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Reggie Middleton is the personification of the freethinking maverick — the ultimate nonconformist as it applies to macro strategies, investment, and analysis. He uses his background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate,... More
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  • The Great Global Macro Experiment, BoomBust Cycles, and the Refusal to See the Truth: Bubble Economics in the Mainstream Media 1 comment
    Sep 1, 2010 11:22 AM | about stocks: MAC, GGP

    Back in September of 2007 when I was preparing to launch a hedge fund, I came up with this interesting name for a blog. It was BoomBustBlog. What made it interesting is that I can literally blog ad infinitum on the synthetically crafted booms and busts of the global economy, for the method of shepherding the economy in this day and age is actually predicated on the existence and/or creation of Booms and Busts. Of course, from my common sense perspective, one would think that the job of a central banker would be to ameliorate the effects of, and in time eliminate booms and busts… Apparently, that doesn’t appear to be the flavor du jour. As a matter of fact, it appears as if central bankers are doing the exact opposite. Of course, attempting to cure a bust with a boom, or worse yet attempting to prevent a boom from busting with another boom is a recipe for disaster, and worse yet the probability of success is close to nil, yet central bankers try anyway. This leads to overt and explicit policy errors, which leads to outsized profit opportunities to those who pay attention. Enter “The Great Global Macro Experiment, Revisited“, from which I will excerpt below. Please keep in mind that this article was written in October of 2008, and turned out to be quite prescient, I will annotate in bold parentheticals the portions of particularly prescient relevance. The original macro experiment piece was posted on my blog in September of 2007… For those that are interested, I plan on discussing this topic live on Bloomberg TV today: “Street Smart” with Matt Miller & Carol Massar at 3:30 pm.

    As the US real estate market (residential, and soon commercial) is tanking (see BoomBustBlog.com’s answer to GGP’s latest press release and Another GGP update coming), the opaque derivative structures that allowed banks to write loans bigger than their balance sheets follow (see Is this the Breaking of the Bear? among many others). This will ripple throughout the world as speculative real estate and exotic financing vehicles follow the same paths in Europe (see the Pan-European Sovereign Debt Crisis series), Africa (reference Dubai’s solvency issues), Asia (see Chubble (The Unmistakeable, Yet Thoroughly Argued Chinese Bubble), Unemployed/Deleveraging Shopaholics Pushing Retail Stocks & Other News and What Are the Odds That China Will Follow 1920’s US and 1980’s Japan?), and South America. Spain’s residential real estate market is currently on fire and 92% of the mortgages issued are ARMs, most of which are concentrated to the lower income buyers (see The Spanish Inquisition is About to Begin…“ and Spain Reports 20%+ Unemployment, a Structural Problem That May Persist For Some Time). Sound familiar? Similar scenes in Brazil. UK residential prices have soared (see Osborne Seems to Have Read the BoomBustBlog UK Finances Analysis, His U.K. Deficit Cuts May Rattle Coalition as well as the near collapse of several large UK banks), Australia up nearly 3 times (relative) (see Australia: The Land Down Under(water in mortgage debt), China homebuilders and contractors or roaring, condos in Dubai everywhere… Add in the US exported structured products… Practically all of the popularized risky assets are destined to follow suit, not just real estate – expect pressure in the emerging market debt markets as a follow-through…

    Understanding my proprietary investment style

    reggieboombustcycles.png

    My own, personal and discretionary investment style leverages long and short positions in any traditional or alternative asset class, in any instrument, in any market around the world with the goal of profiting from macroeconomic trends. Put most simply, I attempt to employ the tried and true adage: buy low and sell high – I simply aim to do it during all phases of the market cycle. The often used, but seldomly recognized as meaningless, investment style classifications of value investing, growth company investing, etc. are silly, to say the least. Everybody is a value investor. We all buy something with the understanding that we will be able to sell it for more, thus the implication that it is undervalued at the time of purchase. The reason why we feel we can sell it for more is the impetus behind these nonsensical monikers of value, growth, Amy, Cindy and Karen! At the end of the day, we all want to buy low and sell high. The key is, how do we successfully go about doing it.

    Now, in reading the now historical missive above which references debacle after debacle that policy makers retort “were impossible to see coming” (yeah, uh huh!), it could conceivably be argued that a) I had a crystal ball, b) I’m just smart as hell, or c) I simply pay attention and adhere to basic math, i.e., 2 + 2 = 4, all day, everyday – you know, realism. I’ll let you decide which answer is most appropriate. I go through this exercise because while reading through Bloomberg at 2 am in the morning (yeah, I know I should have better things to do,  but how else will this blog get written), I came across a statement from some professionals that reinforced my thesis that some investors literally cannot possibly fathom that we are still in a bubble despite 40% drops in commercial real estate prices. Take a look at the chart above, the cycle goes up and down, and has been doing so for centuries. Despite the fact that nothing has really changed for over a 1,000 years, it is amazing that so very few have learned their lesson. Or to put it another way, just because something is cheap doesn’t mean it can’t get a whole lot cheaper. Wait a minute, I’ve got another one… I fall out of a 10 story window, and drop 60 feet in a matter of seconds…. Does this really mean that my fall is over just because I fell 60 feet so fast, or do I really have another 100 feet to go, then a very hard impact before all is said and done???

    Bloomberg writes: Real Estate Premium to U.S. Bonds Signal Time to Buy Property

    Sept. 1 (Bloomberg) — U.S. commercial real estate yields are near the highest level relative to Treasury bonds on record, a signal to some investors it’s time to buy property. Capitalization rates, a measure of real estate yields, averaged 7.22 percent in the second quarter, based on an index calculated by the National Council of Real Estate Investment Fiduciaries. That was 429 basis points, or 4.29 percentage points, higher than the yield on 10-year government bonds as of June 30, according to data compiled by Bloomberg. It’s about 475 basis points higher than Treasury yields as of yesterday.

    That spread is near the record 539 basis points in the first quarter of 2009, when the U.S. was mired in the worst of the financial crisis and property prices sank. Risk-averse investors are seeking the highest-quality office towers, hotels and apartments as the gap widens, according to Nori Gerardo Lietz, partner and chief strategist for private real estate at Partners Group AG in San Francisco.

    “The data indicate that real estate is poised for a rebound,” said Gerardo Lietz, who advises pension funds on property investments.

    Well, I have several problems with the statement above. For one, it is very difficult to “time” real estate markets due to their illiquid nature and a lack of a crystal ball, but if one were a market timer the strategy above makes sense right? Actually, no it doesn’t. For one, we are not in any better an economic or fundamental position now than we were in 2009, its just that the government and the fed have spent so many trillions of dollars to create the illusion that we are under the umbrella of attempting to reinflate the bubbles of 2000 to 2007. With that being said, of course spreads are similar, the situations are similar save the government has less ammunition to fight the battle this time around.

     

     

     

    Chart sourced from CREconsole.com

     

     

     

    The strategy above appears to be borne from the long only asset management mantra of always buying an asset. Sometimes its best just to say “No!”. For instance, the story clearly states that spreads are almost as wide as they were in the first quarter of 2009, the height of the financial malaise. So, if one were to use the logic inherent and bought at those even wider blowout spreads (the argument for the thesis was stronger back then), take a look at what would  have happened to your hard earned (or your client’s hard earned) money…

     

     

     

    The Moodys/REAL commercial property index (CPPI) is a periodic same-property round-trip investment price change index of the U.S. commercial investment property market based on data from MIT Center for Real Estate industry partner Real Capital Analytics, Inc (RCA). The index has been developed with the objective of supporting the trading of commercial property price derivatives. The index is designed to track same-property realized round-trip price changes based purely on the documented prices in completed, contemporary property transactions. The index uses no appraisal valuations. The set of indices developed so far includes a national all-property index at the monthly frequency, national quarterly indices for each of the four major property type sectors (office, apartment, industrial, retail), selected annual-frequency indices for specific property sectors in specific metropolitan areas, and primary markets quarterly indices for the top 10 metropolitan areas in the major property types.

     

     

     

    The biggest hole (and there are a few) in this “spread” thesis is the gross reliance of the spread to Treasuries without recognition and appreciation that Treasuries themselves are most likely in a bubble. This is why it is best to take a truly fundamental look at your investments. Back to the story…

    Some buyers already are acquiring buildings at lower cap rates, which move inversely to price. In June, a group of South Korean pension fund investors bought the 33-story Wells Fargo Building in San Francisco for $333 million from Principal Financial Group Inc. in one of the largest transactions in the second quarter, according to Real Capital Analytics Inc., a property research firm. The office tower sold at a cap rate of about 7 percent, said Goodwin Gaw, the developer who helped broker on the deal.

    My question is, why not just wait until there is a discernible trend in the stability of CRE? Why must everyone rush in to be first? Do rental rates look to be going much higher in the near to medium term due to materially firmer business fundamentals or lessened supply? Do interest rates look to be dropping considerably in the near to medium term? Are the fundamentals of the renters firm and strong? How does supply vs demand look after rampant, bubblicious overbuilding (which is still going on, may I add)? How does the financing and credit landscape look? How about the credit metrics of existing buildings? Do we have low LTVs or are these things thoroughly underwater (see the Macerich excerpt below). Let’s take a few pages out of my CRE 2010 Outlook report for subscribers (click here to subscribe). Be aware that this 47 page report was written nearly 10 months ago…

     

     

    Are US Treasuries In A Bubble?

    Well, if they are, not only does that debunk the “spread only” thesis to CRE investing but it will devastate those who employed said thesis when the bubble pops. As treasury yields spike, the cap rates on said buildings will have to spike to maintain said spread or the spread will have to lessen making the CRE that much more expensive relative to the safer treasuries. Either way, the CRE investor would have wished they waited! Let’s take a look at the NYSE US 10 yr index…

    Whoa!!! Looks pretty bubblicious to me! Herein lies the problem. I don’t think that many investors truly understand the predicament that the US, much Europe and those big boys in Asia are in. Pray thee tell me, how is the US going to pay back its massive debt? Taking this from the beginning, many of us were told that the Federal Reserve’s mandate was to management inflation and unemployment rates. I lost a lot of profit and messed up a 7 year record of investing in the 2nd quarter of 2009 when the federal reserve performed a stealth mandate change, which in essence was to reinflate and maintain the credit and risky asset bubbles of the new millenium. This bubble blowing has been funded by the tax payer through the US Treasury. I challenge anybody to prove that the Fed’s objective has been anything but. The government and the CB has literally pulled out all stops to prevent the “Bust” portion of the Boom/Bust cycle. They have bought trillions in MBS, toxic assets directly off of private companies balance sheets, insured and indemnified private transaction, nationalized failed private financial institutions, purchased treasuries and MBS directly in a bid to artificially lower market interest rates -this is a move which is in and of itself by definition, unsustainable and guarantees a rate spike.

    To make a long story short, nearly all of the biggest private sector problems have effectively been nationalized and made public sector problems without forcing the private sector to right its wrongs. Since nothing has really changed in the private sector and we are not marking bad assets to market but rather letting whatever we couldn’t goose the government into buying and converting into treasuries remain as they were while cash generating from the faux recovery was paid out as bonuses – the banks still have a shit load of trash on their balance sheets amid a worsening macro environment, the most indebted government of our lifetime and crumbling fundamentals. I pray thee tell me, exactly how are rates not going to spike? US Treasures are the new CDOs, wherein back in 2007 private banks scooped the trash they couldn’t convince suckers clients into buying directly, said trash was aggregated and repackaged with a AAA moniker and then sold to suckers clients. So, what is the difference between what Lehman, Goldman, Merrill and Bear Steans did and what out Central Bank is doing – that is picking up the garbage that nobody wants, recycling it into treasuries with a AAA moniker and then reselling them? The biggest difference is that one of the biggest suckers clients buying these repackaged toxic assets cum treasuries is the Federal Reserve, itself. Talk about a Ponzi scheme that is unsustainable. Again, how is it that treasuries are not in a bubble? How will rates stay low enough to justify buying CRE based upon the spread over treasuries at historic lows that are virtually guaranteed to go higher before the fundamentals of CRE improve significantly? I haven’t even touched upon the situation of our friends over there in Europe  – see .Pan-European Sovereign Debt Crisis series, where several nations are skirting default or restructuring (de facto default, you don’t get your money as promised) which will most likely cause some serious interest rate volatility, of which some banks are not prepared to withstand – See The Next Step in the Bank Implosion Cycle???). Since banks lend to CRE investors…. Oh well, back to the article…

    Comparing Yields

    Investors compare property yields with Treasuries to determine how much potential profit real estate offers relative to an investment that’s considered low-risk. The spread shrank to less than 80 basis points, the narrowest in 16 years, when commercial real estate prices peaked in 2007. Property values have dropped more than 40 percent since the October 2007 top of the market, according to Moody’s Investors Service.

    The gap’s widening follows a plunge in bond yields after the global financial crisis spurred a flight to safety and the Federal Reserve slashed interest rates to a record low. Treasury bonds yesterday completed the biggest monthly rally since the end of 2008 amid signs economic growth is faltering, with the benchmark 10-year note yielding 2.47 percent.

    “Property is attractively priced versus the fixed-income market,” said Ritson Ferguson, chief investment officer of ING Clarion Real Estate Securities in Radnor, Pennsylvania, which manages about $12 billion.

    Yes, he’s right. Then again, 2 day old oysters smell attractive versus 3 day old oysters as well. Does that mean that 2 day old oysters smell good? The primary mantra of investing should be return of capital over return on capital!

    The wide spread carries a warning signal to some investors because the economy remains weak, hurting commercial rents and occupancy. To contact the reporter on this story: Hui-yong Yu in Seattle at hyu@bloomberg.net

    Those would be the more prudent investors they are referring to, at least in my oh so humble opinion.

    The Amount of Underwater Properties is Nothing to Sneeze At

    In December of 2009, I posted an article and accompanying research titled, “A Granular Look Into a $6 Billion REIT: Is This the Next GGP?” The following are excerpts from it:

    The results of these activities have been congealed in our analysis of Macerich’s entire portfolio of properties (118+ properties), including wholly owned, joint ventures, new developments, unconsolidated and off balance sheet properties. Below is an excerpt of the full analysis that I am including in the updated Macerich forensic analysis. This sampling illustrates the damage done to equity upon the bursting of an credit binging bubble. Click any chart to enlarge (you may need to click the graphic again with your mouse to enlarge further).

     

     

     

    image001.png

    Notice the loan to value ratios of the properties acquired between 2002 and 2007. What you see is the result of the CMBS bubble, with LTVs as high as 158%. At least 17 of the properties listed above with LTV’s above 100% should (and probably will, in due time) be totally written off, for they have significant negative equity. We are talking about wiping out properties with an acquisition cost of nearly $3 BILLION, and we are just getting started for this ia very small sampling of the property analysis. There are dozens of additional properties with LTVs considerably above the high watermark for feasible refinancing, thus implying significant equity infusions needed to rollover debt and/or highly punitive refinancing rates. Now, if you recall my congratulatory post on Goldman Sachs (please see Reggie Middleton Personally Contragulates Goldman, but Questions How Much More Can Be Pulled Off), the WSJ reported that the market will now willingingly refinance mall portfolio properties 50% LTV, considerably down from the 70% LTV level that was seen in the heyday of this Asset Securitization Crisis. Even if we were to assume that we are still in the midst of the credit bubble and REITs can still refi at 70LTV (both assumptions patently wrong), rents, net operating income and cap rates have moved so far to the adverse direction that MAC STILL would not be able to rollover the debt in roughly 37 properties (31% of the portfolio) whose LTVs are above the 70% mark – and that’s assuming the credit bubble returns and banks go all out on risk and CMBS trading. Rather wishful thinking, I believe we can all agree.

    For those of you who didn’t catch it in the table above, I’ll blow it up for you…

    Notice anything familiar??? There is a very strong chance that every single property on the list detailed in the forensic reports will be taken over by the lenders, that’s a lot of properties. Subscribers should reference MAC Report Consolidated 051209 Retail MAC Report Consolidated 051209 Retail 2009-12-07 03:46:49 580.11 Kb , MAC Report Consolidated 051209 Professional MAC Report Consolidated 051209 Professional 2009-12-07 03:48:11 1.03 Mb, Click here to subscribe!

    So, why has Macerich and the entire REIT sector defied gravity despite the fact they are getting foreclosed upon faster than a no-doc, subprime, NINJA loan candidate who just lost his minimum wage job amongst all of these “Green Shoots”??? Well, I took the time to answer that in explicit detail… I urge all to read The Conundrum of Commercial Real Estate Stocks: In a CRE “Near Depression”, Why Are REIT Shares Still So High and Which Ones to Short?

    Now since the posting of the article above, Macerich as forced to disgorge several of those properties due to solvency issues. The math doesn’t lie! Chances are there will be several more! Anyone who has an interest in the CRE space should download my 47 page outlook for the sector in 2010 (available to all paying subscribers of any level):  see Reggie Middleton’s CRE 2010 Overview CRE 2010 Overview 2009-12-15 02:39:04 2.72 Mb (42 pages). Now, I’m aware that viewpoints and statements may not win me many popularity contests in man professional circles (ie Even With Clawbacks, the House Always Wins in Private Equity Funds), but I aim to call it as I see it.

    More on commercial real estate: More on residential real estate:

    Disclosure: Soon to be short REITs
    Themes: commercial real estate Stocks: MAC, GGP
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  • bangwhiz
    , contributor
    Comments (2235) | Send Message
     
    Brilliant analysis! I can't short REIT's as I am a small cash only investor - but I really like the summation below. Reggie - you don't look that bad - time for a girlfriend at 2:00 AM. :) You do good work.

     

    "To make a long story short, nearly all of the biggest private sector problems have effectively been nationalized and made public sector problems without forcing the private sector to right its wrongs. Since nothing has really changed in the private sector and we are not marking bad assets to market but rather letting whatever we couldn’t goose the government into buying and converting into treasuries remain as they were while cash generating from the faux recovery was paid out as bonuses – the banks still have a shit load of trash on their balance sheets amid a worsening macro environment, the most indebted government of our lifetime and crumbling fundamentals. I pray thee tell me, exactly how are rates not going to spike? US Treasures are the new CDOs, wherein back in 2007 private banks scooped the trash they couldn’t convince suckers clients into buying directly, said trash was aggregated and repackaged with a AAA moniker and then sold to suckers clients. So, what is the difference between what Lehman, Goldman, Merrill and Bear Steans did and what out Central Bank is doing – that is picking up the garbage that nobody wants, recycling it into treasuries with a AAA moniker and then reselling them? The biggest difference is that one of the biggest suckers clients buying these repackaged toxic assets cum treasuries is the Federal Reserve, itself. Talk about a Ponzi scheme that is unsustainable."
    4 Sep 2010, 10:13 AM Reply Like
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