Wednesday, August 30, 2006

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.
This is a big real estate transaction.

Tuesday, August 29, 2006

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.

Monday, August 28, 2006

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.)

Thursday, August 24, 2006

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.

Tuesday, August 22, 2006

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.

Monday, August 21, 2006

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.

Thursday, August 17, 2006

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.

Wednesday, August 16, 2006

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.

Tuesday, August 15, 2006

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.

Friday, August 11, 2006

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.

Thursday, August 10, 2006

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


Mid Cap


Small Cap






International Small


Emerging Markets


* 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.

Wednesday, August 09, 2006

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, 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.

Tuesday, August 08, 2006

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.

Monday, August 07, 2006

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 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.

Tuesday, August 01, 2006

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.