Archive for March 2011
Gulf Oil Spill — Lessons Learned conference
I’ve just been confirmed as a speaker at the big one-year “Lessons Learned” conference on the Gulf Oil Spill, sponsored by Tulane University Law Center, American Lawyer magazine, and the Brickel and Brewer Law firm. The conference will be held at the Weston Canal Street in New Orleans on April 28th. I’ll be one of the “wrap up” speakers that afternoon, focusing on the impact of the oil spill on the value of bank collateral portfolios.
For more info on the conference, click here. Hope to see you there!
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Japan — take 2
A correspondent on one of the news shows seemed almost apologetic this week in discussing investment opportunities following the crisis in Japan. I concur with the sentiment — the focus today must be on humanitarian and environmental concerns.
Nonetheless, Japan will fix the immediate problems, and then must move rapidly toward the economic issues. People need to be fed, housed, clothed, provided jobs, and treated medically. To accomplish this, they need energy (over 10% of their nuclear generating capacity has been wiped out) and capital.
It’s too early to get good facts on the housing disruption, but it is safe to say that the housing shortage will be north of a million units. The final tally will depend on whether or not large swaths of “buffer” zone will be created around the melted-down nuclear plants (probably so, but we don’t know for sure or how big yet). In a typical year, Japan builds less than 1 million housing units (788,000 in 2009), down from about 1.3-ish million a decade ago. Thus, the housing shortage will likely exceed a year’s typical output for their housing industry.
Further, even though Japan is a heavily forested country, they are the least-self-sufficient in terms of lumber of any developed nation in the world. By the last statistics I’ve seen (and these are estimates — Japan itself isn’t very forthcoming with this stuff) they import about 44% of their lumber needs. Canada has historically been their biggest supplier, followed by Russia, Indonesia, Malaysia, and the U.S.
From a global-trade perspective, this is problematic in the extreme. Ironically, the U.S.-Japan lumber trade has declined dramatically in recent years, due to foresting limitations here. China has become a big importer of lumber in recent years, principally from the same markets as Japan. Both China and Japan have faced the same commodity-price increases of late, mainly driven up by increasing demand in emerging markets.
Lumber is not the sort of thing that can be spun-up quickly. Here at Greenfield, world lumber supplies are not our expertise, and we would note that demand in the U.S. is down (due to the housing crisis) by an annual amount roughly equal to the potential housing disruption in Japan. Thus, there may be some offsetting world-supply equilibrium, albeit with prices (and transport costs) going through the roof.
None of this portends good things for prices of new homes in the U.S. One of the saving graces of the construction industry has been that costs of construction have fallen sufficiently so that builders can construct homes at prices which match the overall price decline. If lumber prices soar, as is quite possible, then it may very well be that homebuilders won’t be able to deliver homes at market prices. Since home builders are very much economic “price takers” right now, this could really be a short-term death knell for that industry and many of its smaller — and even larger — players.
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Appraisal and Financial Reporting
Real estate appraisers are, by and large, behind the curve as far as International Financial Reporting Standards are concerned. IFRS is already the norm in most of the world, and will integrate in the U.S. with our accounting rules in the very near future. The Appraisal Foundation recognizes that many (most?) appraisers lack the knowledge and training to compete in the this new realm, and is taking proactive steps to address the problem.
The “ying and the yang” of this — implementation of the IFRS, particularly following the real estate meltdown, will focus considerable attention on asset values rather than asset costs. This has become known as the “mark to market” phenomenon. In an era when everyone basically THOUGHT that asset values gallopped upward non-stop, reporting historical costs-less-depreciation was the norm, and a conservative one at that. However, in an era when real asset values have actually declined, the conservative approach is to mark these values to market. This necessitates regular appraisals. All well and good for appraisers, right?
Not so fast, bucko. There’s nothing in the IFRS that requires an appraiser, per se, and in fact appraisers are so out-of-touch with financial reporting standards that CPAs (who are ultimately responsible for the reporting) may be loathe to use appraisers for these assignments. At best, CPAs are described as “skeptical” on the contribributions to be made by appraisers.
One change will be the migration from “market value” (as is commonly preached to and by appraisers) to “fair value” which is enculcated in Statement of Financial Accounting Standards NO. 157. IFRS will converge Fair Value guidance with US Generally Accepted Accounting Principals with the pending issuance of IFRS 13.
Other changes include new thinging about “market participants”, “highest and best use”, and a concept totally foreign to appraisers, “levels of valuation input.” This latter creates a hierarchy: Level 1, Level 2, and Level 3.
Yesterday, the Appraisal Foundation sponsored a webinar featuring some great thinkers on this subject. Rather than get “down in the weeds”, they were good enough to keep the topic at 20,000 feet and thus cover a wide array of implications in a very short time. Clearly, there’s a lot of education and re-education needed if appraisers are going to have a role to play in this. In the meantime, appraisers can begin familiarizing themselves with the salient information at the IFRS web site, www.ifrs.org.
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…of Japan, earthquakes, and real estate
It’s hard to overstate our sympathies for our friends in Japan who find their country in tatters, with hundreds — if not thousands — of their fellow citizens dead, thousands (tens of thousands? hundreds of thousands?) more homeless, and the economy at a standstill. Fortunately enough, the Japanese are a terrifically resilient and stoic people, with a hard-working culture and more experience dealing with earthquakes than any other developed nation. I have no doubt they started the clean-up and rebuilding process the moment the aftershocks ended.
At Greenfield, we’ve enjoyed a terrific relationship with the Japan Real Estate Institute over the years. It almost seems embarrassing to talk about business while people are still dying, but a quick “google” search on news about the earthquake shows that the top page of stories deals with how this will affect global business, ranging from impacts on energy prices to the availability of Apple’s Ipad-2. Our focus, of course, is real estate, and that may prove to be one of the more interesting problems in this aftermath.
After WW-II, the Japanese people adopted a new constitution which was largely written by U.S. General Douglas MacArthur, the commander of the occupying forces. MacArthur really thought of himself as a Viceroy, and fashioned himself as an expert in governance. (In actuality, his administration of post-war Japan was probably the highpoint of his stellar career.) Despite being relatively conservative in most things, he was a very traditional liberal (albeit in a Victorian sense) in governance. As a result, the Japanese constitution provided for women’s suffrage. It also provided extraordinary rights to small, private property owners, as a mechanism to break-up the hold feudal land holdings. Indeed, eminent domain “taking”, as we think of it in the U.S., is very hard to accomplish in Japan. Small property owners — even the owners of the smallest pea-patch — have exceptionally strong property protections under law.
As great as this sounds, it makes it very difficult to clean up after a disaster. In 1995, Kobe was struck with what is known in Japan as the Great Hanshin earthquake, with a magnitude of 7.2. About the same time (1989), California was hit with the Loma Prieta earthquake, which measured 7.1. Both earthquakes hit in highly populated areas, although the Kobe quake killed over 6,000 while the Loma quake only killed 63. The Kobe quake destroyed about 200,000 buildings, while Loma damaged about 18,000 (12,000 homes and 6,000 businesses).
Of more direct comparison was the destruction in California of Oakland’s Cypress Street Viaduct and a portion of the San Francisco-Oakland Bay Bridge. In Japan, about 1km of the Hanshin Expressway collapsed.
In California, the highway collapses were repaired quickly. Indeed, one of the repair contractors won a huge bonus award for completing a large chunk of the work in record time, and the Bay Bridge was reopened in 32 days. The Cypress Street Viaduct required longer to replace, but traffic was rerouted quickly.
In Kobe, on the other hand, rubble from the expressway was still piled up five years later. Why? At the heart of the problem was access to private property under, near, and surrounding the expressway. Many of these small parcels had hundreds of individuals listed on deeds, and each of those individuals had to be contacted and permissions gained before reconstruction could begin.
Eminent domain can be a contentious issue here in the U.S. — taking agencies typically try to acquire property on a shoe-string, and my own analyses of “takings” appraisals show that they’re not done very well. That having been said, at least we HAVE mechanisms for handling these problems in the U.S., and should be thankful for that.
Again, our best wishes to our friends and colleagues in Japan. They’re going to need a lot of support as they emerge from these trying times. I also don’t want to forget our friends in New Zealand who had, on a relative level, an equally devastating earthquake in Christ Church. I have great friends from that country, and have enjoyed doing business down there. Best wishes to all of them.
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Conerly Consulting
Dr. Bill Conerly of Portland, Oregon, produces a wonderful little economic report called the Businenomics Newsletter. You can check it out here. While it is heavily Pacific Northwest focused, he has some great insights into the “big picture” of the U.S. economy as a whole. I highly recommend his research, and (as long as I’m in the promotion game), he’s a great public speaker.
He discusses two key elements of the “end of the recession” right up front — the current consensus forecasts of strong GDP growth for the next two years and the current “bounce-back” in consumer spending (which fell off significantly from mid-08 to mid-09). Unfortunately, capital goods orders are only sluggishly recovering, and state-and-local budget gaps continue to be a drag on the economy.
As for construction, the decline is over, but the bounce-back is sluggish. Residential construction fell from an annual rate of about $550 Billion in the 2007 range to about $250B in 2009, and continues to flat-line there. Private non-residential peaked at about $400B in 2008/09, and has since declined to about $250B (where it’s been hovering for since early 2010). Public non-residential has been on a bit of an up-swing all through the recession, but is still barely above 2007 levels (about $300B). In short, these three sectors taken together have more-or-less flat-lined for the past year and a half or so, and appear to be staying there for the time being.
Anyone who reads the paper or watches the news on TV knows we’re in the midst of a raw materials crisis, with aggregate materials prices (the “crude materials index) up about 25% from its recent mid-2009 low. However, the price index is still well-below early 2008. Conerly suggests that the rise is “hard on some, but will not trigger general inflation.”
The money supply (M-2) continues to grow, and QE2 has apparently not had an inflationary impact, at least from reading the charts. Indeed, prior to QE2, the money supply chart looked like it was ready to flat-line. In total, as Conerly notes, the stock market appears to be happy that the economy is growing again.
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Mueller’s Market Cycle Monitor
Dr. Glenn Mueller’s Market Cycle Monitor just hit my desk from the folks at Dividend Capital. To access it, or some of their other great stuff, just click here.
I’ve written about Dr. Mueller’s work before — while his model isn’t able to forecast really major moves (like the “fall off the wagon” move of 2008/2009), his Market Cycle synopsis does a great job of assessing how various property types and submarkets are moving through the normal stabilized cycle of business. In short (and I’m sure he’d do a better job of explaining this than I could), at any given point in time, a market or submarket is in one of four investment states: Recovery, Expansion, Hypersupply, and Recession. The way market participants react to one situation drives the market forward to the next situation. For example, in the recovery phase, no new properties are coming on-line. Natural expansion of the market drives up occupancy, and with it rents. The subsequent shortage of space leads to expansion. Too much expansion leads to hyper-supply, in which too much property is competing for too-few tenants. This leads to recession. (In a very macro sense, that’s more-or-less what happened in 08/09, with the added problem that too many banks were trying to loan too much money and thus not properly pricing risk.)
The nuances of his model and report are too numerous to synopsize here. In short, he finds that on a national basis, every property type (e.g. — apartments, industrial, suburban offices) are in various stages of recovery, with the health facilities and senior housing being the closest to breaking out to expansion. Intriguingly, both limited-service and full-service hotels are following in close order.
He also tracks most of the top geographic markets in the country, and all of these are either deep in recession or in the earliest stages of recovery. No markets are close to break-out into expansion. The worst two markets (and “worst” is just relative here) are Honolulu and Sacramento, while the best (again, relative) are Austin, Charlotte, Dallas-Fort Worth, Nashville, Richmond, Riverside, Salt Lake, and San Jose. My home city of Seattle is ranked — along with a dozen others — deep in the heart of recession.
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Construction defects
Took a “day trip” to Marina del Ray, California, yesterday to speak at HB Litigation Conference’s Construction Defects conference. It was very well attended, with a great cross-section of attorneys and experts on this complex topic. I was the only valuation expert on the panel, and spoke about the variety of challenged converting physical defects to market value determinations.
One of the really interesting issues arising now is in the area of “green buildings”. Insurers, contractors, and the attorneys who feed and care for them, are apoplectic over the vision of courtroom battles a few years from now over what was SUPPOSED to be a “green building” that turned out to be “not-so-green”. The industry has entered into a new realm. While there are plenty of prescriptive standards (LEED, Energystar, etc.) these standards do not take on the same level of codification of building codes, nor is there the same level of inspection and certification associated with building permits. Hence, a property PROPOSED as “green” may not actually turn out to be “green”, or at least the same shade of “green” that the investors were promised. When that happens, litigation ensues.
From a small northwestern observatory... 