From a small northwestern observatory…

Finance and economics generally focused on real estate

Archive for the ‘Real Estate Investments’ Category

Collapsing Price of Alternative Energy

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Most — nearly all — of our work is in real estate, but energy has a huge real estate component, so major shifts in the energy market have significant implications for real estate investment.

A recent report out of Lazard reflects just such a major shift.  Specifically, among five major sources of energy, wind and solar are now the low-cost alternatives.  Indeed, since 2009. the cost of solar energy (at a utility scale — not just what’s on the roof of your house) has declined by 86% to about $50 per megawatt hour.  Coal, for example, has declined in price only 8% during that period, and is now $102/MWh, or double the cost of solar.  Wind is even cheaper, at $45/MWh.

Thanks to Lazard for the accompanying graphic.

Lazard estimates

The implications for real estate are obvious. If and as utilities shift supply sources, and focus on alternative energy to meet increasing demands, there will be an accompanying demand for solar farms, wind farms, and new transmission lines.  Accompanying this, we’ll probably see a decreased utilization of coal mines, and certainly a reduced demand for new coal mines.

Written by johnkilpatrick

May 9, 2018 at 8:39 am

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

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

So, folks, where are we going to live?

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Much has been said recently about housing starts being back up to where they were before the recession.  If this is the case, then why does Seattle, for example, have a 0.9 month supply of homes for sale?  As usual, the details are much more complicated than the headlines.

Prior to the “meltdown” (let’s say, 2004 – 2007), housing starts in the U.S. averaged about 1.865 million units per year.  Now, few analysts disagree that this was too many, but figuring out the right number is harder than one might think.  In 2008, the number dipped down to about 905,000, and hit a low of 583,000 in 2009.  Since then, the annual starts have trended up.  However, in 2016, we still were only at 1.207 million.  Of that, only 751,000 were single family units, compared to an average of 1.4 million single family homes per year in the 2004-2007 period.  Hence, nationally, we’re building about half as many homes as we were 10 years ago.

From 2004-2007, we started 7.462 million dwelling units in America, but in the past four years we’ve only started a total of about 4.432 million (all varieties).  That’s a shrinkage of about 3 million new homes, and most of that shrinkage is in the single family category.

One might posit that the decline in home ownership rates should have freed up some demand, and some of that’s true.  The home ownership rate in America peaked at 69% during the run-up to the recession, and dropped steadily after the melt-down, to a low of 62.9% in the 2nd quarter 2016.  As of the end of the 3rd quarter this year, it sits at 63.9%, or about 5 points below the peak of a decade ago.

There are about 76.146 million owner-occupied housing units in the U.S. today.  A five-percent swing in this number is a little over 3.5 million houses.  In short, we’ve now “absorbed” the decline in starts, and structurally we’re more-or-less “over” the recession, and we’re simply not building enough new homes to meet the demand.

Several consequences came out of the melt-down.  First, developing land takes quite a few years — five or more in the “hot” areas like Seattle, where land has to go thru a permitting and entitlement phase long before a house can be built.  All of this requires land planners, both in the private sector and downtown at the county or city hall. Many of these folks lost their jobs during the 2008-09 period, and indeed some county and city planning offices were eviscerated.  New home development frequently requires a significant outlay in public infrastructure, including schools, roads, and utilities.  Worse than that, many construction trades were gutted, with no replacements available.   Financing for acquisition, development, and construction is now problematic (although, arguably, it was too liberal pre-recession).

As such, it’s a sellers market for homes, and in hot markets, buyers compete by bidding up prices beyond reasonable levels.  Some pundits are nervous, and with good reason.

(Thanks to the U.S. Census Bureau for the October 31 data.)

Written by johnkilpatrick

December 11, 2017 at 11:29 am

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

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