January 2010

As a proud follower of the Austrian school, this was excellent:


Let me be clear up front – I do not believe in anthropomorphic climate change – the notion that man, in our industrial wonder, is ruining the earth with global warming.  I am a skeptic and my hackles come up when anyone in the scientific community (or political community) utters phrases like “it’s settled,” and “there can be no denying it.”  Science by its very nature of being “science” is always in pursuit of the truth and if data exists that challenges a theory, the theory must be re-examined.  My natural skepticism is being rewarded by the recent scandals at the University of East Anglia and NASA and now new findings that hundreds of data points that didn’t “fit the model” were left off the charts so that the global warming theory would be left intact.  The Russians have been saying for some time that we had better be buying furs and not sunscreen for several years.

Now, before I get the pointing finger, “Night of the Living Dead” outing, let me follow by saying that I heartily support “green” building practices.  I support them from the position of stewardship – we should minimize any impact we have, it is the right thing to do.  Reduce the amount of forests cleared? You bet! Re-use existing buildings? Absolutely – done that. Reduce heat impact in a neighborhood? Of course – white and green roofs.  And on it goes.  I believe this is the responsible way to develop and manage real estate. Transit oriented development to reduce man’s footprint? YES. Somewhere deep in my core is a Celtic Druidic gene that enervates my sense that trees and forests are sacred.  I am at peace paddling in a pristine river and I want those things to be there for my children, their children and beyond.  We are stewards of this incredible planet, and for those reasons, I support the green movement.

I have concerns, however, when property rights and values are jeopardized by fluctuating standards either by government or non-government organizations.  Such is the chilling case cited in an article this morning in the San Antonio Business Journal: “Risk of LEED Decertification Looms Large for Real Estate:”

As reported by the Villas County News-Review, a group of Wisconsin residents filed a 125-page complaint with the USGBC challenging the award of the LEED Gold certification to Northland Pines, which is generally credited as the first certified LEED Gold high school. The challenge was based on a little discussed provision in LEED 2009, which reserves the USGBC’s ability to revoke certification a project that fails to meet the program’s “Minimum Program Requirements,” which include requirements for minimum occupancy rates, site boundaries, and information-sharing about the project’s energy and water usage for five years after certification. It was reported that the USGBC sent independent examiners to Wisconsin to conduct on-site tests at Northland Pines to determine the project’s qualifications for LEED, and that a final determination on the school’s eligibility for LEED would be decided in early 2010.

Who are the “residents” who filed this complaint that got the ball rolling on potential decertification?  Now this is for a public high school, but consider the impact on commercial property.  This behavior opens the door for an irritated tenant to truly hurt the value of a building by filing a complaint with the USGBC over whether the owner is behaving properly green to maintain their LEED status.  It is widely viewed in our industry that there will be a premium for LEED certified buildings over time (this is unproven so far), but I believe it will be a deal enhancer as our practices become greener.  In an already badly roiled and potentially worsening market, we didn’t need this:

The ramifications of decertification pose significant threats to every party involved in a LEED project, including the owners, lenders, insurers, tenants, architects, engineers, consultants, contractors, and lawyers. As the LEED 2009 program is currently written, a project that achieved LEED certification today would never have absolute certainty that it could maintain that certification in perpetuity. That risk could threaten the validity of many of laws (like building codes), tax incentives, or financings that are currently tied to the LEED program. Given the many things that can change as buildings age — like air quality and energy efficiency — a LEED-certified building may perform as designed for years, only to lose certification many years later. This could result in buildings becoming unexpectedly out of compliance with building codes or with tax or incentive clawbacks (where incentives need to be paid back), and owners who find themselves in default under their leases and loans … overnight, without fair warning. Uncooperative tenants or failures in routine maintenance could lead to disastrous consequences.

The mission of the USGBC should be to promote responsible development, construction and operating practices for real estate.

This is best achieved with training and certification.  They will hurt their reputation immensely if they decide to go into the snitching and inspection business.  It also becomes enormously problematic if the rules are going to change year to year…that’s what “grandfathering” is for.  Perhaps the solution is to date the certifications so the consumer will know, i.e. “LEED Silver 2009.”  We don’t need shadowy figures taking tips from the neighbors on a foggy night – we need advocates and training to help us build a better product that has less impact on the environment…USGBC can do that.

Folks, this time of year I am up to my elbows in teaching over at the Owen School of Management at Vanderbilt.  I am blessed with the opportunity to work with some truly wonderful minds over there and I have to work very hard just to keep up.  This year, I have adjusted the syllabus a little to reflect the real world.  The course I teach is “Real Estate Finance,” and in times past, the focus has been on learning the basics of the craft with models and cases centered around real estate development.  In honor of the current times, I am shifting the discussion and case work to look more at the acquisition business.  Having done this now for five years, I have to admit I have a lot of respect for those teachers that energized a class room when I was in school…I am embarrassed they had to put up with me!

So, with my whining preamble, I must tend to matters at hand and share  some links for you to slap on your grill (or at least the screen of your laptop).  Put on a bib, these are juicy!

1. Ever wonder why man started planting and harvesting grain?  Don’t tell me you thought it was for bread!  Why it was for good old Pabst Blue Ribbon!  Now you know why beer is so good.  Just think, we can attribute by proxy all our current real estate problems to beer: a)man started farming for beer  b) man needed to establish property rights to protect his crop so he could have his beer c)modern real estate evolves so we can have our beer!

2. I am hearing a lot of gloom and doom these days – various interpretations on the general theme that America is finished.  I don’t think so, and neither does James Fallows over at the Atlantic magazine.  Read his thoughts here, it will cheer you up.

3. A corollary to the “America is finished” meme is that China is going to eat our lunch.  There is no question that China is an emerging international force and that we will be engaged with the Middle Kingdom for as long as both our systems survive.  But China has serious problems, not the least of which is an environmental nightmare they are creating.  Take a look at these pictures – not for the faint of heart – and you will start to understand that our problems are pretty manageable by comparison.

4. Do you feel guilty if you don’t recycle?  If so, then you need to peruse this article: “Green Guilt.”  I am all for protecting the environment and developing responsibly, but honestly, some of the green movement folks are starting to act like jihadis…environmentalism has replaced their religion, if they ever had any.

5. Here’s a little inspiration for you – if you think times are tough, imagine if you had no arms or legs.  How would you cope?  Here’s a video that shows the power of the human spirit:

Have a great weekend everybody!

As I am scribing this, the Dow is taking another header – down over 100 points at mid day East Coast time.  While uber-optimists and folks from the White House continue to crow about the recovery, my monthly talk around with bankers, equity players, small business owners and some insurance company execs tell another story.  The sentiment that bubbles up from this random survey that I do is reflected in the following chart:

Find the “You are here” dot in the lower right hand corner and it shows that the current recovery in the equities is well  below average in both duration and strength.  To wit, here are some summary comments from the folks I spoke to:

  • “Last year was just terrible for us, and with unemployment being what it is, we don’t see any improvement in 2010.  There’s so much uncertainty with what healthcare will cost and what the cap and trade legislation will do, that all our guys are just sitting tight.”  (Manager of a diversified holding company)
  • “We are seeing more not fewer foreclosures coming, people are out of gas and don’t see much hope down the pike.” (Commercial lender at a local bank.)
  • “In 2010, our focus is going to be on our existing assets.  The emphasis is on the cost side, we see no upside for income.” (Portfolio manager, large insurance company)
  • “They are telling us it’s 10% unemployment…try more like 18-20%.  There are no jobs out there, they didn’t stimulate anything but themselves.” (President, mid-sized construction company)

You get the picture.  These are man-on-the-street impressions, but provide valuable intelligence on the real state of affairs.  Turning back to the chart above, my sense is the only reason the equities are moving at all is because the cash in the mattress thing is uncomfortable.  Here’s another chart to consider:

This sort of points to what may lay ahead.  Those loans are either going to get reset or the assets behind them are going to find a new home.  The Fed is in a bind.  They have relaxed the accounting rules on the banks…from my friends at Casey Research:

Unfortunately, it has always been difficult to rely on reported financials as they are not forward looking, and a bank’s balance sheet can deteriorate quickly. To make matters worse, in the last year, changes in GAAP accounting measures make it much harder to evaluate the soundness of financial institutions. Banks are no longer required to report the value of their MBS (mortgage-backed securities) at market and can avoid write-downs that would affect their capitalization.

The Fed has also kept interest rates at historic lows for a historic length now, they don’t see that there’s much they can do – from the Wall Street Journal this morning:

Although Federal Reserve officials expect the economy to grow too slowly this year to bring the jobless rate down substantially, they are likely to conclude at their Jan 26-27 meeting that there isn’t much they can do about it.

That means sticking to their stated plans to end purchases of mortgages at the end of  March (!), roll back emergency lending programs in February and maintain interest rates exceptionally low for at least several more months.

I am reminded of the Admiral Stockdale quote in the VP debate back in 1992: “Out of ammo!”

Look, the way out of this is to reduce the fear that every producer of value, aka businessman, feels.  We have done such a poor job teaching economics, that there seems to be a plurality of people that now genuinely believe that the government creates jobs.  Ahem, the jobs that they do create are paid for by the private sector!  The government is not a “for profit” entity.  There are estimates that up to $4 Trillion worth of private capital is sitting on the sidelines.  We need to get that money into the system, circulating with that magical multiplier effect.  That money is a whole lot better than the printed kind coming out of Washington right now.  So how to do it?  Here is my humble “five points to fix the economy” strategy:

  1. Suspend the capital gains tax for the next three years or until GDP growth goes north of 5%, then bring it back in gradually.  This will facilitate the movement of assets and movement of capital to higher and better uses.
  2. Shelve the current healthcare bill and start over.  Start with a bi-partisan commission that arrives at an agreed upon list of problems that need to be addressed and pledge that any legislation will address those problems.  If Washington wants to handle problems, take on the ones they have already created: Social Security and Medicare which are both going in the red at a precipitous pace.
  3. Shelve the cap and trade legislation. Just end it, period.  There is a growing body of evidence that the earth is actually cooling, the climate debate is not “settled.”
  4. Cease government insurance for private entities.  This is a distortion of market economics and encourages irresponsible behavior.  One need look no further than Fannie Mae and Freddie Mac to see that this is true.  These two entities were at the core of the housing melt down, and need to be wound down immediately.  Let’s reinsert some personal responsibility into economic decision making.
  5. Reduce corporate income taxes to 20%.  At present, the 35% rate coupled with an average state tax burden of 10-12% puts U.S. corporations at an enormous competitive disadvantage.  Restricting profitability and growth.

These are modest proposals, but any one of them would be enough to mitigate the sense of doom that is almost palpable in the business community.

When you have this:

You will end up with this:

As a column over at Investors Business Daily points out, the ponzi scheme that is “Social Security,” is collapsing far ahead of the original schedule for 2019.  This is extremely serious and yet no one in Washington is even talking about it right now.  Yet, in secret, they are crafting some kind of takeover of the medical system and increased expenditure from the Federal Treasury.  Either we start creating jobs (aka “funding source for the gov’ment”) or we will have to sharply curtail benefits.

Recognizing that all developers are not a sordid, greedy lot, some cities are jumping in with private/public partnerships to rescue deals that make sense.  From Reuters:

Las Vegas’ city council voted last month to move its city hall, a decision Mayor Oscar Goodman called a “mini-stimulus.” It is a complicated deal that frees up the building’s attractive current location for the development of a district anchored by a sports arena, since Vegas hopes to attract a Major League franchise.

“The city needs something like this right now,” said Eric Louttit, Vice President of Finance at Forest City Enterprises Inc, a national developer of retail, office and apartment properties.

Louttit, the project developer of Forest City’s Las Vegas land, said that, without the move, downtown development could remain stalled for years.

The Las Vegas experience is a good model of a public-private partnership, said Thomas Powell, CEO of ELP Capital Inc, an investment advisory firm that buys real estate debt and equity, mostly in the western United States.

Such partnerships are more important because of the dearth of private capital and because city-controlled land is key at a time when many mid-sized cities are looking to revive their downtowns. The crisis, meanwhile, has made city and state government officials more willing to work with business, since they are keen for any incremental tax revenue.

Conceptually I am on board with this idea.  Win win – the city gets the new city hall that they need, the developer gets to stay alive and build projects that provide the “incremental tax revenue.”  The article in Reuters sited a couple of other examples…Cleveland for one.

The problem I have with this is three-fold.  One, this opens the door for corruption on a scale not seen before…campaign contributions lead to approved projects?  Second, the influence going the other way could be just as detrimental – Madam City Councilwoman decides she doesn’t like the color of the stucco the architect has chosen…”repaint it all or suffer the consequences” she shrieks!  Third, I am just about done with government involvement in real estate.  Government does not create jobs that are self-sustaining.  One need look no further than the shattered hulks of Freddie and Fannie that we are continuing to pour money into to realize that this is not a good idea.  Projects need to be able to stand on their own merit without disequilibriums created by fiat.

I would much rather see rational development policy emerge that uses instruments like property tax holidays and TIFF to help create projects in lieu of direct financing.  Whole neighborhoods have been created that are self-sustaining and generate millions in property taxes to their cities with this type of approach.  Harbortown in Memphis, Tennessee is a superlative example of this.  Some of the projects inside that community on Mud Island in downtown Memphis received incentives like five years of no property tax followed with five years of 50% property tax.  That can get private capital interested very quickly.