August 4, 2014
May 31, 2014
It's time for Google to fight back by funding urban housing... in downtown San Jose!The well-publicized media events where “activists” block and board Google buses in San Francisco’s Mission District set me off. These events lead to the requisite articles about how high-paid tech-workers are driving out San Francisco’s low-income households and leading to Ellis Act evictions. The headlines scream "evictions up by 170% in 2013 from 2010"… but rarely mention the grand total was just 116.
Why do these protests frost me? Let me count the ways...
- This is not about San Francisco, it is about the Mission! The Mission District is becoming a desirable place to live. Desirable neighborhoods become expensive. If you have limited means you don't generally get to live in the district of your choice. I would like to live in Pacific Heights, but I cannot afford it. Activists, how about moving into the Bayview or the Crocker Amazon and make those neighborhoods hip and desirable?
- Old time San Franciscan’s already have uniquely strong protections against being priced out! Unlike most major cities in America that have freely operating real estate markets, San Francisco has (1) Prop 13 to help homeowners avoid rapidly escalating real estate taxes if their homes jump in value, and (2) rent control over the majority of SF’s rental stock. Yes, renters are accepting buy-outs from landlords, some as high as $40,000 to move, but these are voluntary transactions, entirely at the tenant’s option. Ellis Act evictions are up from the depths of the economic collapse, but so are the number of sales, rent levels, home values and all other measures of real estate activity. Ellis Act evictions are still very rare, annually accounting for only 0.05% of the total San Francisco rental stock. Also, these Ellis Act units do not disappear: They are housing for the owner’s relatives or converted to TIC ownership, which is the entry housing option for many renters trying to move into home ownership.
- Who are these “activists” anyway?Although the news stories are about long-time San Francisco residents of limited means; the angry protesters are not long-term residents. They are generally young hipsters who are the same age as the tech workers. These young people want to live in hip neighborhoods for the same reasons. The difference, they studied the wrong subjects in college and are now part-time activist baristas. Activists having special sway with the media is a San Francisco phenomenon; “I hold no public position or office. But my voice counts more than your average voter! Why? Because I am an angry zealot.”
Yet the Google bus controversy highlights an important issueThe Bay Area’s largely car-centric suburban housing stock does not meet the needs and desires of its influx of millennial in-migrants. The Bay Area needs a genuine urban alternative to San Francisco. Downtown San Jose is on the cusp of meeting this need.
Downtown San Jose is at the inflection point of becoming a hip and vibrant place. See this excellent recent report by SPUR about the emergence of Downtown San Jose: .
Jerry Brown killed the skimming of tax increment by redevelopment districts. San Jose was one of the most aggressive skimmers, creating massive, interlocking redevelopment districts that allowed it to use the tax increment from all of the business development in North San Jose’s Golden Triangle to fund projects downtown. The redevelopment punchbowl was taken away but not before the City spent over $2 billion dollars in redevelopment funds in Downtown San Jose on transit projects, museums, parking, an arena, convention center, parks and street beautification. Downtown San Jose is safe, clean and beautiful but it is a ghost town after 6 PM. The 200+ restaurants and bars downtown struggle when it is not Sharks Hockey night.
Without the redevelopment slush fund, San Jose’s city planners are being forced to do what makes sense; incentivize the free-market to bring in high-rise housing to populate its downtown. A few thousand young, well paid tech-workers living, eating and hanging out downtown will change everything. Yet the City should not allow a bunch of low-rise, stick-built apartment houses to spring up downtown. Transit oriented development makes sense only if it is dense: San Jose should demand minimum height limits downtown and continue its current economic incentives for high-rise residential developments.
The Cash-Rich Employers of Silicon Valley should fund high-rise rental projects. High-rise construction requires developers to meet Type-1 fire safety codes. This means buildings that don’t burn made of concrete and steel. Type-1 is expensive construction in earthquake country. Until very recently the only residential buildings that could afford this type of construction in Downtown San Jose were luxury condos (And, most of these projects still when back to the banks). Apartment rents in San Francisco are now high enough for Type-1 construction, but San Jose’s rents are not quite there. So the City of San Jose gave some temporary breaks on development fees for high-rise residential and temporarily suspended inclusionary housing requirements. As a result two apartment towers are under construction in Downtown San Jose.
But, these City incentives will expire at the end of 2014. Likewise banks are starting to lose their fear of funding condo projects. Condo developers historically outbid apartment developers for land. Luxury condos miss the mark, Silicon Valley’s young newly hired tech workers seek apartments to rent.
Google, Apple and the other cash-rich Silicon Valley employers should create venture funds to back high-rise, transit-oriented apartment projects. These would not be corporate housing projects. These apartments would be market-rate, open to any renter. If a developer can propose a project that can achieve an initial unleveraged return equal or higher than a current cap rate, say 4.5%, these tech giants should fund the equity for that project. These tech companies would show they are helping solve the area’s housing problems. They will earn 4.5%+ on their excess cash, far better than they are earning today. And they will not lose money. They can sell the projects or their positions upon completion to restock their transit-oriented housing incentive fund and likely make a tidy profit.
Google forget San Francisco! Go to the genuine urban alternative that will accept your tech workers with open arms, downtown San Jose!
November 26, 2013
Here again is my annual assessment of the Bay Area's Economic Engine. Feel free to download it for your own use... and as always feel free to call or write me with questions or comments!
Warning... data alone does not tell the whole story
Watch corporate IT spending and know the health of Silicon Valley?
DOWNLOAD the 2013 Bay Area Economic Engine by clicking here
October 6, 2013
Learning to trust the Fed – Freely Floating and FearlessLong–term interest rates are up about 150 basis points since the low we saw in May of this year. The consensus is that with the economy strengthening and the Fed announcing they will taper their long-term bond buying, the bottom we saw in interest rates will not be back in the current economic cycle.
So, why are values not falling?The answer lies in how the winning bidders are financing their acquisitions today.
The Carry Trade: Arbitraging higher long-term bonds, using short-term leverage
For the real estate fund manager, the issue is really one of disclosure.The pension fund or endowment investor that invests in real estate funds also invests in financial hedge funds. These investors are making returns of the Carry Trade already. The investors are making two forms of profit, (1) a real estate profit and (2) a profit from the Carry Trade, the mismatch of asset and liability maturities. For the real estate fund manger, it comes down to an issue of disclosure; simply layout the proposed leverage strategy for the fund and disclosing the advantages and the risks.
The advantages can be shown with a simple calculation If an investor believes we are will face a near zero LIBOR rate for the next five years, an un-hedged bank floating rate deal creates a borrowing cost of around 2.0% (LIBOR plus 1.75%). A ten-year fixed interest rate today might be 5.0%. With 66% leverage, the 3% rate difference will return an extra 9% per year on the 1/3rd equity. Over a 5 year holding period the carry-trade portion of the investment will return almost half (45%) of the invested equity.
Learning to float fearlessly.
If you believe in the Fed's commitment to manipulate short term rates to the low side, you negotiate your floating rate loans differently. Do not let your bank force you to buy a cap or hedge: if forced, buy the cheapest insurance possible; highest cap and shortest term. For the last 5-years caps and hedges have been a waste of money and given the current higher costs of these derivatives this is overly expensive insurance.
July 30, 2013
The rigged market has created a bond bubble
“Tapering” = Quantitative Easing will slowly, eventually end.We all knew this, but bond investors fled and both interest rates and spreads jumped. 10-year Treasury Swap yields were 2% on May 27th and 2.75% on July 9th. CMBS spreads increased as the same time. Since there is no good way to lock in an interest rate on a CMBS mortgage, 10-year fixed-rate CMBS mortgages that were getting signed up in the high 3% range were closing (if they closed at all) in the low 5% range, many times with the dollar amount of the loan drastically reduced.
- Life Companies are Investors not Speculators: Market timing investing does not work for life companies, especially now when holding cash is so costly. Chief Investment Officers (CIO’s) who try to time the market can be successful several time in a row, but one miss can cost the CIO his job. No one gets fired for matching the terms of assets and liabilities. Life companies have various product lines, many of which have long liability durations that pair well with long-term fixed-rate mortgages. The CIO’s job is simply to make a profitable spread between the long-term asset (the mortgage) and the long-term liability (the annuity or insurance product). If they just stay constantly in the markets they hope to average out over time. If not, they can sell or close out the line of insurance business. Because of the low-rate environment, Met Life announced they planned to get out of multiple lines of business this year.
- Mortgages do not have to be marked to market: Bonds are actively traded securities, as such accounting standards require them to be “marked-to-market”. Mortgages are much more illiquid and are generally held to term. Thus, mortgages just sit there on the balance sheet at their face value. Bonds can be very profitable when overall rates are falling as these securities increase in value. But the reverse will be true as rates start to rise. Over the last 30-years constantly dropping rates has created a tailwind for life companies as their bond portfolios rose in value. During this time (my whole career) the bond group was treated as the A-Team in the investment departments of most of Newmark’s insurance company clients. In the last few years this reversed. CIO’s are giving their Mortgage Department first billing. They are being told; “Find good mortgage deals and we will find the funds.” Mortgages’ avoidance of potential mark-to-market losses as rates begin to rise is a big factor.
- Call Protection. Mortgages can be a better match for long-term liabilities than bonds. The lender gets to write the documents in a mortgage and the borrower gets to write the documents in a bond. Thus fixed-rate commercial mortgage loans have the type of call-protection (generally yield-maintenance prepayment formulas) that is lender-friendly versus the borrower-friendly call options in a corporate bond. High-rate corporate bonds have a tendency to pay off when the corporation’s credit improves or when overall interest rates decline. Commercial mortgages generally keep their yield until very close to the due-date.
- Better Loss History. Most life companies have a system to equate a mortgage’s risk level to an equivalent bond, with targets usually somewhere in the range of BBB+/A-. Most life companies have fond that their mortgage portfolios have a loss history 15 to 20 basis points better than that bond equivalent. Also, a defaulted bond gives you a total loss, but even a vacant building taken back by the mortgage department has some value.
- Better underwriting and access to information with a Mortgage versus a Bond. In mortgage underwriting there is less need to rely on third-party underwriting and valuation. Most life companies underwrite mortgages themselves directly from the underlying leases and only use appraisals as a final check, simply a closing item. The specter of partiality by the Rating Agencies clouds the bond world (see prior blog posts). Likewise the creativity of corporate accounting is an ongoing challenge, with off-balance sheet entities and hidden derivative risks a real concern.
June 3, 2013
West Coast Competitive Advantages
West Coast’s Biggest Area of Concern
See the attached slide presentation for details
May 7, 2013
What is the lending community’s image of self-storage?My answer: Excellent among the lenders who have learned this sector, with more lenders getting on board all the time.
Where are rates today?My answer: The best they have ever been in my entire career. We have recently closed several loans well below 4% fixed for 10-years on larger, well-located self-storage properties.
Greetings from California!
The importance of asking Why? before What? or How Much? *So you need a loan? You and your partners are buying a self-storage facility or you have a loan coming up for refinance. “This should not be too hard.” you say to yourself. Lenders are coming back into commercial real estate and are looking favorably on self-storage as a product type. As we come out of the recent downturn in 2012 self-storage may not be on top of the heap, but it is near the top. Self-storage has a relatively low rate of foreclosures and a relatively high recovery ratio when loans do go bad. In fact, self-storage weathered the downturn extremely well, except for those doomed facilities built at the top of the bubble near the edge of the exurbs still waiting for the rooftops to appear. Lenders recognize that self-storage does not have the great swings in occupancy and rents experienced by other property types. Lenders can trust self-storage income streams; rents are real and a few years of strong collection reports is better than relying on an office or retail tenant’s credit rating that could be gone tomorrow.
Scenario One: Ready! Fire! Aim!You pick up the phone and call your mortgage banker. He explains there are lots of options available and presses you for some guidance. You say. “Show me what is out there. Get me a variety of quotes so I can see what’s available.” Your mortgage banker pulls favors and runs a wide variety of lenders through their paces and comes back with a mixture of quotes that looks to you like apples & oranges; different loan amounts, rates, loan terms, recourse provisions, prepayment penalties, impounds and other lender controls, and different amortization periods, all from lenders with various reputations as to surety of execution and loan servicing behavior. You want to keep things simple so you focus on only one of the many financing variables (usually the interest rate or total loan proceeds) and compare the options that way. You pick a lender and financing structure that you worry you later may regret, but can’t quite put your finger on what is bothering you.
Scenario Two: Ladies and Gentlemen, Start your Engines!This scenario is even worse than a single mortgage banker casting around without guidance, you and your partners start the financing search by each partner taking the initiative, dialing for dollars, calling multiple mortgage brokers and banks. The competing mortgage brokers get into a footrace to reach lenders before the other guy, so they can protect their fee. Their packages are sketchy and inaccurate because they prepared them in haste. Their presentation of your story is fragmented, poorly rendered and the unprofessionalism reflects on you and your project. The various banks contacted by your partners are competitive and jealous of each other and feel disrespected, but still begrudgingly prepare preliminary term sheets. The quotes come in, with each source selling their solution and disparaging all other approaches. Your partners each champion their financing sources and take it personally that you will not direct the financing to their favorite bank. The quotes are hard to compare because they were based on different NOI projections and different financing requests. You feel you are only getting half the story and you don’t like the pressure tactics from the lenders and brokers competing to secure the business. Given this chaos how do you have confidence in your choice of lender and loan structure? "
* From the book: Greetings from California: Best Practices from the California Self Storage Association features a unique collection of self-storage insights and knowledge from this highly respected group of professionals.
TO PURCHASE: http://www.ministoragemessenger.com/cart/shopexd.asp?id=2484
Voted the 2011 Best State Association, the California Self Storage Association counts among its members some of the most experienced operators, property managers and marketing experts in the self-storage industry.
April 25, 2013
S&P’s lawyers claim, it's puffery...
On Monday S&P’s lawyers filed a response asking that the case be thrown out.
S&P said, “These CDO's are THE BEST!!!” Instead, they turned out to be “OFFAL!”
The S&P lawyers’ defense boils down to that famous line from the movie Animal House, when Bluto and Otter say to a crying Flounder as he confronts his father's ruined car: "You can't spend your whole life worrying abut your mistakes! You fucked up, you trusted us!"
March 19, 2013
This summer will be the three year anniversary of the passage of the Wall Street Financial Regulatory Reform Bill, aka the Dodd-Frank Act.
The bill laid out goals for the reform of CMBS: requiring issuers to have “skin-in-the-game”, requiring greater transparency, reducing conflicts of interests, and increasing the oversight powers for the holders of the mortgage backed bonds, etc.
No, not even close!The earliest any Dodd-Frank mandated regulations could be issued is later this year. And even then these rules will not take effect for two years after adoption.
The CMBS 2.0 changes to the loan pooling process, agreements, ratings and underwriting have so far been voluntary. CMBS 2.0 was a way to patch up a leaking boat to get the bond investors back on board. Market participants now see these minor voluntary CMBS 2.0 changes being dissipated by market forces.
Six Federal Agencies are involved in crafting the proposed risk retention rules; the FDIC, the Federal Housing Finance Agency, the Federal Reserve, HUD, the SEC, and the Treasury Department.
Fine example of the economic principal of “Regulatory Capture”The various interests in the CMBS industry, the originators, the issuers, the servicers, and to a far lesser extent the investors who buy the bonds (forget about the borrowers and the mortgage bankers), have the ear of different regulatory agencies... and are having these advocate-regulators pull the process of “reform” in different directions. This regulatory uncertainty is not good for the commercial real estate finance industry, but for some of the players involved a stalemate preserves the status quo, which is a win. Certain proposed regulation could blow current players in the CMBS market out of the water. The consequences of regulation on a largely unregulated industry could be enormous. So considerable lobbying effort and funds are being deployed.
Original Concept in Dodd-Frank
First Loss Piece to be held by issuer
First Loss Piece to be held by B-Piece buyer
Risk Retention to last for 10-years
Risk Retention to last for 5-years
Issuance Profit to be added to Risk Retention
Issuance Profit can be pulled out up-front
Amount of retention = 5% of “Pool” value
Uncertain: Issuers want 5% of “Nominal” value
The Lobbying Battle to substitute a single word... “Nominal”
Millions of dollars of lobbying is being spent on the effort to insert one word into the Dodd-Frank regulations.: That word is “Nominal”. The CMBS industry issues various classes of bonds with a single blended return. These tranches of bonds sell at various premiums or discounts based upon the priority they hold in receiving cash flow from the mortgage pool. Holders of triple-A rated bonds get paid first, then comes the next lower rated bond holders, and so on. The last one to be paid, the holder of the first-loss position holds the B-Piece. Under CMBS 2.0 the B-Piece buyer holds all the bonds below “Investment Grade”, i.e. below BBB-. Thus the B-Piece is the insurance policy for the investment grade bond holders
The securitization world loves to talk about the “Nominal” value of bonds.
Conclusion: Buyers of investment grade rated bonds are paying more than the total of the face amount of the loans.
|CMBS Loan Pool Economics - Typical - Simplified|
|Pool of Loans Total Principal Balances||100.0%|
|Total Bond Proceeds (sale of securities and servicing)||104.8%|
|Cost of Securitization||0.8%||Rough Guess - ratings, legal, sales commissions, etc.|
|Profit to Conduit||4.0%||Based on Industry Reports of 2% to 5% typical profit.|
Example - NorthStar Realty purchased $74 million B-Piece of $1.14 billion securitization for $23.3 million. (Morgan Stanley, BofA Merrill Lynch Trust, 2013-C8)
% of Capital Raised
% of Loans
Typical Subordination - Below BBB
Investment Rated Bonds (plus sale of Servicing)