CRE Commentary

Paramount Group - Manhattan Island Marathon Swim

I wanted to take the opportunity to thank Paramount for their sponsorship of my team for the Manhattan Island Marathon Swim. The swim was a 28.5 mile counter-clockwise circumnavigation of the island of Manhattan on June 12th.

The Paramount team had a great day in the water and ended up finishing in second place.

Yuan to float - Real Estate Impact?

As predicted in this post. The Chinese government announced today that they would let the Yuan "float" in a limited way. What are some of the potential impacts for real estate:

1) On the retail side there may be an increase in costs for retailers which could hurt retail owners.

2) Treasuries yields may rise as the demand for Treasuries, driven by Chinese purchase to keep the exchange rate constant, eases a bit.

3) The policy, in general, can be seen as a sign of strengthening in the Chinese economy.

Green Street CPPI

The Green Street Index showed a small increase in May and has increased 20% since the bottom. This marks another month the Green Street Index has diverged from the Moody's Index.

Moodys CPPI

The Moody's CPPI index declined .5% in March. The index appeared to be less influenced by distressed sales than the previous reading - perhaps indicating that sellers were more willing to part to with assets at lower valuations. It is important to note that the volume of transactions measured has increased greatly from February. The number of transactions essentially doubled and the value tripled. It will be interesting to see how the index preforms as several of the recent strong sales comps in Washington and New York are incorporated.

Links of the Week

1) WSJ article on funds returning commitments to investors. Contra this article, I expect the pace of investment in increase as we emerge from the recession and improved certainty increases the willingness of players to transact.

2) I think this article by CoStar matches what we have been seeing in the market. Anecdotally, even construction financing is returning in a limited way.

3) Are malls dead? I believe the mall is far more resilient that pundits expect. The mall is declared dead every few years at this point (internet, economy, etc.) - yet they keep coming back.

Unrelated to real estate but interesting:

4) The chocolate bond - the payment-in-kind portion of this bond is the most interesting feature. What does that say about the future of chocolate production costs? The buyer has some inflation protection built in.

5) It is always interesting and important to read about the industries that drive the underlying market. In New York the traditional drivers have always been finance and media. Interestingly, the technology sector in NY is rapidly growing. The best blog on the sector is by venture capitalist Fred Wilson.

Ceiling Height

One important characteristic to consider when evaluating an office building as an investment is the height of the ceilings. Historically there has been a strong preference by tenants for high ceilings and justifiably so. High ceilings allow more light into a space and have an innately pleasing aesthetic. Witold Rybczynski has a nice history of high ceilings in his Slate column:

"Making ceilings taller doesn't add that much to the overall cost of a building," says Robert A.M. Stern, the architect of the Comcast Center, "but taller ceilings allow light to penetrate deeper into the building, which is important if you are optimizing daylighting."

Rybczynski also notes some market norms: 8 3/4 feet in 1965, 9 feet in the 1970's, 11 feet for new projects today. If that trend continues - ceilings for new buildings will be 12.5 feet. at the end of a 15 year hold on an asset purchased today. It is important to be cautious if you are evaluating an asset with ceilings at the lower end of the range and looking at a long term investment horizon as the risk of obsolesces rises.

Of course some markets are not as sensitive to high ceilings. In cities where vertical height is an important constraint on development, the economic cost of high ceilings is much higher. In Washington D.C. the height limit (the width of the street plus 20 feet) forces developers to fit floors under the cap yielding an office environment with much lower ceilings, on average, than other markets without these constraints.

 

Links of the Week

1) Commercial mortgage originations increase from 1y year ago but down from last quarter

2) Moody's CPPI index is down. I will cover the index in more detail tomorrow.

3) The Fed is not rushing to shrink its balance sheet. How the Fed goes about unwinding the massive increase to its balance sheet is one of the key risks/things to watch as the economy recovers.

4) Job loss during the recession. Many are wondering why the losses in Finance and Insuranceare less than one might expect. I would argue the much of the stimulus spending actually targeted this sector through banking support etc.

Unrelated to real estate but interesting:

5) Map of Dutch First Names (HT: Marginal Revolution)

6) Moneyball style analysis for hockey: 1) Copper and Blue and 2)Behind the Net

7) Witold Rybczynski on Andrea Palladio's influence on American architecture.

Green Street and Moody's Commercial Property Price Indices (CPPI)

Green Street has released its monthly price index - reporting an increase of 5% in April and a total increase of 20% from the low a year ago. Green Street also included a discussion of the differences between the Moody's index and the Green Street index that is helpful to understanding the changes. Those differences show up again this month as Moody's reports a decline.

Here is the chart comparing Green Street and Moody's:

 

Why the decline in the Moody's numbers and an increase in the Green Street index? I would expect the difference to be driven by nature of the sales we have been seeing (Moody's is repeat sales driven) vs the universe that the Green Street index measures. A significant portion of the sales last month were distressed - 1/3 of the total, and so far we have seen this distress concentrated in sectors of the market that are less likely to be considered part of the REIT universe of assets that Green Street measures. In short, the indices are measuring slightly different pools of a bifurcated market.

Unlisted REITs

I recently came across this article on private REITs from National Real Estate Investor. The article discusses several supposed advantages to the structure and leaves a very misleading picture of unlisted REITs as a good investment vehicle. Point by point:

1) Buying power and access to capital: It is often said private REITs are "sold" and not "bought" (sales through brokers are an important pipeline) and this model has continued with the private REITs maintaining access to capital through the downturn. Of course, the public REITs have continued to have access to capital as well, though both equity sales and debt financing. Simon, Vornado, DDR, SLGreen etc all raised capital during the crisis.

2) Insulated from stock market volatility: Of all the arguments in favor of private REITs this is by far the weakest. Just because you can't observe a price for an asset doesn't mean it's value is less volatile. Since private REIT shares can be illiquid (note: some argue that Private REITs buy back shares at the issue price so there is liquidity, however, reading the prospectus will show that this buy back is at the election of the company and history has shown they will suspend the share repurchase  programs in down markets.) An appropriate measure of volatility would be to input the price of these shares on the secondary market at these times (steep discounts) and compare.

Drawbacks to the un-traded REIT model:

1) Upfront fees are very large: With up to 15% in fees (upfront load around 7%), investors start with a huge disadvantage relative to other real estate investing alternatives. 

2) Weak returns: I don't have access to the Stanger data, however the performance of major private REITs has lagged their public counterparts. According to Green Street Advisors - CNL's hotel REIT achieved 7.5% annual returns vs 18.5% for a basket of hotel REITs over the same period and Wells/Piedmont underperformed by 7.5% vs similar office REITs.

Links of the Week

1) The Wall Street Journal has a good roundup of recent REIT activity.

2) The New York Times covers the U.S. state sales of real estate. Although many states need to raise revenue, this strategy isn't sustainable and will only provide marginal relief given the size of the problems. The sales can delay, but not prevent, tough choices.

3) The real estate industry is not generally considered vulnerable to disruptive technologies (not since the media declared the retail sector dead at the height of the tech boom). While a site like Airbnb.com won't radically reshape the hospitality sector, it is still interesting and important to think about how tech companies may alter the landscape at the margin. Lodging has been most impacted historically with the web (Priceline, Kayak, Orbitz etc.) now an integral part of the industry.

4) Employment is the key driver for commercial office and the recent data release supports the upturn we have been seeing. Employment jumped by almost 300K jobs (although the unemployment rate also increased as workers who were "out of the workforce" returned).