Wednesday, December 31, 2008

Philadelphia Update

The American Commerce Center appears to be heading in the right direction, while the markets do anything but that…there is no lead tenant as of yet.

Same goes for Cira South (Rendered at right) and Brandywine. Brandywine is reportedly still in discussions with Blackrock to move some 1,000 employees to our fine city.

Poplar Hotel is too big according to the NLNA. It was also changed to an extended stay boutique, which has many concerned of the possibility that it goes condo one day.

Good thing the NLNA Zoning Committee cannot control Center City, because the Zoning Board just approved a 28-story Monaco, an appropriate redevelopment solution to the long dormant Boyd Theater.

The speed at which the planning process in Philadelphia works, these projects will probably be ready when the credit markets are up and running again in 2010.

Llenrock Group

The Second Wave?

Receiving much attention the past week or so was a report aired by CBS 60 Minutes indicating that the next wave of foreclosures would be coming as a result of ALT-A and Option ARM’s. ALT-A loans were mainly used by the self-employed, and individuals with undocumented income to purchase a home at more traditional terms and rates, providing either asset verification, or partial income verification.

Option ARM loans generally had a low teaser rate, which determined your pay rate, but also had a charge rate, which determined the actual interest cost charged, the difference being added to your balance. Golden West, out of sunny California is generally credited with the creation of the Option ARM. They were successful through many real estate cycles, by employing a rigorous underwriting process, and significant due diligence on their contracted appraisers. It has been said that if the subject property was near a high-power transmission line, or freight train track, your loan would not be approved.

The report goes on to give examples of shoddy mortgages falling within these classes, and how the level of defaults will meet or exceed the current carnage in the subprime asset class. Whether or not they are correct is yet to be seen, and is as good a guess as any. However, the causes will be very different. The defaults will be driven by normal default scenarios involving job loss, disability, and rapid deterioration in home values. To paint them as similar to sub-prime is incorrect, as sub-prime were as easy to get funded as a freshman applying for a credit card on campus. These loans, like many other asset classes are more of a victim of the times, rather then their own demise.

And as always, just like a river, those seeking credit will find the path of least resistance ($ WSJ Subscription required). Or maybe a redesign is in order?

Llenrock Group

Thursday, December 18, 2008

Leverage and Lenders taking Sponsor Risk

The generally accepted driver of the financial crisis is leverage, made capable by virtually free money, thanks equally to our Federal Reserve, and the trusting buyers of virtually anything Wall Street could produce. The combination of a 0% to negative real return, and demands to maintain a minimum return threshold pushed normally conservative investors into new un-chartered markets of initially private MBS and CMBS, graduating to BBB-rated tranches, CDO's, CDS's, TRuPs and the various structures and exposures allowed by them.

As more and more reports are published on struggling CRE owner/operators, a pattern is emerging. For example, this well-known and respected NYC investor decided that he could take his equity off the table, and continue managing a noteworthy property, thus completely eliminating any chance at a loss, and preserving unlimited upside. That does not sound like a bad position to be in, especially with stringent rent controls in place tying management’s hands. Saying the owner hedged himself would be a severe understatement. In just 16 months the transaction generated a cool $93,000,000 profit on a $26,000,000 equity investment. In essence the entity that should be bearing the risk has transferred it to their lender at the most aggressive time in terms of property valuation and finance. The lender accepted unimaginable risks, while capping their upside.

What is particularly odd is that the borrower cashed-out, while the lender under-collateralized the property by allowing a $19,000,000 cash-flow reserve.

What are most interesting are the opinions that he remained a conservatively leveraged owner. What this indicates about the newer-vintage owners of real estate is quite scary, and should give pause to those claiming we have reached a bottom. The lax standards at the top of the bubble are postponing a long market digestion, which is both good and bad.

Llenrock Group

Tuesday, November 11, 2008

Opportunity Funds Waiting for a Bottom

One of the overriding capital markets trends of the past few months has been the large number of real estate opportunity funds amassing war chests to go after distressed properties and debt. According to Preqin, real estate private equity funds raised $30.2 billion in the 3rd quarter with much of this focused on opportunistic acquisitions and distressed real estate debt. A few days ago, Blackstone CEO Tony James reported that his firm is sitting on $13 billion of capital while waiting for real estate valuations to bottom out. While no specific market has caught his eye, he does believe that the US market will be the first to bottom out and begin the long climb back up.

To date, there have only been ripples of activity in the distressed debt market. For example Lehman brothers, the poster child of distressed sellers, sold $4.2 billion of mezzanine debt at discounts as steep as 35% in the second quarter. Apparently that discount should have been steeper, and we’re starting to see some debt trading at less than fifty cents on the dollar. Overall, however, the market has been eerily quiet so far. Some suggest that this is because the high-leverage, interest-only CMBS loans made in the past few years have not yet come due and forced borrowers to refinance under today’s stricter underwriting standards. When they do mature, starting in 2009 and accelerating through 2012, when five year loans originated in 2007 mature, the cash that is now on the sidelines should be more than happy to come to the rescue as long as it can earn a 20%+ return. The question on the minds of the funds raising cash in today’s market is not if they will be able to buy distressed assets and debt, but when and at what prices. The answer is one on which fortunes will be made and lost in the next decade.

Llenrock Group

Friday, October 31, 2008

Multifamily Fundamentals in Question

Multifamily is the sector of commercial real estate most directly tied to the broader housing market that has been at the root of America's financial market slump. While the different subgroups of multifamily are being affected differently by today's market, it's generally safe to say that funding multifamily development and acquisition has gotten more difficult, and the trends that had been expected to drive up rents and occupancies have so far failed to show up in many markets. However, compared to other commercial real estate sectors, multifamily has held its own with major owners such as Camden Property Trust and AIMCO reporting flat or slightly positive 3Q08 results.

According to the National Multi Housing Council's latest survey, multifamily industry insiders feel the market is at historic lows in terms of investment volume and availability of capital. With unemployment rising and the national economy in general decline expect fundamentals like occupancy and rents to start declining as well, especially in areas hit hard by job losses. Hopefully some of the 'vulture capital' waiting on the sidelines will soon become active and start transactions flowing again, but for now with buyers and sellers at a stand-still, it's important to remember that medium and long-term trends still bode well for multifamily rental properties.

In the medium term, continued turmoil in the for-sale housing market, projected to last from 6 to 24 more months, will keep renters renting and return some former homeowners to the rental market due to foreclosure. This should keep occupancies relatively healthy although these are not the type of renters who can support big rent growth. Additionally, lenders should return to multifamily before they look at other sectors because of government backing through Fannie & Freddie and the commodity nature of rental housing - consumers will stop shopping, dining out, and traveling before they stop renting a place to live.

In the long term, demand for rental housing should be very strong thanks to general demographic trends toward a younger, more mobile, more urban population. Arthur C. Nelson from the University of Utah predicts that between now and 2020, 72% of new housing stock should be built as rental units in order to maintain relative supply-demand balance. Hopefully we can keep these long term trends in mind as we wait for the good deals to make their way to market.

Llenrock Group

Monday, October 27, 2008

Damage to Hotel Fundamentals Contained?

Hotel investors have been waiting for the proverbial 'other shoe' to drop on the fundamentals of the U.S. lodging sector for some time now, and with the release of Smith Travel Research's latest forecast it seems that 'other shoe' is hitting the ground hard. For the month of September STR reports industry-wide RevPAR (Revenue Per Available Room) is down 2-4% year-over-year, with the lower end of the market being hit hardest as consumers feel the economic pinch. STR is projecting a meager RevPAR increase of 0.4% for all of 2008, which would be even worse if not for stronger performance early in the year. Going forward, STR projects RevPAR will decline by 2.5% in 2009 driven by declining occupancy rates that will continue through 2010 before bottoming out at 58.7%.

Until the economic upheaval of the past two months went global, international tourism was helping to prop-up hotel fundamentals in many markets. The weak dollar was attracting European, Asian, and Middle Eastern visitors to New York, L.A., Vegas, Chicago, San Francisco, and Miami. But now the dollar is strengthening, making visiting the U.S. more expensive, and even wealthy tourists are being hit by declining worldwide stock markets and rampant uncertainty. International tourist magnet New York City is seeing a decline in bookings going forward and is preparing for a weak holiday tourist season. This despite the fact that many analysts had predicted New York would act as a 'value alternative' to a European vacation for many U.S. travelers.

On the bright side, overbuilding appears to be contained and the tight credit markets should keep new supply in check for the foreseeable future. Few new hotel development projects are coming out of the ground right now and deliveries of new rooms should slow to a crawl as we get into 2009. There could be another six to twelve months of very tight financing for hotel construction, keeping construction starts to a minimum in all but the economy sector, and allowing us to come of out of the current downturn with a relatively healthy supply-demand balance, leading to a faster recovery. Only select markets with unique growth stories will see significant new development over the next year, but developers with deep pockets should find plenty of opportunities for bargain purchases, repositionings, and bailouts of weaker operators.

Llenrock Group

Monday, October 13, 2008

Retail Fundamentals Shaky at Best

The fundamentals in the retail real estate sector eventually boil down to American's propensity to consume. If people are buying, stores will open, vacancy will decrease, rents will rise, developers will build and the world will keep on spinning. If, for any reason, people stop spending this process goes into reverse and can unravel quickly. This reversal can be especially painful when retailers have spent the past decade expanding at breakneck pace and now have to pull-back double-speed to maintain profitability - see Starbucks' recent experience for a prime example.

September's retail sales numbers show only 1% growth year over year, the worst performance since September 2001, mostly attributable to the economy-wide slow-down and financial crisis. This growth hides the fact that while most retailers struggle mightily a few are actually benefiting from the economic hard times. Apparel and luxury goods retailers are being hit hardest with sales at Neiman Marcus, Sak's, and Nordstroms down 15.8%, 10.9%, and 9.6% respectively. The bright spots are warehouse stores and discounters where consumers can stock up on essentials at bargain prices. BJ's and Costco saw sales increase by 10.4% and 7% respectively showing that consumers were still spending in September, they just shifted from the mall to the power-center.

It is yet to be seen how falling gas prices, government bailout packages, and a roller-coaster stock market will affect consumer spending patterns through the crucial holiday season, but it is safe to say that while uncertainty reigns the safest bets are in core markets that haven't taken major hits in terms of housing price declines and job losses.

Retail developers that we've spoken to seem to think conditions are still good for non-luxury retailers selling essential products at good prices. Many also think that the 'near-luxury' retailers will attract those customers who want to be prudent but don't want to go all the way down the scale to shop at the discounters and warehouse store. Another area of optimism has been urban markets in dense, central-city locations, although if financial sector job cuts increase, these CBD markets could lose many of the high-earning consumers that make them so attractive.

One bright spot in the retail sector is that, largely due to high construction costs and the credit crunch of the past year, overbuilding has been contained. Many lenders and equity sources have dropped out of the retail game altogether, and those that remain are keeping LTV's low and raising the cap-rates at which they value properties. In today's environment stricter underwriting should continue to keep speculative building in check and keep all but the strongest projects on the sidelines until the consumers come back.

Llenrock Group

Thursday, October 9, 2008

Remember When Fundamentals Were Strong?

For most of the past summer the mantra of the commercial real estate industry was that while the residential market was being battered and capital was harder than ever to come by, the fundamentals of commercial real estate were still strong. This attitude naturally led to the conclusion that as long as fundamentals were strong commercial real estate pricing didn't have to drop by much.

Well so long summer. It has become obvious over the first few weeks of autumn that the fundamentals of commercial real estate are weak and getting weaker and consequently pricing will have to adjust accordingly. The one bright spot for those of us on the transactional side of the business is that falling prices may lead to a slight uptick in transaction volume.

Over the next few days we'll take a quick look at the current state of the fundamentals across various property sectors, starting with retail tomorrow, perhaps the sector with the weakest outlook from today's vantage point. We'll also try to highlight the bright spots in each sector, to give you an idea of the type of deals that can still get done even in today's market.

Llenrock Group

Wednesday, October 1, 2008

Bailout or Bargain?

It is becoming apparent that part of the reason for the initial failure of the $700B federal 'liquidity boost' earlier this week was the fact that it was consistently presented to the public as a bailout using taxpayer dollars - a sickening prospect for many Americans. Given that we're in an election year many representatives couldn't bring themselves to vote for anything that sounded like it threw a tax-funded lifeline to 'greedy Wall Street tycoons.'

In the banking world however, the term bailout has recently sounded pretty good, and could easily be confused with another B-word: Bargain. The 'bailouts' of Washington Mutual and Wachovia by JPMorgan Chase and Citigroup respectively look, to many observers, like really smart acquisitions. Both JPMorgan and Citigroup were able to massively increase their geographic footprint overnight while at the same time accessing the heaping piles of consumer bank deposits held by WaMu and Wachovia. Not to mention the two acquiring banks pulled this off at a time when raising capital for acquisitions is more difficult than ever before.

JPMorgan's bargain purchase cost it all of $1.9B. For this price the New York bank took over the Seattle-based WaMu's $900B in deposits and 2,239 branches in 15 states while taking on almost none of its liabilities. Citigroup seems to have gotten a sweet deal as well, paying $2.16B for Wachovia's banking operations. For this Citi gets over $700B of Wachovia's assets and takes on only $53B of Wachovia debt. The FDIC is even insuring some of Wachovia's riskiest assets such as option ARM mortgages to reduce Citigroup's risk.

There are at least three important lessons for commercial real estate imbedded in these two 'bailouts':

1. Negative hype creates bargain opportunities - look for chances to bailout assets whose prices are beat down because of rumors, hype, or lack of liquidity, but where fundamentals remain strong.
2. Make sure you have strong guarantors - Citi and JPMorgan got the federal government to back them up in these acquisitions. You may not have the full-faith-and-credit, but sponsors with high net worth and strong experience can still get deals done in today's environment.
3. Be ready to act swiftly - keep your powder dry and be ready for that late night phone call telling you that a prime asset is hitting the sales block. If you're the only capable buyer who shows up you may just get a bargain.

Llenrock Group

Thursday, September 25, 2008

Even in Bankruptcy Buyers & Sellers Disagree

If you (like myself and many others) thought Lehman Brothers' bankruptcy would force them to sell off real estate assets at fire-sale prices think again. Even under the pressure of a very public meltdown Lehman was able to bargain with Barclay's to split the difference between two different appraised values on Lehman's million-square-foot, 7th Avenue Manhattan headquarters. An appraisal prepared for Lehman Brothers valued the building at $1.02 billion while Barclay's appraisal came in at $900 million.

This is a scenario we've been seeing a lot of in the markets in general, and until transaction volume picks up and the economy achieves some level of short-term stability we won't be surprised to see more and more variation among appraisals and values in general.

Llenrock Group

Wednesday, September 24, 2008

The Trouble with Marking to Market

At first read this article sounded like really good news for the economy in general and the real estate industry in particular. It's basic premise is that many banks' balance sheets look worse than they really are because of laws requiring them to 'mark to market' their mortgage holdings. After a few quarters of major write-downs most banks' balance sheets now represent a worst-case, fire-sale scenario even if they plan to hold their loans to maturity or work them out. Given the lack of volume in the secondary markets, it is often impossible to accurately mark these assets to market in the first place meaning that the write-downs we've seen so far are likely far from how things will eventually shake out. In some cases the write-downs will probably turn out to be insufficient, but in many other cases I suspect that a year from now banks will have extra capital freed when marked-down assets turn out to be more valuable than expected. Even Sam Zell points to this marking to market as a major cause of our current problems.

The bad news is that for now no one can tell what these assets are really worth so we must, by law, go with very conservative estimates. This means that even those healthy banks who don't need to fire-sale their assets look sick and will be restrained in new lending until things shake out and they know what their true balance sheets look like. This could take a while, so sit back and relax through the next few months, or if you're more proactive and sitting on a pile of cash get out there and pay top-dollar for mortgage assets and get these markets rolling again! Oh wait, I think Uncle Sam might just do that for you, that's fine...

Llenrock Group

Wednesday, September 17, 2008

What a Week...And it's Wednesday

During the past week we've had a whole year's worth of financial markets drama including the bankruptcy of Lehman Brothers, Bank of America's acquisition of Merrill Lynch, the last-second government bailout of AIG, and the subsequent drop in stock market values worldwide.

For the commercial real estate industry, this week should serve as a reality check for those who have refused to accept that property values must come down as the general economy continues to weaken. Any property owner with a Lehman Brothers mortgage, AIG property insurance, or with Lehman, Merrill, or AIG as tenants should be feeling at least a tiny bit nervous. On a more market-wide basis a huge amount of investor capital has been wiped out by the decline in the stock markets, and the capital that is left will be even more cautious about entering the real estate markets. This will mean even stricter underwriting for all types of investments going forward, and a continuing denominator effect for institutional real estate investors who are limited in the percent of their portfolio allocated to commercial real estate. We have already begun to see more onerous terms from some of the lenders we work with even while things are still shaking out.

The good news is that the disruption in the markets should finally force the sale of a significant number of assets and set new pricing levels that make sense in today's markets. Once investors figure out where prices are, under the new reality, transaction volume should increase going forward even if the dollar amount of transactions declines alongside pricing. We've already seen one 'distressed' asset sale due to Lehman's bankruptcy with Barclays' agreeing to buy Lehman's NYC headquarters along with two New Jersey properties for $1.5B.

As is always the case in a downturn there are certainly opportunities in the current turmoil, and finding them should provide for an interesting market going forward.

Llenrock Group

Monday, September 8, 2008

Fannie & Freddie - Winners & Losers

While early indications are that the GSE bailout announced this weekend will have little direct effect on Fannie Mae and Freddie Mac's multifamily lending, there will certainly be indirect consequences for commercial real estate. A few potential scenarios to keep an eye out for:

  • Today's drop in consumer mortgage rates to a sub-6% level not seen since mid-May could bring home-buyers back into the market. This would go a long way towards turning around the overall economy, but may hurt multifamily rental fundamentals given that some percentage of current renters are would-be homebuyers waiting for mortgage rates to improve.
  • As the spreads for GSE bonds narrow investors will be forced to balance the reduced risk of an explicit government backing with lower yields. The investors who still have an appetite for higher-yielding, real estate-backed debt may eventually restart the securitized debt markets.
  • Equity-investors in the GSE's, who's positions have been wiped out by the bailout, will be licking their wounds, but the ones who got out early may have free capital to reallocate to REIT's or homebuilders, two equity real estate plays that look pretty beat down.
The continuing Fannie & Freddie saga should be fun to watch no matter what happens.

Llenrock Group

Friday, August 15, 2008

Branding in Student Housing - Why?

This article is the latest of several I've read that mention the concept of flagging or branding student housing developments across multiple campuses. Flagging is a concept traditionally used in the hotel sector where a property's flag or brand can be just as important as its location, design, or management. Building customer loyalty and having a centralized reservations and rewards system are the main benefits of flagging for hotels, but it doesn't seem like these benefits would apply to student housing because most students don't go from campus to campus, taking their "brand loyalty" with them.

Students make housing choices based on price, amenities, proximity to campus, and of course where their friends live. It seems like student housing developers would be better served by focusing on maximizing these factors, and focusing branding efforts on building a local reputation as the 'cool' place to live instead of attempting to build nationwide brands. Local branding, such as that practiced by Campus Apartments, may make more sense because it focuses on building a reputation among students at each individual university as opposed to creating a nationwide brand that's leveraged over a few campuses. Most students who rent from Campus Apartments don't even realize that the company owns and operates properties nationwide at over 50 campuses, but they do know that it has a great reputation on their campus.

Maybe I'm wrong on this though because the first property under construction for the new Wave's Z Islander flag, mentioned in the article, was able to obtain an 80% LTC construction loan which in today's market is saying that somebody sure thinks it's a great idea.

Llenrock Group

Monday, August 11, 2008

Signs of the Times...

Two distressing articles paint a scary picture of the economy going forward, but in one commercial real estate seems to be a relative bright spot.

The first article, from NREI, describes the losses over the past fiscal year at CalPERS and CalSTRS, two of the nation's largest pension funds. Although mild at 2.4% and 3.7% respectively, these losses are unusual for these massive institutions - CalPERS has earned positive returns in 21 of the past 25 years. The bright spot for the commercial real estate industry here is that the two pension funds' real estate investments returned 8.1% and 11.8% over the past year, with most of these gains coming in the second half of 2007. Unfortunately the 'denominator effect' will cause both funds to allocate less money to real estate investment as long as the value of their other holdings keep going down in order to maintain target asset allocations.

This article from CBS Marketwatch describes the Fed's survey of 52 banks which shows that a majority of them have tightened credit standards across the board. In fact 81% of banks surveyed tightened lending standards for commercial real estate. Given that this is a backward-looking survey we can hope that the tightening is slowing, but most of the sentiment in the market seems to be that it will only get harder over the next year.

So, with banks out of the picture and pension funds likely to pull back on real estate investing, the pool of capital is shallower than ever. Over the next year (or more?) those who can creatively source funding for deals will likely come out ahead.

Llenrock Group

Tuesday, July 29, 2008

Flavor of the Moment: Student Housing

One sector of commercial real estate that has been bucking the downturn of late is student housing. The sector is considered largely recession proof for several reasons and investors seem to be noticing as student housing REIT's have been performing well year to date.

Reasons that student housing is considered recession resistant include:

  • Students' parents are often required to cosign on leases. This puts the student and the parents on the hook for the rent, and reduces credit risk compared to traditional multifamily developments.
  • Recessions often increase enrollment at colleges and universities as tighter job markets make going back-to-school more attractive relative to working. This leads to increased demand for the already scarce housing around many campuses.
  • The current downturn happens to coincide with a trend of colleges and universities realizing the benefits of outsourcing the development and management of student housing. Developers seem to be doing a good job so far of delivering housing developments that have amenities that students want and are willing to pay for.
  • Even though the credit markets are frozen it's still easy to get student loans that can help pay for the newest and best in campus living.
Perhaps the biggest reason that so many student housing developments are succeeding in today's environment is that they can be relatively easy to finance. Colleges and universities will often put up some of the equity required for these projects, and, even with its recent troubles, Fannie Mae has been actively lending on student housing ($264MM in the first half of 2008).

Llenrock Group

Monday, July 21, 2008

Foreign Capital Magnet - The New Politics

Always a cheerleader for America, Rudy Giuliani's latest endeavor may even help reinvigorate American commercial real estate markets. His Giuliani Partners business, which up until this point has focused on security and management consulting, will venture into commercial real estate investing backed largely by foreign capital raised through Rudy's extensive network of relationships. It seems like this could be a win-win-win for all involved as much of the U.S. real estate market is in need of eager capital, Giuliani's investors stand to make excellent returns over the long haul, and Giuliani earns another star in his cap for any future political runs (an attempt at the New York governor's office is rumored).

My one concern is that a fund headed by a former New York City mayor will have a strong bias towards investing in NYC - the one market in which foreign capital needs little convincing to invest, as evidenced by the Chrysler Building stake recently purchased by Abu Dhabi. A real boost to the U.S. commercial real estate market would come if the Dubai's and Qatar's of the world started investing their petro-dollars in secondary and tertiary markets. Places like Houston, Charlotte, and Seattle still have healthy economies and never saw the overbuilding experienced by Phoenix, Miami, or Vegas. However a lack of capital is slowing real estate investment nationwide, taking the good down with the bad.

Additionally, a contrarian case could be made for investing in the most beat-up markets while they're down. Any patient capital that can be strategically invested in battered markets like Phoenix or Detroit stands to reap huge benefits as those markets gradually recover (or IF they recover in the case of Detroit).

Maybe other out-of-office politicians will follow Giuliani's lead and use their clout to encourage foreign money to jump into secondary U.S. cities. Imagine what Clinton Capital Partners could do for Little Rock...

Llenrock Group

Friday, July 11, 2008

Uncertainty for Multifamily on the Way?

During the current commercial real estate downturn for-rent multifamily has consistently been considered the best bet among the four major flavors of commercial real estate. Multifamily investors expect improving fundamentals thanks to foreclosure-displaced homeowners becoming renters and would-be buyers continuing to rent while waiting for a turn-around.

Beyond these fundamentals, the biggest driver of the multifamily market's relative strength has been the continued availability of inexpensive debt from Fannie Mae and Freddie Mac while financing for other property types has become increasingly hard to come by. Now as questions about Fannie & Freddie's solvency rise to the surface multifamily investment may be in for a slowdown. Uncertainty about the ability for multifamily buyers and developers to secure debt will cause equity players to be more cautious. Additionally, even if the government bails out Fannie & Freddie the main focus will likely be on maintaining liquidity for the owner-occupied mortgage market, potentially at the expense of commercial lending programs.

The question then becomes which of three scenarios will play out: Will Fannie and Freddie regain their footing, either with or without government help, and continue to provide a backstop for multifamily investment? Will private players such as banks or life insurers step up to fill a void left by the uncertainty at the GSE's? OR Will the trouble at Fannie & Freddie be the straw that breaks the back of multifamily investment, making it just as difficult to finance in today's market as other property types?

Llenrock Group

Wednesday, July 9, 2008

Observations from a long weekend...

Over the Fourth of July weekend I tried to turn my real estate brain off, but I couldn't help noticing a few interesting things:

  • On a Saturday evening at a pizza joint I overheard a casual conversation about buying packages of distressed residential debt from troubled banks. Seems the vultures are coming out to feed on pizza and troubled loans...
  • While on Cape Cod I saw a slew of retail condominium units for sale, always in strips of 3 to 5 units. They seemed to be the local 'flavor of the week' that had been overbuilt but were now sitting empty as retailers avoid buying into unproven locations while consumer confidence is so weak. A microcosm of the larger retail scene perhaps?
  • On the drive home from New England I missed an exit and ended up going through New York City. I don't think I hit my brakes once on a stretch of road that kept me in traffic for hours last winter. Maybe gas prices really are keeping folks off the road...
Check back soon for our take on the rising importance of sovereign wealth funds and whether the real estate markets have hit a point of capitulation.

Llenrock Group

Monday, June 30, 2008

Point of Capitulation?

We've been wondering for a while if commercial real estate, and the economy in general for that matter, is close to a 'point of capitulation' at which buyers and sellers will get tired of the standoff, adjust prices to close deals, and transaction volume will start to rise. From our vantage point as financial intermediaries and principal investors it seems that most buyers are still factoring a lot of downside risk into their offers and sellers are still having a hard time believing that their property values have really decreased. At the same time lenders, always conservative even in good times, are assuming the worst when valuing many properties. At some point it seems that someone or everyone will have to give a little and hopefully a snowball effect will be achieved.

We're still not sure when we'll reach this point of capitulation or what the 'last straw' will be, but this interview with Hugh Kelly makes a good point by reminding us that real estate investors are at base always buying future cash flows, and those likely haven't been impacted as severely over the long term as the market stalemate would lead us to believe. He also makes a great point that there's plenty of capital in the wings just waiting for a few signs of stability and rationality to return to the market before swooping in.

Another encouraging article is this one from CBS Marketwatch way back in 2002 pointing out that at that time investors saw a Dow Jones at 7,000 as the point of capitulation. It's encouraging that this time around the Dow looks like it should capitulate at a much higher value, and real estate values, even down 10-20%, will still be up significantly when viewed over a 5+ year time horizon.

Any ideas on when capitulation will be reached?

Llenrock Group

Wednesday, June 25, 2008

Shouldn't loan prices be coming down already?

Like many other investors Llenrock Group, through our Llenrock Realty Partners arm, has lately been in the market to buy discounted or distressed loans secured by commercial real estate. However, we've been finding that the situation in the secondary debt market is much the same as in the property markets: buyers and sellers just can't seem to reach an agreeable price and stalemate has set in. This standoff has been noticeable for a while now and predictions that loan transactions have to start picking up were being made almost a month ago but have not started coming true.

It seems to me that lenders looking to unload loans will have to start budging on their prices very soon. If property sales are at a stalemate that means there's a good chance that values will eventually start slipping to effectuate transactions. If values start slipping that means the value of the loans will decrease as well, in line with their collateral. Holders of loans would be wise to sell their loans now in an effort to conserve capital for another day and return some origination money to the streets in the form of new loans. The longer they wait the bigger discount buyers will demand and at some point, depending on how long the current downturn lasts, lenders may be forced to take what they can get.

Llenrock Group

Monday, June 16, 2008

Foreign investors must do a lot of homework...

After our last post about foreign buyers jumping into U.S. commercial real estate I began thinking about the variables at work driving their decisions. In addition to real estate fundamentals such as occupancy levels, rent trajectories, and new supply competition, foreign investors must also take into account currency exchange rates and changes in U.S. interest rates which affect real estate returns and exchange rates. Varying levels of structural risk across borders also come into play when seeking the highest risk-adjusted returns.

The most subjective of these factors may actually be the one that's easiest for international investors to assess - structural risk. While difficult to measure empirically, most investors intuitively consider the United States a very low-structural-risk investment environment due to our well-regulated, liquid, and long-established markets. This perception of low risk is evidenced by the fact that China, while criticizing U.S. economic policy, continues to hold most of its $1.76 trillion in foreign reserves in U.S. dollars as opposed to Brazilian Real or even Japanese Yen.

Exchange rates are trickier. To many foreign investors dollar-denominated assets must look like historic bargains right now as the dollar sits near low-water-marks against many foreign currencies (see historical chart of the NYBOT US Dollar Index below). However, if the dollar continues to weaken long-term, buying dollar-denominated real estate could be a disaster for global buyers.

After considering structural risk and current exchange rates, foreign investors still have one more piece of homework to do. They must make a careful bet on the trajectory of U.S. interest rates. If recent inflation-focused comments by various Fed officials are any indication, monetary policy could soon become less accommodative. If foreign investors foresee the Fed raising rates in the future, investment in the U.S. may look good from a currency speculation perspective, but the prospect of higher nominal interest rates could still point them towards waiting out the downturn before investing in American real estate.

This myriad of complex and interrelated decision drivers helps to explain why some foreign investors seem to think it's a great time to pour money into American assets (like Florida condos) while others are happy to sit on the sidelines and watch. What do you think they should be doing?

Llenrock Group

Thursday, June 12, 2008

Foreign Capital to the Rescue...on the cheap?

News that the emirate of Abu Dhabi is in talks to purchase Prudential Financial's stake in NYC's iconic Chrysler Building makes foreign capital look more and more like the backstop of American commercial real estate values. However it looks like foreign investors are demanding bargain pricing just like everyone else, even if they do have plentiful access to capital and historically favorable exchange rates.

It seems the recent GM Building sale (see 5/27/08 post) for $1400/sf may have been an anomaly for Manhattan office pricing. The equally 'high-cache' Chrysler Building trade is hovering around $883/sf, and Deutsche Bank is currently trying to unload seven other Class-A Manhattan office towers with pricing in the $835-$850/sf range. This pricing is down significantly from what the buildings would have been worth pre-credit-crunch, but maybe prices are reaching a point where more foreign investors will get off the sidelines and the volume of trades will start to pick up.

It's also interesting to note that the Chrysler Building trade doesn't involve a foreclosure or work-out scenario (the GM Building and Deutsche Bank portfolio were part of the Macklowe debacle). It's a straight-up open market sale from a non-desperate seller to a non-desperate buyer providing a sense that true property values really are coming down across the board.

Any thoughts on where the next low-water-mark in pricing will come from? Better yet thoughts on when we'll be trending up again? Will the turnaround in pricing come from foreign buyers rushing into US properties in anticipation of a rising dollar?

Llenrock Group

"You'll stay up till this dump shines like the top of the Chrysler Building!"

-"Hard Knock Life" Annie

Thursday, June 5, 2008

Real Estate as Substitute for Commodities?

Some of you may have noticed the poll in the right-hand column of our blog asking for your opinion on the next hot property type and including the option of 'farm land.' This article in today's NYT shows that agricultural land is getting hotter as more institutional investors use land acquisition as a way to make bets on rising food prices. As the lending world catches up it will be interesting to see if these investors can leverage up their commodities bets with low-interest, high leverage, real estate backed loans.

This article also struck me as one of the few times I've seen Sub-Saharan Africa listed among property markets receiving interest from institutional investors. Could this be the innovation needed to add African countries to the list of true emerging markets in real estate? Institutional investment on this scale sounds like a potential boon to a continent that has been off the radar screens of international capital for decades.

Another question is the effect that institutional investment in farm land will have on the 'green movement.' These two trends are intertwined on many levels - increased production and use of biofuels; open space preservation; and revaluing of ex-urban land to reflect agricultural uses instead of development - but the relationship between agricultural investment and the greening of the world's economies is highly complex and will need to be approached carefully from the start.

Finally, let's hope that since the current interest in farm land was prompted by a bubbly run-up in food prices investors will be careful not to create yet another hype- and liquidity-driven bubble in the price of farm land. This article outlines the already steep price run-ups of some agricultural stocks.


Llenrock Group

Monday, June 2, 2008

Best Hotel Flags Debate Continues...

A fun analogy that I heard from a hotel developer last week: the hotel industry is in many ways similar to the Japanese auto industry when it comes to the perceived quality differences among brands. This is one of those analogies that could easily be taken to far, but it is interesting to think about the similarities.

If we assume that the top two major automakers, in terms of perceived quality and resale value, are Toyota and Honda they seem to match up pretty nicely with the top two hotel franchises, Marriott and Hilton. It's broadly accepted that those two are the best, but when it comes to declaring a clear winner it's more a matter of taste and opinion than hard facts. You could say the Camry and Accord are the reliable workhorse models in the same way Courtyard and Hampton Inn generate volume and solid earnings for Marriott and Hilton. To take it a step further the Lexus and Acura luxury brands represent the same play for the high-end consumer as the Ritz Carlton and Waldorf Astoria brands. In both industries it gets a little murkier after the top two brands, but that doesn't mean that Nissan and Mazda aren't selling plenty of cars or that Starwood and Intercontinental don't have some great hotels, they just aren't up to that top tier.

In both the car and hotel worlds it's all about careful market segmentation and creating customer loyalty that leads to repeat customers coming back to buy more and more expensive products, be they cars or room nights.

Given the success of the Prius and other hybrid cars should we expect all the major players to introduce green hotels soon, or am I taking the analogy too far?

Llenrock Group

Tuesday, May 27, 2008

Boston Properties Buy Confirms '08 Predictions

News of Boston Properties' $4B purchase of the GM building and other Manhattan assets from the Macklowe family shows that a lot of the predictions for 2008 are coming true. For example:

  • It has been apparent for a while that many buyers were over-leveraged and it was only a matter of time before it caught up to them. This may be the biggest example yet of a sale forced by the tightening capital markets, but it probably won't be the last.
  • Coming into 2008 everyone said low-leverage buyers, such as REIT's, would be the most active in 2008 - Boston Properties doesn't disappoint here. Although assumed debt represents 63% of this transaction, that's far below the almost 99% leverage Macklowe used last February to buy the EOP portfolio that now has him in trouble as the loans come due.
  • Many market observers predicted that the major players would consolidate in major markets as riskier secondary and tertiary markets bear the brunt of the downturn. Trophy office properties in Manhattan certainly qualify as major and this looks like a low-risk buy even at a record-setting price.
Thoughts on any other '08 predictions that are coming true?

Llenrock Group

Friday, May 23, 2008

Government Assistance Can Make Weak Markets Attractive

As the capital markets continue to make it harder to get all but the best deals done it's important for developers to be creative in how they can make their projects attractive to investors and lenders, especially in markets that have been hit hard by the economic downturn and housing slump.

One way to make projects in tough markets pencil out is to get local or state governments to pony up for a portion of a project's costs, something more and more municipalities are willing to do in order to have more say in the way development shapes their communities. In Michigan, one of the hardest hit areas in the recent downturn, the city of Troy is working with developers to redevelop a brownfield site into a town center in hopes of creating the walkable downtown that Troy has never had (Article).

Another great example of government assistance making otherwise impossible developments pencil out comes from Camden, NJ. There the Victor Apartments, completed in 2004, would have never penciled out, even during the times of easy capital, without the state selling the building for $1 to offset environmental remediation costs and investing $900MM in a light rail line linking Camden to the state capital in Trenton as well as other infrastructure improvements. The success of this building and continued government investment has subsequently spurred office and now hotel development along the Camden waterfront.

If you're looking to develop in a weak market in today's tough environment getting government assistance with development costs should be a top priority.

Llenrock Group

Friday, May 16, 2008

Perfect Storm for Brownfield Redevelopment

One of the ironies of the current real estate market is that while lenders, investors, and developers have become more risk averse due to the shaky economy one formerly high-risk type of development, brownfield redevelopment in urban areas, has become a sort of industry darling and may be one of the easier types of development to get done in today's environment. In my opinion a perfect storm of macro-economic and social trends are making brownfield redevelopment highly attractive right now. These trends include:

  • Higher gasoline costs - dense infill redevelopment looks better and better as gas passes $4.00 per gallon
  • The green movement - more individuals, companies, and municipalities are focused on creating green and sustainable environments in which to live and work.
  • A re-urbanizing workforce - today's workforce is showing an increasing preference for urban living and many employers and retailers are re-urbanizing as well to be close to their employees or patrons.
  • Relatively inexpensive infill land - government incentives, reusable existing structures, in-place infrastructure, and a limited number of qualified buyers make brownfield sites price-competitive with greenfield land.
  • Increasing comfort with environmental risks - developers, lenders, and investors have all become more comfortable with the ins-and-outs of environmental risks and rehabilitation.
The Hudson Yards redevelopment saga, currently ongoing in NYC, is a great case study in the current ups-and-downs of urban redevelopment, watching how it unfolds will be a great indicator of what can and can't be done with urban brownfield sites. One deal falls through, another pops up...

Llenrock Group

Thursday, May 15, 2008

Conference & Meeting Space in a Down Market

The hospitality industry is considered especially vulnerable to market ups and downs, partly because of the short term nature of it’s “leases” – most tenants only stay a few nights. The next step up in terms of lease length would have to be conference and meeting space, which is often contained within and correlated to the performance of hotel properties. However it is not as clear cut how demand for this space reacts to a down market as most events are planned far in advance, and many, such as the annual ICSC convention, are considered an indispensible part of doing business.

When investing in hotels that include meeting space it’s important to consider how it will interplay with the core hotel business, and how market and macroeconomic trends will affect demand for this space differently than for the hotel property as a whole.

For example will the recent trend of including more leasable conference space in new office buildings (see article here) hurt hotels’ business, or will it allow them to focus more capital and square footage on revenue-generating hotel rooms? Thoughts and anecdotes are welcome on this one.

Llenrock Group

Wednesday, May 14, 2008

Hotel Operators Perceived as More Stable than Lenders too

The recent Wall Street Journal article on the disparity in financial performance between hotel operators and hotel owners (read it here) shows a slightly different angle on one of the biggest issues that we’re seeing when trying to finance hotel development, acquisition, or repositioning deals. Lenders are refusing to consider deals that don’t involve proven brands and experienced hotel management teams.

It isn’t uncommon these days for lenders to list only three or four hotel flags that they’re willing to lend on, and even with the right flag they expect to see highly experienced hotel development and management teams in place before moving forward on a project. This is true even for developers with deep pockets and plenty of experience in non-hospitality real estate.

After reading the WSJ article it becomes apparent why lenders are so concerned about the branding and management side of hotel properties: that’s where the money is being made right now as the real estate side of the business takes its lumps.

If you’re considering a hotel development project but don’t have experience in the industry or a relationship with a top-notch operator don’t give up, but do consider partnering with a more experienced player early on in the process. Having a major hotel developer and operator on board with your project from the start can increase the odds of success, especially in today’s ultra-conservative lending environment.

The Llenrock Group

Monday, May 12, 2008

Adding Value – Llenrock’s Overarching Goal

For the inaugural Llenrock blog entry it only seems fitting to spell out how this blog will add value for our clients, as adding value throughout the real estate development, financing, management, and disposition processes is what Llenrock is all about. It is our hope that this blog will allow us to provide current analysis and commentary on the trends and developments we’re seeing in the real estate marketplace, and that our readers will add this blog to their list of trusted information sources.

By combining intelligent discussion of current events, our experience in the marketplace, and in depth analysis of broad industry trends we will add to our readers’ understanding of what’s going on in the world of real estate and help them maximize value within that world. We will also offer unique perspectives from guest bloggers from the realms of academia, government, and the non-real estate business world.

We hope that this blog will provide a launching pad for further discussion, questions, and interaction across the broad spectrum of people who make up the commercial real estate community. So, please bookmark this site and check back often for updates on what’s going on in the world of real estate. Feel free to leave comments, ask questions, or suggest topics for future entries.


The Llenrock Group