Thursday, July 26, 2007
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.
Wednesday, July 25, 2007
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.
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.
Tuesday, July 24, 2007
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.
Monday, July 23, 2007
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.I will try to find out more information but it will be difficult in the quiet period.
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 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.
Wednesday, July 18, 2007
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.
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.
Friday, July 13, 2007
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.)
Thursday, July 12, 2007
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.
Wednesday, July 11, 2007
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.
Tuesday, July 10, 2007
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.
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.
Monday, July 09, 2007
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.
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.