Eight Cents On The Dollar
I have been in the basement over the long weekend.  This Bloomberg article (and related Calculated Risk post) from over the weekend caught my eye.   I'm no Arizona geography expert, but sixty miles southwest of Phoenix sounds like the middle of scorching Nowhere:

A 10,200-acre (4,100-hectare) desert site in Arizona sold for $32.5 million this week, five years after a group with investors including the California Public Employees’ Retirement System paid $400 million for the land.

Arcus Property Solutions LLC, a private-equity fund with about $100 million under management, paid cash for the property in Goodyear, about 60 miles (97 kilometers) southwest of Phoenix, said Kent Kleinman, a spokesman for the Gilbert, Arizona-based company. The site, now called Amaranth Land LLC, had been planned for a 42,000-home community by the Calpers- financed group when it was purchased in 2006.

The plan for the 42,000 homes is on indefinite hold, with cattle grazing the current use and potential future revenue sources that include selling water rights or allowing Goodyear to expand its landfill.  I like this part of the article:

The 2006 buyers were a joint venture of MW Housing Partners III LP, a real estate fund with money from Calpers and Weyerhaeuser Co. (WY); and Scottsdale, Arizona-based Montage Land LLC, according to Arizona Corporation Commission records. The deal was funded by a $250.1 million loan and $150 million in cash, according to Terry McDonnell, publisher of Business Real Estate Weekly of Arizona in Scottsdale. 


“Of all the speculative deals I’ve seen here, this was right at the top,” McDonnell said in a telephone interview. “It’s hard for me to think of a more speculative deal of this magnitude in Maricopa County.”

Hines REIT Reprices
Hines Real Estate Investment Trust, Inc. filed an 8-K yesterday announcing that it has valued its shares, as of March 31, 2011, at a price of $7.78 per share.   The valuations were determined using the following:

The estimate of the per-share value was made with consideration primarily of (1) valuations of the Company’s  real estate investments, including estimates of value which were determined by the Company’s management and independent third parties using methodologies that are commonly used in the commercial real estate industry (including discounted cash flow analyses and reviews of current, historical and projected capitalization rates for properties comparable to those owned by the Company); (2) valuations of notes payable, which were determined by an independent third party; and (3) the estimated values of other assets and liabilities which were determined by management, as of March 31, 2011.  In addition, the Company engaged an independent third party to review management’s market value estimates as of March 31, 2011 for selected assets that represented a substantial portion of the Company's property portfolio, and such third party has opined that management’s market value estimates are fair and reasonable.  Finally, the Board also considered the historical and anticipated results of operations of the Company, liquidity requirements and overall financial condition, the current and anticipated distribution payments, the current and anticipated capital and debt structure, and management’s and the Advisor’s recommendations and assessment of the Company’s prospects and expected execution of the Company’s operating strategies.

In other words, they wrote some potential values on Post-Its, stuck them to a wall and threw a dart.  Joking aside, you should read this post from the Snyder Kearney blog on non-traded REIT valuations. 

Hines Advisors, LP, Hines REIT's external advisor, agreed to reduce its annual asset management fee from .75% to .50%, for the six-month period July 1, 2011 to December 31, 2011.  In other words, investors get a permenant impairment to value while management gets a temporary financial rebuke.

Real Estate Stories
Real estate fascinates me, especially a building with a history.   The story of how a property evolves over time to either become part of a city, town or neighborhood, or slowly erode is one that interests me.  When I was young, I would spend hours looking through my dad's book, Lost New York, which detailed architecturally beautiful or significant buildings that were torn down in New York City to make way for new buildings.  It is hard to imagine all the mansions that used to line Fifth Avenue that were replaced by today's buildings.

I recently came across two articles on two pieces of real estate with history.  The first is on Atlanta's Equitable Building, one of the city's first office towers.  I have seen this building on numerous trips to Atlanta.  The article does not go much into the building itself, except for its recent financial problems, but it was built in the 1960s and has become a landmark.

The second property is a hotel/motel in Orange County and its demise is detailed in three articles from the Orange County Register.  The articles are here, here and here.  (The slideshows in the first two links are worth viewing.)  In the 1960s and 1970s, the Saddleback Inn was the place to stay in Orange County.  It hosted Ronald Reagan and John Wayne, and the Washington Redskins stayed there before a Super Bowl.  In the 1980s a wave of new hotels across Orange County cut into the Saddleback Inn's business and it slowly began to deteriorate.    It is now closed and is associated with vagrancy, drug abuse and prostitution.  A fire in January gutted a portion of the old hotel and demolition is likely.

You can't compare a kitschy Orange County hotel with the Old Penn Station in New York City, but both properites have a story.  It is sad that the Saddleback Inn is going to get razed, especially now that some retro hotels and motels are getting renovated.  Atlanta's Equitable has the advantage of being a high-rise, and looks to have passed a point where it changed from being an office building to a city icon.

Triple Vision
I am trying to make sense of this Bloomberg article.  It's about as clear as an average cap rate.  The article summarizes commercial real estate price valuations from Moody's, CoStar Group and Green Street Advisors, Inc.  All agree that prices have dropped from their 2007 peak, but there is some big discrepencies in their data:

The Moody’s/REAL Commercial Property Price Index dropped 4.2 percent from February and is now 47 percent below the peak of October 2007, Moody’s said in a statement today.


Prices for investment-grade properties in the U.S. fell 4.9 percent in March from the previous month, CoStar Group Inc. (CSGP), a real estate data service based in Washington, said May 11. Values were up 2.2 percent from March 2010 and down 38 percent from the peak in June 2007, according to the company.


Green Street Advisors Inc., a real estate research company in Newport Beach, California, reported rising prices in April. Commercial property values increased 2 percent from the previous month and 18 percent from a year earlier, the company said May 5. Prices are down 13 percent from the August 2007 peak.

The dates differ and types of properties in the indexes differ.  For example, Green Street includes pending sales, and CoStar excludes properties below a certain size.  The quote below from an economist at a large commercial real estate brokerage made the most sense:

“We have reached the point in the cycle where there is a clear trend in improving demand, falling vacancy and stabilizing rents,” Kevin Thorpe, chief economist at brokerage Cassidy Turley in Washington, said in a telephone interview before the report. “Investors are buying well before commercial real estate has reached a full recovery.”

With data this varied, I have to keep repeating the old axiom that all real estate is local.

"Average" Cap Rates 
Late last year I noted the term "average cap rate" in relation to a Cole REIT's acquisition.  Cole took an average NOI over the anticipated hold period, rather the capitalizing the first year NOI.  Using an average cap rate implies an acquisition at better terms than in actuality.  For example, if you have a 100% triple net leased building that was purchased for $1 million and the first year lease payment is $60,000, the cap rate is 6%.  If the lease rate has 2% annual increases and a ten-year term, the average lease rate over the term of the lease is $65,698.  If the average lease rate is used to calculate the cap rate, the cap rate jumps to 6.57%.  This makes it seem like the buyer did not pay as much for the property.   This is wrong, because cap rates are based only on the first year's NOI.

Now I see another REIT using the bogus average cap rates.  American Realty Healthcare Trust made a filing on Thursday listing three potential acquisitions.  Each of the cap rates disclosed in the filing was based on the average lease rate over the lease term, not the first year NOI. The wordsmithing is:

"calculated by dividing annualized rental income on a straight-line basis less estimated property operating costs by the purchase price"

The phrase "annualized rental income on a straight-line basis" is the slight of pen.  

This cap rate discussion may be a mute point for American Realty Healthcare Trust, as it just broke escrow at $2 million, but will need cash of $28.5 million to close the three targeted acquisitions.  The REIT has to pay offering costs on its equity raise, and it just declared a 6.6% distribution.  It will have to have raise an additional $30 million or more to acquire the three properites, pay its load and distribution.  If the REIT has to use acquisition financing, then the disclosed cap rate figures will be evenless reliable.

Manhattan Development
Here is a Bloomberg article on developments in Manhattan.  The article goes through multiple development projects.  One statistic that jumped out at me was that 64% of Manhattan's office buildings are more than fifty years old.

Real Estate Update
The Blogger blogging software has been having problems since yesterday, which are impacting bloggers everywhere.  My post from yesterday has been temporarily removed, hopefully it will be restored soon.

In the meantime, here is a Calculated Risk post on a Reis report that covers some commercial real estate asset classes.  (Calculated Risk runs on Blogger, too, so it also has not been updating.)  The underlying performance in apartments and office space continues to improve, while malls are experiencing falling rents and increasing vacancies.

Few Degrees of Separation
Here is an interesting article from Bloomberg on Gramercy Capital's failure to repay $790 million of loans secured by approximately 900 properties.  On the surface this looks like another example of the unwinding of the credit boom of the mid-2000s.  To get to the interesting part you have to dig deeper and you'll find that two non-traded REITs are directly and indirectly involved.  In April 2008, Gramercy Capital acquired American Financial Realty, which was a publicly traded REIT.  If that sounds familiar, it should because several of the former principals of American Financial Realty are now running the non-traded REIT, American Realty Capital Trust (ARCT).  The principals had left several years before Gramercy acquired American Financial Realty and were therefore not involved in the acquisition or Gramercy's current financial problems.  The 900 properites that secure the loans in default are the assets from American Financial Realty, and are similar to the properties in the ARCT, stand-along properities subject to long-term leases.

KBS REIT I (through a subsidiary), along with Goldman Sachs, Citigroup and SL Green are the lenders involved. Here is an explanation from another article:

Gramercy Capital Corp. (NYSE: GKK) today announced that the scheduled maturity of its (i) $240.5 million mortgage loan (the "Goldman Mortgage Loan"), with Goldman Sachs Mortgage Company ("GSMC"), Citicorp North America, Inc. ("Citicorp") and SL Green Realty Corp. ("SL Green," and, collectively with GSMC and Citicorp, the "Mortgage Lenders"), and (ii) $549.7 million senior and junior mezzanine loans (the "Gramercy Realty Mezzanine Loans"), with KBS Debt Holdings, LLC ("KBS"), GSMC, Citicorp and SL Green (collectively, the "Mezzanine Lenders") has occurred without repayment by the borrowers thereunder and without an extension or restructuring of the loans by the lenders.

KBS REIT I is in a mezzanine position.  KBS REIT I made a filing last week on this debt that I am trying to understand, and it may be a subject of a future post.

I just found it interesting that the commercial real estate world can sometimes be a small place.

Lame Critique of Non-Traded REITS
Here is an article from Morningstar.com, written by columnist John Wasik on why an investment in non-traded REITs is a bad idea  Its a hack piece of opinion.  The author writes in generalities and innuendo.  Here is an example:

Yet one version of REITs--those that are unlisted--have been attracting unfavorable attention of late. Because they are ripe with problems and there are plenty of alternatives available, they are best avoided.

Regulators have been probing unlisted REITs, which have raised almost $60 billion from investors over the past decade. Watchdogs are concerned that retirees are being sold these investments with the pitch that they are low-cost and low-risk. They are neither.

The article states that non-traded REITs are ripe with problems.  Wasik fails to name the problems and gives no examples of specific malfeasance.  And regulators are probing unlisted REITs?  I have heard that regulators, mainly FINRA, are investigating non-traded REIT marketing and sales practices not the actual non-traded REITs and their operations.

In the nonsensical sentence below, Wasik confuses mutual funds with REITs:

Unlike REIT mutual funds that own stakes in a number of publicly traded companies that own properties, non-listed REITs sell shares directly through brokers.

What???  If you check almost any brokerage firm, mutual fund sales will far exceed the sale of non-traded REITs.  This may be the dumbest point in a stupid article. 

Here is more inanity when the author talks about alternatives to non-traded REITs:

Though you can invest in individual names, for most people, diversification makes even more sense when investing in REITs. You don't want to be too exposed to one sector such as malls, residential, or self-storage, or specific geographic regions. For example, you don't want to be stuck in a REIT that's heavily concentrated in South Florida, where the real estate market is hurting.

Yes, diversification makes sense.  I am not aware, however, of any non-traded REIT exposed to South Florida, or any other single geographic market.   Yes, even noxious non-traded REITs diversify across regions.  Wasik's one alternative to non-traded REITs is a Vanguard index mutual fund.  Its yield is less than 3%, so is it really a competitor?  I am all for indexing, diversification, alternatives and liquidity, but if you are doing a REIT index fund, it's not a stand-alone an income play.  You are going to have to research individual listed REITs that pay strong, consistent dividends to find a true alternative to non-traded REITS.

I know the flaws of non-traded REITs, unfortunately this article added nothing to the conversation.  Quotes from attorneys discussing non-traded REITs adds no credibility.  These attorneys are looking to sue brokerage firms on investor suitability grounds, not because the investment was a REIT.  If you are going to slam non-traded REITs, you have to name names and provide specific examples of why the non-traded REITs are so bad.

Thoughts on WP Carey CPA 14's Merger into CPA 16 Global
I went through the CPA 14 proxy / merger document in my spare time this week.   The entire transaction is affiliated and the values were determined by the WP Carey not the market.   WP Carey obtained a "fairness opinion" on the transaction, but the firm that issued the fairness opinion, based on my understanding after reading the opinion, did not opine on the values involved in the merger, but on the valuation methodologies used by WP Carey.  (How do I get that gig, getting paid big bucks to write a no-opinion opinion?)

As I noted in my previous email, the entire merger went under my radar.   The initial proxy statement went out in December and the transaction closed last week.  I don't have exact figures on the merger other than was what in the press release, and will have to wait until the second quarter financial results are posted in mid-August to get the final data.  Investors could either choose to take cash of $11.50 per share or merge into CPA 16, and see an increase in yield, from about 8.4% to 9.2%.  Up to 50% of the investors could choose the cash option.  The cash that would be available for choosing the cash out option would come from the following sources:

• CPA 14 was to sell properties to CPA 17 and to WP Carey that would net $89 million
• CPA 16 was to obtain a $300 million line of credit
• CPA 16 was to utilize a portion of its cash (which approximated $59 million at 12/31/2010)
• Finally, WP Carey was to purchase shares of CPA 16, if necessary

I estimate that CPA 14 had approximately $950 million of investor equity at year-end, and half that would be about $475 million.   WP Carey had to purchase $121 million of CPA 16 shares to complete the merger and meet the cash out requests.  I have never heard of a sponsor investing this much money in one of its own funds.  I find this figure staggering.  Non-traded REIT sponsors are notorious for not investing in their own deals, the ultimate chefs who refuse to eat their own cooking.  WP Carey not only had to cook, but also got stuck with the bill for a three-star, five-course meal, served with a couple of bottles of First Growth Bordeaux.

CPA 14 had approximately $1.5 billion in total assets at year end.  If WP Carey gets a 1% annual asset management fee, this is $15 million a year on the CPA 14 assets.  It will take over eight years for WP Carey to recoup its $121 million through the asset management fee.  CPA 16 is a long-term investment and should have at least several more years before a liquidity event.  WP Carey has just tied up $121 million for an indefinite period.

WP Carey will probably try to spin its purchase of $121 million of CPA 16 shares in a positive manner.  I don't believe for a second that WP Carey had any expectation it would have to invest so much money in CPA 16.  WP Carey has a reputation as being one of the smartest operators in the non-traded REIT business.  It looks to me like it was too smart by half in this transaction.  I am guessing that the maximum number of investors chose the cash-out options, despite the premium exchange price offered CPA 14 investors and a nearly .80% increase in distribution.   I know I write this too much, but this transaction and how WP Carey gets its $121 million out bears watching.

WP Carey Flies Under the Radar
I did not know about the WP Carey CPA 14 merger into CPA 16 Global until I saw the press release on my Google News screen.  The complexity of the transaction tells me I need to dig deeper into the filings.  I will have more on this in the next few days, but on first blush, this is one huge affiliated transaction.