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Finance and economics generally focused on real estate

Archive for the ‘Real Estate’ Category

Tax Reform and Senior Housing

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We follow some REITs at Greenfield, and in general REITs are having a lackluster year. REITs in general have outpaced the S&P 500 this year (though some have done very well), the goal is for a REIT to outperform its underlying net asset value, or NAV for short.  NAV is the theoretical amount of cash the REIT would have if it liquidated its holdings at current market value.  If the REIT management is doing well, or if the sector is expected to grow, then the REIT price should be higher, and should grow faster than NAV in anticipation of those future earnings.

Unfortunately, this has not been the case, particularly in some sectors.  For that reason, health care REITs have backed off acquisitions a bit, since new acquisitions would be dilute current values.  In their stead, non-REIT players (private equity, for example) are snatching up senior housing under the SWAG analysis that “hey, people are getting older, so senior housing is good.”  Yeah…. Andrew Carle, a senior housing analyst quoted in a November 13 National Real Estate Online article by John Egan, notes that these new players may not be giving “proper consideration to market-specific dynamics.”  That’s a nice way of saying they’re not doing their homework.  This is not to say that senior REITs aren’t a good idea, but like every good idea, picking thru the produce rack for the best fruit is a must, particularly when you’re investing other people’s money.  By the way, private equity accounted for 47% of senior housing deals in the first half of 2017, compared with about 10% done by public entities.

One of the “known unknowns” (to borrow from Donald Rumsfeld) is what will happen in Congress to taxes.  One might think that lowering taxes is generally good for real estate, but that’s not always the case.  Consider the Reagan tax cuts in the mid-1980’s.  Market anticipated one thing, and the final bill had something else.  In the end, much of the mistaken anticipation (for example, failure to grandfather certain deductible items) was one of the straws on the camel’s back that led to the S&L melt-down, FIRREA, the need for Fannie/Freddie oversight, etc.  That said, just like the early 1980s, there’s a lot of private money chasing real estate deals.  Let’s hope it all gets invested properly.  Nothing beats good due diligence, analysis, and careful selection.

 

Written by johnkilpatrick

November 15, 2017 at 8:15 am

Housing…. overheated again?

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“Home price increases appear to be unstoppable,” — a quote from David M. Blitzer, Chairman of the Index Committee at S&P Down Jones Indices, as quoted in a Tuesday article by Christopher Rugaber of the Associated Press, and featured on usatoday.com.  Am I the only one who felt cold chills reading that?

C’mon, David, exactly how did that turn out last time?  Prices, by the way, are headed up because money is still relatively cheap, demand is incessant, and supply is constrained.  S&P, which is in business, among other things, of promoting their Case Shiller index, notes that buyers are in bidding wars.  That index, released Tuesday, showed that house prices are up 6.1% from a year ago — well above inflation — and in 45% of the cities tracked, the house price increase has surged from a month earlier.  In short, not only is the car speeding, it’s accelerating.

However, sales volume has fallen 1.5% from a year ago.  That may not sound like much, but in a market that was already not at equilibrium, that’s economically significant.  Plus, the number of homes for sale was down 6.4% from a year ago, to the lowest level since the NAR started tracking these statistics.  Ever.  In history.

Sigh….

 

Written by johnkilpatrick

November 2, 2017 at 9:02 am

Kroger…. sigh….

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I truly like Kroger.  I do the largest portion of my “commodity” shopping there.  Friends and colleagues know of my constant battle with my weight, and sadly enough, Kroger (or their pacific northwest brand, Fred Meyer) is partly to blame.

That said, I’m very concerned with Kroger (and Fred Meyer) as brands, and by extension as users of big boxes of real estate and anchors of shopping centers.  Kroger’s stock hit a one-year high of $37.86 last July, and is today 40% lower at 22.82.  Admittedly, about 7 points of that loss came on the heels of Amazon’s announced acquisition of Whole Foods.  However, another 7 or 8 points came from slow drift over the last 11 months.  For the record, during the past 12 months, the S&P 500 (not the most aggressive benchmark, for sure) rose from 2000 to 2433 (today, 1pm EDT), for a gain of just under 22%.  Hence, Kroger has underperformed the S&P by 62%.  Ahem…. To put this in more meaningful terms, Kroger has lost about $14 Billion in shareholder wealth in 11 months.

So this morning, I took time out of my nasty, busy schedule to listen to Kroger’s CEO, Rodney McMullen, interviewed on CNBC.  I was underwhelmed, to say the least.  He basically wanted to defend their current modus operandi, and bragged about their cheese department (which, I will admit, is quite good).  Arguably, when one loses $14 Billion in shareholder wealth in 11 months, perhaps one should have a “Plan B” to discuss on CNBC.

From a real estate perspective, Kroger and its other brands (e.g. — Fred Meyer) run 2,778 grocery stores in the U.S.  At about 50,000 square feet each, that’s roughly 140 million square feet of real estate (not counting 786 convenience stores, 37 food processing facilities, 1,360 supermarket fuel centers, and such and so forth).  Further, most of these stores are anchors for community shopping centers.  Lose the grocery anchor, and the entire shopping center becomes a dust bowl pretty quickly.

A long time ago, In Search of Excellence established that businesses “in the middle” of a market are doomed to failure.  You can make money at the top of the market (Whole Foods) or at the bottom (WalMart Super Centers) but not in the middle.  Profit margins in grocery have always been razor thin.  I can think of a dozen business scenarios that make sense for Amazon and Whole Foods, not the least is the fact that Whole Foods, geographically, is well positioned to serve as distribution centers for the sort of “top of the market” customers who would order groceries from Amazon.  I would love to see where Kroger thinks its market lies, but I’m going to guess that everyone in the grocery biz who is not chasing the top of the market will be in a race for the bottom of the market.

Written by johnkilpatrick

June 27, 2017 at 9:27 am

PWC’s Quarterly CRE Review

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PwC’s quarterly commercial real estate review just hit my desk.  I have a particular affinity for this survey-based review — it was founded about 30 years ago by Peter Korpacz, MAI, an alumni of the Real Estate Counseling Group of America and an acquaintance of mine.  PwC took it over a few years ago, and have done wonderfully with it.

The entire report, at 106 pages, is far too robust for a simple summary.  However, a key metric is the review of capitalization rate changes by property type (e.g. — warehouse, apartments) and offices by region (e.g. — Manhattan, DC, San Francisco).  A cap rate, of course, is the ratio of a property’s net operating income to its sales price.  Declining cap rates on a broad front can indicate the onset of a recession, but differential cap rate changes (rising in one market, declining in another) may suggest differing sector views by real estate investors.  By property type, this is what we appear to have today.

For example, warehouse cap rates currently average 5.27% nationally, but this represents a decline by 10 basis points just in the 2nd quarter.  Generally, this points to a favorable view of warehouses by investors — they’re willing to pay a bit more for each dollar of prospective income.  Conversely, offices in the central business district saw increases of 13 basis points, suggesting a softening of CBD office prospects.

Across various regions of the country, offices in general (both CBD and others) showed either no change or declines in cap rates, with the biggest cap rate declines occurring in Phoenix and Philadelphia.  Only Denver and Atlanta showed increases in office cap rates.

Overall, investors expect cap rates to hold steady or increase over the coming six months.  Indeed, only among CBD offices and power centers was there any sentiment for cap rate decreases.  100% of investors expect net lease properties to show cap rate increases in the coming 6 months, which portends value softening in that property sector.

We’ve used the nasty “R” word (ahem… “recession”) on occasion here at Greenfield, and PwC seems to agree with us.  They expect that the office sector will peak by the end of this year, and a large number of metro areas are expected to move into contraction during 2018 and 2019.  They expect 61% of cities in their survey to show retail property recession by the end of this year, but with some limited exceptions (Austin and Charleston).

Industrial properties, on the other hand, should fare well, with only Houston headed for recession during 2017.  They also expect 15 other markets, including Los Angeles and Atlanta, to face industrial recession by the end of this year.  Further, a large supply of industrial property is expected to come to market during the near term, suggesting an industrial over-supply for the next four years.

One bright spot is multi-family, which continues to “benefit from the unaffordability of single family homes”.  Two markets need to play catch-up (Charlotte and Denver) but other markets should fare well, with 40% of markets headed for expansion.

Demand & Supply

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I just read a nice piece by Deloitte’s Robert T. O’Brien, their Global and U.S. Real Estate and Construction Leader, titled Commercial Real Estate Outlook 2017.  It’s far too interesting and too packed with info to summarize here, so have a glance for yourself.  However, I’ll point out a couple of things I believe stand out in his analysis.

First, homebuilders are under pressure due to what he calls the “demand-supply dichotomy.”  I’ve been concerned about this for a while.  During the recession — which admittedly was several years ago — big chunks of the housing infrastructure collapsed, including acquisition-development-construction (ADC) finance, skilled labor, permanent finance securitization, and local government permitting capabilities.  As such, we now actually have a bit of a housing shortage in hot areas (think “Seattle”).  Mr. O’Brien worries that homebuilders’ financial projections may be dampened.  I’m a bit more concerned with the upward price pressure on houses, which could put us back in a bubble situation.  Deloitte believes interest rates hikes by the FED may temper some of the demand side.

He believes private equity fundraising will decline this year, “…as managers focus on deploying existing funds.”  He believes managers will face increasing competition looking for good investments.  I would add that new managers or managers with a new story to tell will find 2017 a bit easier for fundraising than 2016.

O’Brien also sees slowing in the commercial construction arena, and so slugging financial performance for engineering and construction firms.  REITs should do well, though, albeit with continued portfolio repositioning.

Deloitte sees GDP growing about 2.5% this year and unemployment below 5%, which is in line with metrics we see here at Greenfield.  They also see several things disrupting the economy both this year and in out years.  The “collaborative economy” will certainly have implications for the way new start-ups use and lease commercial real estate.  The internet is rapidly disintermediating brokerage and leasing services, with implications for traditional brokers.  A shortage of talent in the STEM area and other shifts in the way millennials view the workplace have implications for location strategies.  Speed and mode of retail delivery — the “last mile” disruptions of Amazon — are still being sorted out.

Trump’s Tax “Reform”

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Mark Twain is usually — and incorrectly — quoted with the phrase “No man and his money are safe while Congress is in session.  (The actually quote goes to 19th century NY politico Gideon Tucker, but I digress.)  There’s little to be said, in general, about TheDonald’s proposals yesterday, simply because there’s little substance to analyze.  However, I’m old enough to remember the last tax overhaul, in the early stages of the Reagan administration, and perhaps I can offer a few observations.  I’ll limit my mental meanderings to real estate for now.

First, the Reagan tax re-hab (the 1986 Tax Act) was a disaster for real estate investing, particularly at the individual, atomistic investor level.  One of the “loopholes” to be cured was the elimination of deductibility of passive losses on real estate investments.  The real estate community reluctantly supported the tax act, in trade for increases in the deductibility of home mortgage interest and a guarantee that passive losses on then-existing real estate deals would be grandfathered.  Indeed, in the run-up to passage, there was a flurry of investing (by Main Street USA folks — the kind of folks who still, amazingly, support Trump) in just such “grandfathered” investments.  At the last minute, the grandfathering was removed, costing Main Street USA investors tons of alternative minimum tax payments on now-sour investments.  Some pundits suggest that this grandfathering-revocation, alone, led to the downfall of the Savings and Loan industry, but that excuse is a bit to simplistic.  It did, however, shut down the time share industry for a while.

Today, according to news reports, single family residences are enjoying record demand (which may or may not be good news).  The hottest market is among first-time buyers, and the demand is greatest among starter homes.  The Trump proposals would double the standard deduction for a married couple filing jointly.  While, on the surface this seems like a good idea, it will drastically shrink the number of tax payers who itemize mortgage interest and property taxes.  In short, for the biggest tranche of homebuyers, the biggest differentiation between ownership and renting would be effectively removed.  As a guy who invests in rental property, that’s nice, but the home building industry won’t react well.

Otherwise, I don’t see lowering the marginal tax rate on corporations as having much of an effect on real estate investing.  For one, most of those projects are either done thru tax-advantaged REITs or thru other pass-thru entities, like partnerships and LLCs.  Even if it did, the demand / supply of investment grade real estate depends on other factors, and slight changes in the tax rate may have an impact on the debt/equity mix, but not on the aggregate output of new commercial construction.  The ONE area most affected will be low income housing, which is funding in no small part by tax credits.  The value of those credits will be slashed, requiring a complete re-thinking in the finance side of low income housing.  The last time such a tax cut went into effect, it was a real mess for low income housing.

If I was the government, and I wanted to create good paying construction jobs, I’d embark on a long-term infrastructure redevelopment plan.  That would probably require actually raising tax rates a bit, but would have marvelous returns on investment for middle America.  But that’s just me….

Sears on life support

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I write mainly about real estate, and while the glass has been more than half full these past few years, the recent announcements from Sears are troubling, to say the least.   For those not keeping up with such things,  In their most recent annual report, Sears made a “going concern” announcement, which essentially said that there is a reasonable chance they will not survive as a going concern for another year.

This is a massive problem, and the real estate issued will take years to sort out.  Sears has announced some steps to try to address this, including selling off real estate, selling key brands (Kenmore, Craftsman) and shutting badly performing stores.  However, they’ve already been doing this for years.  Craftsman is now owned by Black and Decker, they’ve been shutting stores for over a decade, and they formed Seritage REIT several years ago (in no small part owned by Warren Buffett) to monetize their real estate holdings.

As of the most recent reports, Sears runs about 1500 stores in the U.S., mostly under the mastheads “Sears” and “K-Mart”.  They employ 178,000 people, and had revenue of $22 Billion in 2016.  They’re bleeding cash, losing about $1.2 Billion in cash in the past 2 years.  Their net equity now stands at negative $3.8 Billion, according to recent reports.  At an average store size of about 100,000 square feet, they operate about 150 million square feet of retail space, which will be a real problem to deal with.  (I’m writing this while sitting in my office in Key West.  There are 5 big “anchor tenants” of shopping centers in Key West.  Three are groceries, and the other two are owned by Sears.)

Dumping 150 million feet of retail floor space into the market is a pain any way you look at it.  Currently, new retail construction in America is about half that.  However, this “new retail construction” includes a lot of stuff that doesn’t look like an old Sears or K-Mart store.  Indeed, repositioning big-box and anchor tenants can be a daunting challenge, and often the best use is demolition of the structure and repurposing of the vacant site.  Losing a big anchor retailer can blight an entire shopping center and need an entire large neighborhood.

One might suggest that a leaner, meaner Sears could be in the offing.  In someone’s dream world, Sears and K-Mart might retrench to half their current size — say 700 or 800 stores.  This is still a big problem, but at least kicks some of the cans down the road.  I’m a real estate guy, not a retail guy, but I think the problems of running a small chain of big, diversified retailers is pretty obvious.  Distribution, financing, and brand management will all die on the vine.  No, Sears and K-mart have bigger problems.  Sears tries to sell to a slice of the market that doesn’t shop much anymore (your grandmother) and K-Mart tried to be Wal-Marts scruffy little brother.  Neither of these retail strategies work very well.

We’ll see how this turns out, but the complexity of a Sears bankruptcy will keep real estate consultants busy for years to come.

Written by johnkilpatrick

March 24, 2017 at 8:20 am