AIG Turmoil - Here Come The Smart Guys
I have posted before on my perception that AIG's brain power is not up to other top Wall Street firms. Here is a front page article in today's Wall Street Journal detailing the dissent of three top AIG shareholders - Eli Broad, Shelby Davis and Bill Miller. These three have no shortage of brain power and combined with Hank Greenberg, and I don't see AIG's current management team in place much longer.

Thompson - Poised for Big Things
I received a blast email from a TIC industry veteran who is joining Tony Thompson's new real estate venture, Thompson National Properties, LLC. I had heard he had started a boutique real estate firm and looked at the website. This is not boutique - the staffing is incredible. The website shows seventeen professional staff and twelve senior executives, including Thompson. This is amazing. I don't know his plans, but he is staffed to raise billions. He is the keynote speaker at the Orchard Securities conference I am attending this week, and I am interested to hear what he has to say. I like the fact that he is not resting on past successes and has dived head first back in to the business.

Priorities
Today was a wild financial day - the stock market dropped nearly 400 points, unemployment had its largest jump in 22 years, oil jumped 9% to nearly $140 per barrel, the dollar tanked and corn hit a record high. The White House's response (via the Wall Street Journal's Washington Wire blog) was as expected:

White House spokeswoman Dana Perino said the White House is considering options to address the slowdown, but didn’t offer specifics. At HUD, Bush renewed his calls for an increase in domestic energy production, permanent tax relief, and reform of the regulation of Fannie Mae and Freddie Mac.

“There are a range of things that we continue to look at, but at the moment we would ask Congress to act on the things we think would have an impact — not necessarily an immediate impact, but an impact, nonetheless, so that the future of our economy can continue to grow,” Perino said.

The tax cuts do not expire until the end of 2011, the third year of a McCain or Obama presidency. I want these tax cuts extended as well as the estate tax thresholds increased, but it is silly to think that an extension of the tax cuts would have any immediate economic impact. (How strange that the tax cuts were never made permanent with six years of Republican Congress.) If Bush wants to do something he should put an immediate end to ethanol subsidies and stop the charade of ethanol as a viable fuel alternative. A legitimate strong dollar policy would end the commodity surge and bring the cost of oil down, but it's probably too late for him to do anything effective for the dollar.

Stock Slump
Today, AIG's stock dropped to levels not seen since the summer of 1997. That's unfortunate.

Catching Cold
Soured residential loans keep increasing. All real estate is now a dirty word. I am still of the opinion that commercial real estate should fare OK despite the credit strains. So much money went to residential real estate that commercial did not get over built. If the economy really goes in the tank, my opinion will change.

Down Market Realities
Realtors would never have agreed to sharing commissions in a strong market. But in a moribund housing market, realtors have come to realize that working with discount brokers is not such a bad idea. Realtors will not block the discount brokers' access to the Multiple Listing Service (MLS). On the surface, this is good for consumers, but of course my jaundiced view is that traditional realtors will somehow co-opt the discounters and commissions will not drop that much. Commissions are high and many realtors don't do work commensurate with the level of compensation, but many realtors discount their commission if asked. If the new sharing helps start transactions, then it is a good thing. The justice department should be looking at all the additional fees charged with getting a loan and buying a home. These are the fees that annoy me.

10-Q Release
The 10-Q for Wells' Timberland REIT was released last week. A quick read confirmed my previous conversations with Wells. Timberland should have enough offering proceeds to make its first $40 million payment on the mezzanine debt at the end of June. I estimate that Timberland needs to raise over $14 million a month in investor equity to get the mezzanine debt down to $60 million by mid-October 2008. This would extend the mezzanine debt to February 2009. If Timberland's equity effort comes up short, the entire outstanding balance of the mezzanine piece is due in mid-October 2008.

Don't Eat Their Own Cooking
American Airlines' management must not fly on American's planes. American's brilliant scheme to add a $15 per checked bag charge means that few bags will get checked. More bags in the cabin means frustrated passengers and stressed-out flight attendants as they struggle with the added bags. Airlines have stopped food and cut in-plane staff, and now this indignity. Flying is going resemble a bus trip in South America.

Cracks?
The Wall Street Journal had an article yesterday on the departure of a Wachovia real estate executive. The executive built Wachovia's real estate lending business, and one of his specialties was the mezzanine loan on top of a more traditional real estate loan. This is exactly how the Wells Timberland REIT financed its lone timber transaction - first loan and mezzanine loan (in additional to the issuance of preferred stock that can be viewed as more leverage) and no initial equity. The REIT is struggling to repay its mezzanine debt and needs to get it down to $60 million by mid-October to extend the final payment to February 2009. Based on Timberland's filings, I estimate that the REIT has approximately $125 to $135 million outstanding at the end of April on its original $160 million mezzanine loan. I wonder how the departure of this executive will impact Timberland REIT if the REIT's equity comes up short and it needs to extend or refinance. The executive's departure does not change the facts and terms of the transaction but may have repercussions for investors.

Opps
From today's (Wednesday 4/23) Wall Street Journal's Plots and Ploys column:

Sharing the Pain

While the stocks of most real-estate investment trusts have fallen sharply in the past year, few have been clobbered as hard as Phoenix-based Feldman Mall Properties Inc., which owns four malls and holds partial interests in three others.

Feldman's shares have fallen nearly 83% to $2 and weren't helped a bit last week when the company reported disastrous results for its fourth quarter.

It suffered a decline of $2.1 million, or 15 cents a share, in funds from operations for 2007. A key factor was a near doubling of Feldman's operating expenses to $16.5 million, including an extra $1 million provision for missed payments by tenants and $2 million in severance for two departed executives.

But the pain from Feldman's losses isn't limited to its investors. Another victim is Inland American Real Estate Trust, another REIT, which in the past year bought two million preferred shares in Feldman for $25 a share. Starting June 30, 2009, Inland can begin converting its preferred shares to common shares at a ratio of 1.77. Trouble is, Feldman's stock has fallen; if Inland were permitted to convert its shares at today's prices, it would get stock worth only $7.1 million. An Inland spokesman declined to comment.

The loss is 85% of the original $50 million investment. In terms of Inland American's big picture, this is not much more than a blip. It has raised $6 billion in investor equity. It has not released its 10-K yet. Inland American's 10-K will be another interesting read because its whole strategy is to buy shares of REITs rather than individual properties. The decline in REIT prices due should make for interesting valuations and its valuation methods need scrutiny.

Black Swan
This is the new financial term. It means that large unpredictable, unexpected events have big impacts on the markets. I just saw a numb-nut on CNBC stating that two Black Swans are pending, one the unpredictability of LIBOR and the other is inflation. LIBOR has been out of whack since last summer and is the subject of a front page Wall Street Journal article this morning. Commodity prices have been hitting highs for months and food shortages and related riots are well reported. I have read numerous articles that the large cut in interest rates will lead to inflation - plus, this is Econ 101. Neither event, therefore, fit the definition of a Black Swan. When known events and conditions are called Black Swans the term is irrelevant. Here is a good article from the Financial Times discussing Black Swans.

IHM
The IMH 10-K was released two weeks ago. Again, like Timberland, there is significant data to digest. A post will have to wait as other work is pressing. The amount of loans in default shot up in the fourth quarter - which to me, was not unexpected. There have been substantial redemption requests already this year. Defaults and redemptions - yikes. More details soon....

S@%t Rolls Downhill
Linens n Things is preparing to file for bankruptcy. There are multiple Tenant in Common deals with Linens as a tenant. This chain was taken private by Apollo Management in early 2006. Linens was not the only retailer that was taken private by hedge funds or private equity firms. Toys R Us, Petco and others were bought during the era of cheap credit. I imagine the hedge funds and private equity firms leveraged the companies and paid themselves huge dividends. Now this leverage is leading to bankruptcy. I will watch how the bankruptcy impacts the TIC deals I saw.

Pet Peeve
I hate when restaurants serve food in baskets. I don't eat from a basket at home and I don't want to eat from one in a restaurant.

If A Deal Falls In A Forest.....
I don't have time to probe the Timberland 10-K in depth. I think I have enough information - I have to wait for the 10-Q (due in mid-May) for more relevant data. An anonymous reply says about Timberland:

"It might be hard to sell stock in a black box. That's almost six months without pertinant (sic) financial data."

This is a perfect summation. This deal needs to raise substantial equity over the next six months just to keep its one property, and its current run rate is not encouraging. Timberland has become a high risk, high leverage, speculative investment. The investors and advisors that look to Wells do not, generally, look for high risk, high leverage, speculative investments.

Thornburg Mortgage
This is good news. It looks like Thornburg is going to make it through the credit crisis. Thornburg's equity investors got wiped out but at least it stays in business.

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

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

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

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

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

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

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

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

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

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

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

Green - The New Refuge of Scoundrels
The old saying is that patriotism is the last refuge of scoundrels. It looks like patriotism is being pushed aside for the green movement. The sponsor who wants to roll-up its TIC deals registered a real estate investment trust late last year that will focus on sustainable real estate. Good luck. I think the registration's track record section needs updating.

How Do You Spell Stupid? S-P-I-T-Z-E-R
The idiot was reckless and foolish on so many levels and the revelations are just beginning. The stupidest thing - so far - has to be overpaying for services and having a credit with the agency. The stupidity almost defies belief. A credit with a hooker?!? Did they guy think he was shopping at Target? I bet he'd try to return a service he didn't like. The retard is toast.

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

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

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

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

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

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

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

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

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

One More Housing Post...
I just posted against a Government bailout of the mortgage industry. Bush is threatening to veto various proposals, including $4 billion for municipalities to rehab foreclosed homes. Barack Obama has proposed a $10 billion housing fund. Although I don't like the idea of a bailout, these proposals seem modest when compared to the $3.3 trillion spent on the Iraq War.

No Bailout
Here is an article on the Bush Administration's reluctance to bailout the mortgage industry. I agree. This is the banks' problem and they are going to have to fix it. Banks made reckless loans and should not be rewarded with a taxpayer bailout. Here is a post from Greg Mankiw's Blog with a solution posed by Larry Summers. I like the concept - banks cut the loan amount and share in the equity.

What the Housing Market's Up Against
The renter mentality invades home ownership. This article from the New York Times shows what is happening to all those no money down, interest-only mortgages. Homeowners are walking away:

Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989, according to a survey by the National Association of Realtors. Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, said in an e-mail message.

For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.

There is no incentive for homeowners with no equity or negative equity to stay in their homes when the mortgage becomes unaffordable. It becomes the banks' problem. Banks and mortgage companies that were so eager to make stupid loans are going to have to deal with the fallout. With no equity, there is no incentive for an underwater homeowner try to keep a home when the adjustable rate mortgage resets to a higher monthly payment. Banks thought they were so smart with these tricky, draconian loans. The one factor they obviously did not consider was a decline in home prices. To avoid further declines, banks are going to have to fix their mortgage problems, not the Government. The banks need to step in and rework these loans that should help stabilize home prices.

Heheheheeee
Ouch! AIG takes an $11 billion write-down. No mention of the pimple-on-the-ass division where I used to work. Who knew AIG had so much mortgage exposure.

Falling Dollar
The dollar is hitting all-time lows against the Euro. Here is an excerpt from a James Fallow article in January / February's Atlantic magazine:

When the dollar is strong, the following (good) things happen: the price of food, fuel, imports, manufactured goods, and just about everything else (vacations in Europe!) goes down. The value of the stock market, real estate, and just about all other American assets goes up. Interest rates go down—for mortgage loans, credit-card debt, and commercial borrowing. Tax rates can be lower, since foreign lenders hold down the cost of financing the national debt. The only problem is that American-made goods become more expensive for foreigners, so the country’s exports are hurt.

When the dollar is weak, the following (bad) things happen: the price of food, fuel, imports, and so on (no more vacations in Europe) goes up. The value of the stock market, real estate, and just about all other American assets goes down. Interest rates are higher. Tax rates can be higher, to cover the increased cost of financing the national debt. The only benefit is that American-made goods become cheaper for foreigners, which helps create new jobs and can raise the value of export-oriented American firms (winemakers in California, producers of medical devices in New England).

You can read the whole article here. It is a sobering read and I need to re-read it. Another benefit implied at the end of the second paragraph is that a weak dollar helps corporate profits and earnings per share of multi-nationals. (Checkout the two-year stock chart on Coca-Cola (KO) to see the benefit of a falling dollar.) A falling dollar is also good if you own unhedged foreign mutual funds.

It has been this blog's opinion that tax cuts, a falling dollar (that makes for good corporate profits) and consumer spending (debt be damned - i.e. house as a bank with exotic mortgages as the finance source) have been the Bush Administration's economic policies. These are tenuous policies at best. All provide short-term benefits but none have a lasting impact on the economy. Some will argue that tax cuts provide long-term benefits, but I think tax cuts are absorbed quickly into the economy and spending and saving habits revert to pre-tax cut levels. The Bush Administration's economic policies are like Chinese food or cotton candy - both sound good before you eat them, but neither are good for you, and when you are finished you realize you're still hungry.

The next president will have to make tough economic choices. The economy will not be strong enough to raise taxes. Curbs on government spending will have to make up for lost tax revenue. The market will take care of consumer spending - by choking it to death. The house as a finance tool is gone for now and won't be back for several years (but it will be back in some version). The easiest course will be a policy to support a strong dollar. It is not in this country's best interest to have the dollar fall much further.

Housing Overload
There have been multiple articles on the housing market over the past few days. They are presenting mixed signals on the direction of housing. Here is an article on Fannie Mae's quarterly loss. The article has good information on the state of delinquencies. Not surprising but not encouraging. Here is an interesting take-away from the article:

Fannie Mae, which buys mortgages and repackages them into bonds it guarantees, said in its earnings report that it doesn't see any relief coming. Serious delinquencies will continue to mount this year, the company said, as housing markets continue to deteriorate, particularly in states like Florida and California.

"We expect the housing market to continue to deteriorate and home prices to continue to decline in these states and on a national basis," Fannie said in its annual report. "Accordingly, we expect our single-family serious delinquency rate to continue to increase in 2008.

And here is what's happening to all the home buyers who were late to the game:

Fannie said delinquency rates were highest for borrowers with low credit scores or high loan balances relative to the value of their homes, with fast rises in delinquencies among loans with less than full documentation, adjustable rates, and interest-only or variable payment features, many of them made in 2006 and early 2007. Loans used to buy condominiums and second mortgages also saw delinquencies rise rapidly, and Florida was a particular trouble spot, with serious delinquencies there nearly quadrupling.

Here is another article on new home sales. Sales have not been this low since 1995. This is a dramatic headline but I'm not sure what it means in the whole scheme of the housing mess, unless you view 1995 as when the housing market turned up after falling in the early 1990s.

Housing Market Signs
The housing market continued its decline in January. But the data was encouraging in that it did not drop as much as expected. Here are some economists' opinions on the data. The overall opinion is that a bottom is not that far off.

CMB(S)X Index
Here is a fascinating article on the CMBX index that tracks commercial mortgages and is used by conduit lenders to price and insure commercial mortgage backed securities. The index has spiked since the start of the year (but has pulled back this week). Below is the index:



The article states that short sellers may have caused the spike. This quote looks past the credit market hysteria and gets to the bottom line:

Actual delinquencies on commercial-mortgage bonds hit a record low of 0.27% in January, according to Fitch Ratings. Among 40,000 loans in these bonds, only 293 were delinquent last month. The most bearish market prognosticators predict defaults on commercial mortgages will reach 2% over the next year or so, in line with the historical range. By comparison, the performance of the CMBX implies the default rate could be four times that level, according to analysts. "The level we're seeing in the CMBX right now just doesn't make sense," says Lisa Pendergast, managing director for RBS Greenwich Capital in Greenwich, Conn.

Defaults just hit an all-time low, bears predict defaults will revert to their norm but the CMBX index is pricing a default level of 8%. This does not make sense. This index is only two-years old and obviously has not been through many market cycles, and its unfortunate that loans are tied to its pricing. Especially when the article states "(t)he index itself has become one of the most popular ways to make bets on the outlook for real estate, and also to hedge against a downturn." It appears that the index will cause another round of write downs by banks holding commercial mortgage backed securities. There is sizable BS in the CMBX index. All TIC sponsors and other real estate borrowers need to be calling portfolio lenders.

Return of the Portfolio Lender
Tenant In Common sponsors are adjusting to new credit market realities. The old way of financing acquisitions - high LTV loans with extended interest-only periods that were packaged and sold as part of Commercial Mortgage Backed Securities - is no longer available. The large money-center banks that used to make these loans have stopped this type of lending. Another name for these loans was conduit loans. Into this breach, the smart TIC sponsors have approached community banks and insurance companies who make loans and keep the loans on their books. These are known as portfolio lenders. In the heady days of TICs most, if not all, TIC deals were financed with conduit financing. The portfolio lenders were always an option, but TIC sponsors did not want to pay the extra 15 bps to 25 bps that the portfolio lenders charged.

When I started in the business in the late 1980s portfolio lenders were the norm because conduit loans did not exist. I am glad to see the return of the portfolio lender. I think many sponsors will be glad to have a entity behind their loans rather than the faceless world of conduit financing. The TIC sponsors who have found portfolio lenders who understand and are making mortgages to TIC properties are guarding these relationships. Conduit financing will return, albeit not on the terms available before mid-2007. The option of using both is good for the industry.

Bad Housing News
This article makes a compelling point that housing prices, especially in California, Florida and Nevada will keep dropping. Maybe my estimate that the housing market is near a bottom is premature. I always thought that the "affordability" factor was a key to the unsustainability of the housing bubble, and by this measure home prices are still overvalued.

Congress and Sports
I don't know why it is Congress' jurisdiction to investigate steroids in baseball or the New England Patriots' videotaping in football. These are trivialities compared to other issues facing Congress. Baseball and football have the means and structure to deal with these issues internally.

Boo - Hoo - Not Crying for AIG Stock
AIG's stock is getting crushed today. No tears here. I used to work for a company that was acquired by AIG and soon realized what a messed-up corporation it was. The company I worked for was part of a group of companies that even when combined didn't amount to a rounding error on AIG's financial statement. Part of AIG's dysfunction was Hank Greenberg and the organizational fear of him. Executives at all levels were terrified of him and of the possibility of receiving his wrath. The other part was that executives from New York just were not that smart.

I remember a meeting where a group of AIG life insurance executives came out to pitch AIG's life insurance. Their brilliant plan was to give cheap pens to reps that sold an unachievable amount of AIG insurance. The scheme was laughable as well as insulting and it took six guys to present it. I sold my AIG stock after that meeting at over $90 a share - a price AIG has not seen since. (If a company sent six guys to pitch an uncompetitive product with an unappealing incentive it was a bad harbinger for the whole organization and was not a stock I wanted to own.) At another meeting an AIG sales executive invited reps golfing and then tried to get the reps to pay their own green fees! AIG's inability to value its investments comes as no surprise.

Prosaic
I heard from a reliable source that nothing untoward led to Tony Thompson's departure from Grubb & Ellis. It was compared to Eli Broad's departure from SunAmerica after AIG's acquisition. This is a poor comparison because AIG bought SunAmerica. Eli Broad did not have a choice about staying. Triple Net engineered the acquisition of Grubb & Ellis, a public company, to avoid its pending public offering. If Thompson wanted to stay, he could have stayed. Thompson was chairman of the new Grubb & Ellis, plus he is leaving still owning 16% of GBE (7.4 million shares at approx $5 per share is approx. $37 million, which is 16% of GBE's $226 million market cap). Broad got billions but never owned 16% of AIG.

I don't know what percent of Thompson's net worth is in GBE, but unless he is going to liquidate soon (and lose the 60% since the deal was announced last May) it still does not make sense to me why he is leaving. Why would he, or anyone, leave $37 million in someone else's hands , especially since it has already lost 60% in less than a year. I will take the boring explanation for now but will keep my ears open for alternative views.

This Sucks
Delta is talking to Northwest. My frequent flier miles won't be helped by this deal. A Delta / United merger is much more attractive to my flying patterns. I don't have too many calls for long hauls to Asia.

Wells Timberland REIT
I thought I had blogged on this REIT last fall, but I guess not. I recommend reading Timberland's October 15, 2007 8-k. Closely. Especially the passages describing the $160 million bridge loan utilized to acquire the REIT's sole property. There is a $40 million principal payment due at the end of February and an additional $24 million of principal is due no later than April 30, 2008. The section on the REIT issuing preferred stock to Wells Real Estate should also be read.

No Rumors
I know of no rumors on Thompson's departure from Grubb & Ellis. I just find it odd that he would orchestrate the merger and then quit two months later. He owns 13% of the company and GBE's stock has dropped approximately 65% since the merger was announced last May. Thompson has a reputation as a hard-nosed boss who likes control. I'll say it again, it just seems odd that he would depart now.

Clear As Mud
Here is an article on Tony Thompson's departure from Grubb & Ellis. It reads more like a press release than a news article. There just has to be more to this story. So, Thompson is going to stay in the real estate industry. He has to have a non-compete that would prevent him from taking employees from Grubb & Ellis (i.e. former NNN employees) and in starting a competing business. To me, this means no syndicated TIC deals or non-traded REITs. Right, like that will happen. Plus, he still owns 13% of GBE.

I Don't Get It
Tony Thompson has resigned as Chairman of Grubb & Ellis. The resignation is effective February 8th. There has to be a story behind this news. He orchestrated the merger of NNN and Grubb & Ellis, became Chairman in early December. Now he is resigning - strange. He still owns almost 14% of Grubb & Ellis stock. (This is probably why NNN merged with Grubb & Ellis and not a REIT because REIT rules do not allow an individual to own that much.) I wonder it it has something to do with GBE's stock price dropping from about $13 at the time of the merger announcement last May to under $5 today.

Housing Data
The housing data looks bleak. I am sticking with my gut that the housing market is at its bottom. Interest rates are lower than they have been in years and, anecdotally, I am seeing more "sold" signs in the neighborhood. I am hoping the data will reflect this. The data from the article linked above is for November, and I am still optimistic that bottom was reached in November or December.

IMH
I am waiting for IMH's quarterly report. The SEC website has an 8-K for IMH. It is a letter to investors. A pretty strange letter to say the least - the word obfuscate comes to mind. No mention on the status of the almost 30% of its portfolio of loans that matured in the fourth quarter of 2007. It stated that it was dropping its yield to less than 10% due in part to the prepayment of one loan, the proceeds of which had to be put in low yielding money market funds. In talking about defaults it states how much default interest the fund has earned. I guess we will have to wait for the 10-Q to get the real story.

Knew This Was Coming
People are walking away from their mortgages because they lost equity. Fools. I still believe the housing market has bottomed and these idiots and now deciding to default. I guess they will be the subprime borrowers during the next real estate craze.

Bad News is Good News
This article from the Wall Street Journal states, among other things, that housing starts are at their lowest level since 1991. The tone of article is negative, but to me the lack of housing starts is going to lessen supply, which should help stabilize prices. So the bad news is good for the housing market. The housing market peaked in late summer 2005, so we are now two-and-a-half years into the decline. I still think the floor in housing prices was hit late last year. I will find out over the next several months as sales data is released.

The huge bank write-off announced this week are also positive for the housing market. Another case of bad news being good news. The banks can start with a clean slate and get back to making loans.

Another positive sign is the Fed's willingness to cut interest rates. The ten-year Treasury is under 3.7%, and if you believe Goldman Sachs and Pimco's Bill Gross, its yield is heading to 3.0%. This makes mortgage payments lower and houses more affordable.

Countrywide v. Mortgage Fund That Won't Be Named (MFTWBN)
Countrywide posted loan data today that showed delinquent loans at 7.20% of its portfolio and loans into foreclosure of 1.04%. Countrywide's stock has fallen almost 50% in just the last week and at $5.12 per share is barely trading above bankruptcy levels. Compare this to MFTWBN that at third quarter-end (9/30/2007) had a 16.6% delinquency rate and 3.8% of its loans in foreclosure. If the market is betting Countrywide is going to go bankrupt what does it imply for MFTWBN? I'll tell you what it implies - Holy Shit! Plus, Countrywide is still making loans and actually saw a 1% growth in loans in December over November's rate. MFTWBN has temporarily stopped making loans. I expect disaster in MFTWBN's year-end financial statement.

Trifecta
I predicted the resignation of the Merrill, Citigroup and Bear Stearn CEOs. James Cayne just resigned to complete my mortgage meltdown resignation prediction trifecta. Like the other two numb-nuts he is probably walking away with a ton of dough.

Mendoza Line
The ten-year Treasury can't get away from 4.00%. Near Christmas is was approaching 4.30%, but this morning, the first trading day of the new year, it is back under 4.00%.

Piedmont - Never In Doubt
The Piedmont Office Realty Trust's proxy to investors to extend its listing period for an additional three years passed by an overwhelming margin (78%) earlier in the month. I never thought the vote would be close, despite the efforts of the company, Lex-Winn, that has been trying to buy parts of the REIT for over a year. It can be argued that now is not the time to list a REIT. This REIT should have been listed in 2005 or 2006 when the REIT market was hitting historic highs. I never understood why the Piedmont executives waited until the listing deadline to begin the process. Leo Wells could have put the $170 million that Piedmont paid him in stock in his pocket rather than having it unlisted shares.

Solving the Lending Crisis
The big lenders, Citigroup, Lehman, and Wachovia are diverse enough that they can probably not lend for an extended period. Eventually they will have to start lending. The banks' commercial real estate executives are not going to get the bonuses they (and their wives) are accustomed to by sitting on cash. This will flow up as banks' Return on Equity (ROI) will shrink and the senior bank executives won't get their bonuses. This may sound sarcastic and simplistic, but having worked long enough in corporate America, I realized that most important corporate decisions are based on the bosses' bonus pool. Stockholder wealth maximization my ass. It is in the bank executives' personal interest to start lending. When their bonuses drop they will find a way to start lending.

Reality Bites
There is an article in today's Wall Street Journal that summarizes what I have seen in the Tenant In Common market since last summer. Deals are not getting done because lenders won't lend and this is expected to result in lower commercial real estate prices. Pardon, the pun, but it does not appear that the ground floor has been found where lenders will lend and buyers and sellers can come to terms. Until this happens deal flow will be light. It is ironic that the Blackstone / EOP deal early in 2007 appears to be the catalyst. Blackstone paid so much and then sold portions of the EOP portfolio for even more that it help spook lenders.

GBE Props
I questioned this stock when it dropped, but it popped nearly 7.5% today and at one point during the day was up nearly 15%. Not exactly sure why, but the NNN merger was approved today. I am not sure this approval was ever in question so I doubt this was behind the jump.

Prime Borrowers Used Subprime
Finally. The majority of borrowers who used subprime financing were credit borrowers, not subprime borrowers. I have thought this all along and this article in the Wall Street Journal proves it. Many subprime loans were used to speculate on real estate and many were used for the low teaser rates with the expectation to refinance the loans before they reset. This quote shows the extent of the issue:

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores (greater than 620) got more than half -- 55% -- of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study. Even a significant number of borrowers with top-notch credit signed up for expensive subprime loans, the firm's analysis found.

The article states that many brokers were at fault because subprime loans paid more compensation to brokers than conventional loans, and that borrowers did not understand the complexity of the loans. This may true, because no one knows how much mortgage brokers make on a loan (except the mortgage broker and there is no bigger line of BS than a "zero point" loan). But I still think a bigger issue is the mentality of borrowers. They had been borrowing and refinancing for the past ten years with impunity and saw no reason to stop. Mortgage broker greed just fed this twisted mentality. Plus, everyone knew the difference between the monthly payment amounts of a subprime loan with a low teaser rate and a conventional loan with a higher mortgage rate. Mortgages were viewed as short-term way to play a house's appreciation, not a way to build long-term equity. When houses stopped appreciating the the game of financial musical chairs was over.

Where Can I Buy Some?
Look at this chart from Saturday's Wall Street Journal showing the various mortgage back security tranches:


The AA tranche looks like the deal of the century. I wish I knew how I could buy some of the investments that hold these bonds.

Opps
This week I heard about a reputable TIC sponsor who was syndicating a single-tenant deal where the tenant had shaky credit. The tenant was delisted for poor financial health last week - in the midst of the offering period. I have not heard the status, but this is not good and I am guessing the deal needs to be reworked. This may not be possible in today's tough credit market. I should note that I have seen the offering materials.

Didn't Get My Memo
Apparently the housing market and the market experts did not read my last post. Look at this chart:



Not too encouraging. The housing correction started in August 2005 when the Fed started to raise interest rates. The slump has been in full swing for over two years now. Reading the above articles, while negative, show that lenders are starting to lend again. The spread on jumbos is now approximately 80 bps, lower than over 110 bps in August. Most of the data in the above articles is based on data from last summer. For now, I am sticking by my previous post.

Housing Market Turn?
You heard it here first. The ten-year Treasury is now 3.85%. This is going to spur home buying. While prices may not rise, it should stop the slide. It will also help ease the subprime mess as all the non-subprime borrowers (urr.. speculators) who used subprime debt because of the low teaser payments, can now refinance into a more affordable mortgage due to the lower rates. The demand for loans is going to increase and banks are going to have to lend.

Interest Rate Buy-Downs
The credit crisis has spawned interest rate buy-downs where TIC sponsors use proceeds from a TIC offering to "buy down" interest rates. Does this make sense? I am not sure if there is a correct answer, but I am using Net Present Value calculations to determine whether the present value of the savings (increased distributions to investors) is greater than the cost. The trick is the discount rate. I just looked at a deal where the cost made sense if the ten-year Treasury was used for the discount rate. It did not make sense when the bought-down rate was used to discount the savings. Both were close to the cost (i.e. within approximately $10,000) and given the disparity between the two discount rates (4% v. mid-6%) I give the nod to the buy-down.

I Like It
Another title could be "Sharing the Pain." I just say my first TIC deal where the commission has been dropped to 5%. This is amazing. It is from a good sponsor, so I hope it goes over well with advisors. If the advisors are looking out for their clients, it should because the yield starts at 6.73% and then rises to over 7% in later years. I have heard of another plan to pay a smaller up front commission (like 3%) and then a trail commission (like 1%) over several years. I like that plan, too.

Musicians I Never Want To Hear Again
Andrew Sullivan is doing a survey of the best and worst videos of the 80s. I voted for Duran Duran's Girls on Film, in a slight edge over Peter Gabriel's Sledgehammer. The Girls on Film video sums up the 80s, plus its Duran Duran's best song. I liked Robert Palmer's videos and thought they would have made the list. I have not voted for the worst yet, but on so many levels, who can be worse than Lionel Richie?

I have been thinking of musicians and bands I never want to hear again. At the top of my list is David Bowie. I just groan every time one of his songs comes on the radio. I know he was a trend setter in the 70s, but do we still have to be subjected to his music? Another is Steve Perry and Journey - simply horrible - I am glad I don't listen to stations that play this drivel. And talk about worst videos of the 80s, Steve Perry's Oh Sherrie is hands down the 80s' worst video. It takes two minutes before the torture even starts!

UPDATE: Foreigner has to be added to the list of bands never to be heard again.
UPDATE UPDATE: Foo Fighters. Is this the worst band name ever? I have Sirius Radio and it seems like the Foo Fighters get more airplay than any other band. Enough already! Geez, it's not like they're Radiohead.

WSJ As A Tabloid
I am not sure whether it has to do with News Corp's acquisition of the Wall Street Journal, but the new layout for the Wall Street Journal Online looks and feels like a tabloid with its sensational headlines. I don't care that the Bancroft family sold the Journal, they appeared (except for a few) to be either uninterested or slackers looking to cash in, but I always liked and appreciated the Journal's understatement and serious approach to news. If a news item needed hyperbole it was important. Now every title has a snappy heading "Economy Conspires to Dog Cerberus," and "Home Woes Hit Lowe's Again," as examples. I guess I will have to read it closer to determine news and noise. The Journal needs to be careful, because its readers know BS and will look other places for reliable news if its journalistic standards slip. It is still the business paper of record and a great national paper, but this is not assured going forward. I have already started to view the Financial Times as a backup.

Must be Nuts
I made my first post on a stock chat website - I must be crazy. It was on Grubb and Ellis and I alerted the stock gurus that NNN is a real estate syndicator and that some of the assets on NNN's balance sheet they were raving about flows through to NNN's syndications and is not directly NNN's.

Ten-Year Yield
The yield on the ten-year Treasury is approaching 4.00%. At these levels the housing market may start seeing some activity and prices may slow their slide. It will also help the banks.

Goldman Sachs
It is clearly the best firm on Wall Street. Probably the best U.S. corporation, if not the world's best. It's alumni is staggering and it even helped keep A-Rod in New York (and probably salvaged his reputation). This article repeats what I have been telling people. It is amazing - or maybe it's not - that it missed the mortgage mess.

Credit Crunch Curbs Real Estate
This article makes sense. No credit means no deals means real estate values go down. This is not fuzzy math. Banks need to start lending again. This quote is relevant for TIC deals:

Even a slight decline in values could make it difficult for property owners to refinance their mortgages, especially if they have been paying only interest on their existing debt and not paying down principal. Such interest-only mortgages have become increasingly popular.

Every TIC deal I have looked over the past several years has interest-only financing. It was the only financing that allowed sponsors to pay an attractive yield to investors.

GBE Is Off Another 8% This Morning

Grubb & Ellis and NNN
Here is an interesting chart. It is the one-year performance of Grubb & Ellis (GBE). I wonder what the market is saying about the merger between Grubb & Ellis and NNN. The stock's decline started shortly after the merger was announced in late May.


Another, more positive, way to view the chart is to say the the stock performance mirrors the problems in the credit market more than the perception about the merger, because it does mirror the credit problems. The merger of the broker and the syndicator should be complete in mid-December.

All Gossip, All the Time
I heard this morning that a prominent TIC sponsor fired twenty-four employees today. The TIC slowdown caused by the housing market and troublesome debt market is starting to impact sponsors. The syndication-dependent sponsors will be the first to show cracks. My opinion from the start has been that the real estate guys will fare the best in a downturn. We'll see.

Piedmont
Here is the information I promised in an earlier post on the Piedmont REIT:

Data as of 2Q 2007

• FFO/Share (six months) $0.291

• Annualized FFO/Share $0.581
  

• Div Per Share (six months) $0.29

• Annualized Div Per Share $0.587

• Payout 99.01%

• Div Yield 6.99%

• Leo's Shares 19,568,641

• Leo's Ann Dividend $11,482,878.54

• Leo's Ownership % 4.07%

• Leos' Value at Adj. Par $164,180,897.99

• Adjusted Par Value $8.39

Leo's annual dividend will help ease the headache caused by Piedmont deferring its listing. The REIT returned approximately $1.61 per share in 2005 due to property sales, which is why the adjusted par value is $8.39 and not $10 per share. The yields are based on this adjusted share value. I need to find the REIT's FFO growth rate. I will have to investigate this along with the current FFO multiples for other REITs. A low growth rate would logically put the valuation at the low end of the multiple range.

As Much Scoop As I Know
A large TIC sponsor is talking to two or three smaller TIC sponsors about taking over the management of the smaller sponsors' existing properties. I know the name of the large sponsor but was not told the smaller companies (I am guessing its two not three). If the deals happen, I am told, it will likely be within the next several weeks. I am skeptical, but will wait and see. Apparently, the smaller companies approached the larger company due to their inability to get financing for current deals, and lack of deals impairs their financial viability.

Nailed It
Prince expected to offer to resign from Citigroup. My earlier post's guesstimate proves prescient. My other guesstimate about his "go away" payment was correct, too. He is expected to get $40 million. Citigroup loses more than 20% of its market value in less than a month and gives the CEO $40 million, seems kind of retarded.

All Piedmont, All the Time
I search the filings for the Piedmont REIT every couple of weeks. The latest filings have Lin-Wix, the entity that offered to pay up to $9.46 per share, urging investors to vote no on the planned three-year extension before listing. Another firm, Madison Investment Trust Series 79, is offering to acquire shares at a price of $7.50. Piedmont also filed its proxy statement, officially asking investors for the extension. This saga is taking a strange, albeit predictable, turn. The annual meeting on December 13th should be very interesting.

Accountability
The whole mortgage mess, in my opinion, was built on the concept of making money with no responsibility. Mortgage brokers would loan money to any one; bankers provided the financing to mortgage companies and brokers; mortgage companies then sold the mortgages - good or bad - to banks who put the loans into neat securities that were sold to investors. So many hands, so little responsibility. The accountability ship has finally docked. Stanley O'Neal of Merrill Lynch has lost his job (along with all the bond traders he fired), and I am guessing the heads of Bear Stearns and Citigroup won't survive. Mr. O'Neal received $150 million to go away (and people complain about Alex Rodriquez!) and the "go away'" packages for Mr. Purcell and Mr. Prince will be sizable too.

When will the Fed have its accountability moment? It tacitly approved this mess until it was too late. And don't believe for a second the Fed did not know what was happening in the housing market. Not to get political - I trust markets not politicians - but the current administration has not had much of an economic policy, except for a weak dollar (stronger corporate profits), easy credit (see above) to fuel consumer spending and low taxes. The booming housing market and the cash-rich (i.e. leveraged) consumer it spawned was too convenient, despite the wild debt.

More Piedmont
I did some analysis yesterday on the Piedmont REIT. I am travelling today and will have it up in the next few days. I calculated FFOs, yields and how much Leo Wells is going to receive in dividends. All the data is based on Piedmont's second quarter 10-Q.

Confirmation
I never thought that the subprime mortgage problem was isolated to just poor people. All credit types used the subprime loans for the loans' low initial interest rates and never had any thought or intention to pay the higher reset rates. Home values were going to keep increasing and the loans would be refinanced before they reset. This article from today's Wall Street Journal confirms that subprime mortgages were used by a wide range of people to participate in the housing market boom. Many of these non-subprime subprime borrowers, in my opinion, have no incentive to keep their houses when there mortgages reset. In fact, I bet the stereotypic subprime borrower - i.e. poor and bad credit - will be more likely to try to save their house than the speculators who thought they were junior Donald Trumps.

Should Have Seen It Coming
The Piedmont Office Realty Trust has sent proxies to investors to extend the date for it to list by up to three years. The REIT was supposed to list by the end of January 2008, and is asking investors to extend the listing date until January 2011. This is unbelievable, but totally predictable. Leo was never really going to sell. The REIT is blaming the debt market and the poor REIT sector. REITs have been in the tank all year, and the REIT just obtained a huge new line of credit in September, at the height of the credit crisis, so both arguments are thin at best. I think this will be a very interesting proxy vote.

Crazy Times
It has been a busy few weeks and the next few weeks appear similar. I was at the annual TICA meeting yesterday. Interesting. There, to me, was a sense of doom and gloom, due in large part to the credit environment and the downturn in the housing market. Most sponsors I talked to had a deal on the street and others in the works, so I don't get the pessimistic outlook. Plus, there were more reps there than ever before, which to me is a bullish sign because this conference is not required and reps who attend have to pay their own way. I know enough reps to know that if they were pessimistic they would be home saving money, not investing in the future.

Whole Foods' Competition
Publix is opening a separate store (presumably the start of a new chain), GreenWise, that sounds like a Whole Foods - about 40,000 square feet (smaller than a typical Publix but just the size of a Whole Foods), at least half the produce organic, heavy on prepared foods, and many items not found in a regular Publix - in South Florida. Here is an article describing the new store. The Government's bid to keep Whole Foods from merging with Wild Oats always seemed misguided to me and this new concept shows the speciousness of the Government's case against the merger.

Long Slog
I bought the old QQQ sometime in 2000, after NASDAQ was well off its highs of 5,000 and was trading near 2,100 or 2,2oo. I thought I was getting a bargain with the index more than 50% off its highs - little did I know. I am finally close to breakeven with the NASDAQ near 2,700. (I did not know at the time the disparity between QQQ (now QQQQ) and the NASDAQ itself.) I have clients that I bought QQQQ for in the mid-to upper-$20s and $30s per share that have fared much better than I.

Good News
I love Zillow. Real Estate agents hate it. Glad to see it is getting additional financing.

More Piedmont
Piedmont Office Realty Trust, the newly named Wells Real Estate Trust, filed to go public earlier this year. Today, with the Fed's 50 bps rate cut, REITs as a group shot up 5%. I hope Piedmont goes public soon as the market is saying that the rate cut benefits REITs. I am not sure the impact, if any, of the lawsuit noted below on the IPO. Piedmont's charter calls for liquidation if it does not go public by the end of January 2008. The new $500 million line of credit is not the actions of a company planning on liquidating in under five months. According to someone at Wells, the REIT's portfolio appraised between $8.50 and $9.00 per share late last year. I am curious if the IPO valuation will be higher than these appraised values and the last solicitation price of $9.30 per share in July 2007 by an outside firm looking to by 25 million shares.

Piedmont's Press Release Omission
I checked this morning to see whether Piedmont has had its IPO. It has not, but a press release (and corresponding 8-K filing) touted a new $500 million line of credit the REIT has with Wachovia Bank and JP Morgan. After reading the press release I read the 8-K and it did discuss the new line of credit. The press release did not mention one item in the 8-K I thought was important - another lawsuit from an investor angry about the amount of compensation paid to Leo Wells during the REIT's management internalization. Here is an excerpt from the 8-K that discloses the new lawsuit:

Donald and Donna Goldstein, Derivatively on behalf of Nominal Defendant Wells Real Estate Investment Trust, Inc. vs Leo F. Wells, III, et al.

On August 24, 2007, a stockholder of the Registrant filed a putative shareholder derivative complaint in the Superior Court of Fulton County, State of Georgia on behalf of the Registrant against, among others, one of the Registrant’s previous advisors, Wells Capital, Inc., and a number of the Registrant’s current and former officers and directors.

The complaint alleges, among other things, (i) that the consideration paid as part of the internalization of the Registrant’s previous advisors (the “internalization transaction”) was excessive; (ii) that the defendants breached their fiduciary duties to the Registrant; and (iii) that the internalization transaction unjustly enriched the defendants.

The complaint seeks, among other things, (i) a judgment declaring that the defendants have committed breaches of their fiduciary duties and were unjustly enriched at the expense of the Registrant; (ii) monetary damages equal to the amount by which the Registrant has been damaged by the defendants; (iii) an order awarding the Registrant restitution from the defendants and ordering disgorgement of all profits and benefits obtained by the defendants from their wrongful conduct and fiduciary breaches; (iv) an order directing the defendants to respond in good faith to offers which are in the best interest of the Registrant and its shareholders and to establish a committee of independent directors or an independent third party to evaluate strategic alternatives and potential offers for the Registrant, and to take steps to maximize the Registrant’s and the

---

shareholders’ value; (v) an order directing the defendants to disclose all material information to the Registrant’s shareholders with respect to the internalization transaction and all offers to purchase the Registrant and to adopt and implement a procedure or process to obtain the highest possible price for the shareholders; (vi) an order rescinding, to the extent already implemented, the internalization transaction; (vii) the establishment of a constructive trust upon any benefits improperly received by the defendants as a result of their wrongful conduct; and (viii) an award to the plaintiff of costs and disbursements of the action, including reasonable attorneys’ and experts’ fees.

The REIT has had another lawsuit related to the internalization and I am not sure if this is a re-hash of that earlier suit that did not get class certification.

If Only Its Partnerships' Investors Were This Lucky
Petroleum Development Corp's (PETD) stock jumped almost 10% today (9/18/2007). Since 2003 its stock is up nearly ten times. Nice. PETD sponsors oil and gas limited partnerships that offer investors tax write-offs and distributions for an extended period - usually fifteen years or more. The programs are royalty offerings so investors' distributions are their return of and return on investment. Very few of PETD's offerings have returned investor capital to date and to call its deals anemic is unfair to other anemic investments. It is safe to say that investors in PETD stock have done better than any investor in a PETD oil and gas partnership. Remember this: It is better to invest in the entity that is receiving cheap equity financing than the entity that is providing the cheap equity financing.

The End of Non-Bank Lenders
Here is an article on more trouble at mortgage companies from Reuters via Yahoo Finance. I link to it only because it has become clear (to me) that the non-bank mortgage companies are doomed. The big banks don't like the competition and flexibility these firms offer and the financial system's problems are now concentrated in these non-bank mortgage companies. The Fed's cut in the discount rate only benefited big banks as these are only firms that can borrow from the Fed's Discount Window. Many of the big bank's financial problems originate in the mortgages made by the non-bank mortgage companies that the big banks bought, packaged and syndicated. Don't expect any institution to throw these non-bank firms a life-line, unless it's in the form of a fire-sale buyout offer.

Elaborate Scam
There is an interesting article in the September 17th issue of The New Yorker. The article was written by Mark Singer and details a minor British pianist from the 1950s who had a late-life renaissance and became the fancy of classical music world. There was only one problem, the renaissance was a scam orchestrated by the pianist's husband who copied existing piano works and credited the works to his wife. Eventually, like all frauds, the truth came to light, but not before many esteemed music critics fell for the bogus pianist. I relate this story because in due diligence much of the analysis is based on information provided by sponsors. If someone is going to cheat it is going to be hard, initially, to detect the scam. If the sponsor gets a following, which is likely as scam artists tell a good story and investment advisors and broker/dealers love a good story, which is easy to relate to clients during the sales process, the unraveling will cause pain for investors, advisors and broker/dealers.

Greenspan Speaks
Former Fed Chairman Alan Greenspan said he became aware of the subprime mess in late 2005:

Former Federal Reserve Chairman Alan Greenspan admits he “didn’t really get it” that the subprime lending trend was significant enough to hurt the economy until very late 2005, but still defends his lowering of interest rates from 2001 until 2004 that critics say caused the crisis in the first place. Greenspan, who led the U.S. Federal Reserve Bank through 18 years and four presidents, speaks to Lesley Stahl in his first major interview, to be broadcast on 60 MINUTES Sunday, Sept. 16 (7:00-8:00 PM, ET/PT) on the CBS Television Network.

The quote above is from today's Wall Street Journal and was extracted from an upcoming CBS 60 Minutes interview with Greenspan. I am not going to pick on Greenspan because I think he did a great job as Fed Chairman. But it is strange, or maybe just coincidental, that his concerns started to arise just after housing prices crested in the summer of 2005. I find it hard to believe that he did not know the level and exotic nature of the subprime mortgage market until late 2005. I guess as long as real estate was rising and the subprime borrowers could refinance into other mortgages the subprime market was not a problem. I do believe that the leveraged economy - i.e. leveraged consumer - has been the primary monetary policy of the Bush administration. This was fueled by low rates and the explosion in home borrowing.

Housing Help
The interest rate on the ten-year Treasury is below 4.40% this morning. This is going to help the housing market - or at least slow the downward spiral.

When the Herd Runs Off a Cliff
Here is an article about all the speculators - who just had to get in on the booming housing market - defaulting on their loans. One would hope that there is some relief for people who are working and living in their homes and are going to get crunched by exotic mortgage resets (these people should start talking to their mortgage companies, I think they'd be surprised by their flexibility). The speculators don't deserve any relief. Unfortunately, with no equity in a property, I am not sure what recourse there is against the borrowers. The poor schmucks that actually bought homes and condos to live in next to these speculators are the ones who are going to be hurt.

This chart from the article is amazing:

Harbinger for TIC Deals
The outtake below is from Wednesday's (8/29) Plots and Ploys column in the Wall Street Journal's real estate section, and highlights a securitized debt transaction that may foretell the future for many TIC offerings. TIC offerings all use debt that is packaged an sold in to securities that are described in this article. If this deal gets done it will be good news for the TIC industry. Here is the outtake:

Can Wachovia Capital Markets unload $4.1 billion in commercial mortgage-backed securities in this turbulent credit market? The answer may come as early as this week, as the bank continues to market bonds backed by a loan it gave Lightstone Group LLC to buy Extended Stay Hotels in June.

"I know they're not selling well," says David Lichtenstein, chief executive of Lightstone, a Lakewood, N.J.-based real-estate firm. "But I don't think a lot is selling, period."

Wachovia's offering, one of the biggest this year, comes at a time when the markets for commercial mortgage-backed securities and commercial collateralized debt obligations have been severely pressured by investor skittishness. When Lightstone announced it was buying Extended Stay from Blackstone Group for $8 billion in mid-April, commercial-real-estate lending was still aggressive, but the market was starting to react to warnings about lax lending standards. "We were one of the last deals in," Mr. Lichtenstein says.

Besides the credit-market turmoil, another big drawback for investors is that the Lightstone deal is a so-called single-borrower issue, meaning it doesn't pool loans from different borrowers. Thus, it doesn't have the diversity of assets that many other such issues do.

If the series, which is led by Wachovia but includes other banks, is sold out, it would signal that the markets have regained their footing somewhat in the past two weeks as spreads have narrowed, meaning investors are willing to take lower returns on the bonds. And if not? "Wachovia has a pretty big balance sheet," Mr. Lichtenstein says. Wachovia declined to comment.

Piedmont / Wells Update
I spoke to a representative at Wells (not Piedmont) about last month's Wall Street Journal article. The representative said the offer to acquire all the former Wells REIT was never formally made, which is why the REIT's board of directors did not respond to the offer. This matches my unsuccessful search for a formal offer. The only offers I found were tender offers that sought to acquire up to 10% of the REIT, not all of it at two different prices. This information allays concerns about poor fiduciary responsibility. The conversation also revealed that that appraised NAVs were around $9.00 per share or less, with appraised dates of Fall 2006. I expect a listing soon (Fall 2007), although uncertain debt markets could affect the timing.

You Can Run But You Can't Hide
Wells Real Estate Investment Trust has changed its name to Piedmont Office Realty Trust. There is still no word on when the REIT will go public.

Update
The financial markets go to shit and I stop blogging, nice. It's been busy and I expect blogging to be intermittent until after Labor Day. There has been so much financial news I am not sure where to begin to catchup, so I won't. Look for lenders to get back in the market to ease the financial crisis. Lenders have to lend and the appetite for yield is not going away. The pricing will work itself out over the coming weeks or months. Higher debt spreads will lead to a repricing of assets, in particular real estate. Sellers cannot expect the same cap rates if buyers cannot get financing.

How Big Is the Subprime Exposure?
Markets opened this morning down again due to subprime exposure - this time in Europe. French bank BNP Paribas suspended withdrawals of its three funds. A German bank is also struggling with one of its asset-backed funds. When this subprime mess started early in the year it was thought to be a small portion of the market. I don't think this is the case judging by the global market reaction.

Figured It Out?
A scary thought hit me last night as I searched for clues about today's market opening. Maybe the banks are scared about the subprime mess because, in effect, most mortgages they made over the past six years are subprime loans. By this I mean that the high loan-to-value and loose credit loans were the norm, and encouraged, even for strong credit borrowers. What's the difference between a good credit borrower and a subprime borrower if both bought a house but needed an interest-only mortgage so they could afford the payments. When the mortgages reset, the payments are too high and the equity has vanished both borrowers will been in financial trouble. They will not be able to refinance and will likely give the property back to the lender. There is very little difference between these two borrowers. That is what is scaring the bankers because they know better than anyone how shaky their loans were for the past six years.

Lemming Watch
This blog has said before the bankers are lemmings. This article proves it. Why stop all lending and slow the economy? Why not make better loans? Bankers need to get better documentation on their borrowers and make sure their loan-to-value ratios are accurate (get tougher on appraisers). This take-away from the article cracked me up:

The fright among investors is forcing lenders to go back to more-conservative practices that were the norm before the housing boom of the first half of this decade. Many now are focusing on loans to borrowers who are willing to document their income, can make a down payment of at least 5% and have a history of paying bills on time.

Documenting a 95% loan-to-value loan is conservative? Verifying a payment history is conservative? It is scary to think what is considered risky. Maybe the lending mess really is only at the tip of the iceberg. It is naive to think that the lemming mentality will stop at subprime and Alt-A mortgages. These bankers are going to choke off all credit - mortgage, corporate, asset-backed, you name it you won't be able to borrow against it - for the next couple of months.

Energy Expenses Offset Rise In Energy Prices
Finally, my theory was verified in today’s Wall Street Journal. The theroy is that despite the current high price of oil and gas, the rise in acquisition and extraction costs make oil and gas deals a bad investment. The article details how the costs associated with the oil and gas industry have increased over the past few years. The arbitrage that allowed the oil and gas deals that were syndicated to investors in the late 1990s and early 2000s is gone. Elimination of the arbitrage will eliminate returns for many recent programs. This is bad news for oil and gas syndications and their investors.

The deals sold in the early 2000s benefited from high energy prices as they reached their peak production periods during the low cost high revenue period of the early 2000s. Their costs to acquire leases and drill for oil and gas were much lower than they are today. The returns for these were were much greater than the returns for deals done in the late 1980s and most of the 1990s. The money raised in today's deals, based on these returns, will be disappointed as recent deals will under perform. No sponsor talks about these increased costs. I was at a conference two weeks in Vegas and several energy sponsors spoke about all the opportunities in the energy sector, but rising costs were not mentioned.