From a small northwestern observatory…

Finance and economics generally focused on real estate

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Commercial Real Estate — Prices vs Values

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Anyone involved in real estate knows that commercial prices and values have been on a constant uptick since the trough following the recession.  The very length and breadth of the recovery has caused nervousness among investors, appraisers, and lenders.  Today, I’m looking at two somewhat disparate views on the subject.

First, Calvin Schnure, writing for NAREIT, looks at four measures of valuation:

  • Cap rates and cap rate spreads to Treasury yields
  • Price gains, either from increasing NOI or decreasing cap rates
  • Economic fundamentals, such as occupancy and demand growth
  • Leverage and debt growth

At present, none of these is giving off warning signals, according to Schnure.  Cap rates continue to be low compared to other cycles, but so are yields across the board.  There continues to be room for cap rate compression, in Schnure’s assessment.  As for price changes, every sector is showing growing or at least stable NOI, with the proportion of price changes coming from NOI now equal or exceeding price increases coming from cap rate declines.  Across the board, REIT occupancy rates are high and on the rise, with industrial and (surprisingly) retail at or near 95%.  All equity REITs are in the low 90% range, compared to the high 80’s at the trough of the recession.  Finally, debt levels are rising, but at a lower rate than valuations.  Ergo, this is not, in his opinion, a debt-fueled cycle.  Right now, debt/book ratios are significantly lower than in the previous FOMC tightening cycle (2004-2006).  For a full copy of Schnure’s article, click here.

Second, I was at the American Real Estate Society’s annual meeting in Ft. Myers, FL, last week, and had the great pleasure to sit in on a presentation by my good friend Dr. Glenn Mueller of Denver University, the author of the widely acclaimed Market Cycle Monitor.  He tracks property types and geographic markets by occupancy, absorption, and new supply statistics, and for years has proffered a very accurate measure of commercial real estate, both nationally and locally, across four potential phases:

  • Recovery (rising, although unprofitable rents and occupancy)
  • Expansion (rising and profitable rents and occupancy, stimulating new construction)
  • Hypersupply (oversupply of new construction and declining rents and occupancy)
  • Recession (unprofitable and declining rents and occupancy)

Most markets cycle through these phases in a fairly predictable fashion.   Right now, most markets (property types and geography markets) appear to be in the expansion mode, with some (notably, apartments) potentially crossing the line into hypersupply.

In short, commercial real estate markets look healthy, absent the sort of exogenous shocks that sent us into the most recent recession.  That said, many of those same metrics read positive prior to the mortgage market melt-down.  Of course, commercial real estate actually faired pretty well during the recession, compared to many other asset classes, supporting the notion that in times of economic trouble, real estate equities can be great storers of value.

Written by johnkilpatrick

April 16, 2018 at 9:50 am

An important story on trade

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Alexis Crow, who leads the geopolitical investing practice at Price Waterhouse Coopers, has a stunningly important article on trade in today’s Washington Post.  I recommend you read it here.  In short, Trump’s trade war misses a very important point — the U.S. economy has matured from manufactured goods to services, and actually runs a net surplus of such services to the rest of the world.

As she notes, “Providing services is the heartbeat of America’s new economic growth, including IT and communications services, logistics, warehousing, leisure, hospitality, health care, business and legal services.“. She goes on to note that wealth created by America’s trading partners — China, Japan, etc. — translates into purchase of American services, including travel, media, IT, logistics, and entertainment.  By 2026, fully 81% of American jobs will be in such service areas, and our trade surplus in these areas is already nearly $300 Billion per year.

Written by johnkilpatrick

April 11, 2018 at 11:55 am

Damage to Reputation/Brand

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In my last post, I commented about AON’s Global Risk Management Survey.  I want to continue on that theme today, and continue to compliment the great folks at AON for a super job.

Number one on their list was Damage to Reputation / Brand.  The open the chapter on that with a wonderful story, which I will briefly retell here (with full attribution).  A worker in China purchased an electronic device and while charging it, the device caught fire.  He videotaped the incident and uploaded it to the internet.  The clip was soon viewed millions of times around the world.  Other customers reported similar defects.  Even though less than 0.1% of the devices sold were defected, widespread panic followed.  the company was forced to issue a world-wide global recall costing an estimated $5 Billion.  Ironically, this tech company became a victim of the tech revolution.

AON notes that widespread fake news, the lack of fact checkers on social media, and the political cross-fire following the US 2016 elections all have risk for brand damage.  AON estimates that there is an 80% chance a company could lose at least 20% of its equity value in a month over a 5 year period doe to a reputation crisis.

Eight years earlier (2009), Damage to Brand / Reputation was ranked number 6 among risks by respondents.  Today it is number one.  Reputation / Brand events often arrive with little or no warning, to cite the survey, and organizations are forced to respond quickiily.  As such, it is critical that companies have comprehensive reputation risk control strategies in place.  Such strategies include meticulous preparation and executive training, to help maximize the probability of recovery.

Thanks again to the good folks at AON for providing this information.

Written by johnkilpatrick

April 9, 2018 at 3:29 pm

AON’s Global Risk Management Survey

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The good folks at AON just shared with me their very detailed Global Risk Management survey for year-end 2017.  It’s a terrific document, very thoroughly researched, and I commend them for the effort they put into this.  (Full disclosure – neither I nor Greenfield, nor any of its affiliates, have any interest in AON.).  This is the sort of study that should be on the desk of every CEO who has globally-affected interests, and certainly real estate and private equity fall into that category.

The document is chock-full of good stuff, and I’ll revisit this in future posts.  Two interesting comments, however, hit me right up front.  First, and I’ll simply quote from the survey, “…developed nations, which were traditionally associated with political stability, are becoming new sources of volatility and uncertainty that worry businesses…”. Of course, they’re taking about the U.S. and its misguided trade war, BREXIT, the elections in Northern Europe, and the impeachment of the South Korean president.

Second, what are the top concerns for global businesses and wealthy families?  The list may come as a surprise to those who don’t follow these important sectors, but these certainly make sense in today’s climate:

  1. Damage to reputation/brand
  2. Economic slowdown / slow recovery
  3. Increasing competition
  4. Regulatory / legislative changes
  5. Cyber crime / hacking / viruses / malicious codes
  6. Failure to innovate / meet customer needs
  7. Failure to attract or retain top talent
  8. Business interruption
  9. Political risk / uncertainties
  10. Third party liability

I can tell you Greenfield is deadly serious about these issues.  You should be, too.

Written by johnkilpatrick

April 4, 2018 at 11:51 am

NYC Family Office Club

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I had the very real pleasure of attending the Family Office summit in New York City last Friday.  The meeting drew together about 400 individuals, give or take, who are involved in various aspects of management or advice to family offices.   Greenfield was, of course, the one of the leading real estate advisory providers there.

For the uninitiated, a Family Office is more-or-less what it sounds like.  A family views its financial and other holdings as something to be managed for the benefit of the entire multi-generation family.  A very, very rough division might categorized those families with a billion dollars of net worth or more, families with $100 million to a billion, and families with aggregate net worth below $100 million.  For the first category, the family office is usually a separate business enterprise managing just that family.  It may directly employ one or more attorneys, accountants, and investment advisors, or at the lower end of the scale perhaps just one or two professional managers with other professionals on retainer.  The family office manager ensures that the assets are well invested and well managed, that the taxes and other bills get paid on time, and that the family estate is managed.

In the middle category, a professional manager may oversee several families, or in some cases a management team may oversee a dozen or more families.  The suite of services is somewhat less (estate management and day-to-day bill paying may not be on the table).  At the lower end, for families with $50 to $100 million in investable net worth, there are trust companies that manage the money and make sure the tax accountant gets everything needed.

It goes without saying that above a certain level, every wealthy family has some sort of family office.  To quantify this, the wealthiest 0.1% (that is, one tenth of one percent) of American families have an average net worth of $200 million.  Ahem… That’s 125,000 families.  It perhaps goes without saying that these families are shown the best investments, receive the best legal, accounting, and advisory services, and expect mind-boggling results.

Now, you’d think that the lessons learned from these uber-wealthy families and their advisors would have little to do with the average American family, but indeed that’s far from the truth.  Amazingly enough, the lessons learned here are applicable to every family in America, indeed the world.  I’ll summarize just a few.

  1. The family matters more than the money.  Indeed, the wealthy families I’ve spoken with manage their money carefully and purposefully to knit together the family across generations.  Even so, only 30% of earned wealth hangs around past the third generation.  Why?  The biggest single issue was family disputes.
  2. There is an extraordinary global industry of lawyers and others devoted to family reputational management.  Managing a family’s reputation is paramount.
  3. Most wealth families expect their investment advisors to preserve wealth.  They already know how to make money, they just don’t want their advisors to lose it.  That said, they don’t like blind pools, they want to be in control of private equity investments (but are open to partnering with other families or “sidecar” arrangements) and prefer private equity to public.
  4. Wealthy families and their investment managers are rarely open to an investment “pitch”.  They want to get to know an investment manager first, and may not be open to an investment until the third or fourth idea.

There were a lot of other details, and I’ll leave those for another time.

Written by johnkilpatrick

March 29, 2018 at 2:18 pm

Posted in Economy, Finance

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Quarterly Phily FED survey

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Hey, gang!  It’s been a while!  I’ve been having a darned good winter, how about you?  It’s been busy, I’ll say that, hence the gap since my last post.

Anyway, as you may know by now, I’m a regular follower of the Phily Fed’s quarterly survey of economic forecasters.  It’s a delightfully simple model — just ask a not-so-random group of economist where they think the economy is headed, then look at both the central tendency (you know, mean, median, mode, that stuff) as well as the dispersion of forecasts (standard deviation, median absolute deviation, stuff like that).  The results are not only interesting in and of themselves, but also it’s fascinating to track what the forecasters were saying a quarter ago compared to what they’re saying now (which the FED does).

For example, the forecasters, PREVIOUSLY (end of the year last year) projected that GDP growth for 2018 would be 2.5% (real, annualized), the unemployment rate would be 4.1% on average (and 4.0% at year-end) and that we would add 163,400 folks to the nation’s payrolls on average each month during the year.  Today, however, these same forecasters have up’d the ante a bit, forecasting real GDP growth at 2.8% for the year, average unemployment at 4.0% (and ending the year at 3.8%) and adding 175,100 workers to payrolls per month.

Now, don’t get too excited, folks, because as with everything the “devil’s in the details.”  A big chunk of the change comes from shifting the shape of the new employment curve.  Previously, the forecasters projected a fairly flat payrolls change over the year — not bad, just flat.  However, new forecasts project this to be skewed to the early part of the year, and then declining after the summer.  Indeed, 2019 is currently projected to be anemic.  Early employment numbers has the effect of driving up GDP (people earn and spend money for more months in the year).  Note that when we look at the dispersion of GDP growth, there is some great news (very little sentiment for a recession this year) but also some not-so-great news (very little sentiment for growth above 4%).

The Phily FED also surveys for inflation projections, but that’s been flat-lined for years now.  Current CPI projections for the year are 2.1%, which is the same as previous projections.  Of more specific interest to us at Greenfield, the Phily FED is now reporting forecasts of house price growth for the coming two years, although rather than use their regular panel they are synopsizing several publicly available indices (Case-Shiller, FHFA, CoreLogic, and NAR).  In general these indices point to price growth from 4% to 5.2% this year, and slightly lower growth (3.3% to 5.1%) next year.

There’s a bit more to the survey, and if you’d like you’re own copy, just click here.

Written by johnkilpatrick

February 28, 2018 at 12:56 pm

The WalMart Effect

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It’s a sleepy Saturday morning in the Pacific Northwest.  December 23.  Like so many Americans, I have some last minute shopping to do.  Like so many Americans, I’m dreading that, and looking around feverishly for an excuse to not do it.  Fortunately, I have a blog and a functioning computer.

Reading Reddit recently (and always looking for an excuse at alliteration) I happened upon an interesting map of the US showing the largest employer in each state.  I couldn’t help but notice that in a large number of states, WalMart was the largest single employer.  As someone who regularly travels the length and breadth of our great nation, I also couldn’t help but observe that many of the states where WalMart dominates employment are also at the lower end of the economic totem pole.  Aha!  I exclaimed, for I had suddenly stumbled on a distraction worthy of my Saturday morning.

Before I go any further, please let me stress that I have nothing against WalMart.  I’ve actually done a bit of work for them, in the long distant past (OK, maybe 15 years or so ago) on property disposal issues.  They have very tough standards for consultants, but they pay their bills (although, you earn the money!).  Indeed, I have very few bones to pick at all in this study, other than the obvious which is that political and civic leaders owe it to their states and communities to seek out exportive “basic employment” businesses.   Communities do not benefit by sending their money elsewhere (which is what they do when people shop at any retail establishment, as I will do later today).  They benefit when they send goods and services elsewhere in trade for money.  Note that “exportive” is a general term.  In Nevada, for example, the largest employer is MGM Resorts.  The customers are kind enough to haul large sums of money to Nevada from out-of-state and dump it in the middle of the street for the locals to scoop up by the bucketful.

My little study also does not account for states which have lots of exportive businesses, but no single entity which is dominant.  For example, Florida is a bit of an outlier, in that tourism is a big exportive business, yet WalMart is still the biggest single employer.  Go figure.  I would have guessed Disney.  In many states, the University system is the biggest employer, but recognize that Universities are huge exportive enterprises.  Money flows in from research grants, technology transfer, patent licenses, tuition from out-of-state and foreign students (the U.S. is still the preferred place in the world for an education), and alumni gifts, and all we send out are journal articles and educated individuals.  From a local perspective, higher education is the gift that keeps on giving.

Anyway, I downloaded the data.  There are 22 states in which WalMart (“WM”) is dominant, and 28 in which it is not.  I also went to the Census Bureau and grabbed the state-by-state median household income (“HHI”) stats.  I then ran three quick studies (and yes, it’s still morning).  First, a simple correlation shows that having WM as the state’s largest employer has a negative 51% correlation with HHI.  In other words, if your state has WM as its largest employer, your state is 51% likely to have lower-than-average HHI (yes, this is a simplistic way of looking at it, but bear with me).

I then ran a simple log-linear regression. (Since HHI is bounded at zero, the conditions for OLS don’t stand, so a log transform of HHI is needed.  It actually makes it a bit easier to interpret the data.  Plus, there are a few other reason, but I won’t bore you.)  The WalMart Effect, as I call it, is about 15.75%, with a very high (>99%) level of confidence.  In other words, if your state has WalMart as its largest employer, your state’s median household income is likely to be 15.75% below average.

Finally, I measured the actual numbers.  Of the 28 states which do NOT have Walmart as the largest employer, the average median household income was $62,116 in 2016.  If WalMart is the largest employer, that number was $52,290, for a difference of $9,818.  Thus, the Walmart effect….

Now, I’m going to go shopping.  I’ll eventually write this up in a little paper.  E-mail me and I’ll send it to you when and if I get around to it.

Written by johnkilpatrick

December 23, 2017 at 11:58 am

Posted in Economy, Finance

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