More Bluerock
I have a few comments on my previous post on Bluerock Multifamily Trust.   I noted that it was uncommon for a REITs single purpose entity to enter into its own working capital line of credit.  But the more I thought about it, I can see the logic of having the single purpose entity's line of credit.  The property has four owners, and it was probably unlikely that one of the four owners was going to commit financially without committing the other three, unless it received additional ownership or protections, which probably would not have been forthcoming.  In this scenario,  the line of credit at the special purpose entity level makes sense.

It is important to note that the working capital loan, because it is at the property ownership entity level and not at the REIT level, is an off-balance sheet transaction for the REIT, and the REIT's share of the obligation needs to be added when determining the REIT's debt level.

Bluerock Multifamily's restated September 30, 2010 10-Q lists all four of its property investments as investments in unconsolidated entities, which is how you should account for joint venture investments.   Unconsolidated investments are shown on the REIT's balance sheet as a net figure, and don't reflect any debt of the joint venture.  Again, this is the proper method to account for joint ventures, which is how the REIT invested in all four of its properties.  Investors now need to dig through the financial statements' notes to find property-level data.  The four Bluerock Multifamily  investments have an aggregate leverage of 78%, and none of that debt is on the REIT's balance sheet.  The debt on Bluerock Multifamily's balance sheet, which is 74% of its unconsolidated investments, is its borrowings from affiliates that the REIT used to make its equity investments.  This debt is separate from the REIT's property specific debt.  I getting light headed with debt this high.

Bluerock Multifamily Reopens and Raises Another Eyebrow
I wrote late last year about Bluerock Multifamily Trust.   It had to suspend the sale of its shares in November until it restated its past financial statements and filed them in a post-effective amendment with the SEC.  In mid-January, the REIT re-filed is past financial statements and the SEC declared the REIT effective again on January 31, 2011.

On January 26th, Bluerock Multifamily filed an 8-K, which is a filing that a public entity has to make when it has a material event, which disclosed that one of the entities through which it owns its properites had entered into a $500,000 line of credit agreement with an affiliate of Bluerock Multifamily.  Text from the 8-K is below:

On January 20, 2011, BEMT Meadowmont, LLC, a wholly owned subsidiary of our operating partnership (“BEMT Meadowmont”) entered into an agreement with Bluerock Special Opportunity + Income Fund II, an affiliate of our sponsor (“SOIF II”) for a line of credit represented by a promissory note (the "Note").  Under the terms of the Note, BEMT Meadowmont may borrow, from time to time, up to $500,000, for general working capital.  The Note has a six-month term from the date of the first advance and matures on July 20, 2011.  It bears interest compounding monthly at a rate of 30-day LIBOR + 5.00%, subject to a minimum rate of 7.00%, annualized.  Interest on the loan will be paid on a current basis from cash flow distributed to us from BR Meadowmont JV Member, LLC (the “Meadowmont JV Member"). The Note may be prepaid in whole or in part at any time or from time to time without penalty. The Note is secured by a pledge of our indirect membership interest in the Meadowmont Property and a pledge of our direct membership interest in the Meadowmont JV Member.

I can't think of another instance where a separate single-purpose entity obtained its own working capital line of credit away from the parent entity.  Not that it's wrong, it is just not that common.  Working capital needs of single purpose entities are typically paid from property revenue.  Is the property not generating sufficient revenue to sustain itself?  You can't tell from the filing.   It is common for real estate funds to own their investments indirectly through separate entities. These are typically single-purpose entities that own nothing but the underlying property.

The line of credit poses several issues that bear watching.  The affiliated entity that made the loan to the property is a private fund that is paying an 8% distribution.  (It also has an equity investment in the property.)   The same entity made a loan to Bluerock Multifamily at a 7% interest rate so the REIT could acquire the property, and now it made a working capital loan at a 7% interest rate.  If the entity keeps making loans at 7%, and has offering and operating fees to overcome, how can it pay 8% to its investors over the long term?  Bluerock Multifamily is paying a 7% distribution.  It has borrowed money to fund its equity investments in its properties, and now a property in which it invested is borrowing money for working capital, both of which would take away money from distributions.   I will be looking at this REIT's ability to pay its distribution when it releases its 10-K in a month or so.

Here is some additional information on Bluerock Multifamily's ownership in the property that obtained the working capital loan:

Bluerock Multifamily owns the apartment complex with two affiliates and a third party and one of the affiliates loaned money to the REIT to allow the REIT to make its equity investment in the property.  If it sounds complicated, it is.  Here is the ownership description from the REIT's re-stated 10-Q:

We invested $1.52 million to acquire a 32.5% equity interest in BR Meadowmont Managing Member, LLC (the “Meadowmont Managing Member JV Entity”) through a wholly owned subsidiary of our operating partnership, BEMT Meadowmont, LLC (“BEMT Meadowmont”).  BEMT Co-Investor invested $1.17 million to acquire a 25% interest and BEMT Co-Investor II invested $1.98 million to acquire the remaining 42.5% interest in the Meadowmont Managing Member JV Entity.  BEMT Meadowmont, BEMT Co-Investor and BEMT Co-Investor II are co-managers of the Meadowmont Managing Member JV Entity.  Under the terms of the operating agreement for the Meadowmont Managing Member JV Entity, certain major decisions regarding the investments of the Meadowmont Managing Member JV Entity require the unanimous approval of the Company (through BEMT Meadowmont), BEMT Co-Investor and BEMT Co-Investor II.  If the Company, BEMT Co-Investor and BEMT Co-Investor II are not able to agree on a major decision or at any time after April 9, 2013, any party may initiate a buy-sell proceeding.  Additionally, any time after April 9, 2013, any party may initiate a proceeding to force the sale of the Meadowmont Managing Member JV Entity’s interest in the Meadowmont JV Entity (defined below) to a third party, or, in the instance of the non-initiating parties’ rejection of a sale, cause the non-initiating parties to purchase the initiating party’s interest in the Meadowmont Managing Member JV Entity.

The Meadowmont Managing Member JV Entity contributed $4.65 million of equity capital to acquire a 50% equity interest in Bell BR Meadowmont JV, LLC (the “Meadowmont JV Entity”).  A Bell Partners Inc. affiliate that is unaffiliated with the Company, Fund III Meadowmont Apartments, LLC (“Bell”), invested $4.65 to acquire the remaining 50% interest in the Meadowmont JV Entity.  The Meadowmont Managing Member JV Entity and Bell are co-managers of the Meadowmont JV Entity. The Meadowmont JV Entity is the sole owner of Bell BR Meadowmont, LLC, a special-purpose entity that holds title to the Meadowmont Property (“BR Meadowmont”).  Under the terms of the operating agreement of the Meadowmont JV Entity, decisions with respect to the joint venture or the Meadowmont Property are made by unanimous approval of the managers.  Further, to the extent that the Meadowmont Managing Member JV Entity and Bell are not able to agree on certain major decisions, either party may initiate a buy-sell proceeding.  Additionally, any time after April 9, 2013, either party may initiate a proceeding to force the sale of the Meadowmont Property to a third party, or, in the instance of the non-initiating party’s rejection of a sale, cause the non-initiating party to purchase the initiating party’s interest in the Meadowmont JV Entity.

As a result of the structure described above, the Company holds a 16.25% indirect equity interest, BEMT Co-Investor holds a 12.5% indirect equity interest and BEMT Co-Investor II holds a 21.25% indirect equity interest in the Meadowmont Property (50% in the aggregate), and Bell holds the remaining 50% indirect equity interest.  The Company, BEMT Co-Investor, BEMT Co-Investor II and Bell will each receive current distributions from the operating cash flow generated by the Meadowmont Property in proportion to these respective percentage equity interests.

If you find this Byzantine ownership structure confusing, so do I.  The addition of a working capital loan just added to Bluerock Multifamily's complexity.

Texas v. California
As a Californian, I found this opinion piece by Michael Hiltzik in the Los Angeles Times interesting.  Texas has similar debt problems to those in California.  Here are a few quotes, but the entire article is worth reading:

The budget crises afflicting states coast to coast arise from a combination of the nationwide recession and obsolete or wrongheaded state taxing schemes. The National Council of State Legislatures says that at least 15 states face large deficits this year and 35 in fiscal 2012. 

As things stand now, the council's figures place California's projected 2012 deficit at $19.2 billion, or 18.7% of its general fund, and the Texas deficit at $7.4 billion, or 17% of its budget. States with broad-based tax policies that balance property, income and sales taxes are best equipped to ride out economic cycles, because those levies don't all move in lockstep with the economy. Neither California, with its over-reliance on income and sales taxes, nor Texas, which has no income tax, qualifies.

Here is another quote from the article:

The supposed superiority of Texas over California in fiscal policy long has been a conservative article of faith. In 2009 the libertarian American Legislative Exchange Council published a report co-authored by the conservative economist Arthur Laffer underscoring the contrast. The report posited that "Texas' superior policies over the past several years are making the Lone Star State more resilient to the current economic downturn."

But Texas was hardly immune to the recession. From 2006 through 2010, the unemployment rate in Texas soared from 4.4% to 8.3%. Yes, that's a better showing than California, which went from 4.9% to 12.5%, but the difference may reflect the huge effect on California's economy of the popping of the housing bubble, which jumped our unemployment rate to a new magnitude and is likely to keep it there for a while.

And finally this:

Curiously, Texas' reputation as a low-tax, business-friendly state survives although its state and local business levies exceed California's as a percentage of each state's business activity (4.9% versus 4.7% in 2009, according to a report by the accounting firm Ernst & Young). What's different is that Texas business taxation relies more on property, sales and excise taxes and government fees than California, which relies on taxing corporate income.

I got a kick out of talk of Texas secession.   With this kind of deficit and such limited government, good luck with forming a new country.

Really?  
Google News is my new toy (yes, I know I am late to the party, and the party has probably moved to Twitter).  I just saw this Reuters' article summarizing an interview with Vornado CEO Michael Fascitelli.  This line in the article jumped out to me:

Since hitting lows in mid-2009, U.S. commercial property prices are up 33 percent but still off 18 percent from their peak in 2007, according to the Green Street Advisors Commercial Property Price Index.

That is quite a recovery, and if it's correct should take the sting off those nagging legacy property concerns.  I don't, unfortunately, believe the claim, although I'd like too.  It may be true for certain top-end properties in specific major markets, but I would bet that aggregate commercial real estate have not recovered 33% from their 2009 low.

Update:  The above information runs counter to Moody's data that shows property values still 42% below the 2007 peak.  Obviously, someone's numbers are wrong.

Non-Traded REIT Article
I am not sure what to make of this article in Registered Rep magazine.  It is worth a read, at a minimum to see perspective from a financial advisor's point of view.  I found some of the comparisons between non-traded REITs and traded REITs weak.  One proponent of non-traded REITs says that non-traded REITs buying properties now don't have the legacy property issues that plague some traded REITs.  True on the surface, but the counter point is that traded REITs, since they're continually priced, have already been discounted by the market for their legacy assets.  Another weak point is this:

The illiquidity of public non-listed REITs actually drives what makes them popular with many investors — that they are valued based on appraisals of their underlying properties, and can't be sold on an exchange for instant liquidity, Goldberg says. Because their returns are not correlated to publicly traded securities, they can be attractive for diversifying an investor's portfolio.

“I think in large part that's what's fueled the interest,” Goldberg says.  (Mark Goldberg is managing director at WP Carey & Co.,  a sponsor of non-traded REITs.)

I didn't know illiquidity was so popular.  I guess this popularity was why so many non-traded REITs stopped or restricted redemption requests during the credit crisis.  The only reason there is no correlation between non-traded REITs and traded REITs is because non-traded REITs are priced at their offer price, which does not change until eighteen months after non-traded REITs end their capital raising.  Over time, the underlying assets of traded REITs and non-traded REITs should correlate.

Another point is non-traded REITs' yields.  Advisors and investors like the high yields offered by non-traded REITs.  I would caution that not all yields are not equal.  Many non-traded REITs have higher initial yields than the non-traded REIT can generate or support over time.  These high initial yields are to attract capital, and are hopefully based on realistic assumptions for returns the REITs can generate.   Non-traded REIT sponsors have to acquire assets that can support the non-traded REIT's yield.  A non-traded REIT (or any REIT) that continually overpays its distribution will eventually have to drop its distribution.  It's uncanny how the drop in yield seems to correspond with the end of a non-traded REIT's capital raising period.

One huge point not addressed in the article is compensation to financial advisors, which can be a gross commission of up to 7%.  I wonder whether financial advisors would still be enamored with non-traded REITs if their commissions were a half or third of the current rate?  I don't expect a rush sponsors trying to find out.

Channeling Peter Gabriel
As events unfold in Egypt and turn bloody, I am reminded of the lyrics in Peter Gabriel's song Biko:

You can blow out a candle
But you can't blow out a fire
Once the flames begin to catch
The wind will only blow it higher

And the eyes of the world are 
Watching now
Watching now

CMBS Delinquencies Hit Record High
CMBS have hit a record delinquency rate of 9.1%, as defined by sixty or more days late with payments.  The apartment sector was the hardest hit, with a delinquency rate of 15.8%.  Here is an article with all the depressing news.  I did not read much positive news in the article, except that it restated that CMBS issuance is supposed to increase to nearly $40 million in 2011, which we noted last week.

Fracking-A Bubba
Here is a New York Times article on the fracking process for natural gas extraction.  This article details how some drillers used diesel fuel as part of the "cocktail" that is shot into wells to loosen natural gas:

The diesel fuel was used by drillers as part of a contentious process known as hydraulic fracturing, or fracking, which involves the high-pressure injection of a mixture of water, sand and chemical additives — including diesel fuel — into rock formations deep underground. The process, which has opened up vast new deposits of natural gas to drilling, creates and props open fissures in the rock to ease the release of oil and gas.

But concerns have been growing over the potential for fracking chemicals — particularly those found in diesel fuel — to contaminate underground sources of drinking water.

Here is more information:

Two years later, when Congress amended the Safe Water Drinking Act to exclude regulation of hydraulic fracturing, it made an express exception that allowed regulation of diesel fuel used in fracking.

The Congressional investigators sent letters to 14 companies requesting details on the type and volume of fracking chemicals they used. Although many companies said they had eliminated or were cutting back on use of diesel, 12 companies reported having used 32.2 million gallons of diesel fuel, or fluids containing diesel fuel, in their fracking processes from 2005 to 2009.

The diesel-laced fluids were used in a total of 19 states. Approximately half the total volume was deployed in Texas, but at least a million gallons of diesel-containing fluids were also used in Oklahoma (3.3 million gallons); North Dakota (3.1 million); Louisiana (2.9 million); Wyoming (2.9 million); and Colorado (1.3 million).

Where this leaves the companies in relation to federal law is unclear. 

This "fracking" issue is going to be big as allegations of contaminated groundwater grow.

Seizure and Bankruptcy
Here is the latest on the former CNL hotels.  The Bloomberg article is hard to follow, but it looks like junior lenders, led by hedge fund Paulson & Co., completed the foreclosure on the hotels, which Morgan Stanley had acquired in early 2007, and once getting control promptly put five of the the resort properites into bankruptcy.   This is the junior lender's (now owners) strategy to renegotiate and change the terms on the senior underlying debt.  The bankrupt properties included Hawaii's Grand Wailea and PGA West in La Quinta, California.  Paulson & Co., and the other lenders/owners will continue to manage the hotels through the bankruptcy process.

AMB Property Corp Acquires Prologis
AMB Property Corp acquired agreed to acquire ProLogis yesterday.  The deal valued ProLogis near its Friday close of approximately $15.00 per share price.  Based on one estimate of ProLogis' 2011 Fund From Operations, it appears the sales price is at 23 times Prologis' expected 2011 FFO.  This seems like a high multiple given ProLogis debt, but is lower than AMB's 33 AFFO (trailing) multiple.  Some of the executives that formed Dividend Capital, a sponsor of non-traded REITs, have backgrounds at ProLogis.  AMB and ProLogis are the two largest industrial REITs, and combined would be a $14 billion company.  The new company will keep the ProLogis name and symbol (PLD). 

The non-traded REIT sponsors are going to love FFO multiples over twenty and be delirious with a an FFO multiple above thirty.   The impact of the front end costs will be a wiped away with FFO multiples this high.  Better yet, non-traded REITs are now an arbitrage play!  Seriously, the valuations should be kept in the nine to twelve range for Adjusted Fund from Operations for back of the envelope valuation estimates. 

Ex-CNL Hotel Portfolio Update
Here is a good article from Bloomberg on attempts to restructure $1.5 billion of debt on the old CNL Hotel REIT portfolio, which was bought by Morgan Stanley in early 2007, and which CNL has no current association.  The $1.5 billion of debt is due on February 1 (Tuesday).  One billion dollars of the debt is associated with just five trophy properties, and some of the trophy properties in the portfolio include:

The properties are the Grand Wailea Resort Hotel and Spa in Hawaii; the La Quinta Resort and Club and adjacent PGA West golf course in La Quinta, California; the JW Marriott Desert Ridge Resort and Arizona Biltmore Resort and Spa, both in Phoenix; the Doral Golf Resort and Spa in Miami; the JW Marriott Grande Lakes and Ritz-Carlton Grande Lakes, both in Orlando, Florida; and the Claremont Resort & Spa in Berkeley, California.

At one point, the original CNL REIT owned the famous Hotel Del Coronado, located near downtown San Diego. 

This quote could have been said about any property in any property class that was underwritten in 2005 to 2007:

The Doral, Claremont, Grand Wailea, Arizona Biltmore and La Quinta resorts have all suffered from a decline in revenue per available room and low debt service coverage ratio, according to Bloomberg data from last month. 

“Based on operating figures for the first six months of 2010, none of the properties is performing above original underwriting,” Realpoint LLC, a Horsham, Pennsylvania-based credit-rating company, said in a January report about the five properties. 

I'll try to follow what happens to the debt negotiations later this week.

Total Realty Trust - A Rush to the Exits?
I just saw this 8-K, which was filed late last month.  In the fourth quarter, Dividend Capital's Total Realty Trust only met 7% of redemption requests.  The non-traded REIT filled the requests on a pro rata basis.  Another way to look at this is that 93% of redemption requests were not met.  I wonder if part of the redemption requests was due to Total Realty Trust having to disclose a net asset value (NAV) in early 2011.  Investors are probably suspecting that the NAV will be less than the redemption price, and are trying to get out before the redemption price is reset to the new NAV.

Houston Apartments
Back during the tenant in common boom of 2005 to 2007, it seemed like every other TIC deal was a Houston apartment complex.   I'm sure that most of the debt on these TIC transactions ended up in CMBS.  TIC sponsors, apparently, weren't the only people who thought Houston apartments were strong investments, as there is $777 million of seriously impaired loans (see article below) in Houston.  Here is a National Real Estate Investor article on the "sky-high" delinquency rate of loans tied to Houston apartments.   Houston's apartment loan delinquency rate is 21.5%,  higher than the national average of 16.5%.  Here is a strong takeaway from the article:

Of the $777 million in seriously impaired loans in the Houston apartment market today, lenders originated 71% of that volume during the notoriously lax underwriting period of 2005 through 2007, reports Trepp. That’s when the economy was booming and commercial real estate was riding high.


Local broker Jeffrey Fript, a senior associate in the National Multi Housing Group of Marcus & Millichap, says Houston’s high CMBS apartment loan delinquency rate doesn’t surprise him. After all, Houston is the fourth largest city in America based on population. 

Houston also was one of the most active markets for CMBS loan originations from 2005 to 2007, says Fript. “It’s a big market, and a lot of people refinanced with CMBS. Along with that comes a high delinquency rate.”

I will never cease to be amazed at the lemming nature of sponsors and investors.   They must think that if everyone is doing it, it must be OK.   It is so much easier to follow the easy money flow than to seek out other investment alternatives.  This follow-the-herd mentality is a problem with sponsors and investors.  Sponsors want an easy sale and investors want to invest where it is popular.  Throughout history this type of thinking (or not thinking) has been the source of bubbles, ponzi and pyramid schemes, and now "seriously impaired loans" sitting in troubled CMBS.

CMBS Debt Values Soar
Bloomberg has an article on commercial real estate debt this morning.  CMBS prices are increasing as investors are betting the worst in commercial real estate is over. Here are a couple of points I noticed:

Investors are buying bonds tied to hotel, shopping center and skyscraper loans as more financing becomes available to borrowers, helping halt a slide in real-estate values. U.S. commercial property prices, which have declined 42 percent from their peak in 2007, rose for the third consecutive month in November, Moody’s Investors Service said in a statement yesterday.


So-called junior AAA commercial-mortgage backed securities, which are less insulated from losses than senior and mezzanine AAA classes, have increased almost 21 percent to 87 cents on the dollar during the past three months, according to data compiled by JPMorgan Chase & Co. The bonds, valued at about 51 cents six months ago, are at the highest levels since June 2008, JPMorgan data show.

Enthusiasm for real estate debt is generating new debt issuance:

Sales of commercial-mortgage backed securities are poised to climb to $45 billion this year, according to JPMorgan, after banks arranged $11.5 billion of the debt in 2010. Rising sales make it easier for property owners with maturing loans to refinance. Issuance plunged to $3.4 billion in 2009 compared with a record $234 billion in 2007, according to data compiled by Bloomberg.

Real estate has always been finance driven.  When money is available, deals got done.   It is hard to know exactly how much the lack of financing comprised of the 42% drop in real estate prices over the past three years.  In 2006 and 2007, there was $203 billion and $234 billion respectively, of CMBS debt issuance, which led to a frenzy of commercial real estate deals, like the huge Equity Office Properties buyout in early 2007.  When the debt crisis started, the flow of easy debt stopped.  In 2008 and 2009, CMBS issuance dropped to $12 billion and $3 billion, respectively, or just 5% and 1% of the amount issued in 2007.  I would argue that the lack of financing played a larger roll in the price drop of commercial real estate than the recession.  This finance influence can be seen in the market for Class A commercial office properties and multifamily properties, where reasonable debt is available and the demand is strong and cap rates are low.  Lower quality properites are not afforded the same type of debt, and therefore cap rates are higher and demand is not strong, which has lead to a bifurcated market.  

The estimate of $45 billion in CMBS issuance for 2011 is good news.  While it's only about 20% of the 2007 level, it's a big improvement from the paltry levels of 2008 and 2009.  More debt will help the overall commercial real estate market and the existing CMBS market.

More Commercial RE Price Data
Moody's reported that its Moody's / REAL All Property Type Aggregate Index increased .6% in November (link from Calculated Risk).  This is on the heels of last week's CoStar report that showed a decline in November's commercial real estate prices.  There does not seem to be enough data to signal a definitive price move, either up or down, in the commercial market, although it seems clear to me that the downward spiral has stopped.  Calculated Risk's graph of prices since 2000 seems to confirm this:

(The link at the start of this post will take to you the Calculated Risk site, where you can enlarge the graph.)

Moody's reports that commercial real estate prices are off 42% from their 2007 peak.  That's the staggering point, and the graph provides visual emphasis.

Thoughts on IMH 
I get the sense that the Wall Street Journal is looking for scandal in real estate securities. A few weeks ago it picked on Grubb & Ellis, trying weakly to link it to other known problem sponsors, and today it targeted IMH.  The WSJ needs to look a little harder (heck, contact me and I'll point you in the right direction).  I have been writing about IMH for several years and re-read my previous posts this evening.  The WSJ article mocked IMH's moto of "Rule 1: Don't lose money.  Rule 2:  Don't lose money.  Rule 3:  Don't forget Rule 1 and Rule 2."  I noted this silly moto, too, nearly two years ago.

I missed that the SEC was investigating IMH related to transactions and relationships with the broker / dealers that sold the units in the IMH Secured Loan Fund.  I have no idea of what will come of the investigation, but I always thought, from a fee standpoint, IMH was not egregious.  If I remember correctly, IMH Secured Loan Fund's initial costs were much lower than non-traded REITs, and the points paid to IMH were paid by borrowers not the Secured Loan Fund (which, if you look at enough deals, you'll find this not common).   The consolidation of IMH Secured Loan Fund and the IMH management company made sense, because without it investors would have likely lost everything, and of course there is still a chance all could be lost.  The amount paid to IMH as part of the consolidation was $14 million in restricted stock, which is now the subject of a class lawsuit.   If IMH is not successful in working out its SEC issues and is unable to list its shares, get additional capital, and figure how to grow the business, the $14 million won't be realized.  As it now stands, investors have at least a chance of getting some return of their original investment.

My issue with IMH was its refusal, at least in its filings, to fully address the underlying problems in its portfolio.  Everything seemed rosy until it wasn't.  Even today, I would question the value of IMH's remaining assets.

The WSJ article focuses on the unfortunate investment losses of small investors.  Many investors put their money thinking it was a safe, income investment.  But to IMH's defense, it never obscured or hid its business plan, and the business plan had substantial risk.  IMH Secured Income Fund made pre-development loans to developers.  Developers went to IHM for pre-development loans because they couldn't yet qualify for development and construction loans from traditional lenders.   Put another way, the loans IMH Secured Income Fund were making were considered too risky for banks.  This is not saying the loans weren't sound and not made in good faith, just that banks did not make this kind of loan.

The loans were made to developers in many of the "hot" residential real estate markets, like Arizona and Nevada that have imploded on themselves.  Like the WSJ article noted, many of the loans were made on land parcels without any zoning or entitlements (one reason why banks don't make these loans).  No matter the market environment, pre-development loans carry high-risk, even with the collateral.  Throw in the worst housing crisis since the depression and the risk is compounded exponentially.  I am not saying the strategy was flawed, but that it carried significant risk.

IMH Secured Loan Fund paid high distributions, typically north of 10%, and repurchased shares from investors that requested liquidity.  The high yield was what attracted investors.   Investors need to question their brokers, especially on opportunities that offer out-sized returns, like the IHM Secured Loan Fund.  High returns NEVER come without high risk, and risk is a two-way street, both up and down.  This may sound snarky, but if someone figured out how to give high returns with low risk, Wall Street and institutional investors would have moved in and small investors would have been excluded.

The WSJ article was not as bad as its title implied.  It probably could have been worse for IMH.  The story of IMH is not over.  I will be paying attention to the SEC investigation and any potential outcome.  Then IMH needs to tap the capital markets, which will be the real challenge.  This will also be the real test of IMH's valuation assumptions.  The market is unforgiving and if the IMH's asset values are overstated it will be apparent quickly.  I am not sure of positive alternatives to IMH if an IPO is not marketable. 

IMH Smackdown
There is an article on IMH in today's Wall Street Journal.  Here is the link, sorry a subscription is required to view the full article.  I will have more comments on the article and IHM soon.

Trifurcation
I read the term trifurcation in this post on Calculated Risk, which was referencing CoStar's commercial repeat sales index, which dropped in November, erasing a portion of the gains seen the previous three months.  I had not heard this term before.  The commercial real estate market is strong for trophy properties in major markets, weak for smaller assets, especially those in secondary and tertiary markets, and then there are the distressed properties that are coming onto the market.  The post stats that there have been few commercial transactions, and the prices have been volatile.  It is difficult to make sense of any month-to-month change in commercial real estate prices.  I do think it important note that commercial real estate prices are up over 7% since their low earlier this year.

Better Late Than Never
Oil and gas sponsor NGAS Resources, Inc (NGAS) was acquired at the end of December by Magnum Hunter.  The transaction was valued at approximately $98 million.  I am not sure whether the new entity will offer oil and gas tax write-off deals.  Without doing any investigation, this sounds like potential good news for investors in NGAS's current investment programs.

Something to Think About
The last post noted that the former CNL hospitality portfolio traded at a 52% discount from its early 2007 sale price.  (I have no information about whether any of the properites have been sold since early 2007.)  For those of us that have short-term memory problems, early 2007 was the height of the real estate frenzy with trades happening at historical prices.  Here is my early 2007 post noting the transaction. 

Investors in the CNL hospitality REIT received a return of their original investment, plus about 2.5% premium.  This minuscule premium occurred at the peak of one of the great real estate bull markets.  This begs a larger question. If a large non-traded REIT only generated such small capital appreciation at top of a real estate cycle, what does it say about the chances of other non-traded REITs being offered and exisitng today of selling their portfolios at a premium?  It is unlikely that they'll get the benefit afforded to CNL hospitality by selling at the height of a pricing cycle. 

Old CNL Deal Makes News
The hotel / lodging real estate sector seems attractive to me, and presents some significant opportunities. Hedge fund Paulson & Co., seized control of the former non-traded REIT, CNL Hotels & Resorts, Inc.  This deal originally went full cycle in 2007, allowing investors to cash out near their original investment amount.  According to the Bloomberg article, Paulson restructured $600 million of debt, extinguishing $200 million and converting about $400 million to equity.  This is interesting:

Morgan Stanley bought CNL Hotels for about $6.7 billion, adding eight luxury U.S. resorts, including the Grand Wailea Resort Hotel & Spa in Maui; La Quinta Resort & Club and PGA West in La Quinta, California; and the Arizona Biltmore Resort & Spa in Phoenix.

The financing for the acquisition included $1.5 billion of senior debt, $1 billion of mezzanine debt and the $800 million of corporate debt, of which $200 million was previously converted to equity.

It looks like Paulson paid $3.2 billion for the former CNL hotel portfolio.  This is less than half (about a 52% discount) of what Morgan Stanley paid for the CNL assets in 2007.  I wonder whether how much of the original portfolio is intact.  This kind of deal is why the hotel sector is so exciting.

Office Improvement
Here is a Bloomberg article on a Reis Inc. report that states that US office space in the fourth quarter had its first gain since 2007.  Landlords added 2.5 million square feet of leased space.  There is plenty of information in the article.  The vacancy rate remained 17.6%, its highest level since 1993.  Asking rents in the fourth quarter were lower than a year ago, but are higher than in the third quarter.  Effective rents were also higher in the fourth quarter than in the third quarter.  Calculated Risk also discusses the Reis report and has a cool graph showing historical office vacancies.

Kicking The Can
I read this article from the Financial Times on commercial real estate over the weekend.  It confirmed what I believe is happening with many maturing commercial real estate mortgages, lenders are just extending mortgages rather than reworking them.  I think the scale of loan maturities, the likely inability of borrowers to obtain new financing, and the unwillingness for banks and CMBS servicers to realize losses play into the "extend and pretend" mentality.  This quote did not surprise me but is still eye-catching:

To understand this, look at some numbers compiled by the Institute of International Finance, the Washington-based banking lobby group. The IIF calculates that in March 2008, there was about $25bn worth of pre-crisis investment grade commercial real estate in distress. By March this year, however, that number had exploded to $375bn (and has probably swelled since). 

Thus far, the banks have “dealt with potential delinquency problems in part by extending loans until 2011-13”, the IIF notes. Or, in layman’s terms, they have swept it under the carpet. But while this avoided defaults, the IIF reckons that about $1,400bn of CRE loans must be refinanced before 2014. Alarmingly, “nearly half of these are at present ‘underwater’, ie have mortgages in excess of the current value of the property”, it adds.

It's sobering to think that half of the $1.4 trillion in commercial real estate loans due before 2014 are underwater.   Reworking debt - not extending it -  will be the overriding theme driving commercial real estate for the next three to four years.  Lenders are going to have to start getting proactive on their loan portfolios, and stop waiting until borrowers default to begin discussions.

Deal of The Year
My deal of the year is the successful listing of the Piedmont Office Realty Trust (PDM).  The former non-traded REIT listed its shares on the NYSE in February around $15 per share, and it's now trading over $20.  While the stock has risen by about a third since its listing, it is still priced about 20% below its break even level of just over $25 per share.  To exisitng investors, PDM is yielding 5% and at today's price is yielding 6.2% - all covered by operating cash flow.  I buy the argument that if an investor bought shares in PDM ten years ago the overall annual return is pathetic.  But that is not why it's my deal of the year.  The stock not only held its value, but increased in value while successfully accessing the capital markets, positioning itself for long-term growth, all the while achieving its objective of giving investors liquidity.

If there is a black cloud around this deal it is its successful listing and the deferred release of shares, which helped maintain PDM's value through lack of sell pressure, and how I expect this will become the listing strategy for other non-traded REITs.  Baring any bad news over the next month, investors in PDM should have full liquidity of all their shares at prices much higher than the initial listing price.  You can bet that other REIT sponsors watched this smooth transition and will plan to replicate the deferred share release structure.  One non-traded REIT, Healthcare Trust of America, has filed initial documents to list its shares and will also offer staged liquidity, but over eighteen months rather than the twelve months of PDM.  Healthcare Trust of America won't be the last sponsor to exploit PDM's success.

Advantages that PDM had, which other REITs likely won't be able to replicate, are that it had low debt (around 20% near the time of listing), a diversified portfolio of office properites acquired before the spike in real estate prices, and a dividend that was covered by operating cash flow.  The large, stable portfolio offered no downside surprises during the twelve-month deferred listing period, or prompted sell pressure as the tranches were opened to the market.   That PDM is still trading below its break even, even with all those positives, should give non-traded REITs sponsors and the firms that sell them something to think about.  But in the meantime, investors and broker / dealers should thank PDM's management, including the often maligned Leo Wells, for the successful PDM listing.

Bluerock REIT Suspends Sales
The Bluerock Enhanced Multifamily Trust, Inc. has suspended sales.  This is not breaking news, as the 8-K announcing the suspension is dated November 11, 2010, and I am just getting around to posting this now.  The reason for the sales suspension is that the REIT changed auditors and the new auditors are saying that the REIT has to change the way it accounts for its investments in its properites, and therefore restate its financial reporting, resulting in a new 10-K and new 10-Qs.  The REIT's properties are all owned through joint ventures with other, affiliated Bluerock entities and third parties.  The REIT needs to file corrected financial statements and a post effective amendment, and be declared effective by the SEC.

I quickly read the Bluerock Enhanced Multifamily Trust's website and saw no mention that it has suspended sales.  I had to go to the REIT's most recent filings with the SEC to find the 8-K announcing the sales suspension.  This REIT, like the Behringer Harvard Multifamily REIT, has substantial inter-dealings with affiliates and owns its properites through joint ventures.  Real Estate funds and REITs that own their properites through Rube Goldberg structures always make me uncomfortable.

Grubb Gets Scrubbed
The Grubb & Ellis Apartment REIT is changing its name to Apartment Trust of America, effective January 1, 2011.  What an awful, uncreative name.  A better name would be the Legacy and Lawsuits Apartment REIT. 

From what I have been able to extrapolate from various conversations is that the managers of the REIT terminated the REITs relationship with Grubb & Ellis due to poor sales, and are hoping that a new advisor and dealer manager will boost sales.  Unfortunately, the change in advisor and dealer manager requires new selling agreements with broker dealers, and the REITs legacy assets and lawsuits relating to pending acquisitions will likely give broker dealers reason to pass on this deal. 

Quote of the Year
This is a quote from a July Cole Real Estate Investments' press release describing its $310 million acquisition of a building leased to Microsoft:

Cole expects the average capitalization rate for this property over Microsoft’s remaining initial lease term to be approximately 7.70%.  

Average capitalization rate over the term of the lease?  That's a new one.  A cap rate is a property's first year net operating income divided by the purchase price.  Period.  The use of "average" tells me that Cole is afraid to tell us that the actual cap rate is low, probably lower than the Cole REIT's dividend (and the Cole REIT did cut its dividend by a small amount late in the year).  Don't insult us with made up terms.  Instead, tell us that while the Microsoft property was expensive, it will likely outperform all the other real estate in the portfolio.  Forward any other worthy quotes.

TIC Article
Yesterday's Wall Street Journal (sorry, no link) had an article about a tenant in common arbitration that ruled that fraud had been committed at an Austin, TX office property syndicated by Triple Net, one of the large TIC sponsors.  The fraud resulted from Triple Net's failure to disclose a structural flaw in the building's foundation and that Triple Net was negotiating an insurance settlement, and then spent a portion of the insurance proceeds on other properties.  The article states that the structural flaw in the building has prevented it from being refinanced and the lender has filed a foreclosure notice. 

The article spends a good deal of space badly trying to tie the Austin property to other high profile TIC frauds, DBSI and Sunwest.  The theme of the article is that the Austin property offered a look into the sinister world of small investor access to commercial real estate.  The article fails here, too.  The throw away line that raised my eyebrows was that Grubb & Ellis, which is managing many of the remaining Triple Net properties due to its merger with Triple Net in 2007, disclosed in its third quarter report that "the company (Grubb) has been named in multiple civil lawsuits related to its investment management programs alleging negligence, fraud and other claims." 

Triple Net's Austin deal sounds more like a property specific situation than an indictment on an industry.  No commercial real estate deal, regardless of size, was immune from the drop in real estate prices.  The general risks of TIC deals were disclosed to investors.  TIC transactions were single property (no diversification) investments.  TIC deals had limited sources for any additional capital, such as for unbudgeted leasing expenses.  No deal expected to have to pay down a mortgage to allow for refinancing.  Most TIC deals had financing that ended up in CMBS, which had their restrictions disclosed, but no one knew how difficult these restrictions would become when the entire CMBS market closed.  Finally, the fees of a TIC transaction usually required a gross property appreciation of at least 15% to 25%, just to break even. 

It is naive to think that TIC deals would be immune from the recession and credit crisis.  The real estate boom was fueled by easy credit, and the TIC boom in particular benefited from the residential housing boom as rental properties were sold and proceeds rolled into TIC properties.  Commercial real estate prices appear to have stabilized, and might even improve with a growing economy.  The next several years will write the final chapter on the TIC industry as mortgages in CMBS mature.

Natural Gas' Frack Problem
Yesterday the New York State Assembly approved a six-month ban on natural gas drilling that uses hydraulic fracturing until the environmental impact of this process is evaluated.  The fear is that the chemicals used in fracking are seeping into and contaminating ground water supplies.  Fracking is the high pressure process used with water and chemicals to force the release of hydrocarbons from rock formations deep in the earth.   Many natural gas drillers use fracking and many don't reclaim the water / chemical cocktail, allowing it to dissipate into the earth.  Articles on natural gas fracking and the NY Assembly vote are here and here.  I am going to go out on a limb here and say that the environmental impact of fracking is a big deal, and that most gas drilling investments I have reviewed are under insured against environmental damage.

Snarkless in Vegas
A once-major real estate syndicator is selling notes through a newly formed company.  One of the company's first investments with the proceeds from the notes was a single condo in a Las Vegas high rise.  This morning I saw this Calculated Risk post referencing a Las Vegas Sun article that states that there are 4,000 unsold condo units on the Strip alone.  I am trying to think of something nasty to post, but the sheer scale of unsold units and a syndicated real estate investment buying one unit overwhelms my sense of snark. 

Dry Hole
While the fortunes of Atlas Energy are soaring, the outlook for another oil and gas sponsor, NGAS, is murkier.  NGAS reported disappointing earnings yesterday, said it was in violation of debt covenants and that it is:

evaluating all of its strategic alternatives and that it is actively pursuing possible transactions that may include the sale of the company or of some, or all of, the company's assets.

NGAS stock dropped 40% today and closed at $.36 per share.  NGAS has $170 million of oil and gas profits on its balance sheet, but it does not have the cash to repay the up to $57 million of debt that is now due under covenant violation.  NGAS says it will keep drilling despite the financial worries.

Piedmont's Third Tranche Release
The third tranche in Piedmont's listing is occurring this week, as shares are being delivered to custodians.  This likely explains Piedmont's (PDM) small price drop over the past two days.  All Piedmont shares should be full listed by February 2011.  Remember that the breakeven price per share is $25.14.  The current price is approximately $18.20 per share.

I don't want to jinx PDM's shares, but with one more tranche release left, it looks like Piedmont's strategy of spacing share liquidation has helped stabilize the stock.  Rightly or wrongly it appears that deferred liquidations are the new model for sponsors that are looking for liquidation.  The IMH deal I wrote about over the weekend is spacing its sales, and another large REIT is contemplating using the tranche method, but over an 18-month period compared to Piedmont's which took about a year. 

It's not the tranche strategy that stabilized Piedmont's share price, it is a good underlying business.  Entities with shaky business models or suspect financial statements won't have the same results as Piedmont.  The results could be just the opposite of Piedmont's, where a stock's price drops after the initial IPO and continues to drop, especially before and after each tranche release, until all shares are liquid or the company suspends tranche releases in an attempt to halt liquidations.  Investors will be in a frenzy to sell if a company is trending down.

Atlas Hits A Gusher
Well, Atlas Energy Inc.'s stockholders hit a gusher.  Today Chevron acquired Atlas for $3.2 billion or $43.34 per share, a 37% premium over Monday's closing price.  Atlas stockholders will receive $38.25 in cash and $4.09 of units in Atlas Pipeline Holdings.  Chevron's attraction was all Atlas' acreage in the Marcellus Shale natural gas region, which spreads over Western New York, Western Pennsylvania, West Virginia and parts of Ohio.  Atlas controls 622,000 acres in the Marcellus Shale formation with 1 trillion cubic feet of natural gas reserves.  A  Bloomberg article quotes an RBC analyst who figures that Chevron paid $9,000 per acre.  Last spring Atlas entered into a joint venture with India's Reliance Industries, Ltd, at $14,000 per acre.  While not a direct comparison, Atlas contributes its Marcellus Shale lease interests to its limited partners at a value of $45,000 per acre. 

For many years Atlas tapped a network of independent broker / dealers to raise capital for limited partnerships, which in effect were a form of corporate finance for Atlas.   The Atlas oil and gas partnerships are long-lived programs, so I am guessing there must be some kind of plan to continue to manage or to liquidate these assets.  The syndication business is moving to Atlas Pipeline Holdings, so I am guessing Atlas will keep the pushing out its rich, sponsor-feed energy programs.  It looks like any  assets in Michigan and Marcellus Shale (some that are owned by partnerships) are staying with Atlas and will be managed by Chevron.  I have read through Atlas' 8-K discussing the acquisition, but other than what is stated above, there is not much more information.   This is a fluid situation that needs watching.

IMH IPO - Where's My Checkbook?
I had not thought about IMH and its combination of the IMH management company and the IHM Secured Loan Fund lately.  But earlier this week I checked IMH's website and it looks like the consolidation has been approved, and on October 28, 2010, IMH filed a pre-IPO S-11.  I guess IMH and investors in the IMH Secured Loan Fund figured out the senior management compensation issues enough to get the consolidation approved (there are lawsuits filed so the saga is not over).   I always felt that the whole compensation argument was like arguing over carpet and wallpaper on the Titanic. 

I am not going to read the whole S-11, but will cherry-pick a few highlights.  These comments are out of context and if you're serious about this investment you should read the entire document. 

• For the first six months of 2010, IMH posted a loss of $45 million, of which $39 million was loss provisions and impairment charges.  The operating loss for the first half of 2010 was approximately $6 million.
• Accumulated losses are $454 million.
• "Substantially all of our commercial mortgages are in default, and currently performing loans may default in the future."  Yikes.
• IMH is using outside consultants to workout its defaulted loans.  I am curious how much these firms or individuals will receive for their workout efforts and how much IMH will net on any asset recovery?
• At June 30, 2010, IMH estimated that it had $15.9 million in cash funding requirements for existing loan commitments.  At June 30, 2010, IHM listed $3.5 million of cash.
• Existing investors only receive partial liquidity on the IPO, and are having their  equity diluted.

IMH has wide latitude in making investments with net IPO proceeds. It does not look like it is going to attempt to save any of its existing loans or assets.  It will be originating new loans and acquiring exisitng loans to take advantage of the real estate upheaval and aftermath of the credit crisis.

My question with IMH has always been its valuation for exisitng assets.  It still lists nearly $300 million in total assets, about half its asset value at the end of 2007.  I estimate that IMH has lowered valuations about 50%.  Is this enough?  I don't know, but my gut tells me it is not.   Land values have dropped considerably, and more than 50%, especially in the location and in the pre-development space where IHM operated.    The market's appetite for this IPO will tell us whether IMH was accurate in its asset valuation.

I never thought that IHM Secured Loan investors had much of choice but to approve the consolidation.  Snark aside, I hope this investment works out for investors.

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.

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.

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.

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.

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.

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. 

Why?
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?

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.

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.

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:

https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgdRxzXI5hi2OVj9DkbeJK9aKB6olsuRZWwqe8SPePtBuFxDRahxXF48yHzyV1JEHsCK5NyiuiC-AzemiXqFZtzVdvJwSiZmYQSbDgN2a8n__p5kXjz6lKZmCSxLyu64AO_Vd51/s320/OfficeVacancyRateQ32010.jpg


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.

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.

Hard To Believe - AIG to Repay Government
AIG took over $180 billion in tax payer "bailout" funds during the credit crisis.  It has filed to repay this money.  I thought that the government would never get its AIG money back.  While most other Wall Street firms have repaid their TARP money, I figured the AIG money was lost.  If you don't remember, AIG got in trouble because it provided unregulated insurance, in the form of credit default swaps, to other Wall Street firms, protecting these firms against losses against their subprime debt securities and other, similar, securities.  I still hear complaints about "bank bailouts," but with AIG, the largest recipient of tax payer money, attempting to repay its government money it is hard to argue against the success of TARP.

UPDATE:  Ooops.  I had a typo in the original post.  The correct amount to bailout AIG was $180 billion, not $180 million.

Inland American Valuation Is $8.03 Per Share
I am traveling and completing research reports, so I will post more on this valuation over the weekend.  Inland American announced this afternoon that an original $10.00 per share investment in the REIT is now worth $8.03.  That is an amazing valuation.  If you figure that 15% of the REIT's initial value was lost to offering costs, the REIT only lost about 5% of its value in the worst commercial real estate market in years.  Who would have thought that the Inland American's focus on hotels and retail properties - two of the worst performing commercial real estate sectors during the slump - in 2006 through 2008 would have proved so prescient.  Somehow Inland American eluded the decline in a commercial real estate market that has lost over 40% of its value from its peak.

Los Angles Times Article on Housing
I meant to link to this article last month, but didn't for some reason.  Here it is now.   The article discusses how private equity and wealthy investors are buying foreclosed homes and then trying to quickly sell them.  The professional investors are moving in as small investors are getting pushed out.  Many purchases are at court house steps.  This sounds like an easy way to make a quick profit, but it's not that easy.  First you need cash to close the deal.  What would trouble me is buying homes on the court house steps.  These transactions are pretty much "as is," and sight unseen.  You don't know the condition of the home, so it is just a gamble. Here is an example from the article:

Competition at the auctions is brutal, said Bruce Norris of Norris Group, a real estate investment firm in Riverside.

Norris unwittingly bought a house that was the site of a gruesome double murder. No one else bid -- a rare occurrence that showed others knew the history -- leaving Norris with less cash to bid for other houses.

"It's a very lonely place out there," Norris said.

That's only one of many risks in the foreclosure business. People who've lost their homes through foreclosure sometimes vent their anger by smashing walls, knocking over water heaters or ripping out toilets.

"We've literally had people take $20,000 of cabinetry out and feel perfectly justified doing it," Norris said.

What's The Over / Under?
Inland announced today that is releasing the estimate per share value of its non-traded REIT Inland American on September 24.  There is an accompanying conference call late on Friday.   (Is there a coincidence that the 24th is a Friday, the usual day for releasing bad news?)   Inland American's portfolio is full of limited service hotels and retail properties, among other types of real estate.  Inland American raised over $7 billion and bought much of its portfolio in 2006 through 2008.  Does anyone want to start the guessing at a per share valuation?

Here is a quick back of the envelop guess.  Inland American's FFO per share for the first six months was $.2487 per share, and is $.497 on a straight annualization.  Using simple FFO multiples of 9 to 12 gives a per share value of $4.48 to $5.97.  I figure Inland will adjust the number in the REITs favor.  (I am not sure whether a third party is providing the valuation.)  I would set the over / under at $6.25 per share.

Positive Hotel News
Here is a Bloomberg article on an improving hotel market.  Rents and occupancies are up, and sales are following this trend.  I have been thinking that hotel metrics should be improving making the hotel asset class an attractive investment in the rebounding economy.  The travel deals available a year ago are no longer available.  Here is the heart of the article:

A rebound in business and leisure travel is helping the U.S. lodging industry recover after last year’s recession sent occupancies to a 30-year low. Hotels can boost rates quickly to take advantage of economic growth, while tenants at offices and retail properties tend to sign multiyear leases. 

“Hotels have already absorbed the downturn,” said Richard Jones, executive vice president of acquisitions and operations at Atlanta-based developer Portman Holdings LLC. “It’s not as evident what exactly the impact of this downturn is going to be for other commercial real estate.”

Owners of offices, shopping centers and other buildings with pre-recession leases are now signing agreements that will result in “significant cuts in rental income” said Jones, whose company develops lodging, office and retail properties.

Income for hotels, meanwhile, is rising. Revenue per available room, or revpar, in the top 25 U.S. markets rose to $73.87 during the first half from $71.08 a year earlier, according to Smith Travel Research Inc. of Hendersonville, Tennessee. Occupancies climbed to 63 percent from 59 percent during the period, while remaining below 2008’s 66 percent.

The article goes on to compare and contrast hotels with other classes of real estate, and makes the case that hotels can respond quicker to an improving economy.   One important point that the article did not mention is new construction or lack thereof.  The hotel sector was overbuilt during the heydays of easy credit, and limited service hotels seemed to litter many corners.  I don't suspect there is any pending new hotel construction, except maybe some major metropolitan infill, and would be surprised if any sizable hotel development is even in the planning stage.

More Housing
I saw this summary of a government report on Fannie Mae and Freddie Mac last week and thought it interesting.  One third of all mortgages originated in 2005 and 2006 were subprime or Alt-A mortgages.  Over 2005 and 2006, government agencies issued 45% and 44%, respectively, of mortgage backed securities.  This compares to today, where agencies issue of 95% of mortgage backed securities. 

Reading this report, it's clear that government agencies did not cause the housing market bubble.  The market worked well, too well.  People wanted any kind of mortgage to get into the housing market.  When the agencies could not meet demand, or had standards that were too strict, the private market stepped in and created and originated mortgages, and then bought, packaged and sold these into non-government mortgage backed securities.  

The housing market is still recovering from the excess of the mid-2000s.  If the agencies eased their mortgage purchase standards it would help the housing market by increasing demand.  

Are You Ready For This?
Pimco's Bill Gross estimates mortgage rates would rise 300 to 400 basis points without government owned Fannie Mae and Freddie Mac assisting the housing market.   This is because the two agencies guaranteed, through mortgage purchases and subsequent inclusion in mortgage backed securities, 95% of the mortgages created during the past year.  Fannie and Freddie don't guarantee a borrowers mortgage payments, which would create moral hazard, they buy mortgages from banks and include the mortgage in huge mortgage pools, which are sold as bonds.  Fannie and Freddie therefore guarantee the bonds, not the underlying mortgages. 

Without the agencies' mortgage securitization program, there would be much less capital for mortgage lending.  Banks would have to hold the mortgages in their portfolio, leaving much less capital for new mortgages, and borrowers would be subject to strict underwriting due to limited capital.  This makes the assumption that private mortgage securities would not replace the agencies' role of buying mortgages from banks.  But even if private mortgage pools emerge, it is unlikely they'd completely fill the void of the agency debt, and they would not have the guarantee of agency debt.  I have been telling people that while no one likes the idea of government in the mortgage business, are they ready for mortgage rates 300 to 400 basis points higher than current rates?  This weeks' poor housing numbers would look like like boom times compared to numbers if long term mortgage interest rates suddenly jumped from 4.5% to 8.5%.  The price adjustment to housing would obliterate the economy and wipe out the wealth of even those that did not buy in the bubble period of 1998 to 2007.

More Housing
This morning's exisitng home sales numbers for July were bad.  The decline was worse than projected, but in line with the "whisper"numbers.  Calculated Risk has a good summary of the sales figures and excellent supporting graphs.  The jump in inventory stood out to me.  There is now 12.5 months of supply, where the average is closer to 6 or 7 months, which is going to hinder price increases.  I am trying to look at the bright side.  The annualized home sale rates was 3.8 million homes, which breaks down to 316,000 homes sold.  I am not 100% positive, but think I remember hearing on Bloomberg radio earlier this year that the normal housing demand. based on demographic factors alone, is closer to 500,000 or 600,000 home sales per month.  July's figures were well below the sustainable demand. Homes sales have to start increasing just to reach their sustainable average.  Mortgage rates are historically low, and I don't see this changing in the near future.  Low rates will attract buyers at some point.  (Existing home owners that refinance at current low rates will have extra monthly cash, which is positive for the economy, but this is not a subject for this post.)  The housing market will benefit in the coming months from low mortgage rates and pent-up demand (i.e. home sales reverting to their mean), at least that's my opinion.

The impact of the first time home buyer tax credit, which expired in April, inflated sales figures last year and earlier this year, and are weighing down numbers now.  Calculated Risk said all along that the tax credit was providing an unsustainable boost to the housing market.  But I didn't read or hear too much else about impact of the artificial demand.  CR was correct, and today's numbers should not too shocking.   I hope the government resists the urge to step into the housing market again.  Potential home buyers waiting for further government assistance are going to miss a great opportunity.

Housing Article
Here is a New York Times article I have seen linked several places this morning.  The article jumps right to the point:

But many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century, when houses not only provided shelter but also a plump nest egg.

I hate "new paradigm" thinking.  When experts say "never again," that's a sign that there will be an "again."  I remember sitting through a number of presentations in the late 1990s where "experts" said that the tech stocks were experiencing a new paradigm,  and that traditional equity valuation methods were a thing of the past, or that technology was its own asset class, and that income investing made no sense, to name just a few absurdities spawned by the tech boom.  These experts' advice looked reckless when the stock market tanked in the early 2000s and tech companies without revenue or earnings went away.

Reading the article reminded me how the tech pundits overreached.  There are no new investing paradigms, just variations on existing principals.  Investment bubbles and bubble thinking are an investing paradigm and have been around for thousands of years.   Housing experienced a bubble in the 2000s (much like tech in the 1990s), and people used their homes to finance lifestyles, counting on rising market values and easy credit.  Real estate gurus, like tech stock gurus, were a dime a dozen.  Those days are gone, and the home prices dropped significantly.   People that bought homes during the bubble will have a long hold period, but home buyers today should fare well, especially if they take advantage of current low interest rate mortgages.

People used to buy a home, paid their mortgage, and at the end of mortgage owned the home and all its equity, which was either passed on or helped fund a retirement.  The notion of waiting thirty years for equity evaporated in the 1990s and 2000s.  Banks and mortgage brokers invented methods that allowed homeowners to tap their home equity, which effectively turned homeowners into renters.  A return to patience in home ownership is not a bad thing and will prove rewarding.

American Crapital Development
I received an email solicitation from a secondary tenant in common market maker this afternoon.  The information was on an American Capital Development deal originally syndicated in June 2006.  The email did not offer too much data on the deal - 212 units in Washington State and the equity is being offered at $67,591  -  but what stuck out to me was it was not paying a distribution.  Why is that not a surprise coming from this sponsor?

10-Q Season Is Here
How exciting!  I will be reviewing select 10-Qs over the next few days and will pass along any interesting information.

Freddie and Fannie
Here is an interesting article I saw this morning.  Both Freddie and Fannie are fun political whipping boys, but this paragraph underscores their importance to the housing market:

More important, shutting down Fannie and Freddie and having the private market step in, as politically popular a sound-bite as that may be, is economically unfeasible. For better or worse, Fannie, Freddie and Ginnie Mae were behind 98 percent of all mortgages in this country so far this year, according to the Mortgage Service News. Pulling the rug out from under them would be pulling the rug from under the entire housing market as it continues to struggle.

I think we're stuck with these two firms, in some form, for the near term, unless everyone is ready for a huge drop in housing prices due to lack of financing.  PIMCO's Bill Gross had some provocative comments on Freddie and Fannie this morning that I need to read.