Real Estate Finance


Bloomberg reported earlier this week that the Treasury Department will sell a record $81Billion in long-term debt next week.  Umm, that’s bad.  More from the article (emphasis mine):

The U.S. Treasury Department said it plans to sell a record $81 billion in its quarterly auctions of long-term debt next week and will replace the inflation- protected 20-year bond with a reintroduced 30-year security.

The Treasury will auction $40 billion in three-year notes on Nov. 9, $25 billion in 10-year notes Nov. 10 and $16 billion in 30-year bonds Nov. 12. The amounts were in line with the median forecast of $80 billion in a Bloomberg News survey of nine analysts.

The U.S. is headed for a second straight year of budget deficits exceeding $1 trillion, and the country’s legal limit on debt may be reached next month. Treasury debt-management director Karthik Ramanathan told bond market participants this week to expect another year of government debt sales of $1.5 trillion to $2 trillion, minutes of the meeting showed today.

A couple of key points about this data:

1. Replacing the 20 year debt with 30 year debt – both instruments automatically adjust to inflation.  They are telling us quite clearly to buckle down for inflation.  No one will buy our debt right now if there isn’t an inflation hedge.  Pushing the payment schedule out another ten years is an attempt to hold down the annual cash outflow…it’s like trying to pay the minimum on your credit card debt just to keep pushing it out.

Contrarian note here: Real estate is a good investment in inflationary times…but then, so is gold.

2. A second straight year of $1T deficits AND the legal debt limit will be reached.  This latter point isn’t that big a deal, it’s not like they will shut everything down and say “sorry you’ve reached your credit limit,” Congress will just vote a new ceiling in.  But it means that they will either have to print more money (inflation), raise taxes (lose jobs) or cut services at a Draconian pace (not going to happen).

Now my question is this: explain to me why they want to pass a healthcare “reform” bill that will add $1.2Trillion to the deficit?  (The $1.2T figure is the Congressional Budget Office estimate – little secret: they have no idea.  Government programs like Social Security, Medicare and Medicaid get passed with the rosiest of scenarios plugged in.)  Here’s another question – why would you pass “cap and trade” legislation that further slows the economy at a time when growth will be desperately needed just to pay our debt?

Waiting for answers…

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Busy week so far!  We got the newsletter out yesterday and have been in a lot of meetings with owners and asset managers of distressed assets.  But, we still manage to make time to peruse the cyber-universe and bring you the best of the web for our industry.  This week’s theme?  Well, I am in a Halloween mood, so let’s dress up and be Contrarian!

1. Limits of Transit – this is an intriguing study on the costs of transit.  I love the light rail systems in Denver and Dallas, but we need to be careful as we encourage and implement transit strategies around the country.  This article should make you think.

2. Self-Jiving Nation – if you were lulled into a sense of complacency that the economy is turning around and that the GDP numbers released yesterday were “great news,” this article is a bucket of ice-cold water to pour over your head.

3. Bloodhound Blog – what if we haven’t found the bottom of the housing market?  What if Fed policy has artificially inflated pricing by as much as 5%?  Read this analysis and find out.

4. Unsustainable – the Altos Research folks take a stern look at the Case-Schiller numbers recently released. Ouch.

5. Stanford Entrepreneur – OK, there’s only so much bad news I can take too…here’s a great useful link that features pod casts from leading lecturers at Stanford’s Entrepreneurship Center.  Tired of listening to your daughter’s Jonas Brothers tunes over and over? Replace them with a quality podcast from this site!

Well, the storms are moving in so the brats may have to be cooked in some dark ale and broiled for a little char…Happy Halloween!

This morning’s Tennessean is reporting that Terrazzo, an uber-high-end-condo development in the Gulch is going to auction off some of their units.  Of the 117 units in this LEED certified building, only 13 units have sold since March.  Reading the article, and then scanning through the comments, I am reminded of how litigious a society we have become.  The general theme in the comments is that the developer should be pursued!  Off with their heads!

This is just plain silly.  The developer is the one who took all the risk up front.  Now we can argue whether it was excessive risk – they were late to the game, their construction was slow, there were a lot of units already coming into downtown and the Gulch etc. etc.  But, it was the developer who took the risk of putting these units on the ground and they had enough contracts in pre-sales to secure construction financing…here we can get into another round of “coulda shoulda woulda” on whether the bank should have made the loan, but it doesn’t matter.

Now, sillier is the young woman sited in the article for having “three mortgages.”  On what planet do you live?  And thanks, Mom, for outing your daughter’s insane appetite for risk…now get back on the plane and return to the Baccarat table in Vegas.  Yet, Nashville, like so many other markets was infiltrated with stupid money at the height of the “it will never end” craze in 2007.  Remember when a certain Gulch development sold out in 48 hours!! Oh, right, few of those people closed on their units because they had so little down…but that’s another story.

Folks, auctioning is a very legitimate and fair way to get the building’s pricing adjusted to the market. It has been used all over the country, and I expect we will see more of it.  The developer was apparently unwilling to experiment with lowering their prices on their own to find where the market would start to move for their product.  It isn’t rocket science – take a couple of units and push the prices down till you have a buyer.  At that point, you will know whether it is worth lowering all the other units or not.  Well, I was not at the conference table where this decision was made, but again, this is one way to work your way out of the debt.

The losers are the current owners that paid full freight, especially if they had thoughts about trying to sell anytime soon.  These auctioned prices will establish the “new normal” for pricing in the building and it may be well below their current basis.  Nevertheless, getting the building occupied and getting their Homeowner’s Association up and running will be a net positive in the long run.  You need to get the lights on in the building – dark buildings at night scare people and the development will get a negative reputation.

We are looking at this situation across the board with distressed assets.  The banks have been kicking the can down the road with loan extensions at an interest only rate, but they are now feeling the heat.  The developers’ interest reserves have been burned through and their balance sheets are getting wobbly.  Lord knows I hate being pessimistic, but I suspect we are going to be seeing this type of maneuver more and more until we get the supply and demand back into equilibrium.

What will be interesting to see is how many people really do show up at the auction prepared to buy.  If the auction is ill-attended, that would signal a far more ominous sign – Americans are so concerned about the economy that they are not willing to even turn out for a good deal.  Let us pray that does not happen.

A recent report issued by CBRE Econometric Advisors had this interesting chart showing the distribution of distressed assets by property type:

getbinary.aspxAccording to their research, most of these assets are concentrated in the “CANVFLAZ” markets (California, Nevada, Florida, Arizona).  They are also reporting a sharp up-tick in the hotel and “development” sector – the latter being construction loans outstanding.  Retail remains a very large sector, and is anticipated to grow – common sense: if you have between 10-17% unemployment and that number is anticipated to stay constant through 2010, you are not going to have a consumer driven recovery anytime soon.  My guess is the “Development” category will grow too as owners burn through their interest reserve and cannot get restructured due to battered balance sheets.

Don’t know where the next Sam “Grave Dancer” Zell will come from, but some opportunities should start to emerge in the next couple of quarters.  Sense I get from my conversations with lenders and owners is the banks have been willing to extend loans out – probably in the hope that some form of Resolution Trust Corporation relief might emerge – but their patience is wearing thin and they know the sponsors are running out of gas.  Private capital is still sitting largely on the sidelines too – partially due to the sense that there’s more downward pressure on pricing coming to bear and no one likes to “catch the falling knife.”  Partly too, though, from the people I have been talking to, out of fear that the combination of massive Federal debt ($1.4 trillion deficit this year alone!!), so called health care reform legislation and cap and trade legislation will inevitably lead to higher taxation.  It’s not a comforting picture at this juncture.

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A regular smorgasbord of delights awaits your clicking fingers for this week’s edition of the Grill:

1. Futurity – I was never a big Sci-Fi nut, but I love reading about technological break-throughs.  This site assembles news from the leading research universities around the world and sums them up.

2. Entrepreneur Center – The Nashville Chamber of Commerce has launched this on-line platform to help entrepreneurs establish their businesses.  There is a cupboard full of great links and ideas.

3. State of the Cities Data System – Want information about crime, population trends, demographics of your city or region?  Check this nifty little data base out!

4. Recycling Suburbia – this is an insightful and thought provoking article by Ellen Dunham Jones (author of Retrofitting Suburbia).

5. Corpse of a Thousand Houses – I blogged on this earlier…not going to lie, it’s a little depressing, but we need to read everything we can about what is going on out there so we can better prepare for the future.

Enjoy the weekend – cold beer?

The Annual Meeting of the Nashville Downtown Partnership was held today at the Renaissance Hotel, with all the luminaries of downtown’s real estate, retail, philanthropic and political establishment in attendance.  I was there in my capacity as a Board Member of the Urban Land Institute since the Keynote speaker was Patrick L. Phillips, our new CEO for ULI.

A couple of impressions up-front – the ball room was packed!  This is a good sign.  I remember attending these luncheons several years ago and it is remarkable how well attended they are now.  Second, I got the chance to meet Nick Zeppos, the Chancellor of my alma mater, Vanderbilt.  He is a very personable, warm man and has a great vision for where Vanderbilt is going and how inter-related the University and the health of Nashville’s downtown are.

Primary reason for the post though, was to share Patrick Phillips’ observations on the state of downtowns and why he is bullish on their health.  Mr. Phillips opened his talk with the rather bold statement that good downtowns are entering the “best 10 to 20 years in history.”  Given the current shambles that commercial real estate finds itself in, that is a startling statement.  It was enough to break up the game of Russian Roulette that several developers were playing at one of the back tables!  But Phillips backs up his forecast with four key points:

1. Demographics – the population of the United States is expected to grow from 270 million to 360 million over the next 20 years and up to 420 million in the following twenty.  That’s about 4 Nashville’s worth of folks every year.  Now, he acknowledges that most of those people will go to the suburbs, but even if only 5-10% of those people move to the downtown cores of leading cities, there should be some good development opportunities.

The second part of the demographic equation that Phillips discussed is the impact of the “Millenials,” the baby boomlet that was delivered between 1988 and 2000.  This generation seems highly motivated to adopt an urban lifestyle – and they will become renters and homebuyers over the next twenty years – another favorable trend.  The third and final part of the demographic push, is the baby boomers themselves – me included!  No one really knows what the retirement behavior of this generation will be, but the peak of the boomers is currently hitting their mid-50’s and, like the Millenials, they seem to like the urban feel.  I can vouch that our condo sales in midtown Nashville at 807 Eighteenth and 1101 Eighteenth were fueled by empty-nester baby-boomers, tired of the 2-acre yard in the ‘burbs.

2. The Economics of Development – Phillips believes that macro-economic forces on labor and material will drive cost budget up and will put greater pressure on developers to develop (and re-develop) lower cost, more compact urban developments.  Historically, this is why cities have grown and as downtowns improve and add population and amenities, that concentration will begin to feed itself as more services are required.  Clearly one of the “bigs” in this equation is the price of gasoline – once it gets back to $4 per gallon, that 4,000 sf house in the ‘burbs with the 35 minute commute each way doesn’t look so good.

3. Public Service Delivery – some of the same forces that the private sector will have to deal with in the coming years are going to affect state and local governments acutely and make it more difficult for regions to expand across new geography.  This will force a more compact development pattern that will help downtowns continue to turn around.

4. Climate Change – Phillips believes that awareness of climate change will influence more and more people to accept the densified lifestyle of the urban experience.  Further, legislative changes that impact building codes and tax laws will add to the pressure to re-develop and improve existing infrastructure with more efficient, “green” building forms.

Bottom line, and we here at M2H Group couldn’t agree more is this: compact development and re-development opportunities are the “low-hanging fruit” in development right now.  Now, if we could just get the credit markets to open up to allow for this wonderful vision to come to fruition we will be getting somewhere!

While a lot of folks are talking about “green shoots”  (maybe it might be green ‘shutes?) the Fed is paying attention to what is happening in the commercial re-finance market.  There commercial real estate debt that needs to be financed is BIG…I’ve seen estimates  ranging from $150 billion to $1.2 trillion.  This article, this morning puts it at $165 Billion.  The problem is that the debt was booked when commercial real estate values were 25-30% higher, i.e. a lot of these loans are upside down to the current value of the asset.  Having resuscitated the residential real estate market to the point of a pulse and a “fog the mirror” breath with low interest rates, the Fed finds itself with no option but to keep the rates artificially low lest they clang the death knell for commercial real estate and it’s lenders.  It’s a dicey place to be.

The problem, in  my mind, is that the economic situation is clouded with the political one.  We live in a political economy, like it or not – it is not a “free market.”  Freer than most, but not without it’s restrictions.  It is reported that the proposed Cap and Trade Legislation will not only kill jobs, but add to the cost of construction and slow the transferability of real estate with new “green” standards that would not be grandfathered.   Couple those concerns with the pending increases taxpayers will face with skyrocketing deficits and you can see why there’s a lot of gloom in the boardrooms of the real estate firms and their lenders.

Perhaps the silver lining in this is that with the Fed forced to keep rates low and the new sense of frugality in the American public, the “folks” with the big credit card bills will be able to pay down their debt sooner.  It’s a knife’s edge we’re on and we can only hope that the folks doing our “bid’ness” in Washington are aware of how much they are scaring us right now.

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