of 5%, it is still understated. (The deferred acquisition fees payable to CPA 16's Issuer grew 11% in the first quarter.)

Pay Me Now or Pay Me Later
The difference in how sponosrs of Non-Traded Real Estate Investment Trusts (REITs) compensate themselves is interesting and important for investors to understand. Some of the REITs charge fees as a percentage of total assets, some charge fees as a percentage of revenue and some charge fees on both assets and revenue. I determined the Operational Fees for six large REITs, making general assumptions to make the comparison equal - i.e. same amount of leverage and revenue to match the property type held in each REIT. The Operational Fees are shown as a percentage of investor equity. Below are the results along with the corresponding front-end fees:

Front-End Fees			Op Fees
REIT	Load		REIT	Load
Dividend Capital TRT	12.10%		CPA 16	1.78%
Hines REIT	12.20%		CNL Inc Prop	1.78%
Well II	14.00%		Wells II	2.15%
CNL Inc Prop	16.86%		Inland American	2.78%
Inland America	16.93%		Div Cap TRT	3.12%
CPA 16	20.17%		Hines REIT	3.23%

The REITs with the highest Front-End fees have the lowest Operational Fees, and the REITs with the highest Front-End fees have the lowest Operational Fees. It is not suprising that the sponsors of these REITs pay themselves in a way, that in my opinion, obscures how much they are really making, and these fees do not even include any revenue sharing that a sponosr may be paid. An investor hears 1% and thinks its is not that bad. For example, CNL and WP Carey charge a 1% Asset Managment Fee, but this is triple the amount they would earn if they charged a 4% of Revenue Property Management Fee.

Mutiple fees in small amount don't seem bad, until they are added up and compared to what investors are earning. The Hines REIT has three small charges, but added together total more than half of its dividend yield to investors. (Maybe this is one reason Hines REIT has no exit stragegy.) Understand the fees before investing.

Money for Nothing
It is good to be a farmer. As this Washington Post article shows, farmers across the country received Federal aid that totaled $25 billion in 2005. Over the past several years, farmers received payments for damages by drought, frost, wind and even falling debris from the space shuttle Columbia. Isn't frost, wind and drought a risk of being a farmer, and can't farmers get insurance that would cover these business risks? I don't imagine any of these welfare payments were passed on to consumers in the form of lower crop or livestock prices. Welfare payments to farmers need to be dramatically reduced, but I bet no politician has the courage to tackle this issue.

Rental Chic
Saturday's Financial Times (FT) had an entire supplement on the benefits of renting real estate rather than buying. FT's rental options are very expensive - $87,500 for a week rental in the South of France - but I do not think an entire section of the paper would have been dedicated to renting real estate a year ago. Several of the articles were for weekly or monthly vacation rentals, but the whole point of the section was that it is OK to rent and not buy.

Risk/Return
I am impressed with the investment firm Bailard. It offers a variety of institutional products, including two institutional real estate investment trusts (REITs). It has an intutitive method of looking at real estate that has several factors. One part of Bailard's method transfers well to Tenant-In-Common (TIC) analysis and can be used to help determine whether a TIC transaction has a fair risk/return expectation.

Bailard classifies real estate as Core, Value-Added or Opportunity. (Bailard did not create this model. It is widely used and CNL went into it in detail at a meeting I attended in April, but I found Bailard's presentation succinct and straightforward. The goal for any Value-Added or Opportunity property is to make it a Core property, which commands a higher resale price. A detail of the three classifications is below:

• Core properties have the lowest risk and lowest return expectations. Core properties have stable tenants and need little capital improvement and should provide long-term income. Examples of Core properties include fully leased Class A office buildings, single-tenant net leased properties with credit tenants and community shopping centers with one, two or more national or regional anchors.
  
• Value-Added properties have more risk and should have higher return potential than Core properties. Value-added properties should produce income but it will likely be variable. Examples include aging properties that need capital improvements or a properties with near- and short-term lease expirations.
  
• Opportunity properties have the highest risk and highest return potential. These may be development projects, existing properties with significant vacant space or properties that need major capital improvements. Income is unlikely until the opportunity issues are resolved.
  

A TIC transaction's property classification and return expectations need to be determined and compared to similar classification transactions. A Core TIC offering should have a return expectation similar to other Core transactions and a Value-Added TIC transaction should have returns comparable to other Value-Added transactions. Value-Added transactions should have higher return expectations than Core transactions.

I do not have a return expectation ranges for each classification, but will start one now. It will be interesting to see how this evolves. Sponsor resistance will also be interesting, especially when a transaction is Value-Added and has Core-like return expectations.

Rising Cap Rates
The story in today's Wall Street Journal detailing Kimco's purchase of San Diego-based Pan Pacific Properties noted that the cap rate on the acquisition was 6.3%, which was higher than expected. This may signify that cap rates have bottomed. Improved commercial real estate fundamentals (noted below) and cap rates that are moving up is good news for the real estate market.

Strength in Commercial Real Estate
There is an interesting article in today's Wall Street Journal on the strengthening fundamentals in commercial real estate. Occupancy rates are increasing leading to increased lease rates. This was confirmed by a conference call I was on last week with Bailard, who offers an institutional real estate investment trust. Bailard showed a presentation slide with occupancies and lease rates increasing, and with potential for further improvement. The WSJ article offered an acknowledgement that the improving fundamentals will help real estate investors who have paid high prices.

Nat's Prediction
If Ken Heebner is only partially right, a big part of the price decline is going to be caused by all the crazy mortgages that allowed people to buy more house than they could afford. As these mortgages reset in a market that is not appreciating and may even be depreciating people will realize they have little to no equity. People are going to find out the hard way what that term in the fine print "negative amortization" actually means. What's the incentive to keep paying an increasing debt payment on a property with no equity (and with a negative amortizing loan the principal amount growing)?

Ken Heebner's Prediction
In Wednesday's Wall Street Journal, in the monthly Mutual Fund section, fund manager Ken Heebner predicts that areas that had the steepest price increases in residential real estate (California, Arizona, Florida and other parts of the East Coast) could drop up to 50%. Wow! Wouldn't that be a shocker. And if the drop is anything like the early 1990s (the last time California had a real estate decline), prices will stay at the bottom for awhile. Let's hope he is not right, or only right enough so that I can sell my house for enough to move up and off this busy street I live on.

Portable Alpha is Portable Potty
The Wall Street Journal has an article on portable alpha this morning - investing a portion in an index (beta) and a portion in derivatives to capture hedge fund returns (alpha). Apparently this is the investment rage and I have heard the term frequently. Wall Street's big firms are coming out with products to capture this alpha. But as more people invest, as a quote at the end of the article from William Bernstein suggests, alpha will shrink (efficient markets) making alpha that much harder to obtain.

Better Analysis
I am reviewing and rethinking the analytical process for tenant in common (TIC) transactions. I think it needs to be better and incorporate more traditional financial and investment analysis. These deals need a more rigorous financial review. The cost of the deal - for both debt and equity - needs to be determined and compared to the expected return. The tricky part is the cost of equity. To determine the cost of equity I have been using the front-end costs, less money for reserves, but I am not convinced this is fully accurate. I know it gives a good approximation of the cost of equity, but I need to fine-tune it and determine a portable formula that could be applied across multiple offerings.

I searched the CFA Institute website for exisitng research, and there was none. (This could be a good research document.) I am searching Amazon for an appropriate real estate analysis book that will help.

Buying The Sizzle Not The Steak
Investments are an odd thing. Investments that seem marginal can attract loads of cash while good investment opportunities languish. The Wells Real Estate Investment Trusts have raised billions from investors over the past five years. Last July Wells introduced what it described as a mid-term value-added fund, a fitting product for a real estate environment that has seen prices soar making traditional income investments harder to fit into the traditional non-traded REIT structure. The fund, however, took almost a year to meet its impound of $10 million.

Rainier can sell its 1031 programs (which are by no means marginal) in about five minutes but its Income and Growth Fund II, which pays an 8% yield to Class A investors and has substantial diversification for a $10 million fund, has struggled to raise funds.

Why do good fund languish? I don't have an answer. I would not be suprised that the programs are sold by different reps, making it a tough sale for the wholesaler. The rep selling Wells for income and safety is not same rep looking to sel an upside opportunity. Maybe the wholsaler compensation is different? Whatever the reason it's unfortunate and investors are missing good opportunities.

Wednesday's WSJ
Today's Wall Street Journal had an interesting article about apartment investors looking for opportunities outside the investors' home market. The end of the article mentioned that as an alterantive to looking for a specific property, investors could consider a TIC transaction and referenced TICA. I half-thought that the writer was recommending the TIC alternative as a fund-type investment rather than an actual fractional ownership interest.

Implosion
I was talking to a wholesaler friend earlier this week and he told me that a broker/dealer is worried that the TIC market will collapse any day. This scared me because I know the people at the broker/dealer and they are smart. I would bet that the management at this broker/dealer knows more about investments than the managment at any other independent broker/dealer. After the fear of my due diligence review fees evaporating passed, I thought through the comment.

The TIC market will not collapse. Real estate is too varied and illiquid to collapse overnight. It is not a stock. My guess is that it will slow, as real estate in general is slowing. All TIC deals are predicated on the sale of properties so that investors can exchange into the TIC deal. If investors have a hard time selling their properties, this will slow TIC sales.

Here are the biggest trouble spots that I see:

• Specific sponsors going under is a more likely scenario. Sponsors that are leveraged and need deal flow and the corresponding fees will be in trouble. A sponsor that runs into severe financial difficulty will be a black-eye for the industry. (It may also be an oppourtunity for a better capitalized sponsor to take over management.)
• If credit dries up, properties that need to be refinanced when the original debt term expires may find it difficult in a tight credit market. If there are defaults on a number of TIC deals, good programs may feel the affect by finding financing difficult and expensive. Bankers are followers and credit will dry up fast if the bankers get nervous.
• Deals that were "financially engineered" will be the first to feel any pain. Watch the deals from sponsors that put them together. Financial engineering examples include projections that have outsized growth, or have distributions paid from reserves (or any other non-operating source), or interest-only financing for an extended period of time (five years or more) that artificially inflates distributions while adding no equity accumulation.

There are other potential flash points, but rather than a full-scale retreat like the stock market saw in 2000 through 2002, the TIC market will not collapse. In talking to sponsors, the biggest concern is not the ability to raise money or access to financing, but to find affordable properties that fit in a TIC pricing model. This is not the talk of an industry about to implode.

New Whipping Boy
I am updating my review of the Inland American Real Estate Investment Trust. The updated material does not change my original opinion of the program: that it is one to skip. The front-end load approaches 17% and the ongoing fees can hit an outrageous 7% of revenue if investors receive an achievable 5% distribution. Inland receives no acquisition fee if properties are purchased directly. It will receive a fee if a real estate operating company is purchased. The first transaction was another REIT, so Inland gets its acquisition fee. I am uncomfortable with investors paying 17% for Inland to have access to purchase REITs. The original portfolio, if I remember correctly, had marginal properties (thanks Google Earth) with limited lease growth.

I am not against marginal properties. I like properties that make investors money, and it does not matter whether the property is marginal or top-quality. There needs to be upside in lease growth and the acquisition price needs to be favorable (cap rates higher than market cap rates). The deal, in my opinion, fails on both accounts. There is limited lease growth and the cap rate was near 6%. Investors in Inland American should expect flat distributions. Capital appreciation is unknown, but with flat lease rates and cap rates near historic lows, I am not optimistic.

Pitting Investors Against One Another
The more I think about affiliated mezzanine debt deals the more I do not like them. You have a sponsor offering two products that are polar opposites in terms of objectives. The equity offering uses the debt from the mezzanine deal to bridge its property purchase. It is in the equity offering's best financial interest to use the mezzanine debt for as short a period as possible, if at all (fast equity raise). And it's in the mezzanine offering's best financial interest to have the debt outstanding for as long as possible (slow equity raise). Something's got to give.

The sponsor would better serve investors by scraping the mezzanine deal and focusing on raising money for the equity deal. Quality TIC offering's still sell out in a short period of time, negating the need for mezzanine debt. Rather than go to the trouble (and expense) of a debt offering, the sponsor should find better properties, structure the equity deal better (i.e. less fees and higher returns to investors), and hire a better sales force. It is likely that the need for a mezzanine deal is a sign that the equity offerings are not that great.

Inflation?
Inflation worries have taken 250 points off the Dow in two days. Strangely, the ten-year Treasury, which should be falling and its yield rising, has moved very little over the past two days. This may mean that the bond market is more concerned about a slowing economy than inflation.

Forgotten History
When I first started as a due diligence analyst in the late 1980s, I viewed affiliated transactions as a sign of potential trouble. The due diligence department that I worked in and eventually ran, initiated a prohibition against offerings that were affiliated. There was a good reason for this. It was because too many affiliated deals went bad. The Heartland and Meyers land deals went south (note investors against equity holders). The Hill Williams land development deals went south (raw land loans made based on "as completed" appraised values). The Nilcorp housing development deals also had note investors fighting equity investors. There where other affiliated transactions that did not turn out as planned, not just the risky land development programs.

Some deals were structured poorly and the real estate market did collapse. But many failed due to the lack of arms' length negotiations and misvalued investments, and the likely fact that the deal would never have been done if it had not been an unsophisticated affiliate offering.

The affiliated transaction is back with a vengence. The lure of capital - despite its cost - from unsophisticated investors is too great. The disclosure is better because the securities attorneys are better (but it is not the attorneys' job to tell investors whether the deal is good or bad). Disclosure does not make a deal sound and broker/dealers and investors need to beware.

My opinion is the same - these deals are considerably more risky than being presented and investors and broker/dealers should stay away. The returns do not, in my opinion, compensate investors for the risk being incurred. Yield and return hungry investors should look elsewere. History repeats itself and broker/dealers need to avoid the mistakes of the past.

Clarification
The point of this blog is not to bash CNL, although I would admit that seems to be the case. But I am currently reviewing CNL Income Properties, and CNL is merging another REIT and preparing a third for merger / sale or listing (I bet merger / sale). Between the immediacy of my review and the activty at CNL there is a wealth of material to reveiw. My opinion is that CNL's fees are high and its disclosure is poor. Income Properties' load is 200 to 400 basis points higher than some of its competitors, and in a limited-appreciation sale / lease back transaction 400 basis points is significant. When you have to play detective to find simple information about a merger of previous programs it makes you suspect what else is missing. I have other programs to review and will likely bash them, too.

But You're Not Saying Anything
The legal disclosure in prospectuses (or how lawyers can write and present tables for hundreds of pages and not say anything) can be frustrating. CNL combined its restaurant REIT and its income partnerships (I through XVIII) and merged these with an existing company, US Restaurant Properties. The new name is Trustreet Properties (TSY) and it began trading on February 24, 2005. CNL's track record goes on for pages and no mention of the conversion is made. The name of the new entity is buried in an appendix's footnote.

I am not clear as to why the presentation is so opaque because the results are not horrible. I guess it is the company's preference for secrecey and disclosing what legally needs to be disclosed - good new or bad. Whether the diclosure is coherent is another matter and probably irrelevent. I would challenge any investor reading the CNL Income Properties prospectus to determine what happened to all those old partnerships. And what was paid for the management company? This is not in the prospectus either.

Investors received cash and convertible preferred stock. The stock has dropped from $18 to about $13. I am not sure what the conversion or target IPO price was, but it was probably near $20. The convertible stock is convertible anytime with one preferred share convertible into 1.28 common shares at $19.50 per share. The preferreds have never traded "in the money," and convertible preferreds typically trade at a lower yield than non-convertible preferreds. My first instinct is that investors did OK, not great, and likely could have and should have done better.

Feeding the Beast
I was sent some audited financial statements from a TIC sponsor this week. I do not do much business with the sponsor so an unsolicted package is usually tossed. Rather than routing the package straight to the garbage, I happended to open it and found the financial statements. Pretty scary stuff. The company has a leverage ratio greater than 80%, some in the form of debentures and investor notes raised from individual investors not banks. With a leverage ratio that high it's not hard to figure out why there is no bank debt.

The company has substantial cash on hand, so long as it keeps putting deals together it should be able to sustain its high leverage ways. One intriguing comment in the notes is that the company classifies the reimbursement of operating expenses incurred by it in the management of properties (presumably for TIC investors) as income. I would think that this would be a wash on the balance sheet - operating expense reimbursements offset by operating expenses. Not even close, in fact other income (which I am assuming is where the operating expese reimbursements are presented) is three times greater than operating expense entry. I wonder if the reimbursements are marked up? These financials definitely require a closer analysis and raise serious questions, but I have spent too much time on this as I don't closely work with this sponsor.

European Cap Rates
Today's Wall Street Journal has an article on European real estate. If you think cap rates are low in the United States be lucky your not buying real estate in Europe. Yields on retail property in Dublin are 3%, the lowest in Europe. London office yields are 3.75% to 4.75%, depending on location. How do or how can investors finance properties at these cap rates? These cap rates make US cap rates downright frothy. A European can invest in US properties, take a slight hit on the Euro conversion (which is expected to continue to appreciate against the dollar) and still outperform home real estate markets.

WSJ Real Estate
Today's (May 24, 2006) Wall Street Journal had several interesting articles in its Property Report (starting on page B4). Its Blueprint market today is Columbus, Ohio. The article states that Columbus is gaining traction and showing signs of improvement. This encouraging report shows the prescience of Cabot Investment, the TIC sponsor, who had the fortitude to invest in Columbus near its bottom in 2004.

In its Plots & Ploys section it mentions a TIC transaction sponsored by Triple Net Properties. It is a 205,000 square foot medical property 100% leased for ten years to the AA-rated Mayo Clinic. The article states that the cap rate was 6.2% - which I bet is not the Syndicated Acquisition Price cap rate. The interesting point is that the property was sold to the TIC investors by WP Carey. I wonder what return the WP Carey investors received?

Dipping Ten-Year
The ten-year Treasury has dropped to around 5% from close to 5.2% over the past two weeks. This stops a steady year-to-date rise in the ten-year (an increase of almost 1% at its peak). What does this mean? Inflation fears, which have supposedly spooked equity markets, would mean that the rate would go higher rather than lower. It may be the realization that the high gas prices are working their way through the economy in a not-so-positive way. The dip is good for real estate because cap rates have not moved up with interest rates, which have narrowed spreads and made real estate investing tougher. Hopefully this repreive will not be brief.

Juiced Up Portfolio
I am reviewing a major non-traded REIT and have signed a confidentiality agreement and therefore can’t divulge confidential details. But the documents I am reviewing are all public filings so I can comment away. (Anyhow, this company won’t disclose any private details – since when have cap rates become proprietary - and the disclosure in the filings appears more to obfuscate than clarify.) The documents, to me so far, show an almost inappropriate quest for yield – construction and mezzanine loans, ground leases and partial ownership of buildings – with little regard for growth or an exit strategy. Hell, the risk section, in a rare moment of clarity, states that the ground leased properties offer no growth! This is combined with other properties that do not appear to have much more than 5% to 6% returns. If the yield on the REIT was 8%, maybe the investment strategy could be justified, but at 5.5% I am not sure. I will keep you posted on this deal.

Strained Finances
I have seen three articles this week on the rise in defaults on mortgages. All three articles are quick to point out the default rates are below historic standards, but the point remains that the default rate is on the rise. Adjustable rate mortgages are seeing the most defaults. These are the nifty mortgages that let people buy more home than they can afford. Rising short-term interest rates make monthly payments higher when the adjustable rates reset. Jesse Eisinger, who writes the Wall Street Journal’s excellent Long & Short column, had this take-away point in Wednesday’s Journal:

“As demand wanes, there's been an unsurprising but troubling response from banks: They are making it easier to take out a mortgage. According to this week's survey of bank loan officers by the Fed, more than 11% lowered their credit standards in the past three months, while fewer than 2% tightened. And mortgage-payment performance has begun deteriorating. Though absolute levels are still historically low, late payments are rising. “

Eye-opening stuff. When my wife and I bought our house in 1993 the lenders required that the loan payment had to be less than 30% of our combined gross income, if I remember correctly. Those days are gone. The banks have no one to blame but themselves for the defaults and, like a group of lemmings, will all tighten credit in unison. Of course this will be after the housing prices decline and become more affordable.

My guess is that one of the small, high-flying mortgage companies that specialize in the most exotic loans will fail. The rise in short-term rates will accelerate the fall of a company in trouble. Annaly Mortgage, once a Wall Street darling, has cut its dividend to $.11 a quarter from $.50 a quarter at the end of 2004. Its stock has dropped from $20 to $12.50 over the same period.

I have bored many people with my theories on the false run-up in housing caused by silly mortgages people can’t afford and the dire consequences these mortgages may cause. The economy can’t withstand a housing implosion caused, in part, by lender greed and negligence.

Trend to Watch
I have received offering packages recently from TIC sponsors with programs other than TICs. These represent two divergent ideas. The first is a move to diversify away from TICs and present other alternative real estate investments in a general fund format. This makes good business sense as the fund approach will expand the companies' distribution network from both a rep and a broker/dealer standpoint. The second is more disturbing as, at first blush without any analysis, the offerings are affilaited debt transactions. This type of program has never given me a comfort level. I will post back after reading a memorandum or two.

Triple Net G REIT
I received an investor letter from the G REIT saying that investors had approved the liquidation of the REIT. As part of the letter investors are being notified that "we" (presumably the REIT management) have retained UBS Securities to act as the REIT's financial advisor and help it find a portfolio sale. An outright portfolio sale would be good for investors rather than sell the properties over a two year period. The letter states that "we" is still estimating a return per $10 original investment of $10.31 to $11.50 per share

The View from 100,000 Feet
I used to work for a small company that was sold and became part of a very large company. One of the new management's cliches was that the senior executives were busy with the "view from 100,000 feet." I went from being impressed to disillusioned as it became evident that from 100,000 feet management could not see anything - sort of like flying over parts of the western United States on a moonless night. I had not thought about this inane cliche for awhile but was reminded of it today as I paraphrased it to apply it to the current real estate market - the view from 5.5% cap rates.

I pick 5.5% not as an exact number but as one to reflect cap rates at historic low levels. Some view lowered cap rates as a paradigm shift (isn't this another old cliche?) and some view them as a sign of a real estate bubble. Who knows and whoever is right, both face the same future. A future defined by limited capital appreciation and where income is the primary return component. How can cap rates fall much further, with interest rates creeping up and institutional interest rates above 6%? Income growth in the form of increased NOI through expense management and lease increases will be the path to success. Real estate purchased at today's cap rates that have limited lease growth will be tough to make profitable. The "view from 5.5% cap rates" is all about income and how to grow it.

CNL
CNL Retirement Properties agreed to be purchased by Health Care Properties (HCP). CNL Retirement Properties is a non-traded public REIT. Investors paid $10 per share and the HCP bid is $13.50 per share. It looks like the purchase price is about 14.5 times CNL's 2005 FFO. This high compared to historic FFO multiples but lower than recent transactions. Investors will receive $11.13 per share in cash and .08 shares of HCP for every CNL share owned. So, an investor that made a $5,000 investment will be stuck with 43 shares of HCP. Oddlot nightmare. Hopefully, CNL will make some sort of accommodation for the small investor.

I was at a CNL due diligence meeting in early April and asked CNL whether it was exploring the sale of its REITs to another REIT or private equity investor. The question was pointed towards CNL's hospitality REIT but would cover the health care REIT as well. (CNL obviously could not discuss the HCP transaction.) I was told that this type of transaction was not in the prospectus. Since when does shareholder wealth maximization not become part of the prospectus?

I guess CNL wealth maximization trumps whatever is in the prospectus. HCP will pay CNL $120 million for its management company / advisor which was separate from the CNL Hospitality REIT. CNL has a reputation as trying to maximize its own wealth and finally found a participant. (One failed IPO and one failed rollup of limited partnership, which both included large valuations for the external management company.) To paraphrase my dad, "CNL loves investors but loves itself best."

"Major Issues"
I generally discuss the key points of my investment research under the heading Major Issues. This will include economic opportunity, risks and some boiler plate disclosure. Peeling back a deal will reveal one or two prime opportunities risks that need to be exploited or overcome for a deal to be successful. When I talk about deal here, I am discussing TIC transactions. Here are some examples of "Issues" that have recently been seen.

• Long-Term lease to WalMart (great). The lease never increases nor has revenue participation (bad). The deal has become a pure cap rate play with cap rates near historic lows.
• Majority of tenant leases due in the year the deal is supposed to be sold and when the debt is due. Becomes almost pure lease bet and whether the sponsor can get that property leased at a level that will make it attractive to a buyer at a favorable price or at least get the debt refinanced.
• Majority of leases below market. A deal had a majority of the leases up to $4 per sq. ft. under market. Again, a lease play, which if the sponsor successfully implements will be great for investors.
• Negative leverage on an apartment deal. Discussed before. Need outsized rent increases to turn to positive leverage and to justify the low cap rate paid for the property.

Most deals, in my opinion, can be narrowed down to several main risks/opportunities that the sponsor will need to properly manage for investors to have a chance at success. I don't feel this is bad, but investors need to be compensated for additional risk. Investors were not compensated for the WalMart deal, in my opinion, but where (at least on paper) for the second example.

Gas Prices
OK, gas prices are not generally the topic of this blog, but how can one resist. Gas prices are a function of supply and demand. Politicians getting all worked up are a little late to the game - the time to set an energy policy was when oil was at $25 a barrel not $75. The talk of the President and Vice President being pawns to the oil industry is disingenuous, too. Whether it's true or not, $3.00 gas is going to hurt this President's popularity, and the way things are going will hurt Republicans at the polls. That will end that friendship in a hurry.

Oil companies need to view themselves as energy companies and develop alternative fuels; car makers need to develop non-oil-based cars; and consumers need to demand better mileage, performance and alternative-fuel cars. Oh, and drive less. I am one to talk with my Ford Expedition, but at least I drove my smaller and more fuel-efficient Explorer this weekend.

Bakersfield
I checked out some properties in Bakersfield recently. My interest was not directed by a real estate firm, although the properties I saw, if they were for sale would be excellent is purchased correctly. The first property is the hotel where I stay when in Bakersfield. It is a Homewood Suite, a limited-service hotel that is part of the Hilton group of hotels. The manager of the hotel said that Homewood is mostly a midwestern and eastern chain and is now expanding into California. It caters to business and the college is just north of the property. Interestingly, it is also in an area of significant medical offices, in particular cosmetic surgery. I guess cosmetic surgery is is more cost effective in Bakersfield than over the hill in LA. This hotel is mostly full during the week and was even sold out one night when I tried to book a room.

The second is probably the premier neighborhood shopping center in Bakersfield. It is the Marketplace center in west Bakersfield. Located on Ming Avenue, it is near some of the most affluent sub-divisions in Bakersfield. It is just south of the college. Its anchors are Von's, Starbucks, Talbot's, Rite-Aid and an Edward's Cinemas and other national and local retailers. It is 299,000 square feet and 100% leased. It was developed by Castle & Cooke, which is part of Dole, the pineapple company. It was recently sold to Donahue Schriber, an Orange County owner and manager of institutional shopping centers. It was sold for $280 per square foot, a healthy price. Don't even want to think about a TIC acquisition and markup.

Serpent on the Rock
Just finished this book. I did not read it when it came out ten years ago, probably because I was not into the topic as it seemed so 1980s and direct investments had given away to stocks, low fees, indexing and the internet and its endless investment possibilities. Fatigue from reviewing all the fallen deals and helping brokers and their clients, I am sure, also played a part.

The reemergence of real estate through TIC investments and non-traded REITs makes this book relevant once again. The frenzy for oil and gas programs is also high. The over-the-top antics of some sponsors at the recently completed TICA conference brought to mind the excesses of the 1980s hey-day. The rumor was that one sponsor had a hospitality suite running the entire length of the three-day conference and had flown to the conference on his own jet. It is always investor money paying for these antics, if true.

One difference, made clear in Serpent, is that the big broker/dealers and their management are not behind the TIC rush. (At least someone's memory is long.) There was a noticeable lack of major broker/dealer representation at the TICA conference. I only saw one representative and this person was trying to be as inconspicuous as possible. This is largely a rep and small broker/dealer driven market.