Published February 15th, 2011

"Price is what you pay.  Value is what you get."
- Warren Buffett

While this may seem obvious there is concern that the lines may be blurring in today's real estate markets.  A lot of money has been sidelined since the market crashed three years ago, and it's getting impatient.  Seemingly distressed assets can get bid up to close to pre-crash values, while the truly discounted properties (and real values) are mostly passed over as too risky.  The challenge, of course, is how to assess value and over what time period.  Too many investors are using bubble era valuations as the benchmark without taking into consideration the fundamental economic outlook.  While the economy may be out of the ICU it is still hooked on a lot of life saving measures.  True value judgments in real estate today must be forward-looking and long-term. This is where real patience will pay off.

Commercial Real Estate

Commercial Real Estate's Uneven Return
Commercial property took less of a drubbing than residential real estate in the recession but still faces a long and painful recovery. Banks have already taken $80 billion in commercial-real-estate losses—about half of what they are expected to take as a result of the recession, according to the Federal Reserve. But in some markets, commercial-property values have soared more than 30% from their lows in 2009, according to one industry gauge. For properties such as marquee apartment buildings in New York City and office buildings in Washington, D.C., values are even approaching pre-crash levels.
Full Story (WSJ)

Office Vacancy Drops, Lease Rates Languish
According to a new report by Colliers International, the U.S. office market entered the year on a relatively strong note after the fourth quarter, with a sharp drop in vacancy and a healthy increase in occupied space. But rents continue to languish, according to Ross Moore, chief economist at Colliers International and author of the report. The fourth quarter marked a key turning point toward recovery, he says. “With the economy now posting robust growth, all that is needed for a full recovery is a surge in employment.”  With the economy making strides, and the addition of private sector jobs, leasing markets are expected to continue improving as 2011 unfolds.
Full Story (NREI)

To Default Or Not To Default
Borrowers in today’s commercial real estate market face the daunting dilemma of deciding whether to default on their loans as a way to secure discounts in a struggling economy. According to “To Default or Not Default? That Is the Question,” the latest podcast by John B. Levy & Co., commercial real estate owners are considering loan default as a viable strategy for managing troubled debt at a time when access to money has become tight.
Full Story (NREI)

Residential Real Estate

Crash Hitting Cities Thought To Be Stable
Few believed the housing market here would ever collapse. Now they wonder if it will ever stop slumping. The rolling real estate crash that ravaged Florida and the Southwest is delivering a new wave of distress to communities once thought to be immune — economically diversified cities where the boom was relatively restrained.
Full Story (NYT)

Finance & Economy

Outlook Turns Bullish For Capital Flows
Despite risks that can't be ignored, experts foresee bright times ahead for the already much-improved debt markets in 2011. Commercial mortgage markets improved dramatically in 2010, observers say, and that improvement is expected to continue throughout this year.
Full Story (GlobeSt.)

Securitization Market Still Dormant
The securitization market is slowly awakening. So says Tom Muller, real estate & land use partner at law firm Manatt, Phelps & Phillips in Los Angeles. Smaller, specialized securitizations have been placed in the last two years and we're beginning to see some initial interest in larger, more diversified offerings. 
Full Story (GlobeSt.)

Imagining Life Without Fannie And Freddie
A report to Congress from the Treasury and the Department of Housing and Urban Development, published on Friday, provided some long-awaited analysis by the Obama administration about what went wrong in housing finance — and how to fix it. The report, entitled “Reforming America’s Housing Finance Market,” zeros in on the perverse incentives created by the nation’s mortgage complex during the years leading up to the panic of 2008. The Treasury’s recommendation that we wind down Fannie Mae and Freddie Mac and let the private mortgage market step in is spot on.
Full Story (NYT)

What Is The New Normal Unemployment Rate?
In the past, the U.S. labor market has proven to be very flexible and recessions have not usually been followed by long-lasting increases in the unemployment rate. But, in the wake of the most recent recession, many economists are concerned that developments such as mismatches in the skills of workers and jobs, extended unemployment benefits, and a rise in long-term joblessness may have raised the “normal” or “natural” rate of unemployment above the 5% level that was thought to be typical before the downturn. Indeed, a few economists have gone so far as to argue that the rise in the unemployment rate to its current level of 9% primarily reflects an increase in the natural rate, implying there is little slack in labor markets and therefore little downward pressure on inflation. This Economic Letter examines evidence regarding changes in the natural rate of unemployment in the United States since the recession began.
Full Story (FRBSF)

Published January 31, 2011

Uncertainty. There is nothing worse for sound business and investment decisions than an uncertain economic environment.  As the recovery, however tepid, takes hold, we continue to operate with mixed signals and conflicting data.  While there is much talk of a turn around in real estate and a thawing of the credit markets, it is the Shepherd Perspective that only the very top quality properties and sponsors are enjoying these sunnier climes.  The market is bifurcating into haves and have-nots, with most of the market settling into the latter.

Commercial Real Estate

Calpers, After Losses, Plays It Safe

After losing more than $10 billion on real-estate investments, Calpers, the giant California pension fund, is returning to the property market with a new strategy and fewer investment managers, seeking steady, modest gains rather than blockbuster returns. Calpers will be making those investments with less help from some big-name managers, including Black Rock Inc., Hines Interests and Jones Lang LaSalle Inc.

Full Story (WSJ)

Multi-Family Performance May Not Be What It Seems

The year-end data are in, and it turns out the CMBS market isn’t improving, after all. In fact, the delinquency rate hit its all-time high in December, 9.2%, according to a report on GlobeSt.com late last week. And in an interesting turn of events, it’s multifamily that’s seeing the worst of it.

Full Story (GlobeSt.)

Shadow Space Hampers U.S. Office Recovery

The U.S. office market continues to recover at a snail’s pace in large part because of an overhang of shadow space, according to a newly released forecast from brokerage firm Grubb & Ellis. Shadow space — leased but empty office cubes, floors and wings — vacated during the recession will accommodate about one-third of all net new demand in 2011 and about one-fourth in 2012, predicts Bob Bach, chief economist with Grubb & Ellis. This activity will not be reflected in the published statistics.

Full Story (NRE Investor)

Residential Real Estate

Housing Numbers To Be Revised Down

The NAR is planning on releasing revisions for the past three years (2008 through 2010) on February 23rd along with the January existing home sales report. Many housing analysts expect these revisions to be significant – and to be down. Assuming the revisions are down, this will also reduce the “distressing gap” between existing and new home sales.

Full Story (CR)

Finance & Economy

CMBS Delinquency Rate Hits Record High

The CMBS delinquency rate hit 9.2% in December, the highest in history for U.S. commercial real estate loans in CMBS, reports analytics firm Trepp LLC.That includes loans 30 or more days delinquent, in foreclosure or real estate owned. The new delinquency rate represents a jump of 27 basis points in December. The value of delinquent loans now exceeds $61.5 billion, according to Trepp.

Full Story (NRE Investor)

CMBS Payoffs Best In Two Years

Borrowers paid off more than half of the securitized commercial real estate loans reaching maturity in December 2010, marking the highest monthly payoff rate in two years, according to Trepp LLC. The uptick suggests that replacement financing is growing more accessible to borrowers.

Full Story (NRE Investor)

Employment Data Tempers Outlook

For investors eager to embrace recent affirmations of a turnaround in commercial property fundamentals, Friday’s labor report should offer a modest check on their rising sense of optimism. One and a half years following the official end of the recession, US employers added just 103,000 jobs to national payrolls in December. While the unemployment rate dropped to its lowest level in 19 months, that decline reflects a large number of discouraged Americans giving up on their job search and a corresponding decline in the labor participation rate. Neither one of these outcomes is consistent with a robust improvement in the health of the US labor market.

Full Story (GlobeSt.)

How To Identify High-Growth Regions for Land Investments

So you want to take a vacation to some place new and exciting. I’ll bet you’ll spend quite a bit of time researching the area: where to stay, where to eat, how to get around, what’s going on in the area. Would you spend the same amount of time investigating an investment opportunity that could provide you with a comfortable retirement years down the road?
The key – well, one key anyway – to successful pre-developed land investing is identifying high growth areas before the growth arrives. As discussed in Money Doesn’t Grow on Trees, this land banking strategy is known as being in the path of growth.
But this is a big country, with a lot of open land. How do you know where the path of growth is? Of course you can never know with 100% certainty, but there are a series of fundamental characteristics you should look for in any land banking area. These are the qualities that keep the growth moving down a path toward your land.

1. Population centers. The best place to start looking for growth is, quite simply, where the people are now. These are dense population centers that, in order to keep growing, need to expand beyond their current boundaries.
2. Affordable housing. When people can’t afford to buy a home inside the population center they move to the more affordable outskirts. Ideally you’d like to find an outlying area with housing prices roughly half of average housing costs closer in.
3. Level, usable land. This is the land that gets developed first. Hilly, mountainous terrain, or land with other natural barriers to building, is usually the last to be developed, if at all.
4. Available water supply. It’s been said that water is the oil of the 21st century. You need water to support a growing population and, if it’s not there, the people won’t be either.
5. Transportation accessibility: freeway, train, air. Look for existing transportation infrastructure and serious plans for expansion. You may find a good deal in the middle of nowhere, and your great grandchildren will thank you for it.
6. Adequate utilities. In addition to water a growing population needs electricity, gas, telephones, cable, etc. The cost of developing this infrastructure is tremendous so utility companies forecast their budgets well into the future.
7. Educational system. New growth is generally led by families, and families won’t go where they can’t educate their children. Look for well supported primary education system as well as advanced education and training opportunities. Also, look for plans to build new schools over the next 5 to 10 years.
8. Proximity to large, metropolitan areas. New population centers don’t just spring up in the desert. (Las Vegas aside.) They radiate out from existing metropolitan areas. Ideally you should be within commuting distance – say 100 miles or so.
9. Existing and planned industrial and commercial base. Jobs. Jobs attract people, simple as that.
10. Existing and planned residential and commercial development. In real estate we say that retail follows rooftops. Builders won’t go into an area unless their research tells them there is demand.
11. Master plans for community. While we live in a free economy, it is ultimately the local government agencies that decide what will be built, when and where. Most communities are required to have a master plan for growth looking out at least ten to twenty years.
12. Authoritative population projections. There are actually people who spend their lives studying population growth. They’re called demographers and you can find their work at the census bureau, which provides population and economic data on the state and local levels as well. In addition, many local government agencies and economic associations produce well researched growth projections.

These are the principal characteristics to consider in land banking. If a region is missing the mark on a number of these points I would put it in the “not in my lifetime” category. Making sure these fundamentals are in place will definitely help you get into the right ballpark. A closer look at the actual stadium (i.e., which land parcels to consider) will be addressed in our next land banking discussion.

Pre-developed land is a powerful long-term investment vehicle.

Real estate is changing rapidly. Today it is no longer the realm of a select few wealthy investors, but has become an accepted asset class with a variety of solutions to meet the individual needs of each investor. These needs vary depending on the investor’s risk profile, time horizon, yield requirements, knowledge and experience, and available capital, among other factors. The investment options range from office towers, to the mortgages secured by that tower, to the land it sits on (or will eventually sit on.)

I’ll start my musings from the ground up (and ask your forgiveness for the bad pun.) Land goes through four basic phases in the development life cycle, and there are investment opportunities in every phase, each with its own risks and return potential. For the long-term investor, particularly if you’re investing with your self-directed IRA, strategically chosen pre-developed land (phase I) can be one of the best ways to diversify your portfolio and improve returns.

• No tenants to deal with.
• No ongoing maintenance requirements.
• Little to no insurance requirements.
• Limited supply (can’t make more land.)

This investment strategy is often referred to as land banking – buying land and holding it for future development. Immeasurable wealth has been created by people who had the vision and the patience to execute this strategy. The exploding population in already crowded regions places continued demand for land development, and presents the owners of that land with an enviable profit-making opportunity that will never again exist. Once the land is built out the original opportunity is gone.

Land in the path of growth is a common phrase in the industry today, but the operative piece is “path of growth.” Defining and identifying path of growth is the key to profitable land banking as that’s where the largest asset appreciation resides. (Unless your investing for your great great grandchildren.) In my next article I’ll discuss my top-down approach to identifying quality land banking opportunities.