Piedmont - Never In Doubt
The Piedmont Office Realty Trust's proxy to investors to extend its listing period for an additional three years passed by an overwhelming margin (78%) earlier in the month. I never thought the vote would be close, despite the efforts of the company, Lex-Winn, that has been trying to buy parts of the REIT for over a year. It can be argued that now is not the time to list a REIT. This REIT should have been listed in 2005 or 2006 when the REIT market was hitting historic highs. I never understood why the Piedmont executives waited until the listing deadline to begin the process. Leo Wells could have put the $170 million that Piedmont paid him in stock in his pocket rather than having it unlisted shares.

Solving the Lending Crisis
The big lenders, Citigroup, Lehman, and Wachovia are diverse enough that they can probably not lend for an extended period. Eventually they will have to start lending. The banks' commercial real estate executives are not going to get the bonuses they (and their wives) are accustomed to by sitting on cash. This will flow up as banks' Return on Equity (ROI) will shrink and the senior bank executives won't get their bonuses. This may sound sarcastic and simplistic, but having worked long enough in corporate America, I realized that most important corporate decisions are based on the bosses' bonus pool. Stockholder wealth maximization my ass. It is in the bank executives' personal interest to start lending. When their bonuses drop they will find a way to start lending.

Reality Bites
There is an article in today's Wall Street Journal that summarizes what I have seen in the Tenant In Common market since last summer. Deals are not getting done because lenders won't lend and this is expected to result in lower commercial real estate prices. Pardon, the pun, but it does not appear that the ground floor has been found where lenders will lend and buyers and sellers can come to terms. Until this happens deal flow will be light. It is ironic that the Blackstone / EOP deal early in 2007 appears to be the catalyst. Blackstone paid so much and then sold portions of the EOP portfolio for even more that it help spook lenders.

GBE Props
I questioned this stock when it dropped, but it popped nearly 7.5% today and at one point during the day was up nearly 15%. Not exactly sure why, but the NNN merger was approved today. I am not sure this approval was ever in question so I doubt this was behind the jump.

Prime Borrowers Used Subprime
Finally. The majority of borrowers who used subprime financing were credit borrowers, not subprime borrowers. I have thought this all along and this article in the Wall Street Journal proves it. Many subprime loans were used to speculate on real estate and many were used for the low teaser rates with the expectation to refinance the loans before they reset. This quote shows the extent of the issue:

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores (greater than 620) got more than half -- 55% -- of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study. Even a significant number of borrowers with top-notch credit signed up for expensive subprime loans, the firm's analysis found.

The article states that many brokers were at fault because subprime loans paid more compensation to brokers than conventional loans, and that borrowers did not understand the complexity of the loans. This may true, because no one knows how much mortgage brokers make on a loan (except the mortgage broker and there is no bigger line of BS than a "zero point" loan). But I still think a bigger issue is the mentality of borrowers. They had been borrowing and refinancing for the past ten years with impunity and saw no reason to stop. Mortgage broker greed just fed this twisted mentality. Plus, everyone knew the difference between the monthly payment amounts of a subprime loan with a low teaser rate and a conventional loan with a higher mortgage rate. Mortgages were viewed as short-term way to play a house's appreciation, not a way to build long-term equity. When houses stopped appreciating the the game of financial musical chairs was over.

Where Can I Buy Some?
Look at this chart from Saturday's Wall Street Journal showing the various mortgage back security tranches:


The AA tranche looks like the deal of the century. I wish I knew how I could buy some of the investments that hold these bonds.

Opps
This week I heard about a reputable TIC sponsor who was syndicating a single-tenant deal where the tenant had shaky credit. The tenant was delisted for poor financial health last week - in the midst of the offering period. I have not heard the status, but this is not good and I am guessing the deal needs to be reworked. This may not be possible in today's tough credit market. I should note that I have seen the offering materials.

Didn't Get My Memo
Apparently the housing market and the market experts did not read my last post. Look at this chart:



Not too encouraging. The housing correction started in August 2005 when the Fed started to raise interest rates. The slump has been in full swing for over two years now. Reading the above articles, while negative, show that lenders are starting to lend again. The spread on jumbos is now approximately 80 bps, lower than over 110 bps in August. Most of the data in the above articles is based on data from last summer. For now, I am sticking by my previous post.

Housing Market Turn?
You heard it here first. The ten-year Treasury is now 3.85%. This is going to spur home buying. While prices may not rise, it should stop the slide. It will also help ease the subprime mess as all the non-subprime borrowers (urr.. speculators) who used subprime debt because of the low teaser payments, can now refinance into a more affordable mortgage due to the lower rates. The demand for loans is going to increase and banks are going to have to lend.

Interest Rate Buy-Downs
The credit crisis has spawned interest rate buy-downs where TIC sponsors use proceeds from a TIC offering to "buy down" interest rates. Does this make sense? I am not sure if there is a correct answer, but I am using Net Present Value calculations to determine whether the present value of the savings (increased distributions to investors) is greater than the cost. The trick is the discount rate. I just looked at a deal where the cost made sense if the ten-year Treasury was used for the discount rate. It did not make sense when the bought-down rate was used to discount the savings. Both were close to the cost (i.e. within approximately $10,000) and given the disparity between the two discount rates (4% v. mid-6%) I give the nod to the buy-down.

I Like It
Another title could be "Sharing the Pain." I just say my first TIC deal where the commission has been dropped to 5%. This is amazing. It is from a good sponsor, so I hope it goes over well with advisors. If the advisors are looking out for their clients, it should because the yield starts at 6.73% and then rises to over 7% in later years. I have heard of another plan to pay a smaller up front commission (like 3%) and then a trail commission (like 1%) over several years. I like that plan, too.

Musicians I Never Want To Hear Again
Andrew Sullivan is doing a survey of the best and worst videos of the 80s. I voted for Duran Duran's Girls on Film, in a slight edge over Peter Gabriel's Sledgehammer. The Girls on Film video sums up the 80s, plus its Duran Duran's best song. I liked Robert Palmer's videos and thought they would have made the list. I have not voted for the worst yet, but on so many levels, who can be worse than Lionel Richie?

I have been thinking of musicians and bands I never want to hear again. At the top of my list is David Bowie. I just groan every time one of his songs comes on the radio. I know he was a trend setter in the 70s, but do we still have to be subjected to his music? Another is Steve Perry and Journey - simply horrible - I am glad I don't listen to stations that play this drivel. And talk about worst videos of the 80s, Steve Perry's Oh Sherrie is hands down the 80s' worst video. It takes two minutes before the torture even starts!

UPDATE: Foreigner has to be added to the list of bands never to be heard again.
UPDATE UPDATE: Foo Fighters. Is this the worst band name ever? I have Sirius Radio and it seems like the Foo Fighters get more airplay than any other band. Enough already! Geez, it's not like they're Radiohead.

WSJ As A Tabloid
I am not sure whether it has to do with News Corp's acquisition of the Wall Street Journal, but the new layout for the Wall Street Journal Online looks and feels like a tabloid with its sensational headlines. I don't care that the Bancroft family sold the Journal, they appeared (except for a few) to be either uninterested or slackers looking to cash in, but I always liked and appreciated the Journal's understatement and serious approach to news. If a news item needed hyperbole it was important. Now every title has a snappy heading "Economy Conspires to Dog Cerberus," and "Home Woes Hit Lowe's Again," as examples. I guess I will have to read it closer to determine news and noise. The Journal needs to be careful, because its readers know BS and will look other places for reliable news if its journalistic standards slip. It is still the business paper of record and a great national paper, but this is not assured going forward. I have already started to view the Financial Times as a backup.

Must be Nuts
I made my first post on a stock chat website - I must be crazy. It was on Grubb and Ellis and I alerted the stock gurus that NNN is a real estate syndicator and that some of the assets on NNN's balance sheet they were raving about flows through to NNN's syndications and is not directly NNN's.

Ten-Year Yield
The yield on the ten-year Treasury is approaching 4.00%. At these levels the housing market may start seeing some activity and prices may slow their slide. It will also help the banks.

Goldman Sachs
It is clearly the best firm on Wall Street. Probably the best U.S. corporation, if not the world's best. It's alumni is staggering and it even helped keep A-Rod in New York (and probably salvaged his reputation). This article repeats what I have been telling people. It is amazing - or maybe it's not - that it missed the mortgage mess.

Credit Crunch Curbs Real Estate
This article makes sense. No credit means no deals means real estate values go down. This is not fuzzy math. Banks need to start lending again. This quote is relevant for TIC deals:

Even a slight decline in values could make it difficult for property owners to refinance their mortgages, especially if they have been paying only interest on their existing debt and not paying down principal. Such interest-only mortgages have become increasingly popular.

Every TIC deal I have looked over the past several years has interest-only financing. It was the only financing that allowed sponsors to pay an attractive yield to investors.

GBE Is Off Another 8% This Morning

Grubb & Ellis and NNN
Here is an interesting chart. It is the one-year performance of Grubb & Ellis (GBE). I wonder what the market is saying about the merger between Grubb & Ellis and NNN. The stock's decline started shortly after the merger was announced in late May.


Another, more positive, way to view the chart is to say the the stock performance mirrors the problems in the credit market more than the perception about the merger, because it does mirror the credit problems. The merger of the broker and the syndicator should be complete in mid-December.

All Gossip, All the Time
I heard this morning that a prominent TIC sponsor fired twenty-four employees today. The TIC slowdown caused by the housing market and troublesome debt market is starting to impact sponsors. The syndication-dependent sponsors will be the first to show cracks. My opinion from the start has been that the real estate guys will fare the best in a downturn. We'll see.

Piedmont
Here is the information I promised in an earlier post on the Piedmont REIT:

Data as of 2Q 2007

• FFO/Share (six months) $0.291

• Annualized FFO/Share $0.581
  

• Div Per Share (six months) $0.29

• Annualized Div Per Share $0.587

• Payout 99.01%

• Div Yield 6.99%

• Leo's Shares 19,568,641

• Leo's Ann Dividend $11,482,878.54

• Leo's Ownership % 4.07%

• Leos' Value at Adj. Par $164,180,897.99

• Adjusted Par Value $8.39

Leo's annual dividend will help ease the headache caused by Piedmont deferring its listing. The REIT returned approximately $1.61 per share in 2005 due to property sales, which is why the adjusted par value is $8.39 and not $10 per share. The yields are based on this adjusted share value. I need to find the REIT's FFO growth rate. I will have to investigate this along with the current FFO multiples for other REITs. A low growth rate would logically put the valuation at the low end of the multiple range.

As Much Scoop As I Know
A large TIC sponsor is talking to two or three smaller TIC sponsors about taking over the management of the smaller sponsors' existing properties. I know the name of the large sponsor but was not told the smaller companies (I am guessing its two not three). If the deals happen, I am told, it will likely be within the next several weeks. I am skeptical, but will wait and see. Apparently, the smaller companies approached the larger company due to their inability to get financing for current deals, and lack of deals impairs their financial viability.

Nailed It
Prince expected to offer to resign from Citigroup. My earlier post's guesstimate proves prescient. My other guesstimate about his "go away" payment was correct, too. He is expected to get $40 million. Citigroup loses more than 20% of its market value in less than a month and gives the CEO $40 million, seems kind of retarded.

All Piedmont, All the Time
I search the filings for the Piedmont REIT every couple of weeks. The latest filings have Lin-Wix, the entity that offered to pay up to $9.46 per share, urging investors to vote no on the planned three-year extension before listing. Another firm, Madison Investment Trust Series 79, is offering to acquire shares at a price of $7.50. Piedmont also filed its proxy statement, officially asking investors for the extension. This saga is taking a strange, albeit predictable, turn. The annual meeting on December 13th should be very interesting.

Accountability
The whole mortgage mess, in my opinion, was built on the concept of making money with no responsibility. Mortgage brokers would loan money to any one; bankers provided the financing to mortgage companies and brokers; mortgage companies then sold the mortgages - good or bad - to banks who put the loans into neat securities that were sold to investors. So many hands, so little responsibility. The accountability ship has finally docked. Stanley O'Neal of Merrill Lynch has lost his job (along with all the bond traders he fired), and I am guessing the heads of Bear Stearns and Citigroup won't survive. Mr. O'Neal received $150 million to go away (and people complain about Alex Rodriquez!) and the "go away'" packages for Mr. Purcell and Mr. Prince will be sizable too.

When will the Fed have its accountability moment? It tacitly approved this mess until it was too late. And don't believe for a second the Fed did not know what was happening in the housing market. Not to get political - I trust markets not politicians - but the current administration has not had much of an economic policy, except for a weak dollar (stronger corporate profits), easy credit (see above) to fuel consumer spending and low taxes. The booming housing market and the cash-rich (i.e. leveraged) consumer it spawned was too convenient, despite the wild debt.

More Piedmont
I did some analysis yesterday on the Piedmont REIT. I am travelling today and will have it up in the next few days. I calculated FFOs, yields and how much Leo Wells is going to receive in dividends. All the data is based on Piedmont's second quarter 10-Q.

Confirmation
I never thought that the subprime mortgage problem was isolated to just poor people. All credit types used the subprime loans for the loans' low initial interest rates and never had any thought or intention to pay the higher reset rates. Home values were going to keep increasing and the loans would be refinanced before they reset. This article from today's Wall Street Journal confirms that subprime mortgages were used by a wide range of people to participate in the housing market boom. Many of these non-subprime subprime borrowers, in my opinion, have no incentive to keep their houses when there mortgages reset. In fact, I bet the stereotypic subprime borrower - i.e. poor and bad credit - will be more likely to try to save their house than the speculators who thought they were junior Donald Trumps.

Should Have Seen It Coming
The Piedmont Office Realty Trust has sent proxies to investors to extend the date for it to list by up to three years. The REIT was supposed to list by the end of January 2008, and is asking investors to extend the listing date until January 2011. This is unbelievable, but totally predictable. Leo was never really going to sell. The REIT is blaming the debt market and the poor REIT sector. REITs have been in the tank all year, and the REIT just obtained a huge new line of credit in September, at the height of the credit crisis, so both arguments are thin at best. I think this will be a very interesting proxy vote.

Crazy Times
It has been a busy few weeks and the next few weeks appear similar. I was at the annual TICA meeting yesterday. Interesting. There, to me, was a sense of doom and gloom, due in large part to the credit environment and the downturn in the housing market. Most sponsors I talked to had a deal on the street and others in the works, so I don't get the pessimistic outlook. Plus, there were more reps there than ever before, which to me is a bullish sign because this conference is not required and reps who attend have to pay their own way. I know enough reps to know that if they were pessimistic they would be home saving money, not investing in the future.

Whole Foods' Competition
Publix is opening a separate store (presumably the start of a new chain), GreenWise, that sounds like a Whole Foods - about 40,000 square feet (smaller than a typical Publix but just the size of a Whole Foods), at least half the produce organic, heavy on prepared foods, and many items not found in a regular Publix - in South Florida. Here is an article describing the new store. The Government's bid to keep Whole Foods from merging with Wild Oats always seemed misguided to me and this new concept shows the speciousness of the Government's case against the merger.

Long Slog
I bought the old QQQ sometime in 2000, after NASDAQ was well off its highs of 5,000 and was trading near 2,100 or 2,2oo. I thought I was getting a bargain with the index more than 50% off its highs - little did I know. I am finally close to breakeven with the NASDAQ near 2,700. (I did not know at the time the disparity between QQQ (now QQQQ) and the NASDAQ itself.) I have clients that I bought QQQQ for in the mid-to upper-$20s and $30s per share that have fared much better than I.

Good News
I love Zillow. Real Estate agents hate it. Glad to see it is getting additional financing.

More Piedmont
Piedmont Office Realty Trust, the newly named Wells Real Estate Trust, filed to go public earlier this year. Today, with the Fed's 50 bps rate cut, REITs as a group shot up 5%. I hope Piedmont goes public soon as the market is saying that the rate cut benefits REITs. I am not sure the impact, if any, of the lawsuit noted below on the IPO. Piedmont's charter calls for liquidation if it does not go public by the end of January 2008. The new $500 million line of credit is not the actions of a company planning on liquidating in under five months. According to someone at Wells, the REIT's portfolio appraised between $8.50 and $9.00 per share late last year. I am curious if the IPO valuation will be higher than these appraised values and the last solicitation price of $9.30 per share in July 2007 by an outside firm looking to by 25 million shares.

Piedmont's Press Release Omission
I checked this morning to see whether Piedmont has had its IPO. It has not, but a press release (and corresponding 8-K filing) touted a new $500 million line of credit the REIT has with Wachovia Bank and JP Morgan. After reading the press release I read the 8-K and it did discuss the new line of credit. The press release did not mention one item in the 8-K I thought was important - another lawsuit from an investor angry about the amount of compensation paid to Leo Wells during the REIT's management internalization. Here is an excerpt from the 8-K that discloses the new lawsuit:

Donald and Donna Goldstein, Derivatively on behalf of Nominal Defendant Wells Real Estate Investment Trust, Inc. vs Leo F. Wells, III, et al.

On August 24, 2007, a stockholder of the Registrant filed a putative shareholder derivative complaint in the Superior Court of Fulton County, State of Georgia on behalf of the Registrant against, among others, one of the Registrant’s previous advisors, Wells Capital, Inc., and a number of the Registrant’s current and former officers and directors.

The complaint alleges, among other things, (i) that the consideration paid as part of the internalization of the Registrant’s previous advisors (the “internalization transaction”) was excessive; (ii) that the defendants breached their fiduciary duties to the Registrant; and (iii) that the internalization transaction unjustly enriched the defendants.

The complaint seeks, among other things, (i) a judgment declaring that the defendants have committed breaches of their fiduciary duties and were unjustly enriched at the expense of the Registrant; (ii) monetary damages equal to the amount by which the Registrant has been damaged by the defendants; (iii) an order awarding the Registrant restitution from the defendants and ordering disgorgement of all profits and benefits obtained by the defendants from their wrongful conduct and fiduciary breaches; (iv) an order directing the defendants to respond in good faith to offers which are in the best interest of the Registrant and its shareholders and to establish a committee of independent directors or an independent third party to evaluate strategic alternatives and potential offers for the Registrant, and to take steps to maximize the Registrant’s and the

---

shareholders’ value; (v) an order directing the defendants to disclose all material information to the Registrant’s shareholders with respect to the internalization transaction and all offers to purchase the Registrant and to adopt and implement a procedure or process to obtain the highest possible price for the shareholders; (vi) an order rescinding, to the extent already implemented, the internalization transaction; (vii) the establishment of a constructive trust upon any benefits improperly received by the defendants as a result of their wrongful conduct; and (viii) an award to the plaintiff of costs and disbursements of the action, including reasonable attorneys’ and experts’ fees.

The REIT has had another lawsuit related to the internalization and I am not sure if this is a re-hash of that earlier suit that did not get class certification.

If Only Its Partnerships' Investors Were This Lucky
Petroleum Development Corp's (PETD) stock jumped almost 10% today (9/18/2007). Since 2003 its stock is up nearly ten times. Nice. PETD sponsors oil and gas limited partnerships that offer investors tax write-offs and distributions for an extended period - usually fifteen years or more. The programs are royalty offerings so investors' distributions are their return of and return on investment. Very few of PETD's offerings have returned investor capital to date and to call its deals anemic is unfair to other anemic investments. It is safe to say that investors in PETD stock have done better than any investor in a PETD oil and gas partnership. Remember this: It is better to invest in the entity that is receiving cheap equity financing than the entity that is providing the cheap equity financing.

The End of Non-Bank Lenders
Here is an article on more trouble at mortgage companies from Reuters via Yahoo Finance. I link to it only because it has become clear (to me) that the non-bank mortgage companies are doomed. The big banks don't like the competition and flexibility these firms offer and the financial system's problems are now concentrated in these non-bank mortgage companies. The Fed's cut in the discount rate only benefited big banks as these are only firms that can borrow from the Fed's Discount Window. Many of the big bank's financial problems originate in the mortgages made by the non-bank mortgage companies that the big banks bought, packaged and syndicated. Don't expect any institution to throw these non-bank firms a life-line, unless it's in the form of a fire-sale buyout offer.

Elaborate Scam
There is an interesting article in the September 17th issue of The New Yorker. The article was written by Mark Singer and details a minor British pianist from the 1950s who had a late-life renaissance and became the fancy of classical music world. There was only one problem, the renaissance was a scam orchestrated by the pianist's husband who copied existing piano works and credited the works to his wife. Eventually, like all frauds, the truth came to light, but not before many esteemed music critics fell for the bogus pianist. I relate this story because in due diligence much of the analysis is based on information provided by sponsors. If someone is going to cheat it is going to be hard, initially, to detect the scam. If the sponsor gets a following, which is likely as scam artists tell a good story and investment advisors and broker/dealers love a good story, which is easy to relate to clients during the sales process, the unraveling will cause pain for investors, advisors and broker/dealers.

Greenspan Speaks
Former Fed Chairman Alan Greenspan said he became aware of the subprime mess in late 2005:

Former Federal Reserve Chairman Alan Greenspan admits he “didn’t really get it” that the subprime lending trend was significant enough to hurt the economy until very late 2005, but still defends his lowering of interest rates from 2001 until 2004 that critics say caused the crisis in the first place. Greenspan, who led the U.S. Federal Reserve Bank through 18 years and four presidents, speaks to Lesley Stahl in his first major interview, to be broadcast on 60 MINUTES Sunday, Sept. 16 (7:00-8:00 PM, ET/PT) on the CBS Television Network.

The quote above is from today's Wall Street Journal and was extracted from an upcoming CBS 60 Minutes interview with Greenspan. I am not going to pick on Greenspan because I think he did a great job as Fed Chairman. But it is strange, or maybe just coincidental, that his concerns started to arise just after housing prices crested in the summer of 2005. I find it hard to believe that he did not know the level and exotic nature of the subprime mortgage market until late 2005. I guess as long as real estate was rising and the subprime borrowers could refinance into other mortgages the subprime market was not a problem. I do believe that the leveraged economy - i.e. leveraged consumer - has been the primary monetary policy of the Bush administration. This was fueled by low rates and the explosion in home borrowing.

Housing Help
The interest rate on the ten-year Treasury is below 4.40% this morning. This is going to help the housing market - or at least slow the downward spiral.

When the Herd Runs Off a Cliff
Here is an article about all the speculators - who just had to get in on the booming housing market - defaulting on their loans. One would hope that there is some relief for people who are working and living in their homes and are going to get crunched by exotic mortgage resets (these people should start talking to their mortgage companies, I think they'd be surprised by their flexibility). The speculators don't deserve any relief. Unfortunately, with no equity in a property, I am not sure what recourse there is against the borrowers. The poor schmucks that actually bought homes and condos to live in next to these speculators are the ones who are going to be hurt.

This chart from the article is amazing:

Harbinger for TIC Deals
The outtake below is from Wednesday's (8/29) Plots and Ploys column in the Wall Street Journal's real estate section, and highlights a securitized debt transaction that may foretell the future for many TIC offerings. TIC offerings all use debt that is packaged an sold in to securities that are described in this article. If this deal gets done it will be good news for the TIC industry. Here is the outtake:

Can Wachovia Capital Markets unload $4.1 billion in commercial mortgage-backed securities in this turbulent credit market? The answer may come as early as this week, as the bank continues to market bonds backed by a loan it gave Lightstone Group LLC to buy Extended Stay Hotels in June.

"I know they're not selling well," says David Lichtenstein, chief executive of Lightstone, a Lakewood, N.J.-based real-estate firm. "But I don't think a lot is selling, period."

Wachovia's offering, one of the biggest this year, comes at a time when the markets for commercial mortgage-backed securities and commercial collateralized debt obligations have been severely pressured by investor skittishness. When Lightstone announced it was buying Extended Stay from Blackstone Group for $8 billion in mid-April, commercial-real-estate lending was still aggressive, but the market was starting to react to warnings about lax lending standards. "We were one of the last deals in," Mr. Lichtenstein says.

Besides the credit-market turmoil, another big drawback for investors is that the Lightstone deal is a so-called single-borrower issue, meaning it doesn't pool loans from different borrowers. Thus, it doesn't have the diversity of assets that many other such issues do.

If the series, which is led by Wachovia but includes other banks, is sold out, it would signal that the markets have regained their footing somewhat in the past two weeks as spreads have narrowed, meaning investors are willing to take lower returns on the bonds. And if not? "Wachovia has a pretty big balance sheet," Mr. Lichtenstein says. Wachovia declined to comment.

Piedmont / Wells Update
I spoke to a representative at Wells (not Piedmont) about last month's Wall Street Journal article. The representative said the offer to acquire all the former Wells REIT was never formally made, which is why the REIT's board of directors did not respond to the offer. This matches my unsuccessful search for a formal offer. The only offers I found were tender offers that sought to acquire up to 10% of the REIT, not all of it at two different prices. This information allays concerns about poor fiduciary responsibility. The conversation also revealed that that appraised NAVs were around $9.00 per share or less, with appraised dates of Fall 2006. I expect a listing soon (Fall 2007), although uncertain debt markets could affect the timing.

You Can Run But You Can't Hide
Wells Real Estate Investment Trust has changed its name to Piedmont Office Realty Trust. There is still no word on when the REIT will go public.

Update
The financial markets go to shit and I stop blogging, nice. It's been busy and I expect blogging to be intermittent until after Labor Day. There has been so much financial news I am not sure where to begin to catchup, so I won't. Look for lenders to get back in the market to ease the financial crisis. Lenders have to lend and the appetite for yield is not going away. The pricing will work itself out over the coming weeks or months. Higher debt spreads will lead to a repricing of assets, in particular real estate. Sellers cannot expect the same cap rates if buyers cannot get financing.

How Big Is the Subprime Exposure?
Markets opened this morning down again due to subprime exposure - this time in Europe. French bank BNP Paribas suspended withdrawals of its three funds. A German bank is also struggling with one of its asset-backed funds. When this subprime mess started early in the year it was thought to be a small portion of the market. I don't think this is the case judging by the global market reaction.

Figured It Out?
A scary thought hit me last night as I searched for clues about today's market opening. Maybe the banks are scared about the subprime mess because, in effect, most mortgages they made over the past six years are subprime loans. By this I mean that the high loan-to-value and loose credit loans were the norm, and encouraged, even for strong credit borrowers. What's the difference between a good credit borrower and a subprime borrower if both bought a house but needed an interest-only mortgage so they could afford the payments. When the mortgages reset, the payments are too high and the equity has vanished both borrowers will been in financial trouble. They will not be able to refinance and will likely give the property back to the lender. There is very little difference between these two borrowers. That is what is scaring the bankers because they know better than anyone how shaky their loans were for the past six years.

Lemming Watch
This blog has said before the bankers are lemmings. This article proves it. Why stop all lending and slow the economy? Why not make better loans? Bankers need to get better documentation on their borrowers and make sure their loan-to-value ratios are accurate (get tougher on appraisers). This take-away from the article cracked me up:

The fright among investors is forcing lenders to go back to more-conservative practices that were the norm before the housing boom of the first half of this decade. Many now are focusing on loans to borrowers who are willing to document their income, can make a down payment of at least 5% and have a history of paying bills on time.

Documenting a 95% loan-to-value loan is conservative? Verifying a payment history is conservative? It is scary to think what is considered risky. Maybe the lending mess really is only at the tip of the iceberg. It is naive to think that the lemming mentality will stop at subprime and Alt-A mortgages. These bankers are going to choke off all credit - mortgage, corporate, asset-backed, you name it you won't be able to borrow against it - for the next couple of months.

Energy Expenses Offset Rise In Energy Prices
Finally, my theory was verified in today’s Wall Street Journal. The theroy is that despite the current high price of oil and gas, the rise in acquisition and extraction costs make oil and gas deals a bad investment. The article details how the costs associated with the oil and gas industry have increased over the past few years. The arbitrage that allowed the oil and gas deals that were syndicated to investors in the late 1990s and early 2000s is gone. Elimination of the arbitrage will eliminate returns for many recent programs. This is bad news for oil and gas syndications and their investors.

The deals sold in the early 2000s benefited from high energy prices as they reached their peak production periods during the low cost high revenue period of the early 2000s. Their costs to acquire leases and drill for oil and gas were much lower than they are today. The returns for these were were much greater than the returns for deals done in the late 1980s and most of the 1990s. The money raised in today's deals, based on these returns, will be disappointed as recent deals will under perform. No sponsor talks about these increased costs. I was at a conference two weeks in Vegas and several energy sponsors spoke about all the opportunities in the energy sector, but rising costs were not mentioned.

Consider the Catalyst
Today's stock market plunge was triggered by concerns in the corporate debt market. The subprime fears have been known for months, but a spread into the corporate debt market is the current big concern. The would-be deal that triggered the stock drop was the failed attempt to securitize the least desirable part of Chrysler as Cerberus completes its buyout of the company. Potential investors demanded too high an interest rate for this junk debt.

Many companies took a look at Chrysler before it was finally sold to private equity firm Cerberus. The market's today made a big downward move based on assumptions - i.e. that no more corporate debt is going to be bought so credit will stop - drawn from the inability to sell the worst part of a company few investors wanted. I think the market overreacted. Crap is crap whether the market is in a prudent mood, like the past month, or a freewheeling mood, like the past several years. I think it's good this deal could not get done. It is also good that the ten-year Treasury is 4.78%, as this will help ease pressure on the housing market.

Finance Thursday
So many articles in today's Wall Street Journal about finance. An interesting article about Blackstone and how it has flipped 60% of the square feet it acquired from Equity Office Properties earlier this year. Some properties have sold on 2.5% cap rates and many transactions are well north of $500 per square foot. This paragraph buried deep in the article is worth noting, especially in light of TIC financing:

Concerns over the financing of office-building sales, including some of the EOP transactions, forced bankers to raise yields on bonds offered in the commercial mortgage backed securities market over the past two months to make them more attractive to investors. That has delayed the closing of at least one deal.

This builds upon an article last week about rating agencies' tougher stance on the securities that hold syndicated commercial mortgage backed loans. The skittishness of the debt market and its impact on TIC deals will be the TIC industry's most important trend for the second half of 2007.

More interesting debt articles here, here and here. Other publications also have articles on the new credit environment. A smarter lending environment is good for the economy. I hope the banks do not go too far in their restraint, but that is not a banker's nature. Bankers and debt buyers are starting to scare themselves. I will not be surprised if credit drys up for a short period for all but the best corporate credits.

Not Surprising
The mortgage mess is spreading to the prime market. People with good credits, like subprime borrowers, got caught up in the frenzy to buy homes and took out all sorts of crazy loans just to buy a bigger house. The piggy-back loans are defaulting and the negative amortization loans are defaulting. If a house payment is too much and the rational for a crazy loan was price appreciation for future refinancing it does not matter whether you are a prime or subprime borrower. Either way a borrower is in trouble and likely to walk away when values dip and equity is eliminated.

Quirky?
The article in Friday's Wall Street Journal (link below) called Wells REIT quirky. I am not sure how a REIT with $4.1 billion in assets is quirky. If you assume that its asset value is close to its potential market capitalization it would be the second largest office REIT and fifth largest diversified REIT (date from Yahoo Finance). This is not quirky.

Quiet Period
Wells REIT is in the quiet period before its IPO and cannot respond to Friday's Wall Street Journal article (link below). This is too bad. I did a cursory review of the tender offers by Lexington and but did not see the one that article referred too - an offer to purchase the entire REIT for two prices, one price with the management company and a higher price without the management company. The offers I saw were for small portions of the REIT, generally in 25 million share increments.

Here is the relevant, to me, part of the article:

What Wells REIT directors didn't disclose was that at least one potential suitor offered to buy Wells REIT, and the offer would have been more lucrative to Wells shareholders if the fund didn't buy Mr. Wells's management companies.

That buyout offer came earlier this year from Lexington Realty Trust, a publicly traded REIT, which offered to buy Wells REIT for one of two prices, depending on whether Wells REIT bought out Mr. Wells's companies. If Wells REIT didn't buy Mr. Wells's companies, the offer was $9.45 a share; if it did buy the companies, the offer was $9.07 a share. The latter offer was lower because there would be more shares outstanding if Wells REIT bought the management companies.

Wells REIT directors rebuffed Lexington's offer and didn't tell shareholders about it.

I will try to find out more information but it will be difficult in the quiet period.

Huge Article On Wells
I was travelling late last week and only now getting to post on this article. I will have more later, but this article raises serious questions.

Comment on Comments
I got a nasty, name calling response to my previous post and link. I have strong libertarian views (no political party affiliation) so I don't care what people do or what people think and I expect that view to be reciprocated on this blog. I don't appreciate being called names. If you are going to have a take, make sure it does not suck.

What's Wrong With This Country
Draft them all.

Out of Patience
I am on the verge of recommending to my clients that they not approve the latest offering from a major oil and gas sponsor. The program is a high risk high return offering. Previous programs have experienced the high risk through multiple dry holes, but they have yet to receive the high returns. I like risk when it is in the right context, but the sponsor's programs have had more risk than return, and even in a business environment where there is substantial risk, there has to be some programs that have sizable returns to match the risk level. Unfortunately, the risk has overwhelmed these offerings (and I am beginning to believe fees are overwhelming the programs, too). I have a few questions left to get answered, but I'm afraid I already know the answers. There are going to be some unhappy people as the sponsor takes rejection personally.

Bear Hedge Funds Wiped Out
It was revealed today that the two troubled Bear Stearns hedge funds have been wiped out. Ouch. The markets cannot seem to price subprime debt. The uncertainty is too great. The ABX index tracks subprime debt and it keeps hitting new lows everyday. I cannot find how to get information on this index. The one silver lining to the subprime market is that rates may drop to support the housing market. I mentioned before Bill Gross' opinion that rates need to drop 60 bps to 120 bps to slow the housing market fall (and this is when the ten-year Treasury was at 4.60%). Interest rates have dropped from their mid-June highs and are now 5.01%. If rates keep falling this will ease the pressure on subprime markets. This needs to happen before the nervousness in the subprime market further spreads to the corporate markets.

Why No Private Equity Deals for Non-Traded REITs (or Management Wealth Maximization over Shareholder Value Maximization)
I was on a conference call Friday morning with a non-traded REIT sponsor. The subject of private equity came up and he explained why no non-traded REITs have sold to a private equity firm. An acquisition of a non-traded REIT by a private equity firm would likely not include the purchase of the affiliated outside advisors that give the REIT management huge paydays. Private equity firms would likely replace the current REIT management with their own managers, which stops large ongoing salaries for current management. Non-traded REIT managers are protecting their jackpot and cash cows at the expense of investors by avoiding private equity.

In a market where private equity is paying premiums for public REITs, it's strange that there have been no offers to buy the non-traded REITs. When the low relative leverage of non-traded REITs is viewed (private equity firms love low leveraged companies) the lack of deals gets even odder. Private equity firms have been paying large premiums for real estate firms - Blackstone paid a 40% premium for Hilton Hotels - and the low leverage of the non-traded REITs should make them attractive to private equity.

Non-traded REIT managers do not want to miss out on their big payday even if it means investors are the losers. It is time for legitimate, unsolicited takeover offers from well capitalized private equity firms, not the low ball, half-assed offers from proxy firms looking to take advantage of unsophisticated investors to acquire a single digit percentage of the REITs. Stop the nonsense paydays for the bullshit outside advisors and provide investors with better returns.

Let's look at this in other, hypothetical terms. Wells Real Estate Investment Trust bought its management company for $164 million, based on a $8.38 share price, in April. If, when the REIT goes public, it lists for over $8.38 Wells is a hero and the $164 million grows because the $164 million was paid in stock. If the stock trades at $9.00 Wells not only is a hero, but it has a successful track record of providing liquidity to investors. On the other hand if Wells had looked to sell Wells Real Estate Investment Trust to a private equity firm for a a 30% to 40% premium to the $8.38 share price investors would receive $11 to $12 a share rather than the $9, but Wells would be out the $164 million and the annuity for managing the REIT. Unfortuantely, investors will not know about this second option because it does not benefit Wells management. (This is not an indictment against Wells, I am using it as an example because it recently filed to go public. Dividend Capital, CNL, and Inland all bought their affiliated management companies before going public of being acquired, so you can substitute any of these names for Wells in the above example.)

What's in Your Bond Mutual Fund?
Interesting article in Friday's Wall Street Journal on all the bond mutual funds that hold subprime mortgages. It's not just the high yield and mortgage bond funds that are holding subprime mortgages. Bond funds are unique and complex. Look at a bond fund's holdings, which is public information available on any mutual fund website, and it's difficult, if not impossible for non-bond professionals to determine what the investments are let along their credit ratings and underlying security.

Investors need to be wary of bond funds. Not because bond funds are bad, but because the fund name may not tell what the fund is holding. Mutual fund company euphemisms don't give investors guidance. Funds with "high yield" in the title are straight forward. "Enhanced," "multi-sector," and "strategic" are just another way to say "high yield." High yield funds are not bad but they can be risky and are not suitable for every investor. Scratch an "income" or "corporate" bond fund and the "junk" won't be too far from the surface. Beware and do your homework, the last five-years' low yield environment has done strange things to managers looking for high income. Know what is in your portfolio.

IPO Info
I checked with a friend today on IPO timelines and a sixty- to ninety-day quiet period is not uncommon, so I will give Leo and Wells Real Estate Investment Trust a break. But Leo and his bankers should still be talking to private equity.

Wells Real Estate Investment Trust, Inc.'s IPO
Wells Real Estate Investment Trust (REIT I) filed for its IPO on May 23, 2007. As part of the IPO process, REIT I did a stock purchase of its advisor for approximately $164 million. (This is 19,546,302 shares at a value of $8.38 per share (REIT I returned $1.62 in capital in 2005).) The advisor was 100% owned by Leo Wells. REIT I has until January 30, 2008 to list on an exchange before, by its charter, it must start liquidating its assets. I am not exactly sure of the IPO process, but I am wondering why it has not been listed yet. My contact at Wells is coy about the listing and keeps referring to the January 30, 2008 deadline. Maybe REIT I is fielding offers from private equity firms that are higher than the anticipated listing price.

The value per share of REIT I, for dividend purposes, is $8.38 per share. This is the $10 initial share price, less the capital returned of $1.62. I don't know what the market value will be when it lists, hopefully higher than the $8.38 per share. REIT prices in general have been in down this year and are substantially off their highs. I think a private equity firm may be willing to pay a higher price than the market would for REIT I. Blackstone agreed to paid a 40% premium to the market price for Hilton last week. REIT I only has $1.2 billion of debt on almost $5 billion of assets. This should be attractive to private equity firms. A private equity firm would be able to capitalize on REIT I's low debt level to an extent that a public listing couldn't and Leo Wells wouldn't.

In today's capital market environment, private equity is willing to pay more for real estate than the market. I hope Leo Wells, or REIT I's high priced bankers, have picked up the phone and called some private equity firms.

It is worth noting that NNN Realty Advisors did a reverse merger, buying a public company, after it filed its S-11 registration statement. Until REIT I is listed, anything can happen.

Enough Negativity
Here is a positive article on the housing market. High-end homes are selling better than moderate priced homes.

A Little Friggin' Late
S&P cuts the ratings on bonds linked to subprime mortgages. These bonds should have had lower ratings initially and the ratings should have been cut last fall when the subprime lenders started to fall.

TICs on the Cutting Edge
Blackstone's acquisition of Hilton Hotels and Carlyle's acquisition of Manor were the latest examples of private equity's advance into real estate. Both acquisitions were return driven as the private equity investors search the real estate markets for yield. TIC sponsors saw that hotels and nursing homes offered good value and good yields several years ago and have been active in this space.

Surging Rents
This article in last Thursday's Wall Street Journal was overshadowed by the story on sleazy mortgage brokers. I guess the prediction of a commercial real estate slowdown was premature. The article has an interesting point in that private equity owners can wait for higher rents while public REITs have to keep occupancies high due to their quarterly reporting requirements (and the negative perception of high vacancy), and therefore sacrifice high rents for high occupancies. Either way its good for all the TIC deals done over the past several years because they need rent growth.

Another point in the article is that the downtown condo boom in many cities has prevented office construction that is also driving up rents. San Diego is a classic example of this. Only one office building has been built downtown since the early 1990s and the number of high rise condos are too numerous to count. (Wouldn't it be cool if there was a trading vehicle that allowed you to go long on office space and short condos.) If you work in New York for a company whose lease is expiring, you better familiarize yourself with the PATH schedule.

Hedge Fund Underperformance
An article the New Yorker has a profile of a Dutch academic who has researched hedge fund returns and found that after the annual management fee and performance fees, the returns of hedge funds don't provide market beating returns. I can't say that I am surprised by these results. Most mutual funds don't beat the market so why would hedge funds be any different, especially after the "2% and 20%" fee structure. Fund of funds have an additional layer of fees and their performance is even worse. Another shocking discovery.

The interesting part of the profile of Harry Kat is that he has developed a software program, FundCreator, that will mimic the trades of any hedge fund with a track record. He sells this for a fee of .33% of assets and no performance fee. The software owner has to make the trades and the trading costs are additional. Even if this program allows an institution to have average returns, the overall net gain would put the institution ahead because its fees will be so much lower than other hedge funds.

One part of the article worth noting is the section on hedge fund risk:

When Kat examined the databases, he noticed that in most years hedge funds outperformed the Dow and the S. & P. 500; they appeared to have produced alpha. But the figures in the databases don’t take into account the unusual risks that hedge funds take. Many funds use borrowed money to leverage their investments; they short stocks; and they speculate on the price of volatile commodities, such as gold and coffee.

Another section follows:

In a study published in the June, 2003, issue of the Journal of Financial and Quantitative Analysis, he and a co-author, Gaurav Amin, an analyst at Schroder Investment Management, a British financial firm, compared the fee-adjusted returns of seventy-seven hedge funds between 1990 and 2000 with the returns generated by a market benchmark that had a similar risk profile. Seventy-two of the funds—more than ninety per cent—failed to outperform their benchmarks.

So 90% of hedge funds under perform. I find this surprising, too.

Mortgage Brokers are Douchebags
OK, this article did not say this exactly, but it was the implication. Yes, some mortgage brokers are sleazebags. I have found the mortgage brokers that I have used beneficial. But buyers need to beware and proactive in their dealings with mortgage brokers. Know your terms and what type of mortgage you want. Don't fall into the trap where you figure out how much you want (or can afford) to pay per month and then find a mortgage that gets you this payment. This is trouble. The most disturbing part of this article was not the profile of the rouge broker, but how the fee disclosure statements were blatant lies and the broker earned much more than was disclosed to borrowers. This requires complicity by banks.

Information Overload
There were multiple articles I read over the past week that require comment. I will try to get to these today.

Another One Bites the Dust
The subprime market eats another hedge fund.

But will it Play in Peoria?
A record price per square foot in New York City - $1,589 for a thirty-six-year old office building on Park Avenue. The buyer was a private equity firm and it shows that the commercial real estate market is still strong.

Why Apartments Suck
This tidbit was buried in a Wall Street Journal article about hotels last week:

On the recent $15.2 billion buyout of Archstone-Smith Trust, an apartment REIT based in Englewood, Colo., buyers Tishman Speyer Properties and Lehman Brothers Holdings Inc. will have a capitalization rate in the low-to-mid-4% range, well below the cost of capital, expected to be about 6%, according to analysts. Tishman Speyer Properties and Lehman Brothers declined to confirm those numbers, but the estimates have been widely accepted by Mr. Marks and other analysts.

Why do a deal with such a low return? Tishman and Lehman are betting that rents and underlying asset values will increase rapidly enough that its return will eventually rise.

A low- to mid-4% cap rate. Nice. What kind of debt do you put on a deal like this? And will the property have rents increase enough so that the leverage ever becomes positive? And how low does the cap rate go when acquisition costs are added to the price? In a TIC deal the cap rate would have to drop to the low-3% range. Thanks but no thanks.

Boston Capital REIT Throws in Towel
I heard today, and confirmed through its filings, that Boston Capital has suspended sales in its REIT. This happened April 18th and it since has hired Wachovia to help it explore "strategic alternatives." I never liked this REIT and I guess I was not alone. There was significant dealings with other Boston Capital entities. Loans to affiliated entities were costing the REIT 9% or more, but the REIT was only paying a 6% dividend, which was probably a high percentage of principal. The loan paid 9% and the cap rates on apartments are less 6%. This is serious negative leverage.

Lender Roundup
The Wall Street Journal has had three excellent articles this week on the new lending environment. The first explains the favored tool of private equity, CLOs , the second details Wall Street's, and in particular Lehman Brothers', descent into the ugly world of subprime lending. Finally, an article in tomorrow's Journal provides insight into the problems borrowers are having in the changing credit market. On the positive side, it looks like the market is rejecting the crap deals being peddled and lending standards are improving. On the negative side, there was a lot of crap sold over the past several years that is being held by mutual funds and other investment managers and how this debt will behave in the future is a huge wild card.

The Cutting Edge of GM
I was watching CNBC this morning and saw a Cadallic commercial with The Pogues' The Sunnyside of the Street as its song. I almost choked on my Cheerios. At first I thought that whoever was picking the music for GM had good taste and was giving GM props. Then I figured out that GM is using my music against me to sell Cadillacs. Clever sons of bitches. When I hear a commercial with Boys from the County Hell, Streams of Whiskey or one of my favorite rock & roll Christmas songs, Fairytale of New York, I will go test drive an Escalade.

Who's Smart?
People who bought too much house with too much mortgage were viewed as having little financial acumen. Maybe it's the smart money who's lacking the financial savvy. A borrower with little equity and a low payment can easily walk away from his obligation when a rate reset causes the monthly mortgage payment to jump and a new valuation reveals no equity. The smart money, like Bear Stearns, cannot walk away, no matter how much they want to. They have invested and borrowed too much, and now the stakes are too high. I do believe the subprime mess is going to get worse, unfortunately. The near-term financial landscape is going to change. Rising subprime mortgage defaults and devalued housing prices will impair now-healthy parts of the mortgage and housing market. Home mortgage ills will spread to other debt sectors - i.e., commercial mortgages, high yield debt and emerging market debt - that will lead to a global reevaluation of pricing and risk. Easy credit is over. Lenders are lemmings. Many people and businesses (and politicians, but that is another post) benefited when credit was easy, now many good borrowers will be punished for banks' overreaction and herd mentality.

Why I'm a Libertarian
This is nuts. It's scary, too. Activist judges on the Right are as bad as those on the Left. How could anyone be harmed by this, unless someone slipped and fell on some ice from laughing too hard.

Interesting Blog Post on Brookstreet
I found this blog tonight from the OC Register. Make sure to read the comments.

Bear Steps Up
Bear Stearns moves to salvage at least one of its two troubled hedge funds. Wall Street needs to take a breath and look back to Autumn 1998 and the fall of Long Term Capital Management. This was a leveraged hedge fund that made a wrong bet and creditors began calling their debts. For a few weeks after LTCM's implosion there was no market in emerging market debt and the spread on high yield debt widened. Wall Street panicked but the markets came back fast. It is the same for the subprime debt. It looks dire now, but with each passing day Wall Street is figuring how to better price it and how to better factor in its risk. In a short time, Wall Street will be able to price the assets in the two Bear Stearn's funds. Firms that get too anxious and dump their assets at fire-sale prices are hurting themselves.

Wow
I am not sure what to post about Brookstreet's sudden collapse. This is amazing. The brutality of markets should never be underestimated. I don't know the details of the implosion, but it's hard to imagine a firm, especially an independent broker/dealer, having that much exposure to one security or one class of securities that it could self-immolate.

The End of the World as I Know It
The B-52s are playing a casino. What's next a high school prom? All-you-can-eat crab with your Rock Lobster.

Not Good
It looks like Bear Stearns cannot stop the subprime fallout. Merrill's approach appears myopic.

President Bloomberg ?
This gets my attention.

That's Interesting
I was doing research last night and stumbled across a transaction where the Dividend Capital Total Realty Trust, Dividend Capital's latest non-traded real estate investment trust, entered into a joint venture with Developers Diversified to purchase three large shopping centers. On the surface it's a mundane transaction, but it gets interesting because Developers Diversified purchased an Inland sponsored REIT earlier this year.

Subprime Spillover
The housing market is separate from the commercial real estate market. I don't have any figures, but would bet the correlation between the two is lower than most people think. The housing market's subprime problems, despite the differences between the housing and commercial real estate markets, will spill over to the commercial market and the tenant in common market. All the loans on TIC transactions are sold by the lenders to firms that package the loans into Commercial Mortgage Backed Securities (CMBS). To maintain their ability to sell their loans to the packagers, lenders will impose tougher lending standards, require more reserves and command higher spreads. This translates into more expensive financing for TICs, but will allow the CMBS to keep their ratings and marketability. TIC sponsors, and in particular those pushing marginal deals, better get ready for the tougher scrutiny.

A Little Late
Moody's downgraded 131 bonds backed by pools of subprime mortgages. This is not surprising, but its a little late. The whole article is interesting as it highlights the problems with Bear Stearns' two mortgage-focused hedge funds. The outlook for these two funds is not encouraging.

Encouraging
The fuel cell development seems more practical and a better long-term energy solution than ethanol, which takes almost as much fossil fuel to produce as it saves. I wonder what Big Ag is going to do to derail fuel cells? What Big Ag should do is put some of these cells in their huge combines to make the production of ethanol more effective.

More Foreclosure News
All the financial publications I have read today and tonight have articles about the mortgage market. The most troubling is this one about one of Bear Stearns' hedge funds. It invests in mortgages, including subprime mortgages, and earlier this week it had to sell $4 billion of its quality mortgages to meet margin calls. It is not a good sign if a Bear Stearns-related firm is in trouble. Bear Stearns has an excellent reputation and is known for its discipline and risk controls. I am worried about other mortgage surprises lurking in the near future from firms that don't have Bear Stearns' controls.

This article reports that defaults are at record levels, which is stating the obvious. I am waiting for the articles about how higher rates are causing defaults, especially on adjustable mortgages, and how prices are declining because of the rate increase.

I think the rise in rates has peaked. Rates need to drop to protect the housing market. The amount of defaults, and their translation to the overall economy, will begin pushing rates down soon.

Books Before Bars
It would be interesting if Scooter signed a book deal before he gets pardoned. I don't care for current event books - could not get into Bob Woodward's State of Denial, which was the first current event book I tried to read in a long time - but I'd read the reviews and commentary on a Scooter Libby book. For some reason I don't think it would be as sycophantic as this and this.

TIC Article
This article on 1031 exchanges was buried in today's Wall Street Journal. The headline sounds ominous for exchanges, but a closer read shows the opportunity for TIC deals. The article focuses on investors looking for their own properties. Investors are having difficulty finding value in today's market, and many are choosing to pay taxes and not exchange into another property. TIC deals can help these investors by eliminating the property search and paying competitive yields.

Doom and Gloom
Here is more depressing housing data. Housing predictions are worthless. The rise in interest rates is all you need to know about the housing market. If rates stay at this level the housing market is in trouble. In April I linked to a Bill Gross podcast where he predicted that rates would have to drop to 4% to stop the drop in housing prices. Let's hope he is right. (If you believe he's right now is the time to buy longer maturity bonds.)

Tony V. Leo
Tony Thompson, grand poobah at NNN Realty Advisors, has been in the syndication business since the 1980s. Leo Wells, grand poobah at Wells Real Estate, has been in the syndication business since the 1980s. Both men's firms have raised billions of dollars through the broker/dealer channel. Both men are in their 60s and are seeking liquidity events for some of their holdings.

NNN Advisors, a private company, recently merged with Grubb & Ellis, a publicly traded real estate brokerage firm. This will provide a liquidity event for Thompson, the amount of which I do not know, but I suspect it is significant. The merger has been met with skepticism, at least from myself, as there is an impression, at least from myself, that there is more to the merger than building a bigger real estate company.

Leo Wells' first REIT, Wells Real Estate Investment Trust, has filed to go public and the broker/dealer community's response has been one of relief. Finally a Wells syndication is being listed on an exchange, offering investors a chance to sell their shares.

A closer look reveals that Leo should be viewed with the same jaundiced eye as Tony. Reading Wells' new timber REIT's prospectus shows that Leo is 100% owner of all shares of all Wells companies (except of course the syndications where managers and directors receive shares and individual investors own most of the shares). Leo has never shared any ownership with any of his executives, and he has executives that have been with him for years and who have worked hard. Tony has given ownership to various employees over the years. NNN Advisors' public listing will benefit many of its managers, not just Tony. The liquidation of Wells' funds will only have one beneficiary - Leo. The Wells REIT, as part of its listing, will purchase its external advisor, which is 100% owned by Leo, for $175 million.

For years Leo said the "market was not right to sell." I am not sure that now in a time of private equity, rising interest rates, falling REIT prices and REITs going from public to private ownership is the time to list a REIT. But Leo is now in his mid-60s so I think it is more of his timing rather than the real estate market's timing. Look for more Wells "liquidity events" as Leo converts his real estate empire into cash for estate planning purposes.

QIs as Mezz Lenders
I heard yesterday from an industry player that QIs are acting as mezzanine lenders for TIC deals. (QIs make loans with escrowed, exchange funds to a TIC sponsor so that the sponsor can close on a property. The TIC sponsor than repays the loan proceeds when it completes its equity raise.) There are so many bad outcomes and conflicts of interest in this scenario I don't know where to begin. QIs are not qualified to make mezz loans. There are reasons mezz lenders charge rates two to three times current mortgage rates - they are risky loans with variable repayment horizons! QIs are not banks, they are escrow companies. Banks run on the premise that when people make deposits they don't withdraw the entire amount and close the account in less than 180 days, which is the case with money at QIs. (This is why so many checking accounts pay no interest - it's short-term, transitory money.) If mezz lending by QIs is widespread then the TIC industry better address it fast. It may be time for TIC sponsors to start looking for more seasoned, reliable equity partners to supplement the equity from the vagrancies of broker/dealer raised capital.

QI Mess Threatens TIC Marketplace
The greed of Qualified Intermediaries is threatening to undo the TIC business as two QIs stole $250 million of investor exchange funds. I have blogged about this before. The QIs were using exchange funds for their own purposes rather than segregating the cash and holding it in trust for the short (up to 180 days) exchange period. Exchange monies are very short term and should only be invested in the best money market funds or other cash equivalents. The QIs were using the funds for other businesses or personal activities and could not meet payment obligations. One misappropriated $95 million and the other $151 million.

The Wall Street Journal has an article explaining the two cases. A top TIC lawyer, Richard Lipton of Baker & McKenzie, recommends only using QIs affiliated with top firms:

Many large financial institutions have QI services business. J.P. Morgan Property Exchange Inc. is a unit of J.P. Morgan Chase & Co.; Wachovia Exchange Services is a unit of Wachovia Corp. Mr. Lipton of Baker & McKenzie says that because of the lack of regulation, he refers clients to QIs that are affiliated with regulated entities.

This advice is so simple and smart it almost begs the question as to why everyone does not follow it. If you look into the relationship between QIs and registered reps, I bet you will find the answer. QIs are a top referral source for registered reps specializing in tenant in common transactions. The rep gets referred clients who need an exchange and will buy a product that pays a 7% commission to defer the taxes. The QI gets the use of the exchange assets for up to 180 days. This is a mutually beneficial relationship and the client likely has no idea. A rep's allegiance to a QI can be built in a short period. (I would be surprised if reps know of malfeasance on the part of the QI.) Broker/dealers need to stop these relationships immediately and require only QIs affiliated with large banks or title companies. This referral source is brining in clients the rep does not know from a source that may be suspect.

If You Aren't Cheating, You Aren't Trying
It's been the impression for sometime that cyclists use drugs to improve performance. This article adds more credibility to this impression. But if everyone is cheating, is it really cheating? If every top cyclist is using drugs than there is no benefit because the enhancements are canceled out.

Scuttle
Last week I heard the reason why Louis Rogers left NNN Realty Advisors. I didn't know until today that he was terminated for cause in early April. It looks like the fight between Rogers and NNN is going to get ugly. There is nothing like two rich guys (Tony Thompson of NNN and Louis Rogers) fighting over money. The story I heard relating to Louis Roger's departure/termination was second or third hand so I am not going to repeat it here, but from what I heard it warranted termination.

Merger Reason?
Maybe this is the reason for the NNN Realty Advisors and the Grubb & Ellis merger. Disclosure can be such a pain.

NNN Merger
NNN Realty Advisors is merging with Grubb & Ellis. Information on the merger is here. This is interesting merger, as NNN filed to go public earlier this month. At first glance, I am not sure what to make of this merger other than it's an easier way for NNN to go public. There is a conference call tomorrow (5/24) that I will have to listen to.

Putting Your Money Where It Counts
One way of getting around the CMBS market's tightened lending requirements is for sponsors to step up and close deals with their own equity. This eliminates the need for bridge financing and shows just how much a sponsor believes in a particular property. I know of one that did it and I applaud the principals for putting up their own cash to get the deal closed. It is a bullish sign for the property. I don't believe many sponsors would be willing to do this, whether they had the cash or not. It runs counter to the OPM (Other Peoples' Money) philosophy of the real estate syndication world.

Right-Wing French Style
New French President Nicolas Sarkozy was called right-wing in an article in the weekend edition of the Financial Times. The article went on to state that two of his main platforms are protecting environment and preventing human rights catastrophes like Darfur. If this is right-wing, I'd hate to see what would've happened if the Socialist candidate had won the Presidency.

Is this a Disease?
Several times in the past week I have heard 70s' songs and not turned the radio station. What the hell is afflicting me? I listened to more than twenty seconds of the Eagles' Hotel California, Fleetwood Mac's Rumors, and Don McLean's American Pie. American Pie?!?! For chrissake, if this continues I'm going to have to commit myself.

More Chinks in the Armor
I heard today that tighter lending standards in the Commercial Mortgage Backed Securities (CMBS) market are causing some TIC deals with mezzanine debt not to close. This could roil the TIC industry. Most TIC deals are financed with conduit financing - i.e. loans that are sold shortly after they are made to large firms that then package the loans into mortgage backed securities. The packagers are getting tougher on the loans on properties that were closed with mezzanine debt.

This affects TIC sponsors that use the mezzanine debt because they are having a hard time raising equity. TIC sponsors will start to look at portfolio lenders - i.e. insurance companies that do not sell the loans - despite the higher interest rates portfolio lenders charge if the conduit lenders prohibit mezzanine debt on properties. This is a development that may change the TIC landscape. TIC sponsors need to find good deals where they can raise equity, not marginal deals that are hard to sell but that fit a particular model. The mezz issue then goes away. I don't know the spreads between conduit and portfolio loans but a portfolio lender may be easier to work with for a TIC sponsor, especially if a property is going to be sold early or held longer than anticipated.

Looking in the Wrong Place
The TIC industry has been tacitly waiting for some rouge TIC sponsor to steal investor money. The wait was for the wrong part of the TIC transaction. Two Qualified Intermediaries - the companies that act as escrow companies so the an investor affecting an exchange does not handle the funds and therefore invalidate the exchange - have stolen investor funds through appropriation of investor funds for other uses. The 180-day exchange period was just too much for these douche bags. I am not sure who are the big QIs, but I am guessing there are a large number of mom-and-pop outfits. I don't see a reason not to use a bank or major escrow firm. The risks, now exposed, are too great.

Foreclosures in San Diego
This article in today's WSJ sounds scary and gives the impression that a 30% to 50% decline in San Diego home values is a possibility. I am skeptical of these bank auctions and would hesitate to draw definitive conclusions from them. The quote towards the end of the article that San Diego home "prices generally have been drifting lower over the past year" is closer, in my opinion, to reality. In my neighborhood homes are moving and some sales have been surprising, to me at least, for their high prices (thanks Zillow for recent sales information). Several homes sat for extended periods and sold for 20% or more less than their original list prices. Other listings have sold in a matter of days, not months, when priced near recent, comparable sale prices rather than at inflated list prices. It is hard to predict the future, but I am guessing a floor for prices has been reached.

What's A TIC Sponsor Worth?
At the Orchard Securities Conference two weeks ago, Darrel Steinhause (?), a reputable attorney who writes the memorandums for some TIC sponsors, said that some sponsor(s) are using bridge equity financing. Wow! It's hard to believe a sponsor is giving up part of its company to close a TIC transaction. That is expensive financing. This raises questions to me about the value of a TIC sponsor and whether the lack of sponsor equity in the deals they syndicate is the TIC industry's Achilles heel.

I don't think most sponsors are worth much, if anything, if their sole business is doing TIC transactions where TIC investors own the properties. The property management fees are minimal and many are paid to third parties. Real estate commissions are also shared with third parties. Combined, these do not generate substantial value. A sponsor's value is its ability to do deals and earn initial fees. But the initial fee, since it is earned when a deal closes, has no value going forward. In my opinion, a sponsor that relies on bridge equity has no value at all. I am not sure how this can be good for investors.

This was the problem fifteen or twenty years ago. Sponsors stopped raising money and then could not find investors to help with problem properties because they had little equity to offer as an inducement. The only enticement was their back-end participations and ongoing revenue sharing and management fees, which had no value when real estate prices declined.

The outlook for current TIC sponsors is no better. A TIC deal, to qualify as an exchange, cannot have partnership features like revenue sharing and back-end participations. The sponsors of TIC deals have no equity in their deals and by tax code, no participation features. If a sponsor has multiple deals get in trouble the options look bleak.

Not all is negative. The deals today are economic while the deals in the 80s were tax driven. This is an important difference. The financing for real estate today whether through private equity or REIT structures is also improved from fifteen years ago, and would make consolidations of TIC deals better for investors than the crude "roll-ups" of the early 90s.

Allusion Update
This post last week alluded to a sponsor. I found out that it is US Advisor, and as noted here, I heard it is selling seventeen of its apartment deals. Not much of a story, but it is good news. I bet that it is not a big enough portfolio to sell to a REIT or private equity firm and will have to be sold individually.

The American Way
If you can't beat them, sue them. I have been waiting for this article. We must be near a bottom in the real estate bust if home buyers are starting to sue developers. This happened in the late 1980s and early 1990s. Homeowners started to sue when the value of their new homes dropped. Buyers in the early phases of developments sued the builders when prices were lowered for later phases. This is called a market. Developers are not lowering prices due to altruism. What if the developer went back and demanded a higher price from the early phase buyers if it was able to obtain a higher price from later phase buyers. This would be unheard of. I love this section:

Other disputes are more heated. Red Bank, N.J.-based Hovnanian, one of the largest builders in the U.S., currently is embroiled in one such dispute with buyers in Florida.

One of those buyers, Daphne Sewell, received three construction loans, totaling about $750,000, to buy three houses in Cape Coral and Lehigh Acres, Fla., in May 2005.

An administrative assistant in Broward County government, Ms. Sewell said she and her husband, a carpenter, earned $90,000 a year at the time of the deal and never should have qualified for their mortgages. She also claims a real-estate firm involved in the deal promised that it would find them tenants to rent out the houses. But the renters never materialized, her houses are vacant, and two of her loans are in foreclosure.

"If I close on them I deplete my savings in two or three months," said Ms. Sewell. "It's worth the fight."

After she was served with foreclosure lawsuits by the lender, she filed a countersuit, which names the builder, First Home Builders of Florida, the lender and a real-estate firm that she alleges promoted the deal, claiming she was defrauded by an investment scheme that promised minimal risk. A lawyer for First Home Builders said his client denies any wrongdoing.

This lady thought she was Donald Trump. More like Donald's long lost cousin, Gary the Retard.

This quote from a principal of a developer sums up my feeling on the matter:

"These are not situations where a woman bought a unit and she's now a widow and can't pay," he said "These are people who don't want to close because they can't flip and make $100,000."