From a small northwestern observatory…

Finance and economics generally focused on real estate

Posts Tagged ‘REITs

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.

American Real Estate Society Annual Meetings

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For many years, Greenfield had been privileged to participate in the annual American Real Estate Society meetings, held in late April and typically in a warm, waterfront location.  This year’s meeting was at the Sanibel Harbor Marriott Resort, on the bay near Sanibel Island, Florida.

Of the major academic real estate organizations, ARES has the unique mission of bridging academia and practitioners, and as such draws a large contingent of Ph.D.-types (and others) from organizations like Greenfield.  Somewhat surprisingly for an organization which bridges academia and practice, ARES publishes the largest number of scholarly real estate publications, and has the top-ranked academic journal in the real estate, insurance, and banking fields (the Journal of Real Estate Research, edited by my good friend, Dr. Ko Wang of Johns Hopkins University).

Various researchers at Greenfield authored several papers accepted for presentation at the ARES meetings, including:

  • The Impact of Fracking Sites on Brownfield Funding (Dr. Clifford Lipscomb)
  • Can We Forecast the Next Bubble? (Kilpatrick and Lipscomb)
  • A Primer on Cleaning Residential Real Estate Data (Lipscomb and Dr. Andy Krause of U. Melbourne)
  • Using a Random Forest Process in an Automated Valuation Model (Lipscomb, Kilpatrick, Jessica Kenyon of Greenfield and Dan Tetrick of Greenfield)
  • The Impact of the NAREIT Light Awards on REIT Performance (Kilpatrick and Lipscomb)

Additionally, I had the pleasure of serving as co-chair (with the esteemed Dr. Stephen Roulac of U. Ulster and Roulac Global Research) for one of the sessions where doctoral students presented their research.  Dr. Roulac and I heard presentations from students from Yale, from Royal Agricultural University and U. Aberdeen in the U.K, and U. Regensburg in Germany.

I’ll conclude with a big “shout-out” to Dr. Arthur Schwartz, who despite having been retired for quite a few years, serves as the volunteer Meeting Planner for ARES (at no small personal expense) and manages to secure world-class warm-water resorts for these spectacular meetings.  Sadly, he is taking a sabbatical for 2016, and the meeting will be in chilly Denver.  However, I’m pleased that the meeting will return to San Diego in April, 2017, and to Estero, Fl (near Ft. Myers) in 2018.

Written by johnkilpatrick

May 8, 2015 at 11:54 am

Tea Leaves and Such

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Flying back from Milwaukee to Seattle last night, I sat next to a fellow who owns several big truck dealerships in the mid-west.  (Seattle, famed for Boeing and Microsoft, is the lesser-recognized headquarters of Paccar, the world’s third largest maker of heavy trucks, after Daimler and Volvo. Last year, they made and sold over $16 Billion worth of Kenworths and Peterbilts.)

ANYWAY, after the usual “how’s business?” question, I got an earful. Turns out no one’s buying heavy trucks right now, even though financing is historically affordable, and customers have cash. Why?  Simply put, his customers are scared of the fiscal cliff.  (We also talked about customers deferring potential acquisitions until after/if tax rates go up, but he said that this wasn’t a big issue in his surveys of customer sentiments.)  He noted that demand for long-haul trucking was down, and noted that his trucking-company customers were reporting a lower volume of hauling for consumer retailers.

Now, if this was an isolated incident, we could write it off.  However, the danger of the fiscal cliff isn’t just what will happen after January 1.  Much like an impending hurricane, people are already packing their bags and getting out of the way or hunkering down and bolting the doors.

What is the impact on real estate?  While it’s too early to completely quantify, clearly there is reluctance right now to make new investments in office, industrial, and retail.  Add to this the realization that the apartment boom may have leveled off, and we have a fairly flat new development market on the horizon. This doesn’t bode well for real estate private equity firms that are focused on development profits or capital gains, but it does mean that income-oriented real estate (publicly traded REITs for example) may exhibit some buying opportunities due to both their tax advantaged nature.  The most recent Current Market Commentary from NAREIT shows slight downward trends in apartment, office, and retail vacancy, with all three sectors showing positive rental rate growth (albeit at lower levels than earlier this year).   The three-year moving average for renter household formation continues to trend upward, while the owner-occupied household formation is in negative territory (despite recent gains in home sales and housing starts).

Notwithstanding the dangers of the fiscal cliff, changes in non-farm payrolls have been strong and positive every month since mid-2010, and even though unemployment is higher than anyone wants to see it, the trend has been solidly downward since the peak of late 2009.  As such, the fiscal cliff is the most significant economic problem on the horizon today. Fix it, and we continue on the track to full recovery.  Let us drive off the cliff, and…. well, that’s a pretty good mental picture, eh?

Written by johnkilpatrick

December 6, 2012 at 9:57 am

Corporate Investment — Much ado about…. something

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I can’t believe it’s been a month since I posted — I’ve been traveling almost constantly the past few weeks, and between that and the elections, my dance card has been fairly full.

The trigger for day’s post was an article in the Wall Street Journal on Monday, “Investment Falls off a Cliff”, with obvious homage to the impending fiscal cliff.  I don’t want to minimize the danger of the “FC”, and in fact all bets are really off if the worst case scenarios come to pass.  Here at Greenfield, we don’t really believe Congress and the White House will both fail to blink.  Nonetheless, “keeping your powder dry” is always good advise in perilous times.

I’d like to comment on two things, though.  First, while direction of corporate investment isn’t good, it’s not quite “double dipping” just yet.  Indeed, one might argue that the current downswing in investment is nothing more than seasonal backing-and-filling.

courtesy, Wall Street Journal

Note that after coming out of the recession, overall investment spending took a brief respite in early 2011, as well.  Of course, equipment and software appear to continue healthy, but structures are dragging the overall index down.  Part of this can be explained by the relaxation of the apartment construction surge that we saw over the past several quarters.  Many analysts now believe the demand-overhand in apartments is close to saturation (or at least satisfaction) and this sort of slow-down is neither unusual nor unhealthy.  Note that the NFIB optimism survey is still trending upward, although the Business Roundtable CEO survey (which surveys heads of larger firms than the NFIB does) had turned downward.  I suspect that’s a rebound effect — small businesses are still clawing their way out of the recession, and are less affected by what may happen if the FC becomes reality.  The larger firms were the first to enjoy the fruits of the recovery, and would be the worst hurt by tax increases and the FC cutbacks (particularly in defense).  Nonetheless, both of these sentiment measures are well off their 2009 bottoms.  Consumer sentiment, which ultimately drives much of this, is as good as its been since before the recession.

Second, I’m concerned about the negativity spreading to real estate.  Note that real estate investment comes in three flavors — development, capital gains, and income.  The downturn in investment has SOMEWHAT negative implications for the first.  Real estate developers will have to be more careful in a slow-down environment, but that’s been true throughout this recovery.  Financing is difficult, even in the “hot” apartment market, and so admittedly the commercial real estate developers may be in for a tough run.  (Residential development, on the other hand, is rebounding nicely.)  Capital gains is a “long game” anyway.  Certainly the tax changes which seem inevitable in 2013 and beyond have negative implications for the buy-and-sell crowd, but the returns to those who can hold thru cyclical downturns have always been healthy even after tax considerations.

Real estate income (primarily REITs) may actually be benefitted by a slight retrenchment in development.  If and as the economy continues to rebound, offices, warehouses, and shopping malls continue to fill up.  Lack of new supply (from a cyclical downturn in development) benefits the sort of existing structures which are typically part of a REIT portfolio.  As always, investors will be benefitted from looking at good managers with top-drawer properties and a history of increasing FFO.

Written by johnkilpatrick

November 21, 2012 at 10:35 am

Economic outlook — fundamentals and shocks

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I love boating, I really do.  To quote from Grahame’s famous The Wind in the Willow, “…there is NOTHING–absolute nothing–half so much worth doing as simply messing about in boats.”  However, any experienced sailor has had one of those days when the water was perfect, the wind was with you, but off on the horizon a storm cloud lurked.  “Will it head our way, or pass us by?” is the key to whether the fun cruise continues or not.

Today, and for the next few weeks, the economy is like that.  The wind is definitely at our backs, and things are generally looking up.  That having been said, the fiscal cliff continues to loom on the not-too-distant horizon.

First, the good news, and there’s plenty of it.  I’m on the Board of an investment fund (and in fact just got named chairman of the board this month, for a two-year stint).  We had a great briefing yesterday from our lead fund manager, and macroeconomic news was as good as I’ve seen it in a while.  Corporate profits are at near-record levels as a percentage of GDP, and non-financial interest expense as a percentage of profits is at a near-record low.  Lending is back up, although corporate lending isn’t quite as robust as consumer lending,  and current stock market price-earnings ratios (measured on a 12-month trailing basis) are at levels usually associated with strong intermediate-term (5-year) market returns.  Equity risk premia tell the same story.

On the real estate side, everyone’s seen the news that the S&P Case Shiller index is trending back up, and this morning’s news report puts current housing starts above an 800,000 annualized level (note that we’re hoping for a million, and at the trough of the recession we were at a record low 300,000-ish).  Manufacturing has added about a half-million jobs since the trough of the recession (early 2010), and is about 300,000 above where it stood in July, 2009.

The implications for real estate investment are clear, and as I reported earlier this week, the total return on U.S. REITs has exceeded 30% in the past year, besting the S&P 500.

With that in mind, though, the fiscal cliff continues to trouble us all.  If you’re not familiar, on January 1, the Bush Tax Cuts will expire and mandated federal spending cuts are scheduled.  Together, these two will hit the economy to the tune of about 4% of GDP (yes, driving us into a second recession).  Sadly, the solution is political, and this is all coming at a time when Congress and the White House are totally focused on the impending election.

We’ll keep you posted, and we’re preparing some private white papers on this subject for our clients as the season moves forward.

Written by johnkilpatrick

October 17, 2012 at 8:51 am

REITs — good news trumps “iffy” news

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The “headline” in Erika Morphy’s piece in GlobeSt.Com this morning was that was that REITs underperformed the S&P 500 for August and September.  Specifically, REITs were up 1.85% in the 3rd quarter this year, compared to 6.35% for the S&P 500.  You have to dig a little deeper to get to the heart of the matter, though.

First, let’s remember that investors by-and-large buy REITs as an income vehicle with equity up-side.  The current average REIT yield is 3.88% — not bad, compared to corporate bonds or preferred stocks, and more targeted income seekers can go after single tenant retail with a yield of 5.9%.  (For a great review of this, see a piece by Brad Thomas in Forbes.com from September 10).  Couple those sorts of dividend yields with any upside equity potential, and you have a real investment powerhouse in today’s market.  For comparison, the current yield on the S&P 500 is 1.97%.

But, the news gets better.  For the 12-months ending September 30, the NAREIT index was up 33.81%, compared to 30.2% for the S&P.  Do the math — the total return for a portfolio of REIT shares for the past year would have been (33.81% + 3.88% = ) 37.69%.  The total yield for the S&P 500 would have been (30.2% + 1.97% = ) 32.17%.  Thus, slightly more than a 500 basis point return advantage to REITs.

Of course, (and this goes without saying), past performance doesn’t translate into future returns…..

Written by johnkilpatrick

October 15, 2012 at 9:46 am

REIT Research — Real Estate in Volatile Times

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The National Association of Real Estate Investment Trusts (NAREIT) recently commissioned Morningstar to study the role of securitized real estate in the well-balanced portfolio, with a particular eye to the investor attitudes regarding risk, as well as the actual performance of markets.  Both of these two concepts — risk and investor attitudes — are less well understood than researchers seem to think.  In the first, market models assume a degree of normalcy in the distribution of market returns.  However, empirical evidence seems to contradict this, and in fact market volatility is significantly greater (and of greater magnitude) than models would predict.

In the second case — investor attitudes — traditional models suggest that rational investors react to “up” markets in the same way as “down” markets.  More recent behavioral models recognize the fallacy in this — rational investors relish “up” volatility, but loathe down markets.

The results of the research were published in an excellent new research piece from NAREIT titled “The Role of Real Estate in Weathering the Storm” (click on the title for a copy of the paper).  Some high-points from the study:

  • Since 1929, the S&P 500 has had 10 months with declines of 15.74% or more — which is eight more than would be predicted by a normal distribution.
  • Recent studies by James Xiong of Ibbotson Research show that the log-normal distribution fails to account for this down-side volatility.
  • From 2000 – 2009 (often called the “lost decade”), the cumulative return on large-cap stocks was negative 0.95%.

Morningstar then crafted portfolios under the “theoretical” model (normal distribution) versus a more realistic model of volatility, with alternative structures for risk-averse investors and more risk-tolerant investors.  Investment returns were measured over the period 1990 – 2009, which notably included the recent market melt-down.

Under normal distribution assumptions, an optimum risk-averse portfolio would allocate about 6% to securitized real estate and theoretically enjoy a return of 7.6%.  Under more realistic volatility assumptions, the risk-averse portfolio would allocate 14% to securitized real estate and would have returned 8.2%.

A more risk-tolerant investor would have allocated 18% to 20% in securitized real estate, and would have enjoyed a return of 9.7%, with volatility (standard deviation of portfolio returns) of 10%.

The most striking finding of the study was the consistent role played by securitized real estate in all four of the models (normal versus non-normal, risk-averse versus risk-tolerant) and particularly thru the market melt-down.  While this may seem counter-intuitive, given the roller-coaster ride of REIT prices, investors need to realize that REIT shares paid relatively high dividends through this period, thus ameliorating the downward price movements.  In short, the gains from real estate holdings pre-meltdown, coupled with the dividends, more than made up for the price bounce over the past few years.  Further, REIT prices have rebounded better post-recession than have other S&P shares.

Written by johnkilpatrick

September 12, 2012 at 4:56 am