Saturday, June 19, 2010

Refinancing Commercial Real Estate

The 460 unit apartment complex that I manage in Charlotte is owned by the California pension fund CALPERS.  It is the mother of all funds and holds an enormous amount of commercial real estate.

Last week, members of the company I work for began due diligence on a property in Raleigh.  They are also looking to acquire a few more properties in the Charlotte area.

When I speak with the people involved with acquisitions and "upper" management, they explain to me how the market has bottomed.  They all use the word recession in the past tense, and if I used the words "double dip" they would think I was talking about ice cream.

Many of these esteemed decision makers actually believe that commercial real estate bottomed in the first quarter of 2009.  They say these things to me.

Of course I do not spend time trying to explain my point of view on the subject matter.  I would prefer to just continue learning how to best manage and operate the asset they own.  The asset that is losing value every hour of every day. 

I feel that CALPERS and other large investment funds are making a mistake by wading back into commercial real estate at this point in time.  I understand why they are doing it, and that can be a conversation for another day, but let's talk about why they shouldn't.

Commercial real estate is financed with balloon payments that typically have five year terms.  This means that five years into a mortgage an investor must pay the entire balance off or refinance.

The following graph shows the rise and fall of commercial real estate prices from 2000 through today.  As you can see, properties bought in 2005, 2006, 2007, or 2008 are now underwater.  (They are worth less than what was originally paid)


With their five year balloon payments, a vast majority of these properties will have loans coming due in 2010, 2011, 2012, and 2013.  The following graph shows the coming reset schedule:


How will these loans be refinanced if the properties are now worth far less than what was paid?

The answer is that they won't.  The majority of commercial real estate is located on the balance sheets of the smaller community banks.  The government does not care if these banks fail, which is why the FDIC is closing banks at an incredible pace every Friday night.

While the government has a vested interest in protecting the value of residential loans, (these loans house voters) they will be less likely to protect commercial real estate prices. (they are not on the balance sheet of their largest campaign contributors, the "too big to fail" banks)

It is this reason why I see commercial real estate as the next great investment opportunity.  I believe that when we reach the manic stage in the gold and silver bull market in a few years, it will coincide with the bottom of the real estate market.  Astute investors will sell their metal to the public rushing into the market and use their capital to purchase real estate at fire sale prices.

Thursday, June 17, 2010

Act II Begins

George Soros, the legendary investor, gave a speech this past weekend regarding the financial crisis.  He said the financial crisis was far from over and that we have only entered Act II.

Act I can be thought of as the subprime/credit crisis that began in August 2007 and took down markets worldwide.  Act I finished with central banks around the world pumping unprecedented liquidity into the system and creating a temporary reflation.

The system was not allowed cleanse itself of the toxic debt during Act I.  Instead the toxic assets were nationalized and became part of the government balance sheets.

We now find ourselves at the beginning of Act II, which is where the government balance sheets began to experience strain and many will move into crisis as we have already seen in Greece.

Behind the scenes right now Spain is in chaos.  The banks within their border have stopped lending to each other creating a liquidity crisis.  Banks will only lend with the European Central Bank (Europe's Federal Reserve), and the money being held over night at the ECB is hitting new records every week.

This is the exact same scenario that took place during our subprime crisis.  Banks overseas do not know how much government debt from Spain, Italy, or Greece that other banks are holding.  If you lend to a bank and that bank cannot open its doors due to their government debt holdings losing value, then you have lost your money.

This is what took place with Lehman Brothers. 

Just as Act I saw the crisis move from subprime mortgages to credit cards, to auto loans, and then to commercial real estate loans, Act II will move from country to country.

It is important to position yourself today with an investment portfolio of strong government debt.  Niall Ferguson of Scotia Capital recently created a presentation to show which countries were in the most danger.  The following graph shows the order of strength:


As you can see, the United States is in the most danger, followed by Japan, and THEN Greece.

Countries such as Canada and Australia are some of the strongest.  Their currencies and bonds should be viewed as a safer location during Act II.

During Act I Bear Stearns was the first major bank to fail.  Lehman Brothers and Merrill Lynch had equally tarnished balance sheets at the time of Bear's failure, but they did not go down for another eight months.

That doesn't mean investors should have waited till the very last minute to sell their Lehman and Merrill shares.  If you know a company is insolvent and can never recover then you need to sell before the public loses confidence in the asset.

The same concept applies for government debt. The United States is now insolvent and can never recover.  If Americans paid 100% of their income in taxes, meaning they gave every cent of their paycheck to the government, it would not cover the annual deficit. 

Americans are not providing 100% of their paychecks to the government.  In reality expenses are rising exponentially as income (tax receipts) plunge as can be seen in the following graph:


The time to sell your United States debt and currency is before the crisis hits our shores, which will be in the later stages of Act II.

Make a plan for your exit strategy now.  You cannot buy fire insurance when your house is on fire.  Create a life boat of assets that will be safe during this coming storm and begin to purchase them when they go on sale.

Act III, the final act, will be in the form of a currency crisis.  At this point the house will already be on fire and there will be two classes of American citizens:

Those who bought insurance and those who did not.

Wednesday, June 16, 2010

A Peak Point: Real Estate Outlook

I usually provide a small article and summary every day new residential and commercial real estate information is released.  In case you don't track this site daily and you would like a full summary of the current residential real estate market outlook the following article does a tremendous job putting all the pieces together in just a few pages:

A Peak Point: Click Here To Read

Sunday, June 13, 2010

The Municipal Meltdown Has Begun

I wrote an article back in January this titled Greek American States, where I described how America is one large bankrupt country composed of many Greece like states.  If Greece is a stick of dynamite, then America can be thought of as a nuclear bomb.  Ticking.

Obama's first stimulus bill of just under $800 billion in 2009 had about $150 billion in cash going to state governments to focus on "stimulus" projects.  Most astute financial observers said at the time that the money would stimulate nothing and would be used to fill budget deficits at the municipal level.

This is exactly what has occured.

Those same financial observers anticipated the money would run out by the fourth quarter of 2010 and the states would be back at the President's door with hat in hand.

It appears that the money has run out far sooner.

This past Saturday night, like a theif in the night, Obama was at work trying to ram through a $50 billion stimulus bill targeted toward "saving" the states.  From the Washington Post:

President Obama urged reluctant lawmakers Saturday to quickly approve nearly $50 billion in emergency aid to state and local governments, saying the money is needed to avoid "massive layoffs of teachers, police and firefighters" and to support the still-fragile economic recovery.

In a letter to congressional leaders, Obama defended last year's huge economic stimulus package, saying it helped break the economy's free fall, but argued that more spending is urgent and unavoidable. "We must take these emergency measures," he wrote in an appeal aimed primarily at members of his own party.

The bill appears to be moving through with ease as politicians look to win the hearts of public employees across the country at the year end elections.

The $50 billion will be a small down payment for what the states will ultimate need to survive.  As the economy rolls over, tax receipts continue to plunge at a time when many states are reluctant to cut spending.

The Greek American States will continue to suck the life out of the productive portion of the economy and Obama stands ready to provide whatever funding is necessary.

The biggest question many are asking is, "who is going to fund Obama?"

The Darker Side Of Positive

If you are someone that has read this site for a while it may be hard to believe that I am a fairly optimistic and positive person. I am also someone that agrees with the philosophy that positive thinking and visualizing your goals being achieved makes an positive impact on a person's ability to achieve those goals.

However, as with everything else on this site, I also like to study and listen to people who have an opposite belief.

The following is one of those people, Barbara Ehrenreich, who explores the darker side of positive thinking. Some of her points are very valid.  I agree that in regards to things you have no control over such as the larger economy, government mistakes, or weather, a person should focus on a realistic outcome.  However, I also believe a person can control their own destiny by making decisions that will benefit their own lives by preparing and adjusting to the reality around them.

Personal positive thinking surrounded by a real understanding of the world. Anyway, here are her thoughts on the matter: