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