Wednesday, October 27, 2010

Defies Belief
United Development Fund III, LP, (UDF III) is a limited partnership that raised capital to originate and service land and development loans to home builders, both third party and affiliated, that are based in Texas.  It raised its capital starting in late 2006 and finished in early 2009.  At the end of the second quarter, approximately a third of UDF III's assets are affiliated transactions.  On October 22, UDF III released its required per unit valuation in an 8-K that states that the value per unit is $20, the same value that the units were originally issued.

The 8-K lists a variety of valuation methodologies (income, market and asset) and resulting valuations.  Valuations were determined by the general partner and by a third party.  The valuations ranged from a low of $18.05 per unit to a high of $26.19.   The general partner determined the low-end valuation, and the high value was determined by the third party valuation firm.  The passage below discusses the general partner's value reconciliation process and how it arrived at the $20 per unit value:
In determining the Partnership’s estimated unit value, the General Partner considered the independent firm’s range of estimated values per unit of between $18.80 pursuant to an asset approach methodology and $26.19 pursuant to one of the valuation analyses used in the market approach methodology, as well as the lack of marketability discount discussed above. The General Partner also considered its own determination of the Partnership’s assets, less liabilities, of $18.05 per unit, as well as the General Partner’s estimates and projections regarding the execution of the Partnership’s business model set forth in the prospectus regarding the Partnership’s initial public offering of its limited partnership units and the General Partner’s expectation that a public trading market for the Partnership’s units is not likely to develop. The General Partner then determined the estimated value per unit of the Partnership’s limited partnership interests to be $20.00 per unit, which is within the range of values provided by the independent firm.
We are to believe that an original $20 unit price, which paid approximately $2.80 per unit (14%) in offering costs and netted approximately $17.20 per share in net investable proceeds with which to make loans, is still worth $20 per unit?  Well, I don't and here is why.  In general, UDF III took that $17.20 and made loans, and the loans pay interest and principal.  Fine, but the loans don't appreciate, they're generally repaid at par, and some loans don't even pay current interest as is common in the construction industry, principal and accrued interest are due at maturity.

Here is an example:  let's say the fund made a $1 million loan with a twelve-month term and 12% interest.  At the end of a year the fund would get its $1 million back, plus $120,000 in interest.  From that interest the fund needs to pay investors a 9% distribution on the original $20 per unit price, which is approximately $104,650 of the $120,000 the loan earned in interest.  The balance would be applied to the initial 14% load recovery, which only reduces the load by a small amount, so to fully recover the load, the money would have to be recycled 10 times!   Below is the transaction example described above using a $20.00 unit price and fully investing the net proceeds.  It shows that an excess $.26 that could be applied to the initial $2.80 load:

Initial Value:    $20.00
Load:                 $2.80
Net Proceeds:  $17.80

Loan $17.20 @ 12% for one year
Interest:          $2.06

Pay 9% on $20.00 per unit
Distribution:   $1.80

Excess proceeds  $.26 per unit

An astute reader may wonder what happens to loan origination fees and servicing fees.  I believe the bulk of these fees are are paid to the general partner and affiliates and don't stay at the fund.  UDF III's general partner does not have to use the small amount of excess interest to paydown the load, it can use to as part of a new loan or for other partnership purposes. 

I don't see how the independent valuation firm could possibly derive a value of $26.16 per unit.  (Actually, I suspect loan income was somehow capped at a low cap rate with little regard to the actual underlying asset.)   Behringer Harvard and Inland need to find this valuation firm and call it immediately.

This post is not questioning UDF III's business model.  That is a subject for another post or posts, because UDF III's affiliated dealings are worth analyzing.   This post is asking how a mortgage fund with a 14% load is able to publish a value that overcomes its load (and in one valuation significantly exceed the offering valuation) when a portfolio of mortgages does not grow and the fund does not keep origination fees.

Tuesday, October 19, 2010

Good For Intel and Bill Gross Reference
Here is a link to a Yahoo Finance article and a Bloomberg article on Intel investing up to $8 billion in new and renovated manufacturing plants in Oregon and Arizona.  I am glad Intel resisted moving these plants and jobs overseas.  The United States is a manufacturing nation and the rise of low paying service jobs at the expense of manufacturing jobs has been a drain for years.  I didn't know that Intel already manufactures 75% of its microprocessors in the United States.

The latest Bill Gross Investment Outlook is worth a read and ties in directly to Intel's domestic production investment.  He predicts and extended period of low returns on stocks due to low inflation, low interest rates and high debt.  The high stock returns of past thirty years are not likely to be repeated, unless (second paragraph is the key and the bold type is Bill Gross'):
The predicament, of course, is mimicked by all institutions with underfunded liability structures – insurance companies, Social Security, and perhaps least acknowledged or respected, households. If a family is expecting to earn a high single-digit return on their 401(k) to fund retirement, or a similar result from their personal account to pay for college, there will likely not be enough in the piggy bank at time’s end to pay the bills. If stocks are required to do the heavy lifting because of rather anemic bond yields, it should be acknowledged that bond yields are rather anemic because of extremely low new normal expectations for growth and inflation in developed economies. Even the wildest bulls on Wall Street and worldwide bourses would be hard-pressed to manufacture 12% equity returns from nominal GDP growth of 2 to 3%. The hard cold reality from Stan Druckenmiller’s “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated. With deleveraging the fashion du jour, and yields about as low as they are going to go, prosperity requires another foundation.
What might that be? Well, let me be the first to acknowledge that the best route to prosperity is the good old-fashioned route (no, not the dated Paine Webber road map utilizing hoped for paper gains of 12%+) but good old-fashioned investment in production. If we are to EARN IT – the best way is to utilize technology and elbow grease to make products that the rest of the world wants to buy. Perhaps we can, but it would take a long time and an increase in political courage not seen since Ronald Reagan or FDR.
More companies need to follow Intel's lead and invest in production in the United States.

Monday, October 18, 2010

What It Owns
In the next week or so I am going to keep reading the 10-Q for the REIT referenced in the last two posts.  I want to pick two of its properties and try to figure out exactly how much the REIT has invested in these properites, determine the debt, if any on these properites, and finally try to figure of some kind of return or cash flow figures.  I hope to figure a cap rate - net operating income divided by purchase price.  I am only going to look at the 10-Q.

Finding this information should take twenty to thirty minutes.  I am not sure of any REIT that lists its investment, debt and income in one table, so I am not expecting that, but the data should be disclosed and easy to piece together.  I will let you know my findings or whether I threw my hands up in disgust.

Sunday, October 17, 2010

LOC Clarification
In the last post I discussed a line of credit.  I was not questioning the line of credit in itself or its mechanics.  I was showing exasperation on opaque disclosure.   Why does a line of credit warrant such nonsensical misdirection?  Why not just state, "We obtained a $X million line or credit, of which $Y million is available to us based collateral assigned to secure the line of credit and borrowing limits against the collateral.  We have borrowed $Z million on the line of credit."  If a company goes out of its way to obscure something as straightforward as how much it used on its line of credit, it makes me question the entire disclosure document.

Friday, October 15, 2010

Intentional Obfuscation
I am still catching up on the second quarter 10-Q readings.  The excerpt below is from the footnotes from a major non-traded REIT discussing its new $150 million credit facility: 
Draws under the credit facility are secured by a pool of certain multifamily communities directly owned by our wholly owned subsidiaries, where we may add and remove multifamily communities from the collateral pool in compliance with the requirements under the credit facility agreement.  As of June 30, 2010, $73.6 million of the net carrying value of real estate collateralized the credit facility.  The aggregate borrowings under the facility are limited to 70% of the value of the collateral pool, which may be different than the carrying value for financial statement reporting.  As of June 30, 2010, available, but undrawn amounts under the credit facility are approximately $32.9 million.
What does the above say?!?  I read it that the $150 million line of credit is really only 70% of $73.6 million, or $51.5 million.  So the actual line of credit is $51.5 million not that stated $150 million.   How much is outstanding on this line of credit?  Sharpen your pencil.  Rather than just stating the amount outstanding, the undrawn amount on this line is given.  So you have to figure out the amount available and then subtract the undrawn amount.   Using my math, if the amount available is $51.5 and the undrawn amount is $32.9, million the amount outstanding at quarter end must be $18.6 million.

Does this number tie to balance sheet?  No effing way.  The amount listed on the balance sheet for credit facility payable is $10 million.  Nonsense.

The above is but one example of repeated obfuscations.  Try and figure out the total acquisition price for each property from information in the 10-Q.  The details of this non-traded REIT might as well be in hieroglyphics. 

Here is what you need to know about this REIT:   It is paying a 6% distribution, which was recently lowered from 7%, and is not generating operating cash flow.  In the first six months of 2010, the REIT had operating cash flow of -$70,000, but still declared $25 million in distributions.  There is no obfuscation in that discrepancy. 

(This REIT is not even able to disguise its lack of cash flow by playing with FFO and MFFO figures, like other non-traded REITs.  Its FFO was more than $1 million negative and its MFFO was just shy of $5 million for the first six months of 2010, both well off the $25 million that the REIT declared in distributions.)

In rare moment of clarity, the REIT says "future distributions my change over time and future distributions declared may continue to exceed cash flow from operations."  In other words, the REIT will keep overpaying its distributions until it can't, then it'll cut its distribution.  You can't say you haven't been warned.

It is troubling that this REIT has more than twenty properites, many that have achieved stabilized operations, and still can't generate meaningful operating cash flow.  There a number of apologists for this REIT in the broker / dealer community, and this REIT is still raising tens of millions of dollars per month.  I am guessing some broker / dealers will keep selling this REIT until the weight of its business plan causes it to collapse and then look for an external excuse, like the real estate crisis or the economy to justify their decision to keep selling this REIT.  Good luck with that.  The sustained lack of operating cash flow tells the whole story.

Thursday, October 14, 2010

If You Build It, They Won't Come
I am in a foul mood today.  I just read this article on Bloomberg about Dubai's commercial office market and how some buildings, horror of horrors, may stay vacant for ever.  Well, no sh*t Sherlock.  Dubai was a real estate market that was non-existent ten to fifteen years ago - nothing but desert - and only became viable with easy money and a flood of construction and real estate related jobs.  Dubai is a middle east version of Las Vegas without Vegas' charms of vice and entertainment.  When Dubai's real estate musical chairs stopped, people, like in Las Vegas, woke up and realized they were stuck in the middle of a freaking desert and those that could headed for the exits. 

Monday, October 11, 2010

Microsoft is releasing nine new phones that will operate on its Windows operating system.  Why?  The smart phone game is over for the foreseeable future with Apple's iPhone and phones running Google's Android software.  Does Microsoft remember Zune?  Microsoft software is so over-engineered that there is no way this phone operating system will be easy to use and not kill the phone's speed and ease of use.  Microsoft needs to stick with what it does best - designing productivity software.   I always thought anti-trust complaints against Microsoft in the 1990s were a joke, and Microsoft has proved why.  Is it me or is Microsoft always late to the party and wearing a powder blue tuxedo?

Thursday, October 07, 2010

Good News Comes in Threes
The third Reis property report of the week was released today.  It showed that vacancies and lease rates at retail properties have leveled off.  Here is the Reuters' article.  The report cautions that the rent and vacancy stabilization is to recent to signify a trend, and that pending lease renewals may push up vacancies.  I will take the good news where I can get it.

Wednesday, October 06, 2010

Apartment Vacancies Drop
Calculated Risk reported on the third quarter Reis apartment update this morning.  Apartment vacancies dropped to 7.2%, from 7.8% in the second quarter.  Lease rates, net of concessions, increased to $980 per month.  Calculated Risk stares that vacancies bottomed early this year, and that excess housing inventory is being absorbed.  The Reuters story on this news is here.

Tuesday, October 05, 2010

Office Vacancy at 17-Year High
I read over at Calculated Risk (which got its data from Reis) that commercial office vacancies are at a seventeen-year high.  I linked the Calculated Risk graph below:

Graphically, it looks like the rate of decline in occupancy rates has slowed and looks to be leveling out.  Rents appear to be stabilizing, too.

Monday, October 04, 2010

Home Run
In April 2009, I posted on Normandy Real Estate Partners and Five Mile Capital Partners buying the landmark John Hancock Tower in Boston for $20 million of equity and the assumption of $640 million of debt (Normandy and Five Mile bought the mezzanine debt and foreclosed on the property).   Today, I read that the building is being sold for $930 million to Boston Properties, which includes the assumption of the $640 million in debt.  I am not sure if Normandy and Five Mile invested any more than their $20 million in improvements or had to plunk down some cash to lease the building, but on the surface, $270 million profit on a $20 million investment in about eighteen months is incredible.