Saturday, March 29, 2008

Digesting Timberland
I am wading through Wells Timberland's 10-K. There is a significant data to digest. The one parcel of Timberland was acquired in mid-October 2007, so the 10-K reflects one quarter of operations. I have questions that need answers before I can make sensible comments on Timberland's status, especially in terms of timber sales and operations and interest expense.

One item that does not need clarification is that in January and February the REIT raised $12.4 million, and had raised a total of $55.5 million of investor capital. At a $6 million per month run rate, by the end of June Timberland should have an additional $24 million ($6 million for March, April, May and June). At year-end, the mezzanine debt had been paid down by $10.4 million. At the current run rate, it looks like the first $40 million payment (which at year-end was $29.6 million) at the end of June looks likely. The second payment of $30 million in August needs a ramped up run rate.

Thursday, March 27, 2008

Too Smart
Dividend Capital's Total Realty Trust is expected to release its 10-K on Monday, March 31, 2008. This non-traded REIT began its offering period in early 2006 at the height of low cap rate real estate. To off-set the low yields on real estate, the REIT purchased high yielding debt securities. These include CDOs and CMBSs, but no subprime securities. These are the type of securities that are giving the large banks trouble, due to their uncertain valuation. I want to know how the REIT is valuing these hard-to-value securities. Dividend Capital has a leveraged closed-end mutual fund , Dividend Capital Realty Income Allocation (DCA), which owns similar-type debt securities. This fund has lost half its value since last summer. DCA has all its assets invested in debt and income producing securities and is leveraged. The REIT has about 20% of its assets in securities, and I don't think it borrowed to acquire them, so the impact is much smaller, and the securities are performing. But it is an item that needs analysis.

Monday, March 24, 2008

The Waiting Is The Hardest Part
I am waiting for 10-Ks and a 10-Q. IHM Secured Loan's 10-K should be out in a week or so and I'll get to see how its mass of fourth quarter maturities fared. Due to the implosion in housing development, I am not optimistic.

The Wells Timberland REIT's 10-K should be available soon and will give a good picture of its one timber property's operations. The first quarter 10-Q should give the impact of the higher interest rates on its mezzanine loan. Until these are released, not much new information will be known on the REIT.

Friday, March 21, 2008

TIC Sponsor to Cut Distributions
A large TIC sponsor is stopping distributions on three of its deals and cutting distributions on a fourth. All four are office buildings. Actual operations are not meeting projections due to higher than projected vacancies. I read through the operational summaries on the four deals and it appears to me that the problems are management related and not market specific. The lease expirations and corresponding lower revenue that are behind the distribution cuts were known and reserved, but leasing efforts have been poor. (One property had a lease buyout that added to reserves, but another deal is attempting to get a loan to help with leasing costs as its reserve estimates were insufficient.) To the sponsor's credit (or maybe it's to the lender's credit) at least distributions are not being paid from reserves.

The summaries were poorly written, but it appears that the markets where the four properties are located appear solid with increasing rental rates, increased absorption and limited new construction. One point not addressed in the summaries is the debt coverage ratios and the possibility of technical default on the mortgages. I would bet that the mortgages are conduit loans that were sold into Commercial Mortgage Backed Securities. These loans have debt coverage ratios that must be maintained or the loans go into technical default. Higher vacancies and lower Net Operating Incomes drop the coverage ratios. If the loans had an interest-only period and have not started their amortization, the deals may be in for another set of problems as this will lower their debt coverage ratios.

My opinion on this sponsor, based on the limited number of its deals that I saw, was that it had good properties and poor properties. Each deal needed to be reviewed and it was not enough to approve deals based on the sponsor. This sponsor had a steady flow of product and some of that product would take months to sell in a market where product had a shelf-life of days or weeks. Now we are seeing why the market was giving pause to some of this sponsor's deals.

Sunday, March 16, 2008

One Hundred-Year Floods Every Ten Years
After Long Term Capital Management's financial melt down in 1998 I remember "experts" talking about the situation being a one hundred-year flood - i.e. so bad it could only happen every one hundred years. Talk then was of some risk measure called VAR (Value at Risk) that was supposed to measure risk and help prevent financial implosions. I did not understand VAR then and have not heard much of it since. VAR or not, Long Term Capital Management was a case of outsized leveraged bets that went wrong and it impacted the credit markets for a short, unpleasant period. Today's credit crisis is similar, outsized leveraged bets that went wrong - but its on a much bigger scale. From home owners to hedge funds to investment banks, leverage was cheap and easy for an extended period that led to complacency about ever increasing asset values that collateralized the debt. The de-leveraging of financial markets is painful and shows no signs of abating and has led the Fed to make moves it has not used since the Depression and to even invent new ways to add liquidity to markets.

The one hundred-year flood analogy needs to be modified to a ten-year flood, because significant market upheaval seems to happen every ten years. (The ten-year flood is as bad as the one hundred-year flood it's just occurring on a more frequent basis.) The flood of 2008 was preceded by the flood of 1998 caused by LTCM (the stock market declines of 2000 to 2003 were not a one hundred-year flood), the stock market crash of 1987, the hyper-inflation of the late 1970s and the market declines and financial upheaval of 1973 and 1974.

Markets recover after each flood and the brains on Wall Street concoct new products to prevent the next one hundred-year flood. The products getting stressed today are all the derivatives and securities (i.e. CDOs) designed after 1998 to take risk away from banks. I am sure Wall Street is working on the next wave of products that will "prevent" the next flood. Of course it will be impossible to test these products until 2018.

Tuesday, March 11, 2008

Green - The New Refuge of Scoundrels
The old saying is that patriotism is the last refuge of scoundrels. It looks like patriotism is being pushed aside for the green movement. The sponsor who wants to roll-up its TIC deals registered a real estate investment trust late last year that will focus on sustainable real estate. Good luck. I think the registration's track record section needs updating.
How Do You Spell Stupid? S-P-I-T-Z-E-R
The idiot was reckless and foolish on so many levels and the revelations are just beginning. The stupidest thing - so far - has to be overpaying for services and having a credit with the agency. The stupidity almost defies belief. A credit with a hooker?!? Did they guy think he was shopping at Target? I bet he'd try to return a service he didn't like. The retard is toast.

Monday, March 10, 2008

WSJ Gets Back to Reporting
Here is a good article on the commercial real estate market. It states that the downturn will be tempered. Most of the development dollars went to the construction of condos, which are classified as commercial developments during the construction phase. The commercial market did not suffer overbuilding. I looked at existing office properties in South Florida in 2004 and 2005 that were selling for approximately $200 per square foot. When compared to new condo developments that were selling for near $300 per square foot there is no mystery as to why so few commercial properties were built. This dichotomy was repeated in many markets. Some markets missed out altogether, I was in Denver last year, a city that had limited condo development, and it had no office construction either because the market was still weak. I tend to agree with this article more than this one from last week that I thought was shrill.

Saturday, March 08, 2008

I was on a conference call Friday held by a prominent Chicago-based TIC sponsor. It has a mish-mash of TIC-owned properties (office, industrial, multi-family and retail) that are mostly master leased and mostly underwater. Apparently many of the properties are not generating the cash to make the master lease payments and the sponsor is reaching the point where it cannot meet its obligations under the master leases. Plus, some of the properties are in technical default on their debt by not meeting their required coverage ratios.

I am unclear on how the sponsor will effect the roll-up. The sponsor wants to somehow roll the deals into a public entity, but each property is owned by tenant in common investors, not a fund, and any sale will require approval from all investors, not just a majority. Plus, on the call it was stated that the public company (unnamed on the call) that would acquire the properties is not a REIT. The sponsor said that the roll-up would not be an immediate taxable event. I called an executive at a public company that seemed to match the description on the call, but was told that it was not the purchaser. The person I called knew details of the troubled sponsor and the contemplated roll-up, which was surprising coming from this executive, especially since news of the roll-up was released on the call. I am not sure I believe this executive's denials.

Monday, March 03, 2008

This article from today's Wall Street Journal has a scary headline, but the content does not support it. "Wall Street Braces for Its New Pain" prepares the reader for imminent trouble in the commercial real estate market. The headline is based on a study by Goldman Sachs that says the commercial real estate values are going to drop by 21% to 26% over the next few years and banks holding mortgages are in trouble. The problem is that banks are holding real estate mortgages and did not package them fast enough in to Commercial Mortgage Backed Securities (CMBS). (This is just the opposite of all those subprime loans the banks packaged and sold. The banks can't win for losing. They can sell the crap and have to write it down or keep the crap and write it down. )

The article states that write-downs in the CMBS market will be similar to those in the CDO and leveraged-loan markets. The current default rates on CMBS are .4%, but this is expected to rise if loans coming due cannot be refinanced. This makes sense but it has not happened. The headline implies that a shaky market is about to implode. It article does not read that way to me. The real estate market still appears solid and the default rates are near historic lows.

Saturday, March 01, 2008

Reprieve - Maybe...
Wells Timberland REIT's first principal payment on its $160 mezzanine loan through Wachovia Bank was due yesterday. The REIT filed an 8-K yesterday detailing an amendment to the mezzanine loan. (The mezzanine loan is part of the REIT's financing of its first acquisition, a $400 million purchase of timberland in Georgia and Alabama.) The $40 million payment that was originally due yesterday was the first of three payments that were due over the course of 2008. The second payment of $24 million was due by the end of April and the remaining balance was due October 17, 2008. The REIT couldn't make its first payment and has negotiated an extension and amendment to the terms of the loan. The first $40 million payment is now due on June 30, 2008, the second payment is now $30 million and due August 29, 2008. If the outstanding principal is reduced to $60 million by October 17, 2008, the due date is extended to March 2, 2009.

These amendments have come with a price. The interest rate has been increased to 11% from the previous 9%. The 8-K further states that Wells Real Estate Funds, Inc. has agreed to make a substantial principal payment on a separate outstanding loan issued by Wachovia to Well Real Estate Funds, pay additional fees to Wachovia in connection with such loan and increase the collateral supporting its guaranty of the REIT's mezzanine loan. I guess there was a reason Leo Wells eschewed debt for so many years.

It is good that Wells negotiated the extension. It's anyone's guess whether the extension can save the REIT. Capital raised through the REIT's offering is the source for principal repayments on the mezzanine debt and the REIT's offering has obviously not met expectations and debt service requirements. Its cost of borrowing has just increased, which will put further pressure on the money raising efforts. The REIT's capital raising efforts might be impacted if the renegotiation of the mezzanine loan gives the impression of financial problems for the REIT. I don't suspect many advisors will recommend an investment that has a hint of financial trouble.

The REIT's first acquisition was like a python trying to eat an elephant. (The REIT had raised less than $10 million when it announced the $400 million acquisition.) The python has the elephant in its mouth and the battle to digest or die could go either way.