The New Nexus

COPING WITH CHOICE

2012-01-31T19:13:00.000-08:00

How many choices do you think you make every day? 25, 50, 100, 200, 500, 1,000, 2000?. If you are reading this and did not hit "delete", your answer is probably closer to 2,000 and maybe more. Just managing emails - say 300 incoming a day and maybe 150 outgoing - adds up very quickly. So how do you cope with choice and manage the burden of determining what to delete, read, write, say and do?

How do you leverage your time to be better and more efficient at what you do personally and professionally?

Coming off a few weeks of extensive traveling, meeting with CRE investors and managers across all capital segments, including Colliers Skiminar in Vail this past weekend where we hosted over 250 clients for a few great days of fantastic skiing, great food and way too much drink, I asked several clients and friends about how they cope with choice and carve through the clutter amidst sensory saturation.

Does all of this information make us any smarter or better at what we do?

Universally everyone - from CEOs to senior executives, from middle managers and salespersons to all levels and staff - all confessed to often being exasperated by the volume of decisions that had to be made and the contagion of fear that comes not so much from failing to make a good decision, but from worrying about making a bad decision. One natural defense mechanism is to copy everyone so there are multiple sets of eyes, and accordingly, multiple accountability, for many choices. While this makes a lot of sense for important decisions, it exponentially increases email traffic, and with it the number of decisions associated with a particular matter.

Based on this limited and admittedly narrow focus group, we have come up with a few tips that we hope will help and can be shared to help you and your teams accelerate your success in 2012. We welcome your input and thoughts and will continue to share them in our quarterly feature "CRE Hive", which will be all about sharing thoughts and technology ideas and of course the latest great apps (and some tricks in how to use them) to help you learn more ways to make your life a bit easier.

The top 10 ideas for coping with choice:

Wait before responding. Many emails and issues take care of themselves.
Let go! Delegate viciously below your pay grade.
Pick up the phone. Three minutes on the phone can avoid 15 emails.
Get proficient. Learn how to search, group and file emails.
Clean out the mailbox. If it's two weeks old, it's probably old news.
Box your junk. Rather than delete, file junk and have an assistant go through it once a week and unsubscribe to the junk.
Make it personal and friendly. It's a relationship business.
Play to your strengths with thoughtfulness and focus.
Be a giver. "Love is the killer app." In giving, you build loyalty and win support.
Read, learn, try, execute, adjust. The world of communication is changing at an accelerated pace. You have to keep up or be road kill.

We are off to an incredible start to 2012 with over 25 new assignments so far in January alone for CISG Southern California. We see this shaping up to be a banner year for Colliers and wish you the best in your 2012 endeavors as you manage choices, challenges, and opportunities.

CHECKMATE!

2011-11-23T12:37:00.000-08:00

The game of chess is centuries old. In this day of technology and nanosecond gratification provided by game companies like Electronic Arts and Zynga, it is hardly a favorite among the techno savvy and relationship starved who spend real money on fictional tractors. But the word "checkmate" resounds with everyone nonetheless for its certainty of resolution and impending doom.

The appointment of Tom Hoenig as vice chairman of the FDIC could be putting the banks and all the systematically important financial institutions ("SIFI's") clearly in "check". While not exactly checkmate, it's definitely game on and the Obama administration is making a an aggressive move to send a clear message that they intend to turn back the clock on the top 20% financial services enterprises which have grown from 14% of GDP in 30 years to over 80% today.

While many people, which probably includes the "Occupy Whatever/Wherever" gang, advocate breaking them up like Standard Oil (1911) and AT&T (1982) just because they believe that big/concentration is bad, Mr. Hoenig, seems to want to take a different, perhaps more thoughtful and rational approach, which is also more consistent with legal history, and simply make them accountable for the real risks they take.

Welcome back, Glass-Steagall -- Check.

Good-bye government support for money market accounts -- Check.

Good-bye public bailouts for derivative investing -- Check.

And say hello to Dodd-Frank -- Checkmate!

Why is this important to investors and service providers in the commercial real estate industry? The possible implication is that interest rates may finally rise as the pricing of risk is recalibrated across all classes of investment grade assets, from AAA to Junk. It might begin with bonds, swaps, derivatives and commercial paper, then work it's way into lending terms, spreads and ultimately rates. The result would seem to be that the era of cheap debt is about to end.Coupled with what can be at best described as a moribund recovery and you have the making of a price adjustment that is only just getting started.

Already core pricing has pulled back at least 10% across all product types in all but the very strongest markets (Seattle, San Francisco, Silicon Valley and Silicon Beach) and up to 20% or more in Secondary and Tertiary markets. San Diego is about to see an office tower trade at a 9.25% cap rate that would have traded at a 7.5% cap in a more "normal" market. No place is really immune. Even the Big Apple, New York City, is impacted. Transactions are being pulled due to a lack of price alignment between buyers and sellers as underwriting by buyers becomes more conservative in the wake of growing weakness in the financial services industry which is quickly reducing its massive excess capacity in anticipation of the new/old world order described above where profits, and now also losses, are shared equally by private enterprise instead of the taxpayer. There was never a QE III, Ocean Liner, and there is likely insufficient support to allow the FED to bring along QE III to juice the economy again. Nor is it really necessary or would it be effective. That card has been played. Like a narcotic, it might make some feel good for a short while, but the withdrawals will be painful. So, why not just get it over with and hit the reset button so we can clear the bad debt and recapitalize assets?

Economic Armageddon was averted with QE I and QE II. Greece and Italy notwithstanding, it is unlikely that their imminent defaults will result in contagion that will necessitate the launching of QE III in America. American Banks will take a big hit, but survive. The Gang of 12 cannot get a responsible budget passed, so, the stock markets take another dive. Trading on fundamentals is long gone. This market moves on the political winds of capriciousness and recalcitrance. So, if you own a lot of real estate or provide services to those who do, the dual specter of a very slow recovery and a financial services industry that is going to be under severe capital pressure and regulatory control for many years to come suggests a major price reset could be nigh. Certainly the risk seems much more weighted on the downside than the upside.

Given this pessimistic outlook, what do you do? As Jeremy Irons (Mr. Todd) said to Kevin Spacey (Sam) in Margin Call (highly recommended): "It's not panicking if you are the first one out the door..." and survive to invest another day, "...it's just money".

Three words might help as a guide: "Predict" - Anticipate a very bumpy road; "Protect" - Deleverage and sell assets with "at risk" NOI's; and, "Perform" - Invest cautiously with a focus on strong job markets and exit where you can either take heady profits from buyers who want to pay a crazy cap rate or where there is protracted distress.

Notwithstanding the fact that the fear of European contagion and the inability of lawmakers in Washington to resolve the U.S. deficit, keeping pricing on the 10-year Treasury at historic lows, once the fear abates, the risk of a rebound in rates precipitated by the Bobby Fischers of the capital markets (aka Mr. Hoenig) could be significant and swift.

The banks and loan aggregators are not panicking, but they are not waiting around for someone to yell "fire" either, and certainly are not waiting for Mr. Hoeing to say, "Checkmate!"

Carpe Diem!

SIRI SAYS: Lessons CRE Can Learn from Apple and Google - Give Control to Your Customers and Get Out of the Way

2011-10-20T16:20:00.000-07:00

"Siri, open the pod bay doors please."

Space travel may still be science fiction, but for those of you who have the new iPhone and have asked Siri how to find a gas station, what the weather's like in Amsterdam, or to boot up your workout mix, you by now know that this phone and those to follow are the latest "game changers" in the world of technology. This is not science fiction - it's the brave new world.

For those who have only read about it in the WSJ it's no wonder that it is the hottest selling phone in history after only a week. An amazing tribute to the late Steve Jobs who ten years ago ushered in a new era of enlightenment and unlimited possibilities. Where thought, creativity, passion, perseverance and commitment become the new currencies and the barriers to integration dissolve into "the cloud". Where the mass aggregation of niches becomes the new world order of business, communities and perhaps government.

Far from perfect and considered by some to be rather a ruthless and demanding CEO, Steve Jobs not only changed the way we live in so many ways, but he changed the way we all think now. He untethered individuality and creativity. He enabled the creation of platforms of desire, looking only for new modern day explorers to manifest its power and promise. And so we have Google, Facebook, and of course, Apple that in the past 10 years have become some of the most powerful companies on earth. Not simply for their market caps, but more importantly for their idea caps. They have empowered each of us to be more than we ever thought we could be.

In his book, What Would Google Do, which is highly recommended reading if you don't want to be business (or CRE for that matter) road kill, Jeff Jarvis, challenges us all to rethink our business models to create platforms for our customers and clients as opposed to serving up what we think they want. Build a platform, keep it simple, give control to your customers and get out of the way. Apple, Google, Facebook, LinkedIn are changing CRE. A year ago at the Colliers National conference in Nashville there was at best a 5% penetration of iPads. Two weeks ago in Chicago, there was a 75%+ penetration level. Adapt or die! Where there we few CRE apps a year ago, there are now dozens with more coming each day.

What an amazing month it has been, filled with travel and closings. The Colliers National Convention in Chicago, Tucson for UofA parent day, a climb to the top of Mount Whitney in one day, and a trip to Purdue where my sister, Dr. France Córdova will be retiring this year as President made for a busy month. We were also fortunate to close several transactions including Challenger Medical Center, 7500 Melrose Avenue and Genesee Executive Plaza. In addition, we are seeing a renewed interest in servicers and lenders moving product through the pipeline as disposition volume has increased significantly. The great recapitalization of debt this time around is having a profound effect on the CRE services landscape with the processing of the CMBS bad debt and resultant birth of new service line competitors from the CMBS space, including LNR, C-III, CW and others.

Click here to read the latest third quarter submarket reports for Greater Los Angeles, as well as a link to Colliers reports on dozens of markets around the country and several selected pieces for reading that are chock full of interesting information and what is happening in the CRE capital and investment markets around the country. The quick report on GLA is continued leasing strength on the west side (Silicon Beach) and stabilization in most of the other markets, i.e. it's not getting better, but neither is it getting much worse. Sale transactions are tepid.

The Eurocrisis is causing an even greater focus on core and what is truly core. Read this month’s Pulse for a quick round up of what we see happening across the capital markets spectrum for people, product, place, pricing and performance. While greed was the market driver in the first half of 2011, fear is back as offerings with any "hair" on them in all but the strongest markets are being repriced substantially causing some transactions to be pulled. Rent spike are gone from underwriting. In order for buyers to achieve desired yields, cap rates must go up. Buying "on the come" is done. On the other hand, debt is still very plentiful and abundant for certain transactions and sponsors, particularly for NNN retail and Multi-family which are experience irrationally exuberant investor demand.

Fred Córdova at the summit!

In closing, on a personal note, if you ever get the chance, I highly recommend the Mt. Whitney in a day climb. Leaving at 3am we traveled 22 miles roundtrip, 15 hours, over 6,000 vertical feet to 14,497 feet. I came away enthused and exhilarated. Running the last 3 Miles, I felt like I was in college again celebrating life, happiness and health. As they say life is measured not by how many breaths you take but by how many moments take your breath away.

Oh yes, we are now on Twitter and will be using it to keep you updated on a more timely basis. Please check us out and let us hear from you.

THE NEW, NEW DEAL: A Tale of the Capital Markets, CRE, and the State of the Economy in One Act

2011-09-08T12:46:00.000-07:00

"Warren? It's Barry. Can we talk?"

Lights up. In the middle of a well-appointed office, Warren Buffett sits at his desk, eating a sandwich and perusing a copy of “Extreme Bridge Player Monthly”. The phone rings. Washing down his bite with a swig of milk, Buffett answers.

Warren Buffett: Hello?

Voice: Hello Warren, this is Barack. How are you today?

Buffett: Fine, Mr. President, what can I do for you?

Obama: Warren, I need your help. You see, we have another problem with one of our country's largest banks.

Buffett: Bank of America?

Obama: Warren, they need capital, but the government can't come in and bail them out again. The public hates bankers. No one has been held accountable for the financial crisis and the public will just not take kindly to the government handing billions over to bankers again.

Buffett: So, what can I do?

Obama: Well, we were thinking that if you, The Oracle of Omaha, were to invest say, $5 billion into the bank, the public would see it as a sign of strength and the shorts would back off the bank and give it some room to fix this latest mess.

Buffett: So, you want me to throw away $5 billion of my shareholders’ money for a company that's a mess with little end in sight?

Obama: Well, yes, but you will get paid well. You will get assets worth $7 billion and options for a whole lot more. The stock will shoot up immediately by 25%, so on Day One you make 50%+ on your money, not to mention the fact that your own stock will pop.

Buffett: So, the Fed’s out of bullets and you have no juice on the Hill to do anything yourself, and you need my brand to rescue Bank of America?

Obama: That's about right, yes.

Buffett: Will Moynihan accept it?

Obama: He will if he wants to keep his job.

Buffett: Let me think about it, Mr. President.

Obama: Thank you, Warren. You're a great American and a patriot.

Buffett: I did not say I would, but you're welcome. Good night, Mr. President.

Obama: Good night, Warren.

Fin.

* * * * * * *

So, that about sums up where we are with the capital markets, state of the economy and commercial real estate. The Fed has no bullets, the government has no creativity or ingenuity or guts to use fiscal policy to turn things around, and "failure" is not an option.

We are now into the fourth year of our own version of the lost decade and tracking along the same path as Japan did with no end in sight. Awash in capital with no product to buy, pricing for core properties, particularly Multifamily, urban office and triple net retail continues to run at historically unsustainably high levels, while anything with even a little bit of peach fuzz on it is beat up mercilessly on pricing. Except for Multifamily, near term rents spikes are gone. Underwriting has become more conservative. Equity is recalibrating as it adjusts to a languishing economy where jobs are scarce, gas is expensive, and consumer sentiment is lower than a snake's belly in a wagon rut.

After the mad gyrations in the stock market a few weeks ago, it is no wonder that despite the S & P downgrade, the 10-year dropped below 2%. What better way for a rating agency to slit its wrists and confirm its inability to properly assess the quality of sovereign debt?

FEAR is back! And it is ruling the investment world. The choices of where to invest money safely are very few. Hence, gold, treasuries, and core real estate have become the safe investment vehicles of choice – besides putting it under the mattress, that is – rather than back into the bank. If you think back to just 2009 though, this is the exact moment when those brave investors who purchased properties made a pile of money in less than 2 years. Again citing Mr. Buffet, the time to buy is when everyone is running scared.

There has been a lot of news about a grand plan that Obama is working on: "The New, New Deal" will be unveiled today. When your back is to the wall, your approval rating in the tank and your time is running out and you are backed into a corner, you do what every general would say to do - ATTACK! Congress will fight any plan proposed, so why not go large, very large? It will be interesting to see what is proposed, but here are a few ideas that might have some traction to create jobs, get companies to start spending and invest in America, and maybe resuscitate commercial real estate in the process:

1. Impose term limits on senators and congressmen.

2. Mandate a balanced budget.

3. Eliminate corporate income tax.

4. Impose a retained earnings tax on companies who hoard cash.

5. Raise personal income tax rates for the top 5% of income earners (see this Warren Buffet NYT Op Ed article).

6. Reduce payroll taxes and provided tax incentives for hiring long-term unemployed.

7. Spend some money on fixing our infrastructure (roads, dams, bridges).

8. Provide tax incentives for companies that lower the average distance to work of employees.

9. Provide tax incentives for companies that raise the IQ, or test scores of employees.

10. Establish a national innovation incubator and provide tax benefits and awards to companies that achieve results with major policy objectives like a safe car that gets 100 miles per gallon, a commercially viable hover craft, a new battery that can charge a cell phone for a week. Basically, goals that create jobs and new ideas, new products and innovation so America can be the technology and innovation world leader that imports talents because of opportunity.

Please send us your own thoughts and ideas by commenting below.

One thing is for sure, unless "we the people" take a stand and responsibility for fixing America, it will never be fixed and the economy will languish. "We the people" is one of the most famous phrases in our American culture. It was a call to duty and action written in capital letters at the beginning of our American Constitution, not a call to Warren Buffett or a scream for help. We allow 545 people to run our lives (see this article). Unless we hit the reset button and restore some sanity to the way our government operates, we have no one to blame but ourselves. Perhaps the most salient contribution of Facebook will not be connecting with old high school friends, but the re-democratization of America as these ideas spread and take hold. It worked in Egypt and Libya. Why not America as well?

CONTAGIOUS INDECISION: As D.C. Wrings Its Hands Over the Debt Ceiling, Capital Markets Develop a Case of Anxiety

2011-07-22T14:58:00.000-07:00

As we look back on the first half of 2011 and consider where we expected we might be in the recovery, albeit wishfully, it’s interesting to note that some economists (see attached report from Beacon Economics) believe that the recovery is proceeding along as expected and should accelerate in the second half of the year. As this is written, the stock market seems to think so. It’s rebounded some 400 points in two days on strong earnings reports and the seemingly insatiable worldwide appetite for iPads and iPhones (no disrespect to the Android smart phones).

On the other hand, while Beacon is prognosticating sunny days ahead, the G-20 (see attached report) and Federal Reserve (see attached report) presents a far cloudier view in recognition of the risks in the capital markets and inability of developed and developing economies alike to reign in their respective economies from exposure to potential financial contagions or beta / shock risks from tsunamis, earthquakes, political unrest, chronic unemployment, etc.

Nate Beeler/The Washington Examiner

The impact of these dichotomous views on CRE activity and demand for investment opportunities seems to be high anxiety over which way to play the game. Buy (go long) or sell (harvest) while pricing seems nutty. The prevailing CRE themes continue to be focused on how to invest capital with a fair risk adjusted return in light of so much uncertainty and supply / demand imbalance:

• There’s too much capital - courtesy the Fed QE I and II

• There’s not enough product - courtesy congress giving lenders free ride

• Capital Markets are very apprehensive - concern over budget and debt debate

• The risk / yield curve is very steep - invest, but don't lose money

• Financial engineering is back - Debt is abundant and accretive to pricing

• Government action / inaction is driving pricing – fundamentals are disconnected to pricing when the 10 Year T is at 3%.

So how does this all play out?

For one, CRE investors are reaching for deals that they would normally pass on in a more normalized market; especially Core and Core+ investors who have many billions to place and few places to invest it. The result is that value investors are getting squeezed as property prices are bid up for the better offerings.

There is a lot of frustration over lack of product and apprehension about the reaction of the capital markets to the budget debate. This is causing buyers to be very cautious and focus only on transactions where there is a very high degree of comfort that they can win and execute. Anything with short term risk (weak rent roll, weak submarket, a lot of deferred capital costs) is getting punished on pricing.

Nevertheless, investors are casting a wider net due to lack of supply. While Core is king and will attract a stampede of buyers, Core + is as much in demand due to lack of product, and underwriting is similar. Value Add is in high demand but very short supply as owners, lenders, servicers are taking a very slow and methodical approach and still kicking the can down the road if they can, hoping that the economy will come to the rescue even as the mountain of rolling debt continues to rise to Everest proportions making the threat of a catastrophic event more perilous.

From a product perspective, multi-family continues to be the darling across all investment levels with cap rates for some core assets coming in below 4.0%. However, due to the scarcity of large multi-family offerings, from a dollar volume perspective, office has stepped up to a dominant position in the stronger “catalytic” markets with solid employment projections. Likewise, core industrial in the port and coastal markets saw strong demand in Q2, and well positioned retail seems to defy logic in underweighting tenant and demographic risks. All together, volume is up by over 50% from Q2 2010.

Meanwhile, the really big elephants - the capital allocators / opportunity / hedge funds - are going after massive note or stock purchases; e.g. Charter Hall, Anglo Irish Bank. Only a few can play that game and interestingly, the real challenge in winning the bid is not aggregating the capital, which is several billions of dollars, but aggregating the knowledge to understand the assets. Who do you hire to provide property level intelligence when there are only three real national CRE service providers in the country that have the capacity, scope and products available to turn this information around in a short time frame?

Core and Core+ money continues to focus on the Catalytic Markets - New York, Washington, San Francisco head the list, with Boston, Chicago, Houston, parts of Los Angeles and Seattle also seeing strong interest. Secondary and tertiary markets are trying to clear some assets that are impaired but struggling to find pricing as the only buyers in these markets are private capital buyers looking for yield and willing to move up the risk curve to find it.

Value add buyers are still looking hard at the peripheries of some of these markets and second tier cities, examples include Orange County and San Diego on the west coast where employment growth is expected to recover more quickly and there has been an uptick in absorption. They are also buying / gambling on longer term views on distressed cities that have historically recovered well even if the visibility to this recovery is clouded - like Phoenix, Sacramento, and Portland.

The steepness of the risk curve and cautiousness of debt underwriting in these markets with challenging fundamentals and recovery prospects is acting as a governor to price recovery and causing many properties to be pulled from the market.

No matter where you are in the investment spectrum, cash talks and will win the day. If buyers are considering debt, it is always placed after the fact. Sellers want surety of close and quick timing due to supply of capital and minimal supply of product. This drives terms even on complicated assets to 21 day DD, with 5-15 day closings all cash. We are not yet seeing non refundable on execution of PSA, but we would not be surprised to see it start to happen for some very strong core transactions. Serious buyers, regardless of where they are on the risk curve must be able to marshal capital and resources very quickly to be successful.

Debt is being underwritten to provide lift in yield and therefore is very important as a price driver but its ability to play this role is highly dependent on the location of the property, the submarket fundamentals, the investment profile and most importantly, the sponsorship.

All eyes are on government sector and the decisions on the budget which will impact the risk profiles of CRE and hence capital flows as yield requirements react to the cost and supply of capital.

We expect more of the status quo in the coming months with continued focus on the catalytic markets on the part of the core and core plus capital. Submarket fundamentals and employment growth will be key indicator of long term risk profile and continue to triage buyers. Activity will continue to improve slowly as more sellers take advantage of this temporary aberration in pricing that is pushing asset inflation. We do not see any significant event that will push transactional velocity but do expect a steady increase in volume as we expect interest rates to remain low.

Nevertheless, any shock to the system that causes rates to spike and push the 10 Year T to over 4.0% could be a game changer and result in a major price reset.

Please Don't Double Dip

2011-06-08T10:01:00.001-07:00

It is musical chairs time again in CRE as the economy begins to recover and the survivors start to hire while those less fortunate lose key business drivers to competition. Colliers, particularly in Southern California has been on the receiving side of this trend with over 24 brokers coming over in 2010 and 2011 including industry veterans Mark Tarczynski, Chris and Dave Maling, Steve Algermissen, Jeff Smart, Scott Miller, Ian Britton, and Bob Caudill to name a few. We are excited to welcome this terrific talent to the Colliers team to enhance our service platform.

Click to see George get caught in a double dip

On a related bittersweet note, we say good-bye to the editor of The Aggregate, my daughter, Kimberlee, who came aboard three years ago almost to the day and is now leaving to pursue her MFA in San Francisco. She came to work with almost zero knowledge of commercial real estate other than that it was her father's passion and had something to do with the purchase and sale of buildings. Despite her lack of industry knowledge, her smarts, organizational and communication skills and incredible creativity enabled her to establish a personal brand and reputation that would make any father proud. Indeed I am not sure we would have survived this downturn without her amazing effort and commitment to raising the bar for everyone at Colliers.

For those of you devoted followers and fans, please know that we have secured Kim's replacement, Suzy Foster, a friend of Kim's, who is equally talented and creative. So look for more creativity and fun and of course, insight into CRE and the capital markets to help you make the decisions that will drive your business to greater success.

The Dreaded Double Dip

As we move into summer 2011, everyone is talking about the prospect of the dreaded "double dip" recession. With the DOW down for five weeks in a row, employment flat lined, QE II coming into port, several European economies on the ropes, and the budget battle raging in Washington, the “expedient recovery” is now referred to as the "glacial" and "unpredictable" recovery.

As the uncertainty in the global and national economies drive investors to the relatively secure world of treasuries and high grade corporate bonds, pushing the 10 year T down over 75 BP in the last 2 months, CRE investors continue to bifurcate the market with no end in sight. Pricing for core assets in great locations with strong, sustainable NOI's continues to be extremely strong, tracking the compression in BBB bond pricing. Multi-family pricing continues to lead the way with cap rates as low as 4% for the best product, followed by, industrial at 4.5% - 5.5%, retail at 5.0%-6.0% and office at 5.5%-6.5%. As risk levels are adjusted for submarket fundamentals and tenant turnover, these spreads widen quickly, tracking junk bond yields, increasing by 100-300 BP's depending on the level of perceived risk.

The good news is that truly distressed product in high impact submarkets which previously could not achieve price discovery are finally beginning to do so as sellers are letting go of hope that the recovery will rescue property values much, less equity. The great "reset" has begun and will accelerate at the data points facilitate price discovery.

Whether it’s the sale of assets at 25%-50% of replacement costs or auctions like LNR's successful $1B auction of almost 50 loans in Las Vegas (and they are lining up a repeat in Arizona) investors are stepping up and underwriting the risk. Certain submarkets like San Diego are seeing a flood of new office product hit the market.

Amidst the turmoil of this bifurcated market two product types are gaining new value consideration for their focused execution and exceptional long term demand drivers: student housing and medical office buildings or "MOB's".

The housing stock at most universities around the country is under supplied, antiquated and inefficient. As student enrollment continues to soar, many colleges and universities lack sufficient funding to address the housing needs of their students. The result is a increasing shortage of supply met with increasingly stronger demand.

Despite being at the opposite end of the personal life cycle the medical office story is ironically similar. As noted on the attached ULI report, the existing stock is woefully under supplied, inefficient and outdated to meet the pending surge in demand for medical services by the aging baby boomer population. This brings us to our featured offering. Genesee Executive Plaza: an Office and MOB building in the San Diego UTC submarket, which is one of the strongest medical office submarkets in the country. The opportunity to reposition this office campus Into "Genesee Plaza - The Premier Health and Professional Services Center in UTC" provides a tremendous value ad opportunity for investors (call for offers is June 21st).

At any time in the CRE cycle there is opportunity. However, as the business matures and transactions become more transparent, and information becomes more readily available, value opportunities become harder to find. We recommend looking into markets and product with strong fundamentals that others have overlooked. Right now, Student Housing and Medical Office seem to provide plenty of lift for intrepid investors looking for strong value ad opportunities.

Urban Office Lives!!...

2011-04-26T14:11:00.000-07:00

...and its coming to a catalytic job growth market near you!

The elevator pitch: “Zombie office buildings, with no access to capital to maintain or attract new tenants due to the common disease known as "over leverage" are brought back to life by a concoction of cheap money, high hopes, and a lot of optimistic, (if not irrational) underwriting”.

Our zombie friend is here to tell you that life is returning to the office sector as values are recovering to levels approaching their original debt levels, and in some cases, well above what the lender’s adjusted book values were just a year ago.

How did this happen so fast? First let's be clear, it is only happening in certain markets right now, and with certain properties. The beneficiaries of this recovery are the “catalytic” markets like New York, (where the money never sleeps) and Washington DC, (where the money is created) and San Francisco, Boston, Seattle, parts of Los Angeles, Chicago, and Austin (where the money works). Wall Street is pouring money into "creative content" and the systems to support it. Mass customizable social media has come to a neighborhood near you and has changed the game…..again! Facebook, Twitter, Groupon, Zenga, Google, Amazon, and supporting players like Veriphone, Netflix, Priceline and hundreds more, are breathing new life into office employment in certain sectors around the country, if not the world. Factor in the huge amounts of capital the Federal Reserve has pumped into the system (QE I & II) to create jobs and the failure of the US Government to establish effective controls on the capital system that nearly destroyed the world economy (Frank Dodd Act) and you have a perfect recipe for aggressive employment growth in businesses with highly scalable return profiles, like those mentioned above: 1. "pump in lots of money, 2. allow the delay of recapitalization of banks and enterprises, 3. create new regulations that encourages talent to leave Wall Street to form hundreds of new hedge funds and create an off Wall Street capital market to fund new enterprises in a quest for the next "stock rocket", 4. Get the population to focus on foreign turmoil and disaster while congress freezes up over the budget, 5. bake for a few years and 6. pray generously that it will work ….as you get ready for the next election".

We are now well into the 4th year of this great recession and the expectations of the long awaited resurgence in transactional activity has percolated into frustration causing some investors to believe that we are back to 2006 / 2007 era with underwriting metrics that seem to make little sense. First, no matter where we are in the cycle there are always investors who think it is a bad time to buy or sell. It might be helpful to consider where we are in the cycle and what the near term forecast portends to gain insight into why AMB, KTR and Blackstone are making big moves in industrial. Why are Essex, Archstone, EQR and just about every large core apartment investor is aggressively pursuing acquisitions? Why Core cap rates are back to sub 5’s for apartments and sub 6’s for everything else. The same reason why over the next two years will see similar activity from REITs, pension funds and well funded "Value -Add" Advisors in the office arena.

The significance of our zombie friend is to emphasize that recovery is advancing sporadically and intermittently, but resolutely. The capital market hand is near 9 pm, with commodity prices rising significantly and foreign reserves building promisingly, increasing the prospect of inflation to a shorter term horizon rather than a long term concern. What is important to note at this hour is that the CRE hands of The Aggregate Watch, which are usually a full quarter of an hour behind the capital markets through the first six hours are now closing the gap, sitting around 7 pm. This occurs when the smart capital reads these “macro” signs and begin to move money into the CRE sector aggressively to get out in front of the pack so that they can sell at 10-12 o'clock to the late comers when the market is frothy and overheated.

If you read Colliers Q1 2011 quarterly submarket reports for Greater Los Angeles (see the button above) or any of our other major markets, you will see that the fundamentals across the board have either stabilized or are improving. Because of the slow job recovery we expect it to still take a few more quarters to see a meaningful decline in vacancies and growth in rental rates in office, but when it happens, effective rents will spike significantly. Given these observations and doing some sensitivity analysis on the timing, we are seeing value recovery across the board in the 20% range year over year and as high as 30% to 40% for certain assets in some markets based on approximately $500,000,000 in real estate we have underwritten across all major product types in the last 3 months.

If you are waiting to get into the game and think that the metrics are too frothy, think again. The momentum is in place. The governmental policies and intent are clearly in alignment with capital to create jobs and ameliorate the effects of the recession; and the next big thing, "mass customization of socialization", which is infinitely scalable and worldwide, is changing the political and economic landscape around the world. Go ahead and use Argus, but build the model an adjust your assumptions by reading the signs of The Aggregate Watch and listen to our friend. The Zombies are back!

The Aggregate Watch 2Q 2011

2011-04-21T14:35:00.000-07:00

As the commercial real estate (“CRE”) cycle matures and is now into its 4^th year since the collapse of the capital markets (“CM”), the correlation between the CM dial (Grey ) and the CRE dial (Colored) become more pronounced as the CRE hands converge (around 7 O’clock) and close in on the CM hand (just past 9 O’clock). We expect continued convergence as the cycle matures over the next few years and the CRE hands catches up to the CM hands as they approach 12 O’clock.

Colliers Conquers the Mountain!

2011-01-31T13:33:00.000-08:00

A big thank you to all of our clients for joining us in Vail this past weekend for the 6th Annual Colliers Skiminar in Vail, Colorado. This year, Colliers Investment Services Group expanded the outing to include all of Colliers service lines (valuation, property management and leasing) for a blowout event in celebration of the economic recovery fever that is taking hold around the country. With over 250 clients, it was another terrific event. Kudos to the master of ceremonies, Brad Calbert and his team for exceeding expectations once again, and for Vail for allowing us to take over the mountain. Also, many thanks to Dave, Jeff, Paul, Eric, Clyde, Linda, and many others for allowing me to slog along on the slopes trying to keep up with you. And this year, for the first time, we had a perfect safety record on the mountain!

2011 is Off with a Bang!

2011-01-31T12:53:00.001-08:00

To say that they year has started off with a bang would be an understatement. The stock market is on a tear with 9 straight weeks in the black. The consensus among economists is that the GDP will grow at a rate of 3.2%-3.5% in 2011. The economy is adding 100,000 - 125,000 jobs a month with 42% of businesses expecting to hire in the next 6 months, up from 29% a year ago. Consumer spending is increasing significantly, albeit sporadically, banks are starting to make loans to small businesses, air traffic is up and hotel RevPar is growing dramatically. Meanwhile, unemployment is still near 10%, housing is in the tank, municipal and state governments are in dire financial straits due to health care and pension obligations, food and commodity prices are rising rapidly—the cost of oil is heading north of $100 / barrel, the 10 Year T is up 90 BP's (38%) in 4 months, the yield curve is at a 10 year high and the federal deficit of $1.48 T is the highest it’s been since WW II.\

With so much uncertainty, why is everyone so positive about 2011? Is it that Obama is finally embracing business as the prime job generator; a typical year three presidential ploy (Republican or Democrat) to keep one’s job? Will the government reign in military and entitlement spending and direct funds toward creating sustainable jobs?

The perception is that fundamentals have hit bottom in the dynamic / catalytic markets where there are strong job growth drivers including: finance, technology, entertainment, energy, environmental, media, creative businesses and of course the federal government. Other markets will have to wait until 2013 to see fundamentals improve.

It seems the CRE asset pricing is being driven by the Fed's accommodative strategies that have pushed a lot of money into the system, so far without setting off inflation. Even though the 10 year Treasuries have risen dramatically in the last several months and may rise another 50 to 75 BP's before the year is out, there should be enough slack in the spread between the 10 year T and core cap rates to restrain cap rates for most of the year. Accordingly, we do not expect core cap rates to move up from 4.0% - 5.5% until the 10 year T increases by 50 - 75 BP's.

Most of the major trades are occurring with either core / core+ properties or uniquely distressed assets burdened by unsustainable capital structures where the owners have simply thrown in the towel. i.e. the Blackstone / EOP spinoffs: Maquire, Beacon, MacLowe. There continues to be very little price discovery for value add properties in highly distressed submarkets as debt is not accretive to pricing and most lenders and owners still do not want to sell into a tough market when there is no sense of urgency.

The core activity is taking place where the jobs are. Tier I locations like New York, Washington DC, and parts of Boston, San Francisco, Houston, Los Angeles, Seattle and Chicago are seeing pricing on a yield basis that is similar to 2006 and 2007. Rent spikes have returned in submarkets with high barriers to entry and are driving aggressive underwriting. Likewise, distress is playing out in those markets where price discovery is possible due to long-term expectations of job growth and continued leasing transaction velocity, such as coastal California, particularly Orange and San Diego Counties, Phoenix, and So. Florida.

Money never sleeps and it needs to eat. It will search out risk adjusted yield. As its tolerance for risk grows so will its need for yield. For a while, the public and private REIT's dominated the core market as the early movers chasing yield with a growth story and private investors, willing to accept less transparency and liquidity for twice the yield of the public REIT's (3+/-% vs 6.25%-6.5%) have poured money into this vehicle. Lately the REIT dominance has been challenged by the pension funds which have a tremendous need to fulfill funding obligations, which are growing exponentially but cannot be funded by the taxpayer alone. Private capital, with their giant checkbooks, are strategically buying, so don't bet against them if they want an asset. Foreign capital and sovereign funds are aggressively scouring the landscape but are generally not fast enough to beat out domestic money. The value investors are mostly pension fund advisors with high yield funds that can enter with 100% equity and place debt later, often after stabilization when the debt pricing and proceeds are better.

If you are on the Multifamily train the global indicators suggest that despite paying low 4% cap rates, the risk / return profile is by far the strongest of all the major asset classes. Growth in demand is expected to surge with five million new renters in the next five years, while the supply side growth has been significantly restrained for many years at 30% of what is needed to service organic demand. This supply / demand imbalance, combined with high barriers to entry in the aforementioned catalytic markets and very cheap and plentiful debt thanks to Fannie and Freddie should continue to keep multi-family cap rates 100-150 BP below other asset classes.

We have seen solid recovery taking place in retail in selected markets and selected products with cap rates for core product dipping below 6%. As the 90% of the labor force with a job becomes more sanguine about their immediate future and starts spending again retail will continue to strengthen.

We see a strong resurgence also coming in industrial. Growth in retail sales means moving and storing more stuff, and the ports of Los Angeles and Long Beach recorded the largest traffic growth in decades. There is still a lot of capacity in the supply chain, but it can be absorbed very quickly if the consumer starts spending again.

The late comer will of course be office. As the asset class with the highest risk / yield profile of any of the major asset classes, price discovery will be slow as investors will be cautious before diving into this notoriously challenging asset class that is so dependent on timing. Most of the assets that have traded are either properties with very strong NOI profiles or ones with broken capital structures at prices well below replacement cost.

We are expecting a more robust transactional year across all product types as sellers capitalize on the imbalance of capital and product. The depth and breadth of capital continues to vastly exceed the supply of product that will be transacted. The flow should be fairly orderly and rational with a measured increase of 50% to 75% in volume. However if interest rates should jump up by more than 50+/- BP we could see a stampede of sellers trying to get product to the market before pricing is impacted.

Please check out our 4^th quarter office, industrial and retail reports on the various Los Angeles submarkets. Most reflect a solid trend toward stabilization. Hence, the renewed interest by buyers seeing the timing as finally opportune to enter the market aggressively. It should be an exciting year!

iDo Wish You a Happy Holiday Season

2010-12-21T16:21:00.001-08:00

As 2010 comes to an end and we hand-wring over finding the perfect holiday gifts for our loved ones, and whether or not our decisions have been bad or good it seems to me that we have a lot to be thankful and grateful for. First, the iPad. If it could make coffee and exercise for me I would marry it. It’s truly a life changing device. If you don’t own one yet, perhaps you will very soon! Only slightly less important is that we survived, and in many ways thrived despite another very tough year. So thank you to our readers, investors, clients, friends and families, for your support during a very challenging year and allowing us to be a part of your lives.

As we pause for reflection on the year a number of things come to mind. Perhaps most salient is that it would appear that 2010 will go down as the year in which the fog obscuring price discovery finally began to dissipate and buyers of CRE were able to underwrite risk again. While it remains debatable as to whether or not market fundamentals have hit the floor, what is relevant is that fear has again given way to greed as the prime directive in valuing opportunities. We began the year with core cap rates in the 7's across most product lines and are ending it in a world of sub 5% for MF, and sub 6% for office, industrial and now retail for the best of the best. The spread between the 10 year treasuries, which had widened to exceed 4.5%, is now down to less than 2.5%. All the while fundamentals have continued to deteriorate across product lines in most markets. It is interesting to note that the long term spread runs at about 3.0% +/- 50BP's.

This convergence is reflective of the pricing of risk across the capital markets spectrum. A lot of investors are recognizing this inflection point in the cycle as the time to go long. Indeed the Year End 2010 Fed Economic Report presents a rather positive view for modest growth in 2011. The S&P yield curve crested at 7.7% (the last time it was that high was 1994) and has compressed over 100 BP’s to 6.6%. The dominant consensus is that is for record earnings (mid $90’s) next year with the S&P rising to 1350-1400 (6.7% yield). This will help keep CRE yields down (and prices for core high) as long as debt remains inexpensive. The massive quantitative easing of the past two years to the tune of almost $4 Trillion dollars (if you count the latest budget buster approved last week), has mitigated near term financial calamity risk and pumped a tremendous amount of money into the economy. Still, inflation and interest rates remain in check due to continued deleveraging and extensive excess capacity remaining in the supply chain. Some are even arguing for QE3, but at some point, with the government borrowing over 40% of the budget for two years running and on track to hit 50% next year; buyers of our debt might just stop accepting payback in inflated currency and start demanding higher yields. If the price of the long bond shoots up 100 -200 BPs, the ability of debt to drive CRE pricing will be limited unless values fall significantly.

All of this money is very anxious to find a safe home before inflation makes it tough to catch up. Pension funds need to achieve thresholds which are significantly higher than bond yields to meet future obligations. Fund allocations secured by advisors have a fuse on them. What is selling are assets that either do not need financing (core) or cannot get (foreclosures) financing. In both cases, the dearth of product on the market is dwarfed by the capital pursuing it. Accordingly, the bidding is aggressive and furious, especially for trophy assets. Even the pseudo core / core + properties are getting a hard look. If you believe that the risk of another downturn is truly small, then by all means jump on board, have a frosty glass of Kool-aid, click your heels and say, "I do believe in rent spikes, I do believe in rent spikes". Of course, they are real, but to buy into 8%, 8%, 10%, 8%, 8% which amounts to 50% over 5 years (do the math), takes more courage than most rational investors can muster and seems hard to support with so much excess capacity and weak market fundamentals. Outside of Washington DC and a few other catalytic markets (New York, San Francisco and pockets of Los Angeles, and Houston), hope is not an effective investment strategy.

On the other hand, the unique combination of persistent excess capacity across virtually all service and production supply chains, ostensibly due to tepid demand from stubbornly high unemployment, and very accommodating regulatory policy that is facilitating balance sheet recovery for the "too big to fail" banks, is inhibiting the price discovery for value added investments. Almost all investors who invested in this yield category from 2005-2007 are out of money and their lenders and servicers do not want to sell and take losses. The new strategy seems to be to "inventory profit" not so much by kicking the can down the road as putting the can in a truck and drive it down the road a few years, then sell and book profits. It is possible that this strategy may inhibit the reset in pricing for value add properties for several years; or at least until bondholders, shareholders or government start to get more aggressive [litigious].

For now inflation seems to be at bay as corporations and individuals hoard cash, hesitant to invest in a politically uncertain environment. You are probably not going to get fired or starve if you have a healthy bank account. Modest increases in commodities prices driven by massive demand from developing economies alone are not enough to light the inflation fuse. However if the United States engineers a jobless recovery, the need to feed the growth engine could very well put pressure on prices. The Fed and the government are scared to death of a jobless recovery for obvious reasons. If inflation takes off while we have a lot of people out of work things will get real ugly. Ever seen the Zimbabwe $1,000,000,000,000 dollar bill? I think it buys a pack of Chiclets.

All of which brings us back to the persistent question for real estate investors, "should I be a buyer or seller". As usual the answer is both, but the risks of being wrong and missing the timing is severe. If nothing other than an inflation hedge, commercial real estate is a great place to invest. Wait too long to engage and you will miss the jump in value. Execute without a solid vision of the risk profile and a strong capital structure and losses could be severe. We feel that historically solid secondary markets may be the best places to invest on a risk adjusted return basis. With cap rates in the 9's and 10's and debt less than 6%, there is opportunity for strong positive leverage, provided the NOI has minimal risk in the near term. If the core markets truly see the kind of rent spikes noted above, the secondary markets should receive some of this love as well. We can all do the math on a 25% NOI growth starting with a 3.0% debt / equity spread over 5 years. Bake in a little cap rate compression with a firming market and you have a solid 20% + IRR.

Time, and possibly the Chinese (as buyers of our Treasuries) will tell us whether we have created another bubble. But if you study The Aggregate Watch, this is precisely the point in the cycle where cap rate compression and "the spread" should be 200 - 250 BP's. We are just about there, so caution is important. If you need a barometer, keep your eye on the bond market. They are just about the smartest financial guys on the planet and they underwrite risk better than anyone.

We are looking forward to a new year with more velocity and abundance and hopefully more success for all.

Kindest regards and best wishes for a happy holiday season.

A Capital Thanksgiving

2010-11-23T16:34:00.000-08:00

There is much to be thankful for as we enter the holiday season. I for one, am enormously thankful that Election Day is behind us and we no longer have to listen to al those insipid negative campaign smear commercials. Many are thankful that the federal government is more balanced between the two parties. Gridlock is always a welcome stasis for business as it allows companies to plan and manage without fear of political risk jeopardizing investment strategies. There is great uncertainty in government, economic, health care and social policies and many in business are still holding back on their hiring and investment plans because of these unknowns. Still, there does seem to be a feeling of cautious optimism and some retailers are expecting a much stronger holiday sales season, particularly in the high end market, now that consumers have reduced their debt.

As the QE2, the grandest ocean liner of its time, was retrofitted for the Falklands War, its elaborate interior covered in hardboard, hull painted out black, and steamed on to battle without radar or modern navigation aids to avoid detection; its contemporary homonym has taken on a similar metaphorical meaning as a financial war ship hoping to recover the US economy. This QE II ("Quantitative Easing, Part du"), is designed to resuscitate the economy from its current coma by making our currency more competitive (devalued) and thereby jump-starting job growth by ostensibly making exports more competitive.

From our sources inside the Fed, we know the entire Fed board has seen the You Tube video on Quantitative Easing and while they thought it was entertaining, however simplified and a little misguided, “The Ben Bernanke” strongly believes that QE II should have had the same effect as lowering interest rates by 75 BP's. We also have to resign ourselves to what we don’t know; which is how bad things might have been if the Fed had not spent $2T to rescue the economy from catastrophe with QE I.

The subtle notion behind QE II is that there is little cost to waiting things out for now. With low interest rates and inflation not driving anxiety over the loss of purchasing power for the dollar, there is no incentive to do anything but fix the balance sheet, restructure debt, and stay liquid. Whether it's the banks replenishing their reserves or corporate America hoarding $2 Trillion on their balance sheets or individual Americans reducing their spending it's all the same, few are planning for near term growth; which means that recovery in the job market, and for CRE, is still several quarters if not years away. But if you are worried that your money is being devalued by printing more, it might push you to action and use the money to buy things and hire people now.

So what's new in November and what's coming in December now that the conference season and elections are over? Unfortunately, the odds are that it will be more of the same—at least for the next few months. We will have more properties come to market that are either core, or "core plus" and some "core hopefuls", looking for core pricing. The proof will be those that actually clear the market with the impostors exposed and shamefully taken off the market. The poster child for these kinds of frustrating transactions might just turn out to be sale of the State of California portfolio, which is now in danger of falling apart due to the lawsuit filed last week (see State CRE Lawsuit). We have been tracking this transaction for over a year and in last month's Aggregate gave great kudos to the buyer team for pulling off the deal of the year only to find that there are a few people who were once employees of the State who are hoping to block the transaction. California’s financial mess notwithstanding, selling core assets for less than half of their replacement cost and signing up for an obligation that will cost the tax payers $6 Billion more than ownership over a 35 year period, is a pretty tough sell. Despite the high likelihood of a repurchase, the lack of transparency and the fact that the Chinese money is the equity behind the transaction has generated some backlash. Unfortunately, the State of California cannot use the strategy of printing money, (aka, "quantitative easing") to get itself out of this mess, so selling core properties and buying them back later at a premium, is just today’s method of financial engineering to push accountability for balancing the budget off to the next generation.

The mountains of debt are becoming overwhelming for lenders and servicers and we expect to see much more aggressive solutions to maximize value recovery in advance of the capital markets recoiling. Already the bond market is taking a very adversarial position with respect to QE II. If the bond market should dig in its heels and at the same time fixed income investors see a nascent recovery in the near future, we could see a quick bump in rates (100 BP or more) that will completely change the game and cause more product to come to market. Then there is the potential second shoe that is hanging over the money center banks coming from several big investment firms who are trying to get the banks to buy back as much as $100 Billion in bad loans. This has the potential to become a full blown war and this time the government will not be able to come to the rescue. If this plays out badly for the banks, lending, particularly for small business, could get even worse in 2011 & 2012. With small business being the key job growth generator in the US economy, continued restriction in the lending market to small business would be a significant restraint on job growth for some time.

Our message is, "buy quality" and understand risk. Whether you are a core buyer or an opportunity buyer, a conservative, well funded capital structure that can weather 3-5 years of job tepid growth will be the key to optimizing returns. If you are a seller with a core asset and are thinking of harvesting value or have a property with a capital structure that is misaligned with market fundamentals that is inhibiting disposition or recapitalization, we would recommend that you give some serious thought to monetizing now. It is unlikely that CRE fundamentals will grow before the capital markets blow.

There are good opportunities out there with a lot more to come in 2011. Assets of all types are trading. Price discovery is occurring. It's time to grab a bat and get into the game. Now is when the pros earn their money by not just getting granular to understand risk at the property, submarket and tenancy level, but also flying high and watching the capital market flows and public policy decisions (i.e. Frank Dodd Bill) and how they will affect pricing for real property on a macro level. You need to do both to make smart investment decisions.

We are here to help. Have a Wonderful Thanksgiving!

Greetings from Music City!

2010-10-18T10:29:00.000-07:00

As you can see in the picture I caught up with a few friends at Colliers National Convention in Nashville last week. I had the pleasure of seeing Dolly, Trace Adkins and Taylor Swift at the Grand Ole Opry (a real bucket-list item if you make it to Nashville), and was struck by how well their successes in music illustrated the theme of the conference, distinction. The gist of the keynote speaker Scott McKain’s book, The Collapse of Distinction, is that outstanding customer service is not just valuable, it is critical to success.

Inspired by Scott, Dolly, Trace and Taylor, CISG, in collaboration with Colliers Valuation, Property Management, and Leasing Services officially announces our new fully integrated soup-to-nuts web-based platform that will value, manage, lease and sell distressed assets of ANY TYPE, ANYWHERE in the country with virtually UNLIMITED scope and capacity that is 100% unique to the industry. This web-based platform will free lenders from workout-hell by allowing them to easily maximize value recovery for their distressed portfolios. It's also ideal for investors and bidding on whole portfolios of notes. Give us a call to learn more.

And now the market. We have been on an intense series of meetings the last few weeks with a few dozen institutional and private capital investors in LA, San Francisco, Nashville, and DC. Below are some interesting observations we took away from these meetings:

Fear of a second dip is all but gone, particularly since the Fed is about to attack long term rates with purchase of 10 year treasury bills. Clearly an accommodating monetary policy to juice the economy is more important than the prospect of near term inflation. After this however, they are out of bullets. We expect interest rates to stay low for at least 12-18 months.
With the government finally implementing some of the fiscal policies we recommended in last month's "The End of the Endless Bummer", particularly the part about cutting back on government employment and helping small businesses create jobs, there seems to be hope that the worst is over. Also, thanks to the City of Bell, all eyes are on public employee pension reform to rein in costs.
Can there be a meaningful and sustainable jobless recovery without job growth? Most think not. What does that mean for CRE when the economic solutions are not politically achievable? Are we about to enter year 4 of our lost decade.
Less bad is the new good. The worst is behind us, but the worst news is still ahead.
Colliers 3Q submarket reports are out for all greater Los Angeles markets. There is still more “bad news” with declining rents across all office and industrial submarkets. Asking rents are down by 25%-40%; meaning effective rents peak to trough are down 40%-50%. The good news is that vacancies are topping off and should be stabilizing in the next six months as landlords and tenants are making deals. Phantom vacancy however, will keep pressure on office rents for at least 18-24 months. Office values have yet to fully reset in many markets as distress has not come to market….YET. When it does expect another big drop (10%+) in effective rents which are currently 15- 20% below asking rents.
At the national ULI convention in DC this week the prevailing mood was "anxious optimism"
- Price discovery for core has clearly been established. But is it sustainable?
- Debt for core is accretive to value and driving pricing (e.g. California State Asset sale)
- It's tough to have a bubble at the bottom of the cycle without a double dip.
- All the value-add deals are in recovery. Don't expect a flurry any time soon.
- The debate rages on how to underwrite in a down market (IRR's, COC, PPSF, RC)
- Discounts to RC do not motivate capital advisors who focus on IRR's to make decisions.
- Not one Argus model ever run has been accurate. It's mathematically impossible.
- Keeping interest rates low has restored lender balance sheets. “Extend & Pretend” will end soon.
- Don't expect lenders to trade large assets if they expect near term value recovery.
- Get ready for a wave of real estate flotsam from lenders to hit the market.
We are hitting the bottom in most markets, including some of the sand states where distress is a lifestyle. We expect continued softening in office in most markets for another few quarters. Office recovery will lag in this massive debt reset and lenders will be reluctant to take huge hits and clear big ticket assets unless forced to do so. As long as short term interest rates are near zero and there is income to service restructured debt, "extend and pretend" can increase value recovery.
The equity markets are rising again with the Dow over 11,000 and the S&P at 1175 because it has been undervalued compared to other investments. The S&P is trading at a 12.5 multiple to forecasted earnings. That's an 8.0% cap rate vs a 6% cap in February. Money is pouring into CRE because the public perceives greater risk in those earnings, with such poor job and economic indicators, than it does in comparable leveraged yields from real estate which are also about 8.0% for core. There is far more money coming in than there are properties to buy.
Congratulations to Rich Mayo, Hines, CBRE and their teams for executing what will arguably be one of the best single deals of the downturn and may well touch off a flurry of new public entity transactions around the country. With a 60% LTV at 4% IO for 10 years, the purchase, at a 7% cap rate will yield whopping 11.5% cash on cash initial return. With 12% bumps every five years, the effective return will be over 13.5%. Not bad for a captive tenant who will probably never leave. At $319 the price per square foot is significantly below the estimated cost to replace the facilities for the government, which is well in excess of $700 psf in 2010 dollars.

Are we in a "core" bubble or are assets fairly priced? This question was asked at the Colliers CISG Investors panel discussion at our national conference last week and again at our ULI panel discussion this past Wednesday. The response from institutional investors who are doing the buying was "no", but proceed with caution and be careful with debt levels. Unlisted REITS, insurance companies and foreign capital advisors are pushing values with “strategic” buys. The load factors on the unlisted REITs don’t leave much room for mistakes to achieve investor yield expectations. The dislocation in the cost of debt relative to historical norms will not last long, so take advantage of the cheap debt while you can. Just don't pig out on it.

The Endless Bummer's Almost Over?!?!

2010-09-20T13:38:00.000-07:00

We held off on the publication a few days so we could thank the 200+ clients who came to Colliers’s Sunset Soiree last night at the Lobster on the pier in Santa Monica to enjoy a perfect Pacific sunset and compare "Endless Bummer" stories of the market’s last 2 years. The open bar, great food, spectacular view and entertainment made for a perfect evening—even Spiderman stopped by—No joke! We appreciate your support and look forward emerging together from this fog that has clouded our industry for the past few years. Several of you at the event asked when The Aggregate was going to become a little more positive. Well, we also have been a little tired of writing about doom and gloom. Unfortunately, if you read the Korpaz, our prognostications pretty accurately reflect what is happening and overall investor sentiment. While we can't make it go away with a key stroke, we do see signs that the "Endless Bummer is coming to an end. So, please read on!

Much as the cold, grey marine layer that lay over Santa Monica all summer finally lifted yesterday, so too the cold and gloomy clouds of uncertainty that have been lingering over the capital markets and CRE seem to be finally clearing. Low interest rates and a lack of meaningful risk-adjusted returns across the capital market spectrum have been driving domestic REITs and foreign capital to core CRE. But even though the "recovery” is progressing and the Fed pundits proclaim that the prospect of a "double dip" is remote, a strategy of benign indifference will not restore the economic health of the US. Some 25 million Americans need full-time employment and monetary policy alone is not going to create the jobs we need and get them back to work. Attached is the February 16^th Kansas City Fed Report. We annotated the headings to reflect what we think is a little more realistic interpretation of the slides. Despite the consternation over recent changes in financial regulations and the budget debate over new taxes, that has promulgated so much political uncertainty and caused great stress for CRE owners and lenders, fear may be turning to hope with the administration's move last week to help small businesses. Enter phase two of the government agenda: "Fiscal Fortitude". The Feds are out of ammo so all they have left is fiscal policy. But does the government have the resolve to do what is necessary and go the distance?

Here are a few ideas:

CUT BACK SPENDING! Slash government payrolls (federal, state and local) by 20%. Corporate America slashed payrolls by 20%. We can start with the bloated pension system and outsource a lot of government jobs, just like corporate America did. Let a call center in India run the IRS call center or the California DMV hotline.

SUPPORT SMALL BUSINESS. Mandate the creation of small business banking divisions within the large money center banks to lend to small businesses. The community bank model is toast if the government does not step in to help.

CREATE NATIONAL COMMUNITY BANK. Establish the financial equivalent of Freddy and Fannie for small business to fund small business enterprises with preferences and tax incentives to those that hire and train employees with new skills that are adaptive to new technologies and new economies.

INCENTIVISE COMPANIES TO HIRE. Provide employment tax relief to companies hiring and training people who have been out of work for six months or more. One month of tax relief for each month the person has been out of work.

REESTABLISH REGULATORY CERTAINTY. Provide more clarity and transparency to mitigate political risk so business can understand the impact of new regulations and policies on new investment and hiring. Fix the rules and stick with them.

INCENTIVISE CAPITAL TO BE MORE EFFICIENT. Tax the excess accumulation of capital reserves to entice companies to either pay dividends or invest the reserves in product development, new ventures, technology, plant and equipment or personnel.

It was encouraging to see last week that the administration is getting the message. You may recall that a few months ago we said that “cycles trump fundamentals and government intervention trumps cycles.” The key is that the administration is finally acting. The fact that they are doing something should give hope to the CRE industry that the government is committed to making sure that Recovery will bring the "Endless Bummer" to a close. Getting people back to work and helping business to retrain them is the only solution to restructuring the economy to one based on producing and creating value rather than consuming it.

This means that the great is reset coming! We believe that it is coming sooner than most think and is already at hand in some markets. We all know that the reset is inevitable and transactional volume cannot remain in its present suspended state for much longer. Pressure is building and will have to find an escape valve. Workouts can buy time, but they are not a cure and without a restructuring of the capital stacks of impacted properties health cannot be restored.

So, when is it going to happen? Based on conversations with scores of investors, lenders and servicers over the past month, it looks as though the process has finally started, at least for retail and Multi-Family. Office is just starting in some markets. Industrial will lag. Distressed transactions are happening in the "Sand" states (CA, NV, AZ, FL), while institutional investors with stabilized core office assets are exiting where debt is achievable and accretive to value. Servicers and lenders are clearing the distressed chaff and exiting smaller assets (< $5MM) through receiverships and REO to create capacity to focus on the bigger dollar challenges. The larger assets are still going to take some time and the deals that are made are becoming a unique interplay of calculated short sales orchestrated to restructure as much debt as possible. No one wants their money back just yet. Not when they have to book losses much greater than the reserves already taken. Better to reduce pay rates while maintaining spreads (thanks to low interest rates) and mitigate loan loss than to take an all cash payoff at 60%. YES, THIS IS REALLY HAPPENING!

So if your Endless Bummer has been a vain attempt to catch some large distressed assets, you will need a big harpoon and a lot of relationship support and be prepared to be disappointed because there are a lot of other "fishermen" out there with big harpoons and relationships. As we have been saying for some time now, it might be better to cast a wide net (85% of the volume of CMBS debt is loans under $15MM). Either way, Colliers has the people, services and products that can help accelerate your success to catch whatever type of fish you want and we look forward to working with you as the Endless Bummer finally comes to an end.

In the meantime, keep the faith, stay healthy and stay liquid.

Tonight we’re gonna Proforma like it’s 1995

2010-08-13T11:06:00.000-07:00

Tonight we’re gonna Proforma like it’s 1995
I am sure you will recognize this one whether or not you like Prince

I was distressed when I wrote this
Forgive me if it goes astray

But when I came in this mornin'
I learned it was foreclosure day

There was no more income
There were expenses everywhere

Tryin' 2 run from the lenders
Borrowers didn't even care

'Cuz they say two thousand zero ten party over
Just get out alive
So, for now we must proforma like it's 1995

I was giddy when I wrote this
So sue me if I go 2 fast

But real estate has cycles
And cycles weren't meant 2 last

Unemployment is all around us
Yet the REIT’s are in delight

They see value in stable income
With cheap debt to help flex their might

Yeah, they say two thousand ten party over
Just get out alive
So, for now we must proforma like it's 1995

Say it 1 more time
Two thousand zero ten party over
Just get out alive
No, no
So, for now we must proforma like it's 1995

There’s more, but you get the picture. How’s that for connecting the 1990’s, Prince and Obama’s economic agenda with what is happening in the market today? BTW, my co-editor made me do it and since it is summer…..well have some fun.

As the summer comes to a close and most real estate executives are pondering what their strategy is going to be for the “closing season” while probably vacationing in Europe (now that it’s on sale), opinions appear to be divided over which way the market is going to go. Have we hit bottom or is there more pain to come? Are rents stabilizing, or will they drop further? Are vacancies leveling off or will we see another big drop? Is the distress finally coming, or do we have a mini-bubble; or both?

On the distress side, without incentives to reset values debt holders are happy to wait in denial, telling themselves this is a normal recovery and wishfully anticipating being bailed out by CRE fundamentals’ eventual recovery—but if you do the math you will see there is no way to prevent the reset. We need a minimum of 150,000 jobs created per month to maintain stasis and at least 200,000 jobs per month to make a dent in unemployment figures. Except for very few markets, (Washington DC, New York, and San Francisco), the employment picture is getting worse. The economy lost another 130,000 jobs last month. Unemployment currently stands at 9.5% only because 790,000 people threw in the towel looking for work over the past year. Depending on which economist you talk to, there are 25 to 30 million Americans out of work and underemployed. These numbers suggest we may have at least 6 to 10 years to recover the jobs lost from this recession. This anemic recovery will either result in a lost decade for real estate or drive a reset in commercial values-particularly office properties with at risk NOI's.

Whether or not the capitalization of a particular asset is restructured to "get by" for a few years, it will still bear the brunt of competition from the building next door that is not so fortunate and was purchased at 50% to 60% of peak value. The only thing preventing further NOI deterioration in most office markets is the fact that most office leases are long term compared to hotels and multifamily. Retail gets quickly marked to market when tenants cannot afford to pay the rent due to declining sales. Similarly, industrial properties adjust quickly due to brutal competition. There is over 175,000,000 square feet of vacant and available industrial space in greater Los Angeles alone.

Office space has not yet had the same reset because most office tenants are not directly dependent on consumer spending and are locked into relatively long term leases. Also, since office is generally one of the most expensive asset classes, taking just a few losses could severely cripple the capital reserves of the lenders. There is almost always some income on an office property, so a lender can reset the capital base to a Libor plus 300+/- and make good money for the time being. Meanwhile, the borrower can still service an 80% LTV loan with a 40% NOI deterioration if the interest rate is adjusted down by 30%. This works as long as short term interest rates stay at basically zero, but the game is over if they tick up over 100 BP's.

While this appears to be good news for office property owners, it is at best a very temporary solution. Consider the path of job growth necessary to make a meaningful dent in CRE fundamentals to drive NOI in weak submarkets. Now, compare it to the workout strategies that are all short term oriented. It seems very doubtful that office employment growth will be fast enough or strong enough to rescue the capital stacks (yes debt and equity) of impacted properties. Furthermore, when job growth does return, interest rates will rise, putting even more pressure on the NOI to service the debt. So while current strategies will work in the short run thanks to the Fed monetary policy of zero short term interest, the only way to enable growth to return for the long run is by resetting the capital structures.

Now, for some good news. If you are a buyer of property with a good balance sheet and stick to properties with strong NOI's in strong submarkets, you can get great debt. Take for example an office building with a strong NOI in a solid market being purchased at a 9.5% cap rate. Debt expectations were about 6.25% three months ago. The buyer secured the debt at 50% of cost (LTV) at a rate of 4.65%, driving cash on cash to over 12.5%. We are hearing stories of institutional buyers getting debt at 4%. If you are a REIT with a 6.5% dividend yield, that dog hunts all day long.

These days we are dialing back to the mid 1990's, when REIT buyers ruled because equity was cheap. Investors who are tired of getting 1% on their money are more comfortable with risk now and are anxious to put it into real estate where (as reported in REFI) the average REIT dividend yields are 4.57%, according to the FTSE NAREIT All REIT Index. By comparison, 10 Year U.S. Treasuries are under 2.7%. The FTSE NAREIT Equity REIT Index is up 15.61% for the first seven months of 2010, compared to -0.11% and -0.64% for the S&P 500 and NASDAQ Composite indexes according to NAREIT. Everyone is starting a new REIT, or trying to, and they are flexing their muscle to purchase quality properties with strong current and future NOI. When this cycle is over, we will see a real paradigm shift in the ownership of CBD offices back to REIT's and foreign capital, just like the 1990's.

If you are a value investor, we suggest you be patient and let this play out. Unless you are a REIT or have cheap foreign capital with very deep pockets, it's probably best to enjoy the summer and wait for those properties with high risk NOI's to start coming to market. There is simply so much falling apart everywhere that the sheer volume will overwhelm the lending community. The challenge will be to look for properties with good bones in strong submarkets.

True recovery is going to take a lot more time. The prospect of deflation is in CRE is not a fear. It is reality borne of declining real estate values and wages. The sooner it is allowed to play out, the quicker health will be restored.

For additional strategies for working through this period, please see The Aggregate July 2010 - “Ice Age III” – it’s still quite cold!

Ice Age III

2010-07-09T11:33:00.000-07:00

Welcome to Ice Age III - Buyer Distress and the Great Freeze. Many are concerned that the economy’s double dip is already here, putting us in year 3 of what will be a lost decade. Much like the Japanese Recovery that never happened, it's very possible that we could be in for 5 to 7 more years of anemic job growth and tepid transaction volume as owners and lenders hold onto their assets like stocks, content to acknowledge paper losses without taking the hit to the portfolio / balance sheet.

With the stimulus funding starting to lose its effect, the capital markets are looking around for some signs that the seeds planted are taking root. Unfortunately there is simply no juice left in the economy as "now becomes our winter of discontent" in CRE and "buyer distress" settles in like San Francisco fog in the summer, paralyzing all but a few intrepid warriors from venturing out to test the market.

The Colliers 2010 Q2 reports reflect the dismal job growth prospects in most office sectors across the southland as asking rents continue their decline across all submarkets (though vacancies in the hardest hit areas of Orange County and the Inland Empire are leveling off at levels 2.5 to 3 times what they were in 2007.) Keep in mind that effective rents are generally 15% to 20% below asking so actual fundamentals are much worse than reflected in these reports. Except for Central Los Angeles, the decline in industrial fundamentals is generally tapering off and in some submarkets has actually improved with vacancy declining. Despite the deterioration in submarket fundamentals being "less bad" in most submarkets, we expect the "turn" towards recovery to be several quarters away. This is prompting flight to quality in investor demand with corresponding punishing valuations for properties with high NOI risk for the next 3 years.

Unfortunately, there are no arrows left in the Fed’s quiver. The time it takes to recover jobs lost has ballooned from 6 months, (before the 1990's) to 23 months (in the early 1990's) to 38 months (after 2001) to 60+ months in this recession. The only thing the Fed can do is to keep interest rates low in the hopes of stimulating consumer spending. Though, given asset deflation, consumers are not rushing to purchase any major discretionary items that they think can be bought cheaper later.

CRE values are indicative of consumer attitudes toward asset deflation. What is causing the dramatic schism in values between class "A" trophy assets and everything else? Unlike the 1990's, when there was little transparency and government intervention was able to force the clearing of overvalued real estate off the balance sheets of the savings and loans, the problem today is so deep and pervasive that a "solution" a la the 1990’s would render the entire banking system insolvent. Accordingly, the government has not only not pursued a clearing strategy, but has actually taken a clue from Japan and pushed interest rates to record low levels to facilitate the restructuring of $2.5 - $3.0T of debt.

As the banks get healthy with free money from the Feds, which they lend directly back to the Feds in the form of treasuries, they will begin to clear some of the worst assets with the least prospect for near term value recovery. The outlook for servicers is even worse. The dentist from Dayton who‘s retirement money is in a CMBS pool is not interested in selling off the assets for 60-70 cents on the dollar and then investing those 60-70 cents in five-year treasuries yielding less than 2%, especially not if he has the option to get 4% on 100% of his investment. Here is how it works:

Take a $10,000,000 property with an $8,500,000 loan put in place in 2005 that is now coming due. Let's say the property was purchased at a 6% cap rate (i.e. $600,000 NOI). Now let's say that the NOI has deteriorated through a combination of increased vacancy and reduced rental rates by 40% to $360,000. The NOI will still cover the original loan at a rate of 4%; which is 300 BP’s over 1 year treasuries.

If you are the servicer you have a choice: foreclose and get sued by the mezzanine or class "B" holders who will be wiped out in the process, or work it out with the borrower, provided that the borrower can write a check to pay off some principal and allow for a reclassification of the debt to performing status.

Our thoughts for survival in Ice Age III:

1. Small is the new big. Look for the best opportunities to be in smaller properties. Except for a few unique situations where value recovery is limited or doubtful for at least 3 to 5 years, few large assets will be sold at less than par by servicers and lenders. They will more readily clear smaller properties (under $10,000,000) due to volume.

2. There's opportunity in secondary markets. The flight to quality in capital markets is pushing values in primary markets to levels and cap rates reminiscent of 2006/2007. When offers on boutique office buildings with 30% vacancy at 5% cap rates in primary markets are turned down because it is still 12% below par on the debt, it's a pretty sure sign that quality is getting a very high "scarcity premium".

3. Ugly is beautiful. The worse the product is the more likely the lender or servicers will foreclose or sell it through a receiver.

4. Pick your sandbox. There is money to be made in almost any market, but you have to become an expert at understanding and valuing the risk in that product and submarket.

Class “A” - Trade up strategy. Buying quality at a significant discount to replacement cost with the expectation that when the market returns tenants will go for quality and rents will spike faster in class "A" product in prime submarkets.

Class “B” - Repositioning Strategy. Look for class "B" assets in quality markets that can be repositioned at a price point that is 10% to 20% below class "A" properties.

Class “C” - Recycling Strategy. There is a lot of product that never should have been built. Nevertheless it will find an owner, though likely not who was originally intended.

5. “Patience grasshopper.” It will take a lot longer for CRE to return to health this time due to the fundamental challenges that we are facing. This is not a race but a journey.

6. Rain is coming. Be prepared. It will happen. There is too much product for servicers and lenders to continue "kicking the can down the road". Look for distress sales to start later in Q3 and accelerate in Q4 as the Feds accelerate bank closures to 4-6 per week.

7. Back to the Future. Look to 2003/4 for value metrics, not current fundamentals. We are still at 7 o'clock on The Aggregate Watch. Values will take 5 to 7 years to recover in all but the prime markets.

8. Keep an eye on the servicers and who is calling the shots on their capital structures.

9. New regulations on carried interest and capital gains taxes will make it harder to underwrite value add opportunities and putting greater pressure on values.

10. Debt will be accretive to value for core and core plus, but not for value add. Lender underwriting for all but trophy properties with very strong and stable NOI will be severely tested with real proceeds unlikely to be greater than 60% LTV.

Despite the chilling effects of the Great CRE Ice Age, there is life and opportunity. You just have to look a little harder for it and keep a lot of cash on hand to keep you warm until the freeze is over.

World Beat

2010-06-17T10:42:00.001-07:00

June is a great month for so many reasons. The NHL playoffs, the NBA playoffs, the US Open, and this year, the World Cup all charge June with the euphoria of victory and the agony defeat. We look forward to each day with eager anticipation, wondering what tomorrow will bring. For those of us who live in the world of real estate transactions, it's also the season in which sellers and buyers of real estate make decisions that set the tone for the remainder of the year. We spoke of fear and greed last month and how important it is to balance the two to sustain a healthy market. Last month uncertainty returned to the capital markets as fear took the reins and whipsawed the shattered nerves of a skittish market with concerns about a second shoe slamming to the floor with a thud.

Fear of global capital cataclysm spawned by the disintegration of the European economic system, the collapse of eastern bloc economies, and the swollen Chinese asset bubble threatening to burst has gripped the international capital markets, and is confounding custodians of capital into making decisions that are often conflicting and confounding. So, though corporate profits and cash positions are at nearly record levels and earning fundamentals are very strong (Perspective – Wells Capital Mgmt), executives continue to clutch their wallets with white knuckle anxiety as cash remains king. They are certainly not rushing to hire in anticipation of pent up consumer demand driving top line revenue growth.

As the world watches in eager anticipation of the kick, the putt, or the shot that will determine who wins and who loses, it seems that the season of choice in the capital markets is equally capricious. Will the capital crises in Greece, Hungary, Spain, Portugal, France and England coupled with the waning effects of a juiced rebound in the United States precipitate another worldwide financial meltdown? Or will the Fed get away with inflating the economy to ever higher levels without recourse as world capital flies to the protective environs of the omnipotent albeit deflated dollar. Even Bill Gross, the Pharaoh of Fixed Income is taking cover in treasuries. Private sector cash holdings are over $10.0 trillion in low yielding bank savings accounts (pg 10 Wells Report).

The next few weeks will script the story of Q3 and Q4 and if the last several weeks are any indication, we will see the ominous debt clouds that have been long on the horizon begin to open up and water the parched investment landscape with opportunity. Lenders are loading up on properties and will need to start selling them at some point (RCA 6/10). We are already seeing a great deal of activity in the heavily impacted "sand" states of Florida, Arizona, Nevada and California. Cap rates are not value indicators. Properties are trading at 30% - 40% off the debt based on price psf. Much of this first wave of product is severely distressed, thus very hard to value, but activity is building in stronger coastal markets where the capital markets are driving pricing and facilitating value recovery. In the last few weeks we have seen a few well known institutional core buyers (REIT's and "C" corps) aggressively buying class "A" office and industrial properties in strong coastal submarkets at 5 and 6 caps. We have also seen institutional value add and opportunity buyers acquiring class "A" and "B" properties in currently weak but historically solid submarkets at even lower cap rates because they are half off replacement cost. Still in many cases, even at half off replacement cost, the underwriting based on optimistic rent growth is hard pressed to generate leveraged returns anywhere near historic value add levels of 15% to 20%. Again it comes down to faith, those who believe will engage and execute. Those who don’t believe, who are fearful and content to hoard capital, will wait for better signs and better pricing. Notwithstanding the possibility that “fear” becomes reality, World economic fundamentals, including those in the United States are actually recovering well.

As the clouds continue to build and the mist of opportunity continues, the rain cannot be far away. When it starts, it is expected to accelerate and continue for some time as the product supply overwhelms the supply of capital and demand recovery languishes in a bog of uncertainty and doubt. As our future unfolds, the recovery in CRE will be all about jobs. Without job growth, it will not be possible to sustain this mini-bubble in the core markets and values could very well take another hit. Hence, tread cautiously, but be able to strike fast. Off market opportunities are accelerating. Our thoughts for June:

1. Enjoy the games!
2. Play more golf.
3. Keep an eye on the servicers and who is calling the shots as their capital structures change.
4. Pay up for quality assets in quality markets, but be mindful of price per pound.5. Class "B" in "A" submarkets could be the best buy strategy.
6. FDIC foreclosures are going to accelerate to 4-6 per week.7. Buyers of FDIC loan pools will start processing workouts and foreclosures.
8. Lenders will start trading more in Q3 and accelerating transactions in Q4.
9. New regulations (carried interest and capital gains) taxes will alter investment protocols.
10. Debt will be accretive to value for core and core plus, but not for value add.

Now, as a little thank you in honor of Father's day and the US Open being held this year at Pebble Beach, we are going to give away numbered prints of "The 18th at Pebble" to the first 20 readers who share a golf joke or Father's Day message in the comments section below. I commissioned the painting four years ago by a young artist. It looks terrific when framed and makes a unique and special gift for dad. Best of all, you cannot buy one. Only 250 prints exist. So hurry before they are gone.

Happy Father's Day and Go Lakers!

Old Habits Die Hard

2010-05-14T14:45:00.001-07:00

It’s no secret that there is a great deal of money out there searching for risk adjusted returns. While it seems that the low treasury yields are causing a stampede to quality which is bidding up prices for properties with strong income profiles, many value investors consider this phenomenon unsustainable due to the continued deterioration in CRE market fundamentals in almost every submarket. The debt market is becoming increasingly more creative in driving value as the demand for quality debt is growing stronger every week.

The much hyped State of California "Golden State Portfolio" presents an interesting case study. With over 300 bids from buyers all over the world it is clear that there is plenty of money for quality NOI. It should be interesting to see how it plays out (second round bids were due May 11^th). Before the capital markets drama almost two weeks ago which threw some cold water into the faces of investors who were becoming a little too comfortable in pricing risk, the anticipated pricing was being handicapped at $2.2B; roughly a 6.8% cap on projected income of $150M. Now that risk is again being carefully reviewed by investors, it will be intersting to see if pricing changes. In at least one case, a domestic prospective buyer is putting together a structured "club" deal that will slice up the equity in strips and use "club" debt to create an arbitrage play for the equity in which the highest risk piece could get a return on a 20 year State of California lease in excess of 10%. Such a return would be extraordinary for a state lease and could only work if the debt is accretive to value. We are hearing of debt that is sub 5.0%, which at 60% LTV would yield a cash on cash return of 9.5%+. If you traunch that return, the high risk piece would get well over 10%. Never mind that the lease is a mess: it’s not bondable and needs to be completely reworked, the operating expenses ($25+ psf) are double the norm, and there is no money in the state budget to pay the $250+/- million a year (with bumps) in lease payments, the cap ex costs have not been baked into the underwriting, AND to top it off, you can expect the state to stiff you for at least 2 months every year as they argue about the budget. Does any of this sound familiar? Financial engineering is clearly a tough habit to kick.

Until the last two weeka, the Bulls were been trampling the Bears in the capital markets. It will be very interesting to see going forward how the recent capital markets gyrations will affect CRE values. Where will core product CRE values go now that the Jenga stack is wobbling again. NOI’s are down an average of 25% across the board in all product types. Fortunately, cap rates have also dropped by 25% (which is predictive by the Aggregate Watch). With more deterioration in CRE market fundamentals assuredly to come, value-add investors will not buy now unless the NOI is bullet proof for at least 3 to 5 years and they can obtain a risk adjusted return that will allow for debt to be accretive to value.

Such returns will normally attract equity if priced at least 150-200 BP above debt. Hence, we are seeing very little value-add product coming to market because it needs to trade at cap rates of 7.5% - 8.5 % (in core markets) to entice buyers though sellers don't want to trade at those yields. Unfortunately, time is working against sellers (including lenders and servicers), who while hoping for a recovery in fundamentals to lift values even further now that they have seen the recovery of liquidity drive values by 20%, risk losing sight of CRE's main value driver: Captial Markets. The fallacy of this strategy lies in the misunderstanding of the correlation of the capital markets to values. As the fundamentals improve, the Fed will have to let out some steam and try to slow down the economy, which assuredly means raising rates. We all know what happens when that occurs. Cap rates go back up by 100 - 200 BP and with no improvement in NOI, values will drop quickly, and quite possibly dip below where they were six months ago. The events of the last few days might just accelerate this correction.

Clearly special servicers are incentivized to mend and extend. The attached report from Deutsche Bank is a must read if you want to understand how they think and why there will be no tsunami coming from them. Simply put, they made the best loans so most have some cash flow and they are getting paid very well for managing the loans and working them out rather than foreclosing or selling the debt. With fees of 25BP’s per year for managing the loans and 100 BP’s for working them out, a special servicer is looking at a cash flow on a $1B portfolio of $2.5M per year and $10M for restructuring the loans. Better yet, if the loans come back, the special servicers get the same fees again. So, why foreclose? To be sure, there will be more transaction volume, but look for the most distressed and ugliest properties to come first. Then, as volume builds, they will have to let out some of the pressure to avoid a complete system failure.

While waiting and kicking the can down the road has worked very well until now, waiting longer to hopefully take advantage of a highly liquid market and improving economy could prove to be very costly to the bond holders. The economy may not be heading for a double dip, but there is a lot of deep anxiety in the capital markets and CRE fundamentals are still quite far from stabilization.

Our thoughts going forward for 2010:

Buy occupancy and fill your buildings. When the economy comes back, rents will spike quickly in buildings that are occupied.
Sell properties if at 80% or better stabilized (min 3 years) occupancy.
Exit tier 3 markets. Jobs and rent growth will be compromised for many years.
Buy "A" and "B" quality assets in tier 1 and 2 markets with strong drivers.
Target quality multi-family, retail, industrial, in good submarkets.
Hotels are a great buy if you have plenty of cash and operating experience to weather the current storm.
Value Buyers should wait at least another 6-12 months.
The storm is coming, but it will be the lenders, not the special servicers who will bring the rain.
Near term value returns will be mid to upper teens, not much north of 20%.
Seek to partner with banks to get at the debt. Transparency is not required of lenders as it is with special servicers.
Be wary of Greeks (FDIC) bearing gifts. There are few "ponies" this time around. If the FDIC is selling it; buyer beware!

Think Colliers! We have the service line capabilities, product specialists, market experts, geographic coverage and tools to help accelerate your success!

The Sultan of Quan

2010-05-13T14:19:00.000-07:00

The official position of the Oracle of Omaha and his sage partner at the annual Berkshire Hathaway Shareholders barn dance was, "don't blame the tiger, blame the tiger's keeper." We said the exact same thing in 2008, albeit using a hamburger on the coffee table analogy. How can you blame Fido for eating your lunch if you’ve left the room? Telling a dog not to each your lunch without any physical oversight is at best an exercise in futility. When left to its own devices, a dog will act in accordance with its nature. So here we are, Goldman Sachs, er the dog, just ate our burger, and shame on us for letting them do it. So how do we run with the pack without losing our lunch?

Remember Occam’s razor? Simple is better. Rather than trying to outsmart Goldman with overly complicated financial regulations, all we need to do to rein in financial predators is to ask them to show us the money and hold them accountable for what they produce. Where is the money coming from, where is it going and who is bearing the risk? As Rod Tidwell said, "Jerry, if you want to be my Ambassador of quan, then SHOW ME THE MONEY!"

CoStar: Scarcity Premium Seen Driving Current Cap Rate Compression

2010-05-06T13:51:00.000-07:00

Thank you to CoStar's Mark Heschmeyer for interviewing me for his watchlist article "Scarcity Premium Seen Driving Current Cap Rate Compression."

If you are not currently a subscriber to Mark's watch list, I highly reccomend signing up and becoming a regular reader.

Read the full article here

Fear and Greed in Los Angeles

2010-04-07T17:14:00.000-07:00

Most investors in financial markets think of themselves as rational decision makers. They know that a controlled balance of fear and greed fuels transaction volume by inciting action from both buyers and sellers thereby teasing out price discovery and facilitating bid-ask alignment. Trouble and confusion ensue when values swing to levels unsupportable by market fundamentals by buyers and sellers who have become emotional and let fear or greed motivate irrational behavior. Greed and fear are aligned at the more stable high end of the market, but fear continues to dominate the distressed market as evidenced by the current lack of product available in the market for all but top quality properties.

An owner of an office building portfolio in a “gateway city” market provides a recent example of the emotional decision making rampant in this market. This month he passed on a great opportunity when he let greed get the better of him and turned down an offer of $25 million ($345 psf) for a B- office building in a B+ submarket. This offer represented a 3.78% cap rate on market rents with 80% occupancy. The property, which was purchased for $19.4 million in 2003, has less than $15 million in debt and needs well over $1.5 million in cap ex to bring it to a class "B+" status. Needless to say, the buyer was very motivated but the seller lost out. If there is a double dip, or capital dries up as allocations dissipate, or product flow increases significantly, this property could easily lose 20% in value.

Meanwhile, extreme fear of the Second Shoe consumes the Federal Government and lending community, preventing them from allowing market forces to recapitalize real estate in a normalized process. Lacking the monetary and human capacity to process more than a few hundred bank foreclosures a year, the Fed’s strategy of keeping interest rates abnormally low to help lenders return to health; thereby facilitating the use of workouts and recapitalizations as the preferred strategy to achieve value recovery rather than dispositions. And while the miraculous “moon-bounce” economic recovery of 2010 is in full swing; does it matter much when the economy and CRE fundamentals (which are expected to hit bottom this year) are still under water as reported in the attached report from Wells Fargo? The March 2010 report from Beacon Economics suggests that applying the brakes is going to be significantly more challenging than we thought. So if you are a lender, there is no penalty to waiting. When there are no bullets in the gun to your head you can act with impunity and wait out the recovery.

The market’s fear/greed bipolar condition has created a scarcity premium that has pushed cap rates down by as much as 200 basis points, driven asset values up by 20%, for high quality, stabilized assets in submarkets with historically solid fundamentals in just 3 months. The only distressed properties that are coming to market are those with little hope of value recovery for the foreseeable future (>3 years). The most common examples of these are residential lots, followed by broken condo projects, apartments in markets with high unemployment and vacant unanchored retail properties.

Neither the mini-bubble on the high end, nor the freeze on distressed asset transactions is sustainable. On the high end we have an excess supply of capital and the need to invest it driven by the business models of the custodians of that capital, pushing values beyond what the fundamentals support. So if you have a reasonably stabilized property in a good market and are thinking about selling in the next few years and are not selling now, you should consider doing so immediately. While the deterioration in markets fundamentals prevalent for the past two years in every asset class in every market may be decelerating in some markets, as reflected in the Colliers 1Q 2010 Market Reports, it does not portend an imminent or aggressive recovery that will support high rent and occupancy growth for years. On the contrary, the occurrence of a “second shoe” event could cause the volume of product on the market to catch up with capital capacity, (which is really a lot lower than many people think,) resulting in a precipitous drop in values once again.

There is opportunity on the buy side, but only for those willing to let go of fear and Argus. It's all financial voodoo anyway; always has been and always will be. It's a tool used by financial alchemists, not real estate professionals who really understand bricks and mortar. Smart buyers, check the historical value trend lines, employment prognosis for the submarket, price per square foot, replacement cost, submarket fundamentals and property level components, (e.g. vacancy, rent levels, asset quality, deferred maintenance, etc.), and don’t spend too much time running extensive Argus models. You might as well bring a ouija board to the investment committee meeting. Argus has its place, but is only a small part of the story. A sub 4% cap rate could be a good buy if the rest of the financial metrics add up, while a 10% cap rate could be a sucker play.

So, if irrational greed or fear seems to be keeping you from transacting, don’t worry. This will not last and rationality will resume. In the meantime, here are a few of our latest observations on what's happening out there to help calm your fears and temper your greed:
- There is 2-3 times more capital (debt and equity) in the market than there is product.
- The return of liquidity and lack of product has pushed values up by 20% in 3 months.
- Debt is available for quality properties in good markets as low as 5.0% - 6.0%.
- Lenders are very risk averse and underwriting is tough on new debt; cash flow is key.
- Tenants are looking to go long, recognizing that the economy is stabilizing.
- Well capitalized landlords are refraining from entering into long term leases at current market rates and prefer to wait out market recovery.
- Effective rates in good markets are flattening. Rent deterioration is decelerating.
- It is an excellent opportunity for investors to upgrade and diversify their portfolios.
- CMBS is back, but with conservative underwriting and restrictions on proceeds.
- THIS MINI BUBBLE WILL NOT LAST LONG - BEWARE THE SECOND SHOE

CISG's Olympic Investment Sales Team

2010-03-03T14:09:00.000-08:00

The U.S. dominated the Vancouver Olympic Games, our athletes setting a new record winning a total of 37 medals. Canada likewise tops the podium their athletes winning a record-setting 14 gold medals (a total of 26). With Canadian ownership, Colliers US likewise is setting up to become a dominate force in the real estate services industry. Already the Lipsey Company awarded Colliers the silver medal in their 2010 Top Commercial Real Estate Brands Survey. Colliers - Southern California is likewise stacking our all-star investment team roster with the addition of two Olympic caliber investment sales teams, lead by Kitty Wallace (Multifamily) and Scott Heaton (Industrial). Both are at the top of their game and together with Tom Lagos (retail), Fred Cordova (office, industrial, retail, redevelopment) and Bret Hardy (Corporate) complete Colliers Southern California's “Olympic” Investment Sales Team.

February has been quite a month! The stock market is nodding up and down like a dashboard bobble head on a 1993 Tercel speeding down an unpaved highway. New home sales are lower than a snake's belly in a wagon rut. Freddie and Fannie are hemorrhaging money like a 12 gage ripping though a Sparklets bottle. The European economy is bloodier than the SAW franchise. China, India and the U.S. economies are worried about what will happen when the ‘roids wear off. US Federal, State and City governments are desperately trying to avoid a fiscal “China Syndrome”, and even the venerable Toyota, the gold standard of the auto world is “moving forward…even when you don’t want to” And will be fighting lawsuits for decades.

Why then do we remain guardedly optimistic about the CRE industry? Provided the "second shoe" does not drop, (and frankly, given the number of issues noted above, there could be more shoes than Mrs. Marcos’s famously large collection), we are seeing 8 investment sale trends taking shape that are driving the market:

1. The Investment Market is out in front of the leasing market.

In response to the improving global capital markets and the fact that the investment market is behaving more like the stock market; i.e. in front of the economy by 6-9 months, investors are desperate for quality product and will pay a “scarcity premium” translating into 100+/- BP for quality product that is well insulated from the economy for the next 3+ years. There continues to be a lack of product (see #5 below) and this point in the economy is when risk is actually low, so buyers rightfully pay lower caps on lower NOI’s. Examples include:

a. Cornerstone’s (fronting for Mass Mutual) buying 12121 Wilshire ($102+m;$325psf;5% cap on market rents) – Hines paid $640 psf for a similar building across the street at the top of the market. This was highly bid. They beat out Douglas Emmett. There were reportedly 40 offers on the building.

b. Dekka purchased 1999k Street in Washington DC for a reported $835+/- (6.3% cap) in the fall….this touched off the “new paradigm” of flight to quality.

c. A few new assets are just coming to market that will probably trade for sub 7% cap rates:

i. Shorenstein is selling 1111 Pennsylvania avenue in Washington DC

ii. Principal is selling 333 Market in San Francisco –100% leased by Wells Fargo

iii. Broadway Partners is selling 340 Madison Avenue in Manhattan (750K sf)

2. The Market is clearly bifurcated.

Institutional Capital (and private capital) will only pay a premium for real quality product; but they will look at distressed as well; provided that the market fundamentals are reflected in the price. Private Capital prefers distressed. Distress is basically the orange county story where good properties are trading for $150-$175 psf. Phoenix, Miami are worse off. Cap rates there (MF excluded) will be double digits. Seattle, Portland and parts of SD & Sacramento are in the middle; say 8.5%-10%. Strongest markets are Washington DC; San Francisco; NYC and parts of Los Angeles.

3. Argus is dead.
No one is buying based on Argus. Investors are looking at:

a. Sustainability of NOI (quality of tenants, near term roll, cap ex, etc

b. Cash on cash returns

c. Price per SF

d. Submarket fundamentals – how long to recovery

4. Liquidity is back
There is a lot of money out there, both equity and debt for any property.

5. Values are locking in at historical trend lines
For quality properties like those mentioned above, it’s 35%-40% off peak, for distressed assets it’s more like 50%+.

6. Fundamentals are still deteriorating…albeit at a slower pace
Vacancies and lease rates are expected to continue to be stressed for the next 6 to 9 months in most major markets…. longer in secondary and tertiary cities.

7. FEAR of Second Shoe is very real
Investors are very worried about the stress in Europe, inflated Chinese markets, and the US federal, state and local governments’ deficits. There are a lot of places that could touch off another collapse.

8. All of it has to be recapitalized and someone has to write a check
In any given workout, lenders are expected to write a check for half and the “new money” (existing borrower or new buyer) will write the check for the other half. If the property goes REO, lenders lose an additional 20% more value. Some care (all servicers and local and regional banks who can get wiped out of they take big losses). Some don’t (large banks, thanks to the government).

Whether investors’ aggressiveness will be short lived or a new trend in risk analysis remains to be seen, but for now investors are clearly recognizing that the risk level associated with this stage of the cycle as reflected by The Aggregate Watch is at green, which reflects a low risk point in the cycle. We predicted months ago that properties would trade when buyers and sellers would agree to pricing that was 35%-40% off peak for quality assets, a trend reflected in property trades like 12121 Wilshire. We do not expect this pricing to extend to properties with compromised fundamentals and compromised submarkets or weak locations.

The next few months should be very telling for CRE. Hopefully the deterioration in fundamentals will flatten out and the investment community will be right about the shape of the recovery looking more like a “U”. This is one case where a "W" does not mean a "Win" for anyone.