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  • J.C. Penney, The Real Estate Play [View article]
    Good post, Todd. I can't say specifically whether the Vornado deal is a good one for each party, but there's plenty of evidence that unlocking shareholder value by transferring real estate assets to a company that specializes in managing them is generally a win-win. And of course shareholder-hostile corporate governance moves are never a good idea (except for the executives being protected).
    Thanks for giving this deal such clear thought.
    Oct 30, 2010. 07:23 AM | Likes Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    I'm not sure we're so far apart, WestCoaster. The fact that banks are underwriting to DCRs rather than LTVs is the essence of the "pretend and extend" policy, and when I say that the Federal regulatory agencies will pull back from that policy, what I mean is that they'll force banks to underwrite to LTVs again. And when I say that private owners' property values will continue to drop, in many cases it's despite the fact that operating fundamentals--and therefore NOIs--will be improving at the same time. It's just that the overall average price will decline because the income-producing properties will be outweighed by the non-income-generating properties owned by the distressed sellers.
    Either way, thanks for your thoughts.
    Oct 29, 2010. 03:18 PM | 1 Like Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    WestCoaster, I agree that capital is available to owners, but as the Federal government bank regulatory agencies pull back from their "pretend and extend" policy, banks will be forced to recognize the actual values of the properties in computing loan-to-value ratios rather than to underwrite new loans based purely on cash flow pretending that values haven't fallen. Because of that, even though there's capital available, owners who over-paid during the market bubble will have trouble getting it.
    Also, it's not the fact that REITs have access to capital that will force owners to sell. It's the fact that when their debts mature, they'll have no way of repaying them other than by selling one property to make the payments on another. The debt maturities are what will force the transactions.
    Oct 29, 2010. 01:25 PM | 1 Like Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    Dmitri, the "distressed" index that, according to Professor Geltner, is now down 62% comprises those property transactions that were identified by Real Capital Analytics as involving a "distressed asset." I'm not sure exactly how they determine which assets were distressed, and therefore I can't be sure that none of them is owned by a publicly traded REIT. Generally, though, distress means one of two things: (1) a property that is severely run-down or otherwise sub-standard, which its owner bought during the bubble on the gamble that s/he could make money on it anyway simply by holding it for a little while and flipping it at a higher point on the bubble; or (2) a property of reasonably good condition whose owner is in financial distress. Neither of those situations describes publicly traded REITs to any significant extent.
    So yes, essentially I'm saying that investors are happy with publicly traded REITs because generally they're long the properties whose values are already increasing, and because they're expected to be able to buy more high-quality properties from distressed sellers at good prices.
    Oct 29, 2010. 09:15 AM | Likes Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    The reason that investors aren't punishing REIT stocks, Dmitri, is that REITs are the ones that stand to benefit most from this situation. The winners in this kind of market are the ones who have access to capital on good terms, plus the incentive to use that capital well; the losers are the ones who don't have access to capital (because they rely on bank lending or private equity raising) or who have a pile of cash but have an incentive to overpay. REITs are the ones with access to capital plus a business model that forces them to use it wisely.
    The result is that investors expect REIT earnings to grow strongly over the next several years, first from their ability to acquire good-quality properties at good prices and second from their ownership of good properties as operating fundamentals improve.
    Also, keep in mind that the values of high-quality properties have already been moving up strongly--and that's where REIT portfolios tend to be concentrated.
    Thanks for raising your question.
    Oct 29, 2010. 06:39 AM | 1 Like Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    We've started to see seller capitulation, WestCoaster, but there's still a huge gap between seller asking prices and buyer offer prices, except in the high-quality segment. But I agree with you: it'll take a while before the market becomes unstuck. I think it'll end up being seller capitulation driven by debt maturities, rather than buyer bidding wars or bank willingness to lend, that gets the market moving again.
    Oct 28, 2010. 08:49 PM | 2 Likes Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    Agreed, JGB: the 5-year balloon timing is key. My own thought is that property values won't recover meaningfully before 2012, and may go down further--that's on average, because higher-quality properties are already seeing values go up but distressed sales will outweigh them for the next couple of years. Meanwhile, the banks will regain their health, so the "pretend and extend" policy will end. That means that when the five-year loans that were originated in 2007 come due, they'll mature into about the trough of property values while banks won't have leeway to extend them without recognizing their actual values. That's when distressed sales will reach their peak--again, even though operating fundamentals may even be much stronger by then.
    Oct 28, 2010. 08:45 PM | 2 Likes Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    Thanks for your comment, JGB. I'm not sure I understand your first question--the evidence is simply that higher-quality properties from non-distressed sellers are increasing in value.
    As to your second question: Yes, definitely, publicly traded REITs made secondary equity offerings to raise new capital. There have generally been three purposes: first, to pay off maturing debt (especially in the spring of 2009 when, as you note, there was very little access to new debt); second, to strengthen the balance sheet by bringing down leverage; and third, to acquire new properties. Acquisitions mostly haven't happened yet because the properties aren't for sale, but I do expect to see a great deal of additional new capital--both equity and debt--raised over the next few years to purchase properties as they become available.
    Oct 28, 2010. 08:39 PM | Likes Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    Actually, Granger, I think the opportunities over the next few years will be driven more by conditions in the capital market than by differences in the fundamentals for particular property types or locations. In other words, I think there'll be opportunities in all segments for investors who have access to capital on favorable terms but who are not under pressure to invest quickly.
    Many would-be real estate investors can't take advantage of those opportunities because they can't access public equity or public debt markets, and the private debt and private equity markets continue to be seized up.
    Other investors (or investment managers) have capital to invest, but will end up overpaying because they're under pressure to put committed capital to work. Overpaying at the bottom of the market is just as harmful to eventual returns as overpaying at the top.
    What are your thoughts?
    Oct 28, 2010. 05:41 PM | 1 Like Like |Link to Comment
  • More on the 'Trifurcated' Commercial Real Estate Market [View article]
    It will eventually show up, mostly through distressed property sales. Investment managers that paid top dollar during the bubble (especially 2007), and used huge amounts of debt in the process, will run out of wiggle room when their debts mature and they don't have access to capital to repay them. They'll either default (in which case the assets come on the market through REO) or sell one asset hoping to rescue the rest of the portfolio. That hasn't happened yet because, first, transactions reveal what the portfolio is really worth and, second, the debts haven't forced the sale yet. But when time runs out, I expect overall average property values to slip even more sharply downward--even if fundamentals are improving by then--because the distressed transactions will overwhelm the non-distressed transactions.
    Thanks for your comment!
    Oct 28, 2010. 12:47 PM | 4 Likes Like |Link to Comment
  • New PREA Report Recognizes Value of REITs [View article]
    Thanks, Brad. I plan to follow PREA's methodology to extend their analysis in several ways, to see how robust their results are. I don't know how quickly I'll get to it, but I'll post an article about it when I do.
    Oct 27, 2010. 08:20 PM | Likes Like |Link to Comment
  • What's Wrong With Capital Appreciation in Core Real Estate? [View article]
    I understand your point, ConsiderBothSides: capital appreciation of a property is not the same as capital appreciation of a share of ownership in a company that owns properties. Still, from an investor's point of view, there are two ways to benefit from an investment: income and capital appreciation. Those investors who accessed the real estate asset class through core funds got income but no capital appreciation, while those investors who accessed the same real estate asset class through publicly traded REITs got essentially the same income PLUS significant capital appreciation.
    The implication is that core funds are in the business of watching properties deteriorate while they throw off income, while publicly traded REITs are in the business of generating capital appreciation from their properties while enjoying essentially the same income.
    Oct 27, 2010. 08:18 PM | Likes Like |Link to Comment
  • What's Wrong With Capital Appreciation in Core Real Estate? [View article]
    Thanks for your comment, Chieftains. (The musical group, I assume?)
    Unfortunately you must be a NCREIF member to access the data--but if you're affiliated either with a large pension fund that is a NCREIF member or with one of their real estate investment managers, that may give you the access you need. Or you could ask someone else who has access to the data to verify the result.
    As to your first question, there's actually no methodology: the ODCE (open-ended diversified core equity) fund index provides gross and net returns, total as well as separated into income and capital appreciation components. The income index now is the same (within rounding error) as it was in 1977Q4, when the index was introduced.
    I should point out that, according to ODCE, fees and expenses of core funds are paid purely out of capital appreciation, not out of income. That is, gross income and net income are identical.
    Oct 27, 2010. 08:13 PM | Likes Like |Link to Comment
  • What's Wrong With Capital Appreciation in Core Real Estate? [View article]
    Thanks for your comment, ConsiderBothSides. Actually, I don't ever want to suggest that REIT executives are smarter than the rest of the industry--in fact, I think it's much more likely that transparency, liquidity, investor-oriented governance, and other differences between the REIT business model and the private fund business model account for the difference, rather than any difference in smarts. I'll post other blogs on those business model differences.

    I don't think it's likely that other return streams explain the difference, since any other return streams would also be included in each REIT's dividend and therefore be included in its income return rather than its capital appreciation. Besides, even at their peak, those three companies accounted for only about one-twelfth of the total industry.

    Finally, for pension funds and other institutional investors I don't advocate investing 100% through REITs. In two other articles I report on research that suggests holding something like one-third in REITs, one-third in core fund investments, and one-third in opportunistic fund investments. That's because, even though all three invest in the same real estate assets, their returns happen on a different schedule, which means that investors who hold all three can benefit from diversification.
    Oct 25, 2010. 03:00 PM | Likes Like |Link to Comment
  • What's Wrong With Capital Appreciation in Core Real Estate? [View article]
    Yes, ssg13565, I've plotted the gains and losses over time, and what's shocking is that private real estate investments (meaning those not made through publicly traded REITs) have never provided very much capital appreciation except in the few years of the bubble. Even at the highest peak of the bubble, capital appreciation was unbelievably low: as of 2008Q2 (the high point), for example, core funds showed capital appreciation averaging just 0.80% per year over the previous 20 years. For publicly traded REITs, though, the capital appreciation averaged 5.39% per year.

    That means it's not just a matter of the endpoints. The truth is, capital appreciation in real estate has taken place--but the managers of private real estate investment funds have missed it completely.
    Oct 25, 2010. 08:48 AM | Likes Like |Link to Comment