Property Grunt

Thursday, July 14, 2005

Getting the hell out of dodge

Sometime ago the Grunt was having dinner with an amigo that worked in the finance industry. My amigo informed me that managers of certain funds that owned portfolios of real estate were liquidating all of their real estate assets and basically getting the hell out of dodge. It was his assertion that they were being motivated by the notion that the market was at its height and this was the time to get out.

The Grunt’s intelligence was confirmed by a recent NYT article about the commercial market and how that industry was coping with the looming bubble while making deals on commercial real estate and has confirmed there are many players from pension funds to private real estate owners who are dumping their property as we speak.

"Some sophisticated investors are sending strong signals that prices cannot rise much higher. Among the big sellers that have been shedding billions of dollars worth of office and retail property in recent months have been Calpers, the nation's largest pension fund; Equity Office Properties, the giant real estate investment trust; and many private landlords like the Shorenstein family of San Francisco."

Obviously sellers are jumping in since this could be height of the market and factions are lining up to put their money in real estate due to its return comparing to the other investments at this time. What also works in the seller’s favor is the current lack of inventory in certain markets, e.g. New York City making it even more valuable.

"Commercial real estate is awash with capital, and many buyers are accepting initial returns of 5 percent or even less because they have few investment alternatives."

Real estate is also very management intensive comparing to other investments. I often hear this argument from sales people or mortgage brokers whenever they are backed in a corner about the real estate market they chant, “You can’t live in a stock or bond but you can live in a house.” No s**t Sherlock.

Stocks and Bonds aren’t designed as homes. They are simply investment tools. Real estate on the other hand serves as dual purpose from investment to sanctuary. However it means more responsibility and headaches for the owner.

The beauty of a stock, bond mutual fund is that the purchaser of the stock is not in charge of maintaining the investment. That responsibility lies in the hands of the hierarchy of the CEO and the board. As an owner of stock you are just there for the ride and if you are dissatisfied then you can leave or leverage your shares in making some changes in the company depending how much pull you have.

Not with real estate. If you own a portfolio of investment property you need the infrastructure to maintain the building. That includes property managers who have a staff of superintendents who make sure the fires are stoked in boilers, the apartments are renovated and cleaned. You also need a crew of badass lawyers to deal with negligent tenants and lawsuits that are either meritorious or frivolous filed by everyone who has a raging hard on to take down a landlord. So it’s pretty much a no brainer why portfolio owners would take a Bill Gates ransom in exchange for their inventory.

So why would someone be crazy enough to buy a portfolio of buildings at this time? The NYT article points out that the commercial market has become just as risky residential.

"To Jim Titus, the managing director of Realpoint, the research arm of GMAC Institutional Advisors, today's prices are reminiscent of the late 1980's, when Japanese investors overpaid for trophy buildings and went on to suffer huge losses. "I sort of see a similar situation potentially brewing," Mr. Titus said."

""The volume of outstanding commercial mortgages has been growing and the total is now equivalent to 14.4 percent of gross domestic product, a level not seen since the days before the real estate crash of the early 1990's, according to Moody's Investors Service. As with residential real estate, the proportion of interest-only loans has risen sharply."

However it makes note that this is not 1989 where owners were lining up to do the voluntary conveyance dance with their lenders and turned in enough keys for a carnival cruise line of wife swapping parties. The article points out that the options of financing are more varied than ever which allows more ways for the high profile investors to protect themselves.

"Another difference is that 15 years ago, most financing came from banks and savings and loans. When rental income fell below mortgage payments, many landlords were unable to refinance their mortgages. Today, by contrast, real estate financing has become highly complex, with many types of lenders assuming different levels of risk. "There were much fewer choices 15 years ago than you have today," said Sam Zell, the chairman of Equity Office Properties."

Another point I would like to stress that the people who are buying these gi-normous portfolios are not idiots. They are the cream of the crop of the finance world and a lot of them are lifers who have survived many a campaign in the investment world. They have licked their wounds and have seen the errors of the past and make an effort to walk the path of victory. They are well aware that they are walking on deadly ground realizing a bubble is hard to kill and any plans for a quick return is marked for death. One false move and they could find themselves under siege.

So when the correction occurs they will already have the proper measures in place to protect their interests. Which means getting the right mortgages, financing and getting the right people and cleaning house in getting rid anything that could harm their investments which includes negligent workers and deadbeat tenants.

Unlike the first time investor, they will be able bear the storm resulting in the proper execution of their strategy of buying and holding onto their investments for the duration.

The shrewd investor should treat these types of trends as the canary in the mine. It’s definitely an indication that a correction is looming because the big players are dumping their inventory. However when its going to happen and what form it will manifest itself in is unknown.

I would never say these people are right all the time. The financial world is strewn with the corpses of former dynamos who were filled with the arrogance that their way was the right way. To simply blindly follow what the Goliaths do would be suicidal. It is just something to consider when you are analyzing your own status and making the decision to buy or sell.

But in my personal opinion this is just another sign of the pop.